We are re-initiating our coverage of MEC, and our fundamental analysis of this stock lead to a HOLD rating. »»MEC’s 2009 contract with BaoSteel Ba Yi to sell up to 10 million tonnes of coal between 2010 and 2020 is still valid.
»The company also confirms that the conclusions from the 2009 John T. Boyd technical report still constitute the company’s mine development objectives. The report recommended a target production rate of 3 mta, and considered the maximum capacity 8 mta.
»Production have not started, but test shipments to the border point had begun in late 2011. In our valuation, we assumed the production will begin in 2013, or 1 year from now, at the target rate of 3 mta. We also assumed an optimistic ramp up schedule of reaching the 8 mta maximum in three years after production begins.
»Whether the Khushuut coal mine should be classified as a strategic deposit is frequently debated in the Mongolian media. The production at Khushuut may have been delayed by such political reasons, although the company stated that the production has been delayed for technical reasons. The Government of Mongolia automatically receives partial equity ownership of all companies developing strategic deposits.
»The 2011Q3 interim financial report shows that the current liabilities exceed the current assets by 386 million HKD. The auditors noted that this creates uncertainty as to the financing capability of the company. The expense item that lead to this imbalance was an advance to a director, Mr. Lo. This negatively affected our working capital forecast for 2012, hence contributed to a lower valuation.
»According to the Rule 194 issued by The Mineral Resource Authority of Mongolia (MRAM), mining activities cannot be conducted in river basins and forested areas. Four of the companies mining licenses as well as one exploration license may contain areas affected by this regulation, and it is not yet clear how the company will be compensated if the permission to operate in these areas are to be revoked. This poses a risk to the exploration projects, but we did not attribute values to these projects in our valuation.
HOLDApril 30, 2012
Stock Information (hkd million)
Stock Code 0276
Price 0.64
Target Price 0.66
Upside Potential 4%
Market Cap 4,230
Key Financials
Assets 15,692
Debt 2,433
Cash 10
Revenues 3
EV/Resources 6
P/B 0.32
Main projects (JORC est.)
Khushuut 149 mt coking and thermal coal
Analyst
Dotno Dashdorj
+976 70112023
dotno@micc.mn
Company OverviewMongolia Energy Corporation (MEC) was known as New World CyberBase before 2007, and operated in the internet telephone industry. After acquiring exploration license covering an area of 34,000 hectares in the Darvi soum of Khovd province in Mongolia, the company changed its name and focus. The company IPO-ed on the Hong Kong Stock Exchange in 2007 to raise funds for its mining operation. MEC also has oil, coal and metals exploration investments in China’s Xinjiang Uyghur Autonomous Region The following table contains the major shareholders of the firm as of September 30, 2011. Of nearly 6.6 billion issued shares, the chair of the board Lo Lin Shing owns about 18% directly and indirectly (through the company Golden Infinity).
MEC’s subsidiary in Mongolia MoEnCo LLC is developing the Khushuut mine. MEC sold its 100% owned subsidiary Business Aviation Asia Group to Wellington Equities for 36 million HK dollars in 2011. MEC did not publish any revenues from operations as of Q3 2011, but posted some revenues from interest. Also, the chairman, Mr. Lo, received 364 million HK dollars as an advance, which caused the current liabilities to exceed the current assets by a large proportion. This shows that the company may be having liquidity problems. Our forecast of the working capital for 2012 and beyond were affected by this large deficit in the company current balance, which resulted in a lower per-share target price. By June 2012, the company should post its financial statements as of March 2011, which should help clarify the liquidity questions.
Projects
Khushuut
Since Khushuut is the only MEC asset at or near operational stage, we only considered projections of this project in our valuation. In 2009, the company received the permission from the Khovd governor and the Ministry of Road, Construction and Urban Development to pave a 311km road from Khushuut to the Yarant border crossing, and to use it for 30 years. The road was officially commissioned on Nov 27, 2011, and has been used for test shipments ever since. Of the two contracts signed for the Khushuut coal, the company has announced that one is with BaoSteel Ba-Yi, a steel producer in China. The contract involves MEC selling up to 10 million tonnes of coking coal in 2010-2020. The contract was announced in January, 2010, and it is still valid as of April 2012, according to the company. he coal resource and quality estimation were conducted by the John T. Boyd company in 2009. Please see the following for details:
1. JORC compliant measured and indicated resources
2. daf - dry air-free basis
3. ad - air-dried basis
Aside from the John T. Boyd JORC compliant estimations above, the company also states that the Khushuut mine contains 149.2 mt of indicated resources in other corporate literatures. Also, the report mentioned that the JORC reserves must be determined with additional exploration work, and as of April 2012, this information is yet to be published. Since 2007, about 500 hectares of the Khushuut license has been explored, and by the end of 2010, 355 holes of 84,243 metres were drilled. In June 2010, MEC signed a mine development contract with Leighton Asia, thus beginning the rock stripping work. Leighton also works on MMC’s Ukhaa Hudag mine.
Other Projects
ValuationWe assumed in our DCF valuation that the production will begin in 2013 at the target production rate of 3 mta, and ramp up to the maximum production rate of 8 mta in three years after production begins. Based on the company’s presentation on the possible prices the coal would fetch, we assumed that the average coal price will be at 1000 CNY/tonne, which is about 150 USD/tonne. Per our calculation, the value per share of the company’s equity is 0.66 HKD, with the total equity value of 4.4 billion HKD. As this price is very close to the current market price, we issue a HOLD rating for MEC’s stock. Please see the following table for some of our forecasted figures:
Please see the following tables for sensitivity analysis on the variables that affects the valuation significantly, but had to be assumed. We assumed the long term operating margin to converge with the industry average of 15.9% in 10 years, and that discount rates are similar to the market average on the Hong Kong Stock Exchange.
ABOUT MICCMongolia International Capital Corporation (MICC) was established in 2005 as the first investmentbanking firm in Mongolia. Mongolia’s rapid economic development and favorable financial environment present unique prospects for investment opportunities and growth potential for companies. In order to enable our clients and investors to take full advantage of these opportunities, MICC offers investment banking, asset management, securities underwriting and brokerage services. In addition, we conduct periodic macroeconomic research, develop analyses of domestic industries and provide equity research domestic as well as foreign-listed stocks. MICC continues to make history in the Mongolian financial sector. We serve leading companies in the mining, manufacturing, financial, retail trade, airline and construction sectors, and prize our close and long-standing working relationships with our clients. Our goal is to assist both local and international companies realize their strategic goals by offering innovative and efficient financing solutions.
Contact Informatio n:
Central Tower, Suite 912
Mail Box 42, 2 Sukhbaatar Square, SBD-8
Ulaanbaatar 210620a, Mongolia
Tel: +976 7011 2023
+976 7011 2024
Fax: +976 7011 2025
Email: info@micc.mn
DISCLOSUREThis material was prepared independently of the Company by the research analyst(s) named at the beginning of this document, for informational purposes only, and is not intended to address the needs of any specific person or entity. Any forecasts or recommendations made in this report are certified to accurately reflect the exclusive views of the aforementioned research analyst(s), based on all available information, as of the date of publication. The research analyst(s) will not be held responsible for the accuracy or completeness of the information provided in this document. The opinions expressed herein are not intended to be the sole basis upon which investment decisions are made, and neither Mongolia International Capital Corporation nor the Company will assume liability for any losses that may arise from investment activity relating to securities profiled in this report.
While no part of the compensation of the research analyst(s) is dependent upon the contents of this report, Mongolia International Capital Corporation is not prohibited from transacting with companies profiled in research reports, and may at the present time or at any time subsequent to the writing of this report be involved in conducting business with the Company.