Drummond lays out stall for Colombian asset sale

12 Mar 2018 Nick Trevethan

Progress in exploring the sale of Drummond’s Colombian assets has moved beyond assessing its equity options, and it is actively seeking buyers, according to financial and mining sources.

Drummond released a statement last Friday after questions from IHS Markit, saying it was “exploring investment options” for its equity in Colombia.

IHS Markit understands that the process has advanced and potential suitors have been approached with a view to acquiring most, if not all the assets.

Drummond has declined to comment beyond its initial statement.

Placing a financial value on the assets has prompted a wide range views from mining equity specialists.

Some pointed to the sale last year of Rio Tinto’s stake in Coal & Allied, including an interest in Hunter Valley Operations (HVO), to Yancoal for $2.59bn, as a possible benchmark for a deal.

The acquisition has already helped Yancoal make a A$458m turnaround, when it reported profits of A$229m for the half-year ending 31 December 2017.

Drummond produces more coal than HVO and has its own Cape port, plus a 41% share of the Fenoco rail line.

The key metric is production cost and Colombia is home to some of the most competitive mines in the business.

Drummond’s production costs are estimated in a range of $38-42/t FOB (export terminal price), which is low for the Atlantic market. Indonesian coal producers will be lower, but the heat value of its coal is lower on average than Drummond’s 5,700 kc NAR product.

Drummond also exported 32.48 mt to global markets in 2017, making it Colombia's biggest coal exporter for a second year running.

By contrast, HVO produced 14.00 mt of mainly thermal coal and while output is lower, its production costs are higher. It produced coal with a heat value in a range of 5,500-6,043 kc NAR, according to its previous owner, Rio Tinto.

Beyond that, the only guide on Drummond’s potential value is from 2011 when Japanese trader Itochu paid $1.52bn for a 20% share, which valued the entire asset at $7.60bn at that time. Other bids for the stake valued the company at $6.00bn.

But that was in a different era for coal, when prices were in a range of $120-125/t DES Amsterdam-Rotterdam. They are now in the low $80s/t DES AR.

Prices are lower than in 2011, but they are still well above the cost of production, while just two years ago many global miners struggled to stay in profit at all.

This skews the valuation optic even further so a direct comparison with the Itochu valuation adjusted for the change in prices is difficult, and contemporary valuations for Drummond are closer to half those at the time of the Itochu deal.

A valuation between $3-4bn, for example, would be relatively easy to swallow for a company such as Glencore, which reported adjusted net profits for 2017 of $14.8bn, helped by global strength in commodity markets. Glencore CEO Ivan Glasenberg has spoken enthusiastically of the strength and potential of the seaborne thermal coal market.

Other big miners are likely out of the picture as they either move away from coal or slash their debt levels, but market sources have suggested possible suitors in the trading community looking to expand upstream.

However, Itochu, having taken a stake seven years previously, could be interested. One trader speculated that Itochu and Glencore could work together in a similar same way to how Glencore and Yancoal acquired Rio Tinto’s Hunter Valley Operations, where Glencore ended up with significant marketing rights to coal production.

Murray Energy has been mentioned as a possible suitor. Murray has shown an appetite for growth. Interest from Turkish industrial conglomerates has also been indicated.

One aspect of Drummond the market can agree on is that it is a world class mining asset, with supporting infrastructure. Coal has also outperformed most commodities the past couple of years and Drummond is well-placed to serve growing demand in Asia-Pacific markets in addition to existing demand in the Atlantic.

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