Hunnu Coal market analyse

Price (8/25/2011)         A$1.10
Target Price (TP)          A$2.15
Upside Potential             43.5% 
   
Stock Data   

Market Cap (A$ m)           $266.3
Market Cap (US$ m)         $278.4

Shares Outstanding (m)    242.1

From Speculative BUY to BUY with Target Price of $2.15    
 

• We are rating Hunnu Coal with BUY with TP of A$2.15. We are changing our recommendation from speculative buy to BUY based on a number of developments in the company
• Production plan on target; mining to commission in 4Q2011.  The mining license has been approved for Tsant Uul and management expects to commission the mine in 4Q 2011. Based on the company’s production target, we have assumed the company will produce 1.5mt in 2012, 3mt in 2013, and ramp up to 5mt beyond 2013. The construction of the road from Tsant Uul to the existing haulage road has also been approved.
• Confidence in Hunnu’s management. We believe Hunnu’s management is fully capable of successfully commissioning its mining projects in Mongolia and increase shareholders’ value. The chairman of the company has more than 18 years of experience in the resource sector, and plays a key role in acquisitions and deal making. The managing director Lkhagvadorj Tumur has an extensive experience in managing mining projects in Mongolia. He recently managed the development of the UHG mine for MMC, Mongolia’s “national mining champion”. Comparatively the Tsant Uul project is of a much smaller scale.  Though Hunnu is a new company, the record of its experienced management is very encouraging.
• Strategic Partnership with Banpu Minerals will bring in capital and expertise. Banpu Pcl, one of the largest mining companies in Asia, purchased 12.39% of Hunnu’s equity shares at a 20% premium in March, becoming the largest shareholder. The strategic partnership allows Banpu to share its operational expertise and support Hunnu’s development.
• Resource expansion potential. JORC resources for Tsant Uul and Unst Khudag have been updated, and today total over 800mt. Altai Nuurs project has an exploration target of 250-500mt. This project will provide volume growth and higher margins (preliminary coal quality results are encouraging). Hunnu holds a majority interest in 11 projects, and has an exploration target of 1.0-1.5bt of coal, which implies resource upside potential.
• Attractive valuation. HUN is currently trading at US$0.45/t EV/Resource, while the average EV/Resource ratio for Mongolian miners is US$6.6/t. The low multiple certainly indicates HUN’s exploration stage status. HUN is an attractive buy given that: 1) once production starts we believe Southgobi Resources will be the closest peer due to Ovoot Tolgoi’s similar coal quality to Tsant Uul’s. Southgobi is currently trading at US$6.0/t EV/Resource compared to HUN’s $0.45/t. 2) Banpu bought HUN at A$1.50, when HUN’s share price was at A$1.25. This clearly shows Banpu sees great potential and growth for the company, and at current share price of A$1.10 HUN is a cheap buy.

Valuation

We used both DCF model and industry multiples to derive our target price of A$2.15.
Given Tsant Uul’s mine plan and its ramp-up schedule, a DCF model was built with a mine life of 20 years and discount rate of 10%. We assumed that Tsant Uul will have an initial production of 1.5mt in 2012, and ramp up to 5mt beyond 2013. Our price assumptions for Tsant Uul are based on “1/3 coking coal” price at Ceke border, which is where Southgobi products are trucked to. The latest price at Ceke border was around US$101. We assumed Tsant Uul’s similar quality coal will be sold at the Gants Mod border. Our estimated capex for the project is A$45m. Based on this model we value Tsant Uul property ~420m.

As for the Unst Khudag deposit, we derived a NAV of ~110m. The NAV was derived by using the average EV/Resource multiple of non-producers with thermal coal projects in Mongolia. We specifically used the average of Xanadu Mines, and Prophecy Coal’s EV/Resource ratio and multiplied by Unst Khudag’s resource to determine the EV. We have applied some premium to the Unst Khudag asset value, as the industry EV/Resource ratio has been pulled down due to the current market condition.

The Altai Nuurs property has been valued at its acquisition price for now, as we await initial JORC resource and coal quality results.