Thungela - Model Update
Thungela was unbundled from Anglo American in 2021. It is the leading SA producer of high-quality, low-cost export thermal coal. The company recently announced the acquisition of a stake in Esham coal mine in Australia. Attributable production from Australia will then add ~10% to production.
The thermal coal market
Thermal coal is used to provide heat energy in combustion to generate electricity. Although its use has declined over the last decade, in 2022 35.8% of global power generation still came from thermal coal. Thermal coal is also used to produce steam for use in industrial plants in the chemical and paper industries.
Per the International Energy Agency, overall coal demand increased to record high levels in 2022. Coal-fired electricity generation was supported by overall weak nuclear power and hydropower production, contributing to a new record global high of 10.44 TWh being generated from coal. The thermal coal market is in backwardation, however, meaning that prices are expected to come down over time. Thermal coal demand is expected to peak in 2026 and decline steadily thereafter. The reason for the decline is the declining cost and improving technology of renewable energy. The decline in thermal coal is expected to be led by low energy content coal, since more of it needs to be burnt to produce the same amount of energy, resulting in higher carbon emissions.
Thermal coal is benchmarked based on its energy content and ash, as well as other elements such as sulphur and phosphorus content. The coal is typically tiered by energy content (kcal/kg). Lignite has an energy content of less than 4 500 kcal/kg; sub-bituminous coal has an energy content of 4 500 to 5 400 kcal/kg; bituminous coal's energy content is between 5 400 and 6 900 kcal/kg; and anthracite's energy content is above 6 900 kcal/kg.
South African coal
South Africa is the fourth largest producer of thermal coal globally. Demand for South African thermal coal is dominated by the domestic market (~74% of demand), while the remainder is exported to the seaborne market.
South Africa primarily produces good quality bituminous coal and a very small amount of anthracite. It has low total moisture and inherent moisture, which makes it more effective to heat during combustion. South African coals have high ash levels, however, which results in it having to be washed before being accepted by importers (except for India). Importantly, South African coal has low sulphur content.
Prices for thermal coal from South Africa are typically linked to local benchmark price indices, specifically the 6 000 kcal/kg Richards Bay bituminous coal price (RB1) or the 5 500 kcal/kg high ash Richards Bay bituminous coal price (RB3). The RB1 coal price usually trades at a slight discount to the Newcastle benchmark coal price (the global benchmark) due to the higher freight costs to key demand locations, offset by quality adjustments.
Group operational overview
Thungela produces thermal coal predominantly from seven mining operations, namely Goedehoop, Greenside, Isibonelo, Khwezela, AAIC (operating the Zibulo colliery), Mafube Coal Mining (operating the Mafube colliery) and Butsanani Energy (operating the Rietvlei colliery) in both underground and open cast mines located in the Mpumalanga province. The group also holds a 50% interest in Phola (operating the Phola Coal Processing Plant) and a 23.22% indirect interest in RBCT, which owns and operates the Richards Bay Coal Terminal. The company is in the process of developing the Elders project, which is intended to replace Goedehoop Colliery volumes as the operation nears the end of its life, as well as Zibulu North Shaft that will increase the mining area of the existing operation.
The group mines and processes sub-bituminous thermal coal with energy content between 4 600 kcal/kg and 6 000 kcal/kg that is mainly sold for use in electric power generation. In FY22, attributable production totalled just 13.1 Mt of thermal coal to export markets and 6.9 Mt to the domestic market. Aggregated sales volume totalled 12.1 Mt for exports and 6.7 Mt domestically. Domestic sales constitute a lower quality and lower value coal compared to export thermal coal and therefore fetches lower prices.
The group has run of mine (ROM) thermal coal reserves of 266.4 Mt, which translates to an estimated reserve life of ~10 years. Brownfield options have the potential to extend the life of the group's assets to approximately 2040 (~17 years). The group also has greenfield optionality through the Elders (12 years) and other projects.
In February, Thungela announced that it will take a majority stake in the Esham mine in Australia with a life of mine of ~16 years, producing high quality coal (5 850 kcal/kg, with low ash and sulphur content).
Dividend
Thungela targets a dividend payout of at least 30% of the cash flows from operating activities after funding sustaining capital expenditure.
Investment Case
Risks
FNB SPM View
We valued the company using a range of valuation techniques and calculate a fair value of R156.30. The Esham acquisition will be detrimental to free cashflow near term, but will add stable export production to the portfolio, supporting free cash flow over time. We calculate that the acquisition adds ~R40 to the fair value of the company, although it adds execution and forecast risk to estimates as well.
