Essay: Analysis Of East Coast Coal Ltd - Growth Opportunities.

Instructions to students

Instructions to students Students are required to use the Case study as the basis for analysis in Task 1 and the Assignment. Ensure you spend sufficient time familiarising yourself with the content of the case study. The purpose of the case study is to explore, at a broad level, a number of issues relating to a fictitious resources company, East Coast Coal Ltd. The use of financial ratios and similar analytical approaches is not required. The figures are given to provide a sense of the size of the company and the relative importance of the issues affecting the company. 

James Skater is the managing director and chief executive officer of East Coast Coal Ltd (ECC). James was elected to these positions on the retirement of ECC’s founder two years ago. ECC is a public unlisted company limited by shares, with $300 million issued share capital. The majority of these shares are held by institutional investors, the board, and some private investors. ECC had a humble beginning, with a solitary underground mining license in the Hunter Valley region of NSW. Following its initial success in extraction and sale of black coal to regional NSW electricity plants, ECC was granted two additional mineral development licenses from the NSW Government, where it began to extract via the open cut method in the 1980s. Seeking expansion into other regions, it purchased a further two mines in the Bowen Basin region in Queensland over the next decade, giving it a total of five currently operating coal mine sites. Its current production across the five sites is approximately 12 million saleable tons per annum. ECC also has interests in a coal processing and transport facility in the Newcastle region, which allows it to oversee the process of getting its coal onto coal ships for international delivery. To assist this expansion, it expanded its engineering department significantly in the early 2000s, hiring local and international staff.

The progressive purchasing of Australian coal mines has contributed to the growth of the company from a minor supplier of coal to NSW electricity generators with some limited exports, to a supplier of coal electricity generators in NSW, Queensland and Asia. Its primary export targets to date have been China, Taiwan and Korea. Over the past five years, ECC has weathered the uncertainty of fluctuating commodity prices and demand by investing in technologies to increase efficiency in its mining operations, as well as using its interest in the processing facility to reduce its Free On Board (FOB) costs in NSW; that is, the costs of getting coal onto ships. Its engineering team has won awards for some of its process enhancements, and ECC has found a niche market for its consultancy services. The company has total assets of A$1.2 billion, with long-term debt of A$500 million and short-term debt of A$150 million. ECC is profitable and has been paying its shareholders regular dividends. In the last 12 months, ECC had coal and services sales approaching A$800 million (up from A$500 million four years ago due to export expansion), with a net profit of A$15 million. ECC’s average net profit over the past four years was a steady A$12 million. ECC has made a strategic decision not to list on the ASX, but this has meant it has had to turn to a syndicate of both Australian and overseas financial institutions to finance its operations at a higher cost than a capital raising from investors. Nonetheless, existing long-term contracts with its customers, means that ECC can service and progressively repay its debt. The extension of long-term contracts by existing long-term customers, as well as potential new customers, some of whom are located in India, means that ECC is considering expanding its operations. All overseas contracts with its customers are denominated in US dollars (USD). The contracts allow ECC’s customers to renegotiate both price and tonnage on an annual basis, within limits.

East Coast Coal Ltd: Background

Profitability is expected to improve strongly in the current financial year (20XX/XY) to close to A$20 million as ECC has secured substantial price and tonnage upgrades in its latest round of negotiations with its existing coal customers. However, James has some doubts as to whether ECC will be able to meet its contracted tonnages in the coming year. Penalties will apply if tonnages are not met due to factors within the control of ECC (these factors are set out in ECC’s contracts with its customers). James is also concerned that the Australian dollar may fluctuate in the coming year, especially with political uncertainty in the US, and ongoing European turmoil. The company operates a relatively sophisticated in-house financial risk management operation to minimise exchange rate and commodity price risks. This operation generally works well but errors have occurred in the past. There are intractable labour and union problems that affect both the Hunter Valley and the Bowen Basin coal mines. The geological features of the underground mine make its operation more expensive than the open-cut mines and potentially more dangerous. Some existing mines have a strong union presence, and work practices at these mines lead to overmanning and inflexible work practices that have a substantial negative impact on productivity. ECC considers that at their peak its five mining operations should be able to yield greater than the current 12 million tons per annum. Two of ECC’s Hunter Valley mines are also nearing the end of their economic lives in their current configuration. While there are substantial coal reserves nearby, mostly on ECC’s current leases, a substantial investment in machinery would be required to continue to extract coal. The existing continuous mining machinery would have to be replaced with newer technology to improve the technical efficiency and scale of the mines. FIN101_CS_v3 3 © Kaplan Higher Education The railways in Queensland that transports ECC’s coal to port for export are owned by a government rail monopoly which, in ECC’s opinion, charges excessive rates and uses the revenue to subsidise the fares of urban rail passengers. Further, chronic underinvestment in rail assets has caused service delays and has hampered ECC’s ability to deliver coal to some ports. Lastly, while most ports are privately owned, their operation is subject to substantial government regulation. While ECC believes that port charges are too high, and that expansion of port capacity is hindered by government regulation, the port owners complain that the rates are too low to justify the expansion of port facilities. These and other problems, as well as opportunities for growth, have led ECC to consider options to diversify its operations.

Current Challenges and Opportunities for Growth

 ECC has been approached by a business broker to gauge interest in the purchase of a mine located in Indonesia, owned by a US coal miner who is partnered with a reputable Indonesian coal miner. The mine is in its infancy, with prospecting complete, and one year’s production ready for export. It has solid prospects for a large supply of saleable coal and the extraction costs per ton are roughly equivalent to ECC’s Australian costs in USD equivalent. The coal transport facilities are rudimentary, however, but generally dependable. ECC’s technical team confirms that the mine itself has been established with modern and efficient equipment, meaning that short term expenditure on plant and equipment would be for operation and upkeep only. In addition to ensuring that the economics of any acquisition are correct and that any new mine operates efficiently, an overseas purchase would be strategically important to ECC because it would be the first time the company has had an offshore production base. This would represent an important diversification of production, lessening the company’s dependency on domestic mines to fulfil its contracts, and theoretically shorten delivery timeframes. However, additional significant funding would need to be raised to enable the purchase to proceed.

 An alternative strategy under consideration is to acquire a Coal Seam Gas (CSG) production company called InterStrata Extraction (ISE). ISE has operations along the Eastern seaboard, mainly concentrated in the Queensland coal basins. It has a sound production process that is compliant with local regulations, and is particularly looking to partner with a coal producer for easier access to mine sites to expand its operations. It is yet to turn a profit after four years of operation, however this is due to the initial start-up costs, licensing and other overheads necessary to commence operations. ECC senior management are familiar with the ISE management team, as they have worked co-operatively, and attended various Bowen Basin planning and environmental meetings hosted by the regional councils. ISE has so far not sought out gas deposits under pastoral land for its operations, but has indicated that this will likely need to occur to remain viable. In order to proceed with the acquisition, ECC may need to borrow from its lenders, though it can feasibly utilise some of the company’s cash reserves for this purpose. ECC considers that the acquisition of ISE will have a positive effect on the company’s future, opening it up to the natural gas market, and with the hope of maintaining profitability even if coal demand and prices fall in future. If production can be ramped up quickly, and supply contracts put in place for the gas, ECC also hopes that any breach costs due to coal undersupply may be temporarily smoothed.

You have been appointed (as a consultant) along with James and other senior managers to the Acquisitions and Expansions Subcommittee (the subcommittee). The subcommittee has been asked to map out a recommended course of action for ECC, focusing on the costs, risks and benefits of purchasing the Indonesian coal mine versus acquiring ISE. If the Indonesian option is accepted, ECC will be renamed Indo-Pacific Coal (IPC); if ISE is acquired it will likely become East Coast Resources Ltd (ECR).

LO1: Explain the interrelationships of the major domestic and global market sectors.

LO3: Assess the changes and impact of key economic and financial indicators on the Australian financial markets.

In preliminary meetings, many of the board members raised concerns regarding the outlook for global economic growth as well as the possibility that ECC’s contracts with China will not achieve the scale of projected profitability.

Note: You should approach this in the same way you approached the answer from your first analysis task. There is no right or wrong forecast as long as you use appropriate economic reasoning. Use the start date of your study period as your base.

(a) Evaluate the outlook for global economic growth over the next twelve (12) months. Are there any concerns that the board should be made aware of regarding demand for commodities? In your answer include a percentage forecast for global economic growth. 

(b) The Chinese authorities are presently in the process of restructuring their economy. Explain what is meant by this restructuring, what are the implications for future Chinese economic growth and what sectors of the economy will be impacted by this restructure.

Then discuss how in your opinion (a) will impact on ECC’s operations over the next twelve months. Justify your opinion.

Explain the interrelationships of the major domestic and global market sectors.

The firms in a domestic economy operate completely within the country. What they normally do is that they can import their supplies or make exports but these activities involve only a small share of the entire business market or activity (Rey, 2015). Domestic markets are normally governed by the security laws of the country for instance the ECC is seen under to be controlled by the government when they are charged excessively for transportation where the money is used to subsidise the fares on the urban rail passengers. On the other hand, international firms’ headquarters might be located in the country but these firms maintain their investments outside the country and have diverse geographic profit centres. The operation of a branch of a firm that is international is governed by the laws of that country (Boniface, Cooper, and Cooper, 2016).

LO3: Assess the changes and impact of key economic and financial indicators on the Australian financial markets.

The changes that have been made by the key economic indicators and the financial indicators on the market of Australia consist of; one, the Gross Domestic product of the nation of Australia has changed. This is because it’s clear that for over the last 12 months, the sale and services offered by ECC was A$800 million which was an increase from A$500 million for the previous four years. The net profit was A$12 million over the last four years. The performance of ECC over the few years shows increased production leading to change in GDP.

In preliminary meetings, many of the board members raised concerns regarding the outlook for global economic growth as well as the possibility that ECC’s contracts with China will not achieve the scale of projected profitability.

Note: You should approach this in the same way you approached the answer from your first analysis task. There is no right or wrong forecast as long as you use appropriate economic reasoning. Use the start date of your study period as your base.
Evaluate the outlook for global economic growth over the next twelve (12) months. Are there any concerns that the board should be made aware of regarding demand for commodities? In your answer include a percentage forecast for global economic growth.

In the year 2017, there was 3.8 percent world economic growth with noted rebound in global trade. This was as a result of investments in advanced economies, growth in Asia and also notable upswing in Europe (Zweig, 2018). There were also signs of recovery in commodity exporters. Therefore the global growth is expected to rise this year and especially in the next twelve months by a 3.9 percent. This will be achieved through the support of favourable market sentiment, financial conditions that are accommodative and the repercussions of expansionary fiscal policy in the whole world. The slow commodity prices should give the exporters’ way to improve gradually.  In the market that is emerging, the economies are expected to grow as gradual recovery in the projected increase for the period of the next twelve months. Though, around 40 markets that are emerging in developing the economy are expected to grow slow as per the terms of the capita than the economies that are advanced. Therefore addressing the board, it needs to be aware of the expected market conditions in the next 12 months and have good plan on how to prepare accordingly (Rodrik, 2014, p.5-39). This is because there is higher expectation of increase in economic growth and thus demand for coal is expected to raise, hence need for East Coastal Coal Company to plan accordingly.

East Coast Coal Ltd: Background

(b) The Chinese authorities are presently in the process of restructuring their economy. Explain what is meant by this restructuring, what are the implications for future Chinese economic growth and what sectors of the economy will be impacted by this restructure.

Basically what structuring means is different organization or in other words different organization. Economic structuring on the other hand refers to the phenomena of shifting of the Western urban for instance from manufacturing to service sector economic base (Lu, 2018).The positive implications that might arise in the future as a result of China’s economic growth are, like reduction in poverty. This is because as at now, only 3.3 percent of the population leaves below poverty line which is set at 2,300 Yuan. Compared to the world’s population, China has 20 percent of the population (Burke, Hsiang, and Miguel, 2015, p.235). Therefore, as its people become richer, there will be more consumption. Companies will be making efforts to sell to this market that is the largest in the world hence tailoring their products to the interests of the Chinese. Another positive effect of China’s future economic growth is that it will make China a world economic leader and the signs of this are visible today because China is the biggest aluminium and steel producer because exports rose by 25 percent in the year 2015. Chinese technology companies will became the words market leaders (Gitman, Juchau, and Flanagan, 2015). For instance Huawei from China is the words top cellular equipment maker and it also becoming the world leader in the development of 5G technology. Lenovo also is a world-class personal computer maker. We also have Xiami which is No. 1 Smartphone from China.

On the other hand, the future Chinese economic growth might have some side effects in that the government will incur expenditure total of debt-to-GDP ratio of more than 260 percent. There might be also the creation of ultra-rich professionals who want more individual liberties and reside in urban areas where there are more jobs. Since the economy will be grown the savings that people save might bring back low returns because of low interest rate on their savings therefore there would be no much expenditure and ensure reduced domestic demand and slow growth (Rey, 2015).

Then discuss how in your opinion (a) will impact on ECC’s operations over the next twelve months. Justify your opinion.

With the expectations that the global economic growth will increase over the next twelve months, there expectation on high income generation due to increased sale of Coal globally. In addition to increased income growth, ECC Company might make investments on other areas of their desire. Therefore increased economic growth will lead to more investments by the company. Increased economic growth will lead to more money being acquired. Some of this money might be put aside for the conservation of the environment. This is because there are always environmental effects associated with the mining of coal (Dabla-Norris, Kochhar, Suphaphiphat, Ricka, and Tsounta, 2015). Also in addition to all these benefits of increased economic growth and the increased income generation from good sales of coal, the company will not experience a lot of borrowing from other financial institutions.

References

Boniface, B., Cooper, R. and Cooper, C., 2016. Worldwide destinations: The geography of travel and tourism. Routledge.

Burke, M., Hsiang, S.M. and Miguel, E., 2015. Global non-linear effect of temperature on economic production. Nature, 527(7577), p.235.

Dabla-Norris, M.E., Kochhar, M.K., Suphaphiphat, M.N., Ricka, M.F. and Tsounta, E., 2015. Causes and consequences of income inequality: a global perspective. International Monetary Fund.

Gitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson Higher Education AU.

Lu, N., 2018. The dynamics of foreign-policy decisionmaking in China. Routledge.

Rey, H., 2015. Dilemma not trilemma: the global financial cycle and monetary policy independence (No. w21162). National Bureau of Economic Research.

Rodrik, D., 2014. The past, present, and future of economic growth. Challenge, 57(3), pp.5-39.

Zweig, D., 2018. Internationalizing China: domestic interests and global linkages. Cornell University Press.