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Large coal assets well placed for hungry markets prepare the miner for a re-rating

by Dan Coatsworth

Polo Resources, (PRL:AIM) 6.25p, Stop loss 5p

Shares summary

The coal group has been punished for failing to buy a rival. A recovery is due as it brings its first mine into production, provides clarity on coal resources and finds buyers in Asia.

Business:

Coal miner with assets in Mongolia and investments in two Aim-quoted rivals

Vital stats:

Market value: £117 million

Historic PE: n/a

Prospective PE 2008: n/a

Prospective PE 2009: n/a

Sector PE: 8.4

1-month relative strength: -18.5%

1-year relative strength: n/a

Yield: n/a

NMS: n/a

Spread: 7.7%

As it has fretted over the fate of potential corporate transactions, the market has neglected the value of Polo Resources’ Mongolian coal assets.

The Aim-listed miner’s shares have fallen 75% since an offer for rival coal group GCM Resources (GCM:AIM) was rejected in June and stake building in Caledon Resources (CDN:AIM) stopped. Once Polo’s £48 million cashpile and the combined £59 million market valuation of its GCM and Caledon holdings are accounted for, the firm’s £117 million market cap implicitly values its coal mines at a mere £10 million. So Polo should enjoy a re-rating once it has brought its first mine into commercial production in a few months’ time, published several resource statements and forged potential partnership agreements to sell coal into Asia.

Polo floated in September 2007 with the intention of becoming a mid-tier coal business through acquisitions. To date, it has only been judged on corporate activity rather than the quality of its mining assets. It has built up a 29.8% in GCM and offered 175p cash per share for the entire business. The approach was rejected on grounds that it offered too low a price. Nomad JP Morgan Cazenove had previously suggested GCM was worth £12 a share. Under takeover rules, Polo cannot re-bid until December at the earliest.

The company has also acquired a 25.8% stake in Caledon, a former gold explorer founded by Polo chairman Stephen Dattels, who then left in 2005 before a switch to coal. Polo paid 151p a share for its stake, so this is the minimum it has to offer in cash for the rest of the business, equivalent to a total sum of £237 million.

Putting corporate transactions on the back burner should help divert attention to the portfolio of Mongolian coal mines. The first project, Ereen, starts commercial production in October at a rate of a million tonnes of coal a year. A resource statement should be published next month, and the project is expected to contain around 20 million tonnes at the measured and indicated level. A local power generator has signed up to take the first 500,000 tonnes of thermal coal at $32 a tonne, against $10 a tonne costs.

Polo is talking to a Japanese group about exporting the rest of the coal from Ereen via Russia. A South Korean company is also discussing potential offtake. A Chinese business has entered negotiations about exporting coal from Union, which will be Polo’s second mine to go into production, potentially in mid-2009. The company believes it has around 200 million tonnes of coal across this deposit, Ereen and Khashaat, a third project.

Next to hungry markets

Its largest deposit is Erds, east of Mongolia, which deputy chairman Neil Herbert reckons to contain 750 million tonnes of coal. It is fairly low quality but is the type widely used by Chinese power stations. Polo’s priority exploration asset is South Gobi, with the highest-quality coking and thermal coal in its portfolio, and is the closest to China, a market short of coal.

China last week raised its coal export tax in a bid to protect domestic supplies for power stations. Rumours suggest Russia will act similarly. Polo can serve these markets as it neighbours both countries. China is already easing transport of coal from Mongolia by installing loading stations along the border. Chinese and Russian companies are buying coal properties in Mongolia to exploit a relatively undeveloped region. Polo has 58 coal licences in Mongolia and would not think twice about selling properties if the price was right. Coal consumers are prepared to dig deep to secure supplies around the world. Russian steel producer Severstal last week paid $1.3 billion for US coal miner PBS.

Mining stocks have fallen out of favour and other factors could work against the share price – a governmental decision on GCM’s Bangladesh mine could still be a year away and potential changes to state ownership levels of mines in Mongolia may be unfavourable. But the strong outlook for coal and Polo’s aggressive development plan suggests the rewards could be much greater, especially given the coal assets’ low implied valuation.