Market ripe for Mongolia Mining if it can overcome delivery risk

PUBLISHED : Wednesday, 22 September, 2010, 12:00am
UPDATED : Wednesday, 22 September, 2010, 12:00am

Cuts to China's domestic coal output, along with rising production costs and transport bottlenecks in Australia are helping fuel growth in Mongolia's coking coal sector, although analysts are warning of operational and policy risk.

Mongolia Mining, the nation's largest exporter of coal used in steel-smelting primarily in China, is marketing its offering of 719.42 million new shares at HK$6.29 to HK$7.34 each to raise up to HK$5.28 billion in a Hong Kong listing. The price range represents around 11.6 to 13.6 times next year's forecast net profit, compared to 11.2 times for its peer, Fushan International Energy Group.

Mongolia Mining plans to use the proceeds to raise output from 3.8 million tonnes this year to 14.7 million tonnes in 2013, part-fund construction of three coal washing plants with combined annual capacity of 15 million tonnes and to build a US$104 million, 18 million tonne-a-year paved road linking its mine and the Mongolia-China border 240 kilometres away.

South Mongolia is known for its abundance of premium quality coking coal that is cheap to extract at ground level. Mongolia Mining's cash production cost is around US$22 a tonne, compared to US$42.3 a tonne for rivals targeting the same markets in China, according to its preliminary listing prospectus.

However, it costs Mongolia Mining US$20 a tonne to truck its coal to the border with China, and from there its needs to be hauled by rail at around 5 US cents per tonne-km.

A lack of coal-washing facilities and higher transportation costs explain why Mongolia Mining's gross profit margin of around 40 per cent based on listing book-runner JP Morgan's forecast average selling price of US$70 a tonne for this year, is lower than Shanxi-based rival Fushan's margin of 70 per cent in this year's first half.

Still, as China's coking coal output fell to 488 million tonnes last year from 527 million tonnes in 2008 after small mines closed and the industry consolidated, imports rose to 29 million tonnes from 7 million tonnes.

Australia is the largest supplier of imported coking coal to China and sets the pricing benchmark, but its competitiveness has been eroded by rising costs and the strong Australian dollar, as well as by bottlenecks at its ports and railways.

Wood Mackenzie, a consultancy hired by Mongolia Mining to provide industry projections for its listing prospectus, forecast that Mongolia's share of China's coal imports would rise to 51.9 per cent in 2015 from 10.5 per cent last year, while Australia's would fall to 22.2 per cent from 55.3 per cent over the same period.

Wood Mackenzie has forecast that Mongolia's exports to China would reach 30 million tonnes in 2015 from 13 million tonnes this year.

Still, CCB International analyst Karen Li said coal trucked from Mongolia carries delivery risks due to border controls, and Australian coal has established a reputation for quality.

BOC International analyst Lawrence Lau said the key to how fast Mongolia can boost its output is how soon it can build up its railway capacity to China. This depends on how soon the Mongolia government approves railways to China.

Mongolia Mining, which plans to build a US$699 million 30 million tonne-a-year railway to the border, could ultimately see its transport costs fall to US$3 a tonne from US$20 a tonne by trucks currently, according to JP Morgan.

The prospectus said the Mongolia government had recently decided to build a railway to Russia first, before building railways to China.