Coal exports – Westshore Terminals

Westshore Terminals Investment Corporation (TSX: WTE) is a holding corporation that owns all the limited partnership units of Westshore Terminals LP. The LP is controlled through a partnership agreement by Westshore Terminals Ltd., and functionally speaking control is held by Westar Management Ltd (not to be confused with another company, Westar Energy, which is unrelated).

The whole reason for the verbose description is that although it may appear at first glance that shareholders of Westshore Terminals have control over its operations, in reality this is a situation where shareholders are in the minority and external actors control the firm. One must always be mindful of the motivations of the controlling entity and whether there is significant alignment with shareholders.

Skimming the documents, I am not entirely sure who controls Westar or the General Partner, Westshore Terminals Ltd., but would assume the present directors of Westshore Terminals Investment Corporation have a say in the parent controlling entities.

Jim Pattison (a very prominent BC businessman that usually keeps his ventures privately held) owns 18.6% of the company as of May 2015. Since then his entity (Great Pacific Capital Corp.) has acquired another 4.1% of the company, according to SEDI disclosures, roughly at an average of $25/share. An early warning report on October 30, 2015 confirmed 22.5% ownership.

The whole Canadian investment world can see this public investment and thus one has to ask what Pattison’s firm is thinking.

Westshore’s entire business is about exporting coal, primarily to Korea, Japan and China/Taiwan.  The coal is majority sourced (58% in 2014) through mines owned by Teck (TSX: TCK.B).

Financially, the corporation has been very profitable over the past couple fiscal years – earning about $130 million in profit over 2013 and 2014, and $101 million for the first 9 months of 2015. As the corporation has 73.9 million shares outstanding and is trading at $17.50/share, some simple math will indicate that they are trading at a P/E below 10 according to their historical profitability.

The nature of their coal exports can be divided into the following categories:

And here is where we have the problem – steel commodity in China has cratered. There’s various types of indicies and types of steel that you can measure (rolled steel, rebar, etc.) but all indications show that demand is dropping:

Adding to the woes of the coal industry is the fact that there is a gigantic supply glut of thermal coal due to western nations suddenly deciding they wish to phase out coal power generation. Taking a look at charts of Peabody Energy (NYSE: PEA), and Arch Coal (NYSE: ACI) should pretty much tell this story. Take a snapshot of their charts before they go into Chapter 11! Or if you don’t wish to waste your money on their equity, Peabody’s senior unsecured debt is trading in the teens – a fairly good sign of imminent capital restructuring.

Teck’s stock has also gotten killed over the past 5 years – an investor’s shares has gone from about CAD$60/share to CAD$5/share today, plus Teck’s corporate debt has cratered – e.g. their senior debt maturing in January 2021 (4.5% coupon) has the following ugly chart:

Despite Teck being rated Ba1 (Moody’s) or BB+ (Fitch), their debt is clearly trading in the junk status and one has to start wondering about counterparty risk when your medium-term debt is trading at such high yields (and the nearest liquid issue, January 2017, is trading at a yield to maturity of about 10% presently).

Financially, it just doesn’t look good for coal producers (most of them are deeply encumbered by debt), but does these financial issues reflect the actual economics of Weststar Terminals’ industry which is the shipment of coal?

Weststar does not have any debt on its balance sheet – its primary liability is the $91 million unfunded portion of its pension plan at the end of September 2015. It is primarily functioning as a flow-through operation for its shareholders and to this effect, it has reduced dividends from 33 cents to 25 cents quarterly as it anticipates increasing capital expenses and also anticipating a decrease in coal shipped, according to an October 28, 2015 corporate update.

So we have a perfect storm brewing in the coal world – decreased demand for steel, decreased demand for power generation, and thus lower shipments and lower revenues, spread on a relatively large fixed cost base – suggesting decreased profitability in the future.

This also doesn’t factor in the increasing scrutiny of coal shipments in BC from a political perspective. While the existing provincial government is clearly supportive, there is election risk for the upcoming 2017 election in terms of economic impact.

Westshore does have several advantages that cannot be easily obtained with competition. There are three terminals in BC that are in the same business – Ridley is up north in Prince Rupert, but they are limited in capacity (although well strategically positioned to take coal from mines in the BC northern interior). In the greater Vancouver area, there is Neptune and Westshore – Westshore has a significantly larger capacity, but Neptune is still under its capacity. Neptune is 46% owned by Teck as well, which will put it in conflict with Westshore.

The market has clearly seen all of these negatives and has subsequently “adjusted” the equity value of WTE very dramatically – about 50% over the past 6 months. The question as an investor would be:

1. Financially, what would the “trough” look like for Westshore? Does the underlying entity still generate cash?
2a. Will coal recover from what are decidedly anti-coal government legislative regimes (USA EPA, Germany, Alberta, and now possibly Canada?)
2b. If so, what would the timing be where enough supply has been stripped from the system, and perhaps a recovery in demand?
3. Competitively speaking, how much shipping capacity will the other two terminals in BC represent?

The answer to 2b will presumably rely upon the economic fortunes of Korea, China and Japan, all of which have their own internal issues to deal.

I will leave this post now as an exercise for the reader. No positions as of this writing.