Company Research

Portfolio. Tavan Tolgoi JSC (TTL) offers exposure to high-quality coal resources in Mongolia. Total proven and probable reserves for TTL’s deposit (also known as “small Tavan Tolgoi”) are 40Mt of primarily coking coal and resources are estimated at 90Mt, according to company estimates. The company’s 270ha coal mining license area is located within the world-class 6.4Bt Tavan Tolgoi coking and thermal coal deposit (known as “large Tavan Tolgoi”).

Growing Production. TTL’s coal output increased at CAGR 77.2% from 2002 to 2010. Annual output hit 3Mt in 2009 and is estimated to have further increased to 3.5Mt in 2010. We expect coal output to continue growing, reaching 4Mt by 2013 and stabilizing at around 5Mt per annum afterward.

Healthy Cash Flow. TTL exports most of its output to China and generates healthy cash flows. Exports to China grew from 0.79Mt in 2006 to an estimated 3Mt in 2010. Sales increased 11.8 times to MNT95.4bn and net profit grew 8.8 times to MNT42.8bn from 2006 to 2009. The Company has high ROA, ROE, gross margin and net margin ratios at 103%, 116%, 58% and 44.8%, respectively.

Advantages. TTL maintains a highly competitive standing within its industry based on cost advantages over peers (production costs of only US$9/tonne), high coal quality (6,500-7,500kcal/kg, 20% ash and 8.5% moisture), proximity to China (250km) and state-supported railroad infrastructure development in the region.

We initiate equity research coverage on TTL with a BUY rating, targeting a MNT1,209,250 share price by year-end 2011 or an 83% upside in MNT and 102% in US$ (due to an expected 10% MNT appreciation against US$) compared to the current price. We view TTL, with its 2010e PE of 5.6x and current EV/Reserve of 6.7 US$/t, is substantially undervalued compared to its international peer average at 13x and 11.5 US$/t, respectively.

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The largest beverage company. APU JSC is the largest beverage company in Mongolia. Established in 1924, APU was one of the first companies privatized in 1990s and is listed on the Mongolian Stock Exchange. The Company’s current share price is MNT2801, up 40.8% YTD in 2011, after having posted impressive performance of +216% in 2010. APU produces and sells six brands of vodka, eight brands of beer, two non-alcoholic beverage brands and the Pure Milk and Frutta Juice brands. The “Bolor” and “Altanturuu” vodka brands and “Fusion” and “Borgio” beer brands are the most popular in Mongolia. APU has the largest share in vodka and beer market, and in water sales in the country. In 2009, it had a 40% market share in vodka and 46% in beer sales. APU exports its products to South Korea, Japan and Germany.

Expanding Capacity. In 2002‐2003, APU invested MNT25bn for the renovation of vodka, beer, water and soft drink factories and a state-certified laboratory. APU’s current beer factory capacity is 50mn liters per year, with utilization close to 100%. In APU’s vodka segment, the urgent issue is exports to the US, European and Asian markets. APU has registered "Chinggis Khan" vodka trademark in the US and Europe. The Company invested MNT15bn for alcoholic production in 2008‐2009, and opened a new spirits factory in February 2009.

Efficient distribution network. APU has the largest and most efficient distribution network in the country with 6000 outlets within four distribution channels, truck fleet for country-wide deliveries and a strong marketing team.

Modern production facilities. APU has modern plants specialized in manufacturing vodka, beer, soft drink and diary products. “Natur Agro” pure alcohol distillery is equipped with the technologies from Germany, Italy and New Zealand. The vodka and soft drink plants were fully modernized in 2003 and 2004. The “Natur Agro” facility was completed as a greenfield project in 2008.

Recent developments:

• APU cooperated with New Zealand\'s NZM‐Food Company in development of a milk factory in 2005‐2007. APU also renovated factory technologies in 2008 and started selling milk in February 2009. The milk factory’s capacity is 25mn liters per annum, or around 30% of the Ulaanbaatar city market.
• In May 2010, EBRD provided APU with a US$25mn loan to expand beer and non-alcoholic beverages production capacity and diversify product range.

We believe the outlook for APU over 2011 is positive given the demand for beverages and branded alcoholic drinks, which are expected to substantially increase thanks to the rapid income growth in Mongolia over the coming year. APU will also increase its market share after recent modernizations in 2010 and expand its brand portfolio targeting both domestic and international consumers.

We initiate equity research coverage on APU JSC with a BUY rating, targeting a share price of MNT4300 by year-end 2011 or 54% upside in MNT (69% in US$). We view APU, with its current PE of 15x (2010e) and estimated PE of 11x (2011f), is undervalued compared to an international peer average of 23x.

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We raise the target price of PCY from C$0.70/share to C$1.25/share based on the revaluation of Ulaan Ovoo, Chandgana and the Wellgreen properties. We update the valuation of Ulaan Ovoo on the news that receipt of the mine permit is imminent and the company can begin coal production. Using DCF method, we obtain US$92.1 mn. for Ulaan Ovoo. 

PCY is making significant progress on development of Chandgana and is partnering with international and local business groups. PCY’s strategic partners will assist the company with obtaining necessary permits and licenses and finance the construction of the power plant. The company expects to sign strategic partnership agreements by the end of this year. We project a long term coal production of 4.8mn tonnes at Chandgana which will be supplied to local power plants. Our DCF valuation of Chandgana yields us a valuation of US$89.3 mn.

We update the valuation of the Wellgreen property based on positive drill results. According to the management, the potential ore at the Wellgreen property is in the range of 77 – 254 mn tonnes at 0.26 to 0.38 % nickel, 0.26 to 0.36% copper, 0.55 to 0.85 g/t platinum and palladium. Based on comparable valuation, we conservatively apply a US$1/t to the Wellgreen’s historical resources of 55mn tonnes  and reach a valuation of US$55mn.

We estimate PCY’s NAV at US$261.6 mn or US$1.24/share and set the 12-months target price at C$1.25/share. This represents an upside of over 60% to current PCY’s share price of C$0.78 (01.11.2010). We therefore maintain our BUY recommendation. We use fully diluted shares outstanding of 209.5 mn which includes possible future capital raisings to develop Ulaan Ovoo mine.

About Prophecy Resource Corp.
Prophecy Resource Corp. is an exploration and production company listed on the Toronto Venture Exchange with market capitalization of C$82mn. Prophecy Resource Corp. is focused on developing coal assets in Mongolia, and PGM, nickel, copper and vanadium mines in Canada. www.prophecyresource.com

About Eurasia Capital
Eurasia Capital is a Hong Kong-based pan-regional investment bank with focus on Mongolia, China, Russia and Central Asia.  The Firm offers cross border M&A and advisory, capital raising, sales & trading and research services to its international and regional clients including government agencies, major energy and resource companies, sovereign wealth funds, private equity groups and global portfolio investors. www.eurasiac.com

To access Eurasia Capital’s report on Prophecy Resource Corp. published on 02.11.2010 please click the below link.
 

We participated in recent analyst trip to the Ovoot Tolgoi mine and had an opportunity to meet the SGQ management. The management meetings confirm our estimates of production growth and pricing improvements. SGQ is in the process of signing 2Q 2010 contracts with a significant hike in coal prices at the mine gate. The volume-weighted average coal prices will likely be in the range of US$42-44 per tonne, effective 1st April 2010, which represents an increase of 48% to ASP in 2009 (US$29/tonne). This is consistent with our ASP estimates of US$43/tonne for 2010. We maintain our target price of CAD24 per share. Our 12-month target price is based on a blended DCF and resource-based valuation approach. This represents 45% upside to current SGQ’s share price of CAD16.5 (March 30, 2010).

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TPL provided further details on oil test results from AKD01 (Doris) oil discovery. TPL estimated oil in place to amount to 28.9MMbbls in Cretaceous based on an excellent
permeability (1.75 Darcy) and a large investigated distance (in excess of 10 km). The lower Dolomite zone may contain 3.8MMbbls based on a good permeability (700 millidarcies) and an investigated distance of 4 km.Generally, oil reserve estimations are in line with our projections (29.7MMbbls) that we used in our DCF valuation.We reiterate our BUY rating and 12-month target price CAD2.00/share.

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Tethys Petroleum Limited (TPL), a Toronto listed company, offers unique exposure to large-scale oil and gas resources in Central Asia. TPL has five exploration and production projects in the vast hydrocarbon basins of Kazakhstan, Tajikistan and Uzbekistan where several global major oil and gas companies are currently operating. TPL has recently discovered oil in its Akkulka property, Kazakhstan and the company may materially upgrade its oil reserves. We estimate potential recoverable oil in place in its Akkulka property at 149mn bbls. We believe the likelihood for further increase in oil reserves is substantial from Kulbas exploration property, Kazakhstan. Our 12-month target price is based on a combined DCF and resource-based valuation approach. We apply DCF valuation to TPL’s producing and near production assets and use resource-based valuation EV/Resources for valuing undeveloped oil & gas resources in Kazakhstan and Tajikistan.

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SouthGobi Energy Resources (SGQ) announced on 21 January 2010 that it has priced its share offering on the Hong Kong Stock Exchange (HKEx) at C$17 or HK$ 126.04 per share, the top end of the indicative price range. The shares have been significantly oversubscribed on the back of strong investor demand.  As the only Mongolian coal producer listed outside Mongolia, SGQ attracted strong interest from Asian institutional investors. Chine Investment Corp and Temasek, two prominent sovereign wealth funds, have subscribed for US$50mn worth shares each as cornerstone investors, sending a powerful signal to institutional and retail investors alike. SouthGobi to amass up to US$1 billion in four months (US$500mn from CIC in October 2009 and up to US$500mn from this global offering) which will make SGQ the best capitalized resource company in Mongolia. SGQ is already an outstanding success story of bringing a coal mine from exploration into production in a record time.  The next target is to become the largest coal producer in Mongolia in coming years.  Thanks to superb management team, strong balance sheet and pole position in Mongolia in terms of expansion and M&A deals, SGQ has all ingredients in place to transform into one of the most dynamic resource companies in Asia. We maintain our target price of C$24 per share, representing 35% upside to current SGQ’s share price of C$17.8 (Jan 22, 2010). 

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Eurasia Capital research team has recently made a site visit to Ovoot Tolgoi mine and met with SouthGobi Energy (SGQ) management to receive updates following the recent successful closing of substantial financing. Our key takeaway from these management meetings is that the company will be able to substantially improve their margins by bringing the pricing of their products in line with coal prices in China thanks to improvements in product quality, CIC partnership and infrastructure development. In addition, the major share of SGQ’s production will consists of high quality hard and semi-soft coking coal going forward, marking the company’s entrance into upstream of the Chinese steel industry. We believe the market has yet to price in these two significant factors leaving big upside in the share price. We have increased our target price to C$24 per share. This represents 40% upside to current SGQ’s share price of C$17.1 (Dec 31, 2009). 

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SouthGobi Energy Resources (SGQ) reported on October 26, 2009 that China Investment Corporation, the country’s Sovereign Wealth Fund, will provide US$500 million in financing to support accelerated investment program in Mongolia. We rate this development as positive as it will allow SGQ to significantly ramp-up its coal production, develop transportation infrastructure and build value-added processing, which will significantly boost the company’s revenue and profitability margins.

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