Predominantly thought of as one of the major coal miners in South Africa, many are surprised t hat t he majority of Exxaro’s earnings are derived from iron ore. Exxaro’s 20% interest in the Sishen Iron Ore mine remains its core asset, however, a large number of projects are underway, with the end goal being diversif ication across a number of resources, including renewable energy. Despite this, coal remains important to Exxaro, given that the insatiable appetite for the mineral is expected to continue both locally and abroad, particularly from Asia.
The investment case for Exxaro is built around a sum-of-the-parts valuation that values each of Exxaro’s assets based on their current market valuation. These assets include a 20% holding in the Sishen Iron Ore Company (SIOC), a 44% ownership in Tronox, a global chemical business listed in the US, and 26% in SA Mineral Sands. Given that the majority shareholder of SIOC is Kumba Iron Ore, and that SIOC is essentially Kumba’s only asset, the value placed on Exxaro’s stake in the company is about R42bn. Likewise, Tronox is a listed business in the US with a market cap of $2.8bn, allowing a value of R12.4bn to be placed on Exxaro’s shareholding in that venture. The last non-coal asset is the SA Mineral Sands business, which Exxaro has the option to convert into a further 4% of Tronox. Therefore, valuing the stake in the Mineral Sands business on this option, results in a valuation of R1.1bn. The sum-of-the-market valuations of Exxaro’s non-coal assets equal R55.5bn.
Currently, Exxaro has a market cap of R59bn. By adding back the debt and stripping out the cash on the balance sheet, I arrive at an enterprise value of R68bn for Exxaro. This implies that the South African coal assets are valued at R9bn. At their latest interim results the coal assets produced earnings of about R800m which, when annualised, puts the coal assets on a P/E ratio of 5.6 times, which compares very favourably with the global average of 12.5 times.
Exxaro’s iron ore exposure through SIOC is the major contributor to Exxaro’s earnings and, therefore, market value. As a result, since listing in 2006, Exxaro has offered investors a near identical capital return to that of Kumba Iron Ore. However, recent years have seen management making a deliberate effort to diversify Exxaro’s earnings away from SIOC. The Grootgeluk Medupi Expansion Project (GMEP) is one such effort, which will supply Eskom’s Medupi power station with 14.6m tons of coal per annum, increasing coal production by 36%. GMEP is 96% complete, and is expected to be finished in the second half of their financial year.
A second potential game-changer is the Mayoko iron ore project, located in the southeastern region of the Republic of Congo, with rail access to the port of Pointe Noire, which is crucial in getting the ore to market. The production of the first ore is scheduled to commence during the latter part of 2013, pending the finalisation of the Mining Convention, which includes rail and port agreements. The mine has a mineral resource of 730m tons, which will be able to sustain an estimated life of mine of over 60 years.
Alongside t he t wo exciting projects mentioned above, Exxaro has also teamed up with Tat Power in a joint venture called Cennergi, which aims to be the leading cleaner energy Independent Power Producer (IPP) in Southern Africa. And lastly, there is the Thabametsi project, a prospective greenfields opencast mine, which is expected to coincide with the 600MW coal-f ired baseload IPP power station in the Waterberg. The Thabametsi mine will supply approximately 3.8m tons per annum of coal to the 600MW Waterberg IPP post rampup.
Given the negative sentiment surrounding the resources sector in general, the attractive valuations, the ongoing demand for coal globally, and the continued diversification efforts from Exxaro, we believe this presents an attractive investment opportunity.