Australia | Mar 03 2010
By Chris Shaw
Broker DJ Carmichael has looked at a couple of junior resource companies with overseas exposure in the past week, initiating coverage on China Steel Australia ((CNH)) and Wildhorse Energy ((WHE)) with positive ratings given what it sees as value on offer in both cases.
With respect to China Steel, which is a nickel pig iron play operating in China, the stockbroker sees a combination of excellent value and a good management team at a company offering direct exposure to the world's largest stainless steel market.
The company acts as a throughput operation with stainless steel customers supplying raw materials and acquiring all of the nickel pig iron the company produces from its Shangdong blast furnace, which is currently operating at full capacity.
This implies output of 45,000 tonnes annually but Carmichael's notes this should jump to 195,000 tonnes annually once the second plant has been completed. Work is currently underway on this project and the stockbroker expects once it is fully operational the company will see a large jump in free cash flows to something in the order of $20 million annually.
As part of the deal in building the second furnace, the company has converted $52 million of debt into equity at $0.30 per share, Carmichael's noting the move has put China Steel in a net cash position. The fact this was done at a premium to the share price suggests strong investor support and confidence in the outlook for China Steel in its view.
Further funding is needed and it is expected another $48 million or so will be raised as a mixture of debt and equity, and the second furnace should be completed within six months of the funding being sourced.
Factoring in the expansion in capacity sees Carmichael's forecast solid earnings growth, its earnings per share (EPS) estimates coming in at 0.5c this year, 1.5c in FY11 and 2.4c in FY12. On its numbers the company has a net asset value in FY11 of $0.16, while the stockbroker has set its price target at $0.21. This is enough to justify a Buy rating in its view.
In contrast to the Chinese nickel market exposure of China Steel, Wildhorse Energy offers exposure to coal projects in Hungary courtesy of the acquisition of Peak Coal Ltd, an unlisted Australian company. The acquisition also gives Wildhorse a management team among the leaders in underground coal gasification (UCG).
UCG is the gasification of in-situ coal by injecting water and oxygen mixtures and undertaking controlled burning of the coal to recover a high quality synthetic gas. The advantage of this method is lower emissions and a reduced carbon dioxide content.
Carmichael's notes the Peak Coal acquisition gives Wildhorse projects with exploration potential of between 1.0 to 1.25 billion tonnes of coal, with a drilling program to be undertaken once the acquisition is completed.
Along with these coal assets, Wildhorse has some uranium assets in both Wyoming in the US and in the Mecsek Hills in Hungary, which is the same area as the just acquired coal assets are located. The latter offers an inferred resource of around 30 million pounds, while the current exploration target is for reserves of between 90-120 million pounds at grades between 0.08% and 0.12%. Carmichael's suggests this would be a large resource, likely at good grades.
The other possible source of good news for Wildhorse, in Carmichael's view, is the announcement of two strategic alliances, one with a supplier of specialist process engineering services and one with a specialist directional drilling company.
This sets Wildhorse up for significant news flow over the course of 2010 and 2011, while Carmichael's also expects the diversified nature of the energy projects to attract the attention of investors going forward as the latest value in each option isn't being priced in at present in its view.
To reflect all this, Carmichael's has initiated with a Speculative Buy rating, suggesting a likely time line for the company is to develop a substantial resource over the next 12 months, conduct a pilot burn to confirm the technical and economic parameters of the UCG project in the second year and by year three focus on synthetic gas sales to generate some revenues.
While DJ Carmichael sees upside in both stocks the small market capitalisations of around $34 million for China Steel and just over $60 million for Wildhorse mean little general coverage in the market, the FNArena database showing no other brokers research either company.
Shares in China Steel today are unchanged with a last sale at $0.125 and a 12-month range of $0.05 to $0.20, while Wildhorse shares are also unchanged at $0.38 and a range over the past year of $0.05 to $0.70.