Mining

The Company

Separate from Erdenes Tavan Tolgoi, Tavan Tolgoi (TT), or small Tavan Tolgoi, is one of the largest coal mining companies in Mongolia. TT has around 80m tonnes of coking coal reserves and 100m tonnes of high-grade thermal coal reserves.

The company operates in Tavan Tolgoi, one of the world’s largest untapped coking and thermal coal deposits, located 267 km from the Chinese border in the Gobi desert in southern Mongolia. According to exploration work conducted under the Soviets, the deposit is estimated at 6.4bn tonnes of resources.

TT is set to gain a competitive advantage in 2015, thanks to its location next to a new railway dedicated to transporting coal to China. This will help to make Mongolian exports to China more competitive in comparison to other countries like Australia and US, which are desperately trying to cut costs.

Established in 1966, TT initially provided the South Gobi Province with thermal coal. In 2004 the company received an order to export 3000 tonnes of coking coal to China, and by 2011 it had become the largest coking coal producer in the country, with over 6m tonnes in annual exports. TT is also the largest company listed on the Mongolian Stock Exchange, with a market value of $400m.

In 2012 TT’s exports declined to 2.3m tonnes on lower prices, slower infrastructure development and weaker demand. The company faced strong competition from seaborne coal from Australia, whose exports to China increased by more than two-fold year-on-year in 2013, to reach 21m tonnes.

China consumes up to 95% of TT’s products, making the firm extremely sensitive to Chinese economic and infrastructure policies. The company has also supplied the Gobi provinces with thermal coal for 13 years at a significantly discounted price of MNT8000 ($4.80) per tonne, incurring losses of around $500,000 per year. Fortunately, starting in September 2013, the South Gobi local government nearly doubled the fixed thermal coal price to MNT15,000 ($9) per tonne.

The local government currently owns 51% of TT, with another 15% of shares trading on the MSE. Unlike other coking coal producers in Mongolia, the mine is operated entirely by Mongolians and does not hire contractors, which helps ensure strong local support.

Performance

TT accounts for approximately 34% of the revenue generated in South Gobi. In 2013 the company’s revenues reached MNT161bn ($96.6m), a 57.5% increase from the previous year. Net profits increased substantially to MNT62bn ($37.2m), up seven-fold over 2012, as the cost of goods sold fell by nearly 11% despite a strong increase in sales.

Over the past four years, the company has an average dividend yield of 19%, with shareholders receiving nearly 90% of earnings in dividend payments. Should the company maintain this dividend policy, this would yield an estimated MNT720 ($0.43) per share at a closing price of MNT3800 ($2.28).

Development Strategy

The establishment of the coal-dedicated railway connecting Tavan Tolgoi and China will place Mongolian coal ahead of Australian competitors. At present, it costs around $10 per tonne for Australian coal to reach China, compared to $20 per tonne for Mongolian coal. However, according to estimates by miners at Tavan Tolgoi, this is set to drop to $8 per tonne once the railway is operational.

Some of the major risks that TT faces include a recovery in coking coal prices and demand for Mongolian coal. Prices could be affected by any number of factors, including Chinese economic and infrastructure policy, global steel production, infrastructure development in Mongolia, and economic growth in major export markets like the EU and the US.

China’s coking coal import levels account for approximately 10% of total demand, so any small shift in this delicate supply-demand balance could have a large impact on coking coal trade. If the Chinese government decided to support local small-scale miners, for example, it would prompt some suspended mines to resume production, hurting TT in the process.