When it rains it pours in Pine Valley

The list of problems for junior coal-producer Pine Valley Mining (PVM-T, PVMCF-O) is long: a washplant with poor recoveries; a pit with more oxidized coal than expected; and a loan agreement that could cost the company up to 35% of its common shares, but still falls $17.5 million short of the amount it wanted.

And as if the list wasn’t long enough, the consensus on the Street is for lower prices in the coming year for the hard coking coal that Pine Valley produces.

It all adds up to a pretty glum picture for the Vancouver-based company — and the market has responded accordingly. Pine Valley shares have fallen from the $4.99 mark on Sept. 23 of last year to an Oct. 16 close of just 33.

The situation would make the summertime departure of former president and chief executive Graham Mackenzie appear rather prescient — if the company’s fortunes hadn’t already been falling at the time of his resignation.

Pine Valley’s troubles centres around its Willow Creek project in northeastern British Columbia. With disappointing recoveries and less than sensational cash flow, the company was already in a weakened position when it discovered that its coking coal pit contained three times more oxidized coal than anticipated.

The news sent its shares down 18% on Oct. 11.

The company says the oxidized coal will make a large amount of raw coal production unfit to sell or saleable only at a lower price. The production plan for the three months to Dec. 31 is to mine roughly 113,000 tonnes of raw oxidized coal out of total anticipated raw coal production of 482,000 tonnes.

While Robert Bell, Pine Valley’s current president and chief executive, says the company will look to sell the oxidized coal as thermal coal, further metallurgical testing must be done first to determine its ash content.

In a press release, the company took a more cautious stance, saying the oxidized coal “will be treated, in the main part, as waste material.”

Oxidized coal is lower-grade and the transportation and handling fees can easily outweigh the cost of its production.

To date, Pine Valley has been generating cash flow from the sale of coking coal and pulverized coal injection (PCI) coal. For the three months ended June 30, Willow Creek put out roughly 187,000 tonnes of coal — 147,319 tonnes of which were PCI coal and 49,489 tonnes, coking coal.

Average cash costs for the period were $82.13 per tonne against an average realized coal price for the same period of $104.95 per tonne. By comparison, for the same period in 2005, the company produced roughly 206,000 tonnes with a cash cost of $61.74 per tonne.

Those increased costs were due in part to a higher strip ratio of 7.82:1 — compared to roughly 7:1 for the same period in 2005 — caused by recoveries at the washplant being lower than anticipated in its feasibility study.

That higher strip ratio places projections from the company’s March technical report in doubt. The report forecast 2007 production at the site at 744,000 tonnes of PCI coal and 755,000 tonnes of coking coal with a strip ratio of 6.6:1.

Coal at Willow Creek is drawn from a recoverable reserve estimate of roughly 18.6 million tonnes.

Debt

While cash inflows for the company have been coming from sales of its PCI product, they haven’t been significant enough to free it from a $10.5-million working capital deficiency compared to cash at hand.

The deficit reflects the company’s debt issues, which are aggravated by the fact that Pine Valley still relies on debt and equity financing to fund exploration, development programs and working capital requirements.

In order to pay off the debt — while the total debt is still undisclosed, the company could owe the Royal Bank as much as $20 million and separately owes the Rockside foundation $8.8 million — it has come to an agreement with an undisclosed lender for a $10-million loan and a $15-million credit facility. That is considerably less than the $20-million loan and $17.5-million credit facility that in late September it said it was looking to secure. It also comes at a considerable borrowing cost — and will affect its stated intentions of paying the Royal Bank in full, Rockside in part, and funding working capital, although Bell would not say exactly how funding is to be divided.

Pine Valley has agreed to pay an interest rate of prime plus 4% per year; in addition, it will issue the lender common share purchase warrants for 10% of the company at 34 apiece. That cut of its shares can grow by an additional 25%, at the same price per share, if Pine Valley can’t raise another $10 million within 30 days of the initial credit facility closing.

Also of note in terms of the company’s debt, is the fact that Pine Valley has already asked for two extensions on payment due dates to Rockside. The latest one gives the company until Oct. 31 to make an undisclosed payment on its US$8.8-million principal.

Falling prices

Pine Valley’s debt and production issues are compounded by what analysts anticipate to be lower hard coking coal prices in the coming year.

Both Desjardins Securities and CIBC World Markets forecast a drop to US$90 per tonne for hard coking coal for 2007, citing the increasing substitution of hard coking coal with lower-cost and lower-grade coals.

The trend is already visible in China where a CIBC World Markets report says that Chinese imports of lower-grade Mongolian coal this year increased to a whopping 60% of imports in June from roughly 15% in March.

Such negative indicators for Canadian producers of hard coking coal will be felt most severely by juniors, analysts say, as in general, they have higher production costs and a more difficult time securing lucrative contracts.

John Hughes, an analyst with Desjardins Securities, says that sea-borne steel producers are looking for the high volumes and sustainable supplies that only larger coal producers can provide. He says it will be increasingly difficult for juniors producing roughly 1 to 2 million tonnes a year to compete with companies like Fording Canadian Coal Trust (FDG.UN-T, FDG-N) which produce well over 20 million tonnes annually — especially when a company isn’t meeting its own production targets.

“The economics for a junior become less attractive when there is a question mark as to their longer-term ability to produce,” Hughes says.