Sherritt could sell coal mines worth market cap

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Sherritt International (TSE:S) may look to dispose its coal assets in order to gain funds to expand its nickel mining operations, three industry bankers told dealReporter.

The Toronto-based company, which is Canada’s largest producer of thermal coal used by power plants, is aiming to move away from its slow-and-steady coal business and focus on its higher-margin nickel mining, the bankers said. One of the bankers said he has heard that Sherritt is considering the disposal.

Phone calls left with Sherritt were not returned.

Much of the coal Sherritt produces at its nine mines in Saskatchewan and Alberta is tied up in long-term contracts with Canadian utilities. This means Sherritt has not been able to fully capture gains in thermal coal prices over recent months, the first banker said. The coal would be more valuable if it were exported from British Columbia ports and sold internationally, this banker said. The company produced close to 40 million metric tons in 2010.

While the coal business generates solid cash flow—accounting for half of Sherritt’s 2010 revenue of CAD 1.8bn—it would make more sense to separate the coal from the nickel business, which accounted for 30% of 2010 revenue, the first banker said. Other revenue last year came from Sherritt’s oil, gas and power operations.

Sherritt’s metals production comes from its 50% ownership in the Moa Joint Venture nickel and cobalt mining, processing, refining and marketing operation with General Nickel of Cuba. The venture produced 33,972 metric tons of nickel last year.

Sherritt also owns 40% of the much larger Ambatovy nickel project in Madagascar, which has annual design capacity of 60,000 metric tons of nickel and a mine life projected at about 30 years. Sumitomo and Korea Resources each have a 27.5% stake, and SNC-Lavalin has a 5% interest.

While Sherritt wants to be viewed as a nickel company, right now it is being traded principally on its coal assets and is at a discount, the first banker said. Sherritt is likely undervalued using a sum-of-parts analysis, a fourth banker said.

“The highest and best use of their coal assets is with someone else,” the first banker said.

Sherritt would probably be able to get a strong valuation for its coal assets, the first banker and a second banker said. The assets could fetch CAD 1.2bn to CAD 1.5bn in a sale, these bankers said. The second banker cited Sherritt’s market capitalization and the premium needed to buy the assets, while the other banker added that a discounted-cash-flow analysis and current thermal coal prices yield a valuation in that ballpark.

With Sherritt’s roughly CAD 1.7bn in debt as of 30 June, its enterprise value is roughly double its CAD 1.5bn market capitalization.

Because of the size of such a deal, likely suitors would probably be larger coal companies like Arch Coal (NYSE:ACI) and Peabody Energy (NYSE:BTU), the first and second bankers said. One of the bankers added that Alpha Natural Resources (NYSE:ANR) could be interested, while the first banker said Glencore International (LON:GLEN) could be another suitor.

Glencore and Peabody representatives declined to comment. Representatives for Arch and Alpha did not return phone calls seeking comment by publication time.

Nonetheless, there could be hurdles facing a sale of Sherritt’s coal assets, the three bankers and an additional banker said.

Sherritt’s relationship with the US is limited because it owns assets in Cuba, which is under a US embargo. This could give potential US buyers pause, said the second, third and fourth bankers.

However, there might be some wiggle room for US companies because a sale would involve them buying non-Cuban assets from a Canadian company, the second and third bankers said.

Because of the locked-in lower returns on some of coal assets, they would be hard to sell to private equity, the first banker said.

Further, coal-hungry Chinese companies would not be interested in the coal Sherritt has that is tied up at local utilities, the fourth banker said. And the fact that the coal is of the less-lucrative thermal variety, instead of the metallurgical coal used in steelmaking, leaves Sherritt’s coal assets with less of a “wow factor,” the fourth banker said.

If Sherritt were to successfully sell its coal mines, the company could use the money for acquisitions, the second and third bankers said. The third banker said Sherritt could buy another nickel asset, but would more likely use the proceeds to contribute to upcoming capital expenditure requirements.

The USD 5.5bn Ambatovy project has received USD 2.1bn in debt financing from 14 lenders. And late last year, Sherritt announced it agreed to acquire a controlling 57.5% equity interest in the undeveloped Sulawesi Nickel Project in Indonesia from Rio Tinto (NYSE:RIO), which continued to own the remaining 42.5%. As the operator, Sherritt committed to fund USD 110m toward producing a feasibility study from which a development decision will be made.

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