What Is Rio Tinto’s Motive Behind Selling Two South African Coal Mines To Forbes Coal?

Rio Tinto (NYSE:RIO) has agreed to sell two small coal assets in South Africa to Forbes & Manhattan Coal for 440 million rand ($53 million). Forbes will acquire Rio’s stake in the Zululand Anthracite Colliery (ZAC), a producing anthracite mine, and the Riversdale Anthracite Colliery (RAC), an undeveloped anthracite resource. Rio owns a 74% stake in both these assets. The remaining 26% stake in each is owned by the black economic empowerment partners. In addition to the base price of $53 million, Forbes will also pay Rio an annual revenue share of 10% on incremental revenue above 850 million rand until 2025. ^[1]

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What’s In The Deal For Forbes?

The Zululand asset is thought to be one of last, large-scale producers of high-quality anthracite in South Africa. It has shown an average run-of-mine production of 700,000 tonnes of coal a year over the past five years and generated EBITDA figure of $10-$15 million a year over the past four years. To put this figure in perspective, we should consider the fact that Forbes had a second-quarter total run of mine (ROM) production of 414,551 tonnes of coal. Hence, the ZAC mine alone constitutes a significant expansion in Forbes’ production capacity. Anthracite is a high-margin metallurgical coal so it will boost the company’s bottom-line. Rio Tinto also expects the synergies generated due to the proximity of the ZAC mine to its Aviemore property will boost consolidated EBITDA by a further $5 million.

Forbes also has a long-term growth strategy and it eventually aims to produce 3-4 million tonnes of coal per year. It can expand capacity at the Zululand facility with relatively little capital injection and, thus, boost organic growth to meet its objective. ^[2]

So, Why Is Rio Selling Such High-Margin Generating Assets?

The official explanation provided by Rio suggests that these two assets are too small for its operations. It says that selling these assets is part of its strategy to shed smaller operations. However, we are not entirely convinced that this is the only reason. For one, Rio Tinto has now been trying for a year to divest its 57.7% stake in South Africa’s largest copper producer, Palabora Mining. This is not a small operation, so we reckon there is more to Rio’s decision than what it is being officially explained.

We think that Rio is working toward reducing its overall exposure to South Africa as a result of an environment of policy uncertainty. The policy environment has deteriorated due to a wave of violent strikes in the platinum sector this year. These strikes have unnerved foreign investors. The strike and violence began at the mines of the platinum mining company, Lonmin, and further spread to other platinum, gold, and coal mining companies. While the strike at Lonmin has now ended, at other places it has not. While Rio Tinto has been left untouched thus far, there are chances that it may get caught in a similar situation.

Also, in the wake of the recent unrest, the ANC Youth League has shrilled its pitch for nationalization of oil, steel, and mining companies. The ANC Youth League is the youth wing of the ruling ANC party, and the latter has assured that nationalization is back on the agenda. This is giving sleepless nights to mining companies which might be forced to give up their assets for a little compensation. We think that they wouldn’t exactly be in a mood to go through lengthy litigation or arbitration proceedings if they can avoid all of that by simply exiting when they can. ^[3]

One may point out that earlier this year, Rio doubled its stake in Richards Bay Minerals, a producer of titanium dioxide in South Africa. However, it needs to be kept in mind that Rio didn’t go scouting for this deal. Rather, its increased stake came about as a result of a put option exercised by BHP Billiton. This put option was agreed upon as part of Richards Bay’s restructuring process in 2009. The increasing of stake in Richards Bay was thus more of an obligation than a consciously deliberate decision.

The coal and uranium businesses combined constitute 11% of Rio’s Trefis price estimate.

We recently revised the Trefis price estimate for Rio to $45 which is approximately in-line with its market price.

Understand How a Company’s Products Impact its Stock at Trefis

1. UPDATE 2-Rio Tinto sells small S.African coal assets, Reuters [↩]
2. Rio Tinto to sell two SA coal assets to Forbes, Business Day [↩]
3. ANC Youth League to propose nationalization of coal mines in South Africa, SteelGuru [↩]