Ready to Fire Up: Coal to Power Stocks

Progress of one sort or another is being made at all four of the coal to power projects (in Tanzania, Mozambique, and Pakistan) owned by AIM companies that I first described back in the November Magazine. I follow them because with extremely large project costs and investment sums at stake, against the present extremely small market values of their owners, there must (mustn’t there?) be scope for some of the former to rub off on the latter. Some investors hope that the outcome will prove to be multi-bagging for the owners’ present (and even future) shareholders.

The first to release full details of the sort of financing now available for such projects will be scrutinised for the implications for the others, and be the first real clue the markets will get as to what value there might be for their owner companies. So far there is only one broker (Oracle Coalfields’) who has attempted any professional estimate of potential value for shareholders. (There are others who have merely used the ‘bogus’ NPV per current shares in issue ‘method’ – which readers will know to ignore unless it produces a ‘spike’ they can trade out on). However, Ncondezi Energy (LON:NCCL) (for a 300MW stage one plant) and Oracle Coalfields (LON:ORCP) (for a 600MW stage one plant) have each announced the bare bones of their expected financing structures, which enables a stab at the price at which equity might be raised. (As usual, Kibo is still pretending to private investors that they will receive the full NPV of the projects with no admission that equity funding, and dilution, will occur.)

Oracle Coalfields is promising Financial Close for its initial 600MW plant, when all should be more fully revealed, in H2 2016, with first electricity in 2019 (although, a year ago, it was also promising Financial Close by late 2015!) while Kibo Mining (LON:KIBO) (for an initial 300MW plant) is ‘promising’ it in H1 2017.

All four (and ‘another’ where investors are jumping the gun by many years) have seen recent short-lived spikes as news has come along promising that answers to the valuation puzzle might arrive soon. But said news usually turns out not to be news at all but merely a reassurance that all is still on track.

The ‘other one’ to have seen a spike is GCM Resources (LON:GCM) with its project in Bangladesh, whose different circumstances and far longer time scale to any power project, if at all, makes a spike even less justified. GCM merely owns a (very large) coal mine for which there is a suggestion that a power station might be built. It has as yet no licence even to operate the mine, so quite why anyone thinks there is currently much shareholder value to speculate about is a mystery.

As for the three who might be on the verge of signing the necessary deals, the complexity of the projects and of their likely financing structures, taken with seemingly few analysts who have any clue how to value them, makes it difficult. Also difficult is to work out exactly where each project has really got to in the long process of conceiving and designing the plants, getting together the partners and contractors, gaining the various types of permits and electricity customers, and not least finding investors whether for loans or for raising equity – the latter being the most vital but most vague and long drawn-out part of the process.

In fact, it seems that the Chinese, who will build all four plants, are happy to provide the debt financing (around 70% of the more than $3bn combined capex, although for some elements of the projects it might be more) at around a 7% interest rate, which is very competitive compared with Western banks and institutions. But that still leaves a large call for equity funding, where the returns institutional investors will want are much higher – some owner companies are planning to have to raise equity to give a more than 20% per annum return, which implies that equity raise prices will be relatively low. That means, in turn, that present shareholders will be considerably diluted – but compensated by the fact that on present indications the equity raise prices that will be justified by the net cash flows to equity after all debt and interest has been met will be higher than present share prices.

I refer readers to the December 1st web version of Master Investor ‘Ranking the Companies’ where I described a rough and ready method of estimating what this raise price would be for each company, and related it to their then share prices, based on two cases providing equity returns of 15% and 20% p.a. These might look high, but are nevertheless what the only two companies who have been open about the funding requirement say they have to plan for.

The exercise did unearth potential multi-baggers, although stressing that it was merely a way to check whether any one company looked cheap compared with the others. A solid estimate of the actual raise prices has to await full details of the whole funding package and a detailed cash flow forecast which will have to take account of the different tax rates and incentives that seemingly will apply in the three host countries – information that will only be available at Financial Close, and perhaps not fully even then.

To recap, the raise prices thrown up by that exercise for a 20% equity return (the minimum likely) were 12.8p for Kibo, 16.8p for NCCL, 14.5p for ORCP; and 0.34p for Edenville (LON:EDL). In comparison the ‘spike-top’ share prices in the last six months for those shares have been 5.5p, 6.2p, 2.8p and 0.05p respectively. Current prices, reflecting the market’s perception of how close and feasible are the projects, or the amount of publicity they have received, are: ORCP at 1/5^th my raise estimate; Kibo at 1/3rd my raise estimate; NCCL at 1/4 my raise estimate; and EDL at 1/15th!

And as for the accuracy of my method, the only one of the four where any sensible broker research has been published is for ORCP, where its 10p raise price estimate compares with mine of 14.5p.

I stress that these are only very rough guides, and for the moment what is dominating the various shares is investor perception of how far along they are to financial close and raising the equity. Here Oracle Coalfields has recently presented to private investors, and although its own time-line has slipped by six months so far, and probably will go another six months, it is already talking to institutional investors. The fact that its shares have been more stable and less ‘spiky’ (on a 2 year view – the chart shows 6 months) than Kibo or NCCL, and closer to the raise price mooted by their broker (although that doesn’t mean it will be achieved), reflects that investors are more confident that ORCP is on the right lines.

Other significant news has been for NCCL and its 300MW Tete project, although the market remains sceptical, stemming not only from a so-far unexplained two year hiatus in its project’s development, but also because the top company has been running out of cash and in danger of going bust while having to negotiate with its construction partners for ever-lengthening extensions to key milestones. But the significant news overlooked has been that management and key shareholders have stumped up the necessary $1.3m loan to keep going until at least the end of Q3 when it expects the delayed Joint Development Agreement with Shanghai Electric Power Co (SEPCO – not to be confused with Shandong Electric Power, who is involved with some of the other projects) will, at last, have been implemented.

NCCL’s JDA details, first announced in January when they stimulated a 6p share spike, stipulated that SEP is to pay $25.5m for a 60% share stake in a new power plant holding company (NPC), and later will pay NCCL (outside NPC) another $35m to reflect the historic costs NCCL has run up in getting the power plant plans to this point. In other words, that $35m (nearly 10p per share) will be available to NCCL to plough back, if desired, into its share of the power project (which will apparently be financed separately from the mine).

As for that power project share, here is where much (private) investor confusion seems to lie (and is being exploited by Kibo) as to the real value to them. NCCL’s press release – “SEP will invest up to US$25.5 million to fund the balance of the Power Project development costs to Financial Close in return for a 60% shareholding in the Ncondezi Power Project” – could have been worded more accurately. What it should have said is “…in the Power Project holding company (or SPV)” which will be the vehicle by which the project loans and equity will be raised from investors – including Ncondezi itself and outside investors. To keep its present 40% share of the whole project, NCCL will have to find far more than its current £15m market cap (a factor which I allowed for in my December raise price estimates). But with its mine and power project to be financed separately, any estimate of implications for shareholders will have to await full details at Financial Close. I believe readers should, however, expect some to start to emerge in the near future, as well as the explanation for the delays which is that SEPCO wants to go from the original fluidised boiler to a pulverised coal type, involving re-running all the related design and economics.

Like Ncondezi (although it was inadvertent) Kibo also allows (seemingly deliberately) private investors to keep thinking they will keep 100% of its mine and power plant. Although coming out with frequent ‘news’, and appearing on various private investor platforms, its efforts result in a weakening share price – perhaps because savvier investors recognise that Kibo is dissembling about the share dilution that is going to have to accompany any development. Kibo’s Annual Report is due any time now, and might throw more light on what has, so far, been more of a fog. It will be interesting to see what valuation its auditors will have agreed on the intangible asset of its Mbeya Coal to Power Project which, in the 2014 Accounts, was carried at a vague ‘NPV value’.

One move Kibo is probably going to have to make is to hive off its exploration activities from its power project, to protect investors in the latter from the former’s uncertainties. By doing so it might enable some value to emerge from the assets it has in Tanzania’s Lake Victoria gold field. Until it does so, and starts to talk, as do the other three companies, about its power financing options, the shares will probably continue to drift, which won’t help confidence on the part of its power development partners.

Up to now this whole coal to power sector has been under most investors’ radar (India’s AIM listed OPG Power is a producer/developer, so isn’t really a comparator) but with three of the companies promising Financial Close by late this or early next year, more research and road-shows are likely. This article wasn’t intended to update my estimates of shareholder value – which will come later when the details are available – but meanwhile I suggest that while these four companies may not offer the sky-high potential multi-bagging the fantasists on the bulletin boards hope for, there is some scope for share price appreciation. Of these my guess is still (as it was back in December) that NCCL offers the best medium-term value at today’s prices. The risks are that the owners go bust before reaching their goal (less likely the further along they are); that the projects are cancelled for political reasons (very unlikely – all three countries desperately need the power, and to limit alternative energy imports); or that the £1bn or so total equity required might be too much for AIM to deliver. (One company, at least, is thinking of the main market.)