Wescoal: Just Being Given Away…

Wescoal (WSL) released their FY 19 results yesterday showing earnings basically halving off a terrible H2:19 period.

Counterparty risk saw a mining contractor at their largest mine go under and necessitating a change in this service provider. Labour disruptions and above-average rainfall further hurt negative impacted on operations. All of these events cost the Group volumes that operating leverage aggravated towards a halving in the bottom line.

Like I said, H2:19 was a terrible period for Wescoal.

Before I go on, I strongly suggest that you work through the Group’s nicely transparent results presentation over here. It holds a lot of valuable information that I will not go into nor even touch on.

Rather, what I will do is show you what I believe is a mind-blowing reality in the market: Wescoal’s current valuation (&, yes, I do currently still hold it in the AlphaWealth Prime Small & Mid Cap Fund).

Free cash flow is the net cash that a business generates after collecting from debtors, paying creditors and other bills, and spending on any capital items to either keep operations rolling (in the strictest sense) or grow operations (in the expanded sense).

In other words, free cash flow is the single closest true profit that a company actually makes each period. You cannot spend IFRS profits, but you can spend FCF!

In Wescoal’s FY 19 period, its free cash flow can be calculated as follows:

(1) FY 19 cash generated from operationsR462m
(2) Tax paid(R113m)
(3) Finance charges(R33m)
(4) Capex spent (sustaining & expansionary)(R115m)
(1) + (2) + (3) + (4) = (5) Free Cash Flow (FCF)R200m
(6) Wescoal’s market capitalisationR604m
(5) / (6) = FCF Yield33%

You will note a number of things from the above calculation:

  • It ignores acquisitions as one-time items, but it does include internal expansionary capex projects spent during this period. In calculating non-growth-based FCF, one should separate sustaining capex from expansionary capex. I do not do this here.
  • I have not tried to “normalize” or adjust this FCF in any way to take into account steady-state production. This is relevant as H2:19 was an anomaly and FY 20E should arrive at (much higher) steady-state. In other words, a more normal year should see FCF much higher than the above. I have ignored this fact.

These assumptions make the above FCF imperfect, but they do simplify the number of other assumptions that go in. And, in a way, they make it more conservative.

Now what does Wescoal’s current 33% FCF Yield mean?

It means that if Wescoal does nothing differently, carries on operating at this level, pays all its bills, creditors and financiers as per normal and then pays out the rest of its cash as dividends to shareholders, that shareholders will have had their entire capital (assuming that they paid 135cps for WSL shares) returned to them via dividends within c.3 years.

I.e. 33% cash yield x 3 years = 100% of capital returned by the end of Year 3.

Yes, this ignores dividend taxes and a range of other assumptions (both good and bad, as noted above) but I am just keeping it simple here.

Is the 33% FCF Yield for Wescoal good or bad?

Well, if you work through Wescoal’s existing (once again, ignoring their growth projects) portfolio of mines, you find that their Life of Mines (LoM) range from 3 years to 7 years. More importantly, from a portfolio perspective, if you calculate a weighted-average LoM, then Wescoal’s portfolio’s average LoM is c.6 years.

(Yes, VG5, Moabsvelden & Arnot will add materially to the Group’s average LoM, but I am ignoring these here.)

In other words, at the current market price for Wescoal shares with its 33% FCF Yield, you are paying for a 3 year LoM and getting another 3 year LoM free.

Oh, and then as noted above, you are getting all the growth projects free. Oh, and the Coal Trading segment free too. Oh, and, finally, this is also assuming that FY 19E is the best Wescoal can do, yet we all know that H2:19 was quite the anomaly and sustainable profits and cash flows should be higher.

In other words, as far as I can see, Wescoal shares appear to be at an absolute bargain basement pricing. No wonder yesterday the CEO explicitly stated their intention to launch a material share buy-back program.

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