Hillsborough Resources HLB.TO
December 11, 2006 - 9:07am EST by
2006 2007
Price: 0.58 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 34 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Hillsborough Resources is a small Canadian coal company with a solid current valuation of at least $1.02 per share and potential appreciation to $2.46 by 2010 with little or no equity financing required.

Valuation summary  (all amounts in Canadian dollars)

Current Value
Basis for Current Valuation
Potential Value
Basis for Potential Valuation
Quinsam Mine
Current production of 500,000 tons per year at a margin of $10/tonne generates $5mm of EBITDA.  Worth at least a 5X multiple.
Assume production of 1mm tonnes per year at a margin of  $10/tonne.  Assume a 6X EBITDA valuation.
Peace River Coal
HLB’s initial capital account per partnership agreement
Assume 5mm tonnes per year met coal production at a margin of $15/tonne.  Assume a 5XEBITDA valuation.  Assume HLB will own 14% of PRC.
Wapiti Mine/Power Plant
Permitting uncertain
NPV of 30 years cash flow discounted at 10%.
Link to HLB 2005 Annual Report:
Link to HLB AGM Presentation:

Quinsam Mine

Quinsam is an underground thermal coalmine on Vancouver Island.  Output has relatively high heat content and low sulfur. The mine’s primary competitive advantage is location close to the waterfront where HLB owns a barge facility.  Transportation costs are low compared to competing coal that must travel by rail.  About 2/3 of Quinsam’s output goes to regional customers such as cement plants.  The balance of production is sold in the international sea borne market where it competes against coal from Indonesia and Australia.
Current capacity is about 600,000 tonnes per year, although actual production has been closer to a rate of 500,000 tonnes due to maintenance and time devoted to upgrades.  Quarterly production data fluctuate based on the timing of large shipments.  I think 5X EBITDA is a very conservative valuation for a consistently profitable business with a local market that is somewhat insulated from competition.  One could easily argue that this business deserves more of a utility type valuation of 7-8X EBITDA.
HLB has documented a substantial resource and estimates that capacity could be gradually increased to 1.2mm tones per year at a cost of  $25mm.  Financing would come from a combination of internal cash flow plus debt provided by the company’s international sales agent.  The increased production would be sold on the international market.  Quinsam’s advantage would be inexpensive access to a dedicated port.

Peace River Coal

In early 2005 HLB acquired several Northeast coal concessions in exchange for an upfront payment of $0.4mm, conditional payments of $2.0mm and conditional payment of 3.8mm shares.  In November 2006 HLB contributed some of these properties in exchange for 20% of a new partnership called Peace River Coal.  Partner Nemi Energy contributed coal properties including the recently completed Trend Mine.  Partner Anglo Coal contributed primarily cash in exchange for a 60% partnership interest.  After a lengthy valuation process, the initial value of HLB’s partnership interest was set at $34.6mm.
I think the market has not recognized the value of this transaction to HLB and its partners.  PRC will generate substantial cash flow in 2007 from the Trend Mine.  The combination of Trend with the adjacent Horizon property contributed by HLB will allow very efficient expansion.  Partners have the option of providing cash to meet capital calls or accepting dilution.  Essentially, expansion can be financed by Anglo rather the small partners.  An agreement with Western Canadian Coal suggests potential efficiencies will be realized in development of the entire district.
Formal development plans have not been announced for PRC, but HLB has mentioned a long-term annual production goal of 12mm tonnes of met coal.  I assume that by 2010, production could increase to 5mm tones per year at a margin of $15/tonne.  I assume that HLB has not contributed to capital calls and that its ownership interest has been diluted to 14%.  I assume the business is worth 5X EBITDA.  Production could be higher, margins could be higher, operating cash flow could reduce capital requirements and dilution, and the market might be willing to place a higher valuation on the partnership.
Link to Trend Mine Feasibility Study (Filed by Nemi Energy 11/10/05)
Link to Peace River Coal Partnership Agreement (Note on page 28 that the initial balance in HLB’s capital account is $34.6mm)

AES Wapiti

The Wapiti thermal coal project was part of the Northeast BC package acquired by HLB in early 2005 at very modest cost.  HLB formed a partnership with AES and submitted a mine mouth power plant project that was granted a 30-year contract by BC Hydro.  Environmental permits are still required.  The coal is low in many polluting trace elements and the plant is designed with clean coal technology that meets or exceeds all British Columbia regulations.  In addition, the project will secure offsets for 100% of greenhouse gas emissions.
Progress towards permitting can be monitored on the web site of the Environmental Assessment Office.  Obviously it has generated substantial opposition and it’s uncertain whether the project can be built.  Public comments follow two main themes:
v     Concern about whether the level of air, water, and CO2 pollution.  AES Wapiti should be able to satisfy these concerns by providing extensive documentation to support its commitments.
v     Opposition to coal power on principal.  Environmental groups oppose coal power based on gross emissions of greenhouse gas, regardless of offsets.  BC law does not prohibit coal power, but opponents may be able to generate enough political pressure to force the government to reject the Wapiti project.
If the project is permitted then it will employ a substantial number of people, bring investment of $500mm, and generate electricity at about half the cost of small hydro and wind power.  It will also generate an attractive return for AES and Hillsborough.  Building the power plant at the mine mouth eliminates road and rail transportation costs that are normally a large portion of the cost of coal to users.  Hillsborough estimates that the initial capex required to build its open pit mine would be about $20mm, all of which would be covered by debt financing as part of the overall project finance package.  A  margin of $12/tonne on annual production of 600,000 tonnes creates a discounted net present value of $48mm.  Returns could easily be higher, but it’s early to make predictions and there’s no public feasibility study so I’d rather be conservative.
Link to AES Wapiti web site:
Link to Environmental Assessment Office index of Wapiti project documents:


In 2005 Hillsborough acquired an open pit mine in Kentucky with a goal of converting it to an efficient underground mine.  In August HLB announced that it would have to abandon the mine due to “adverse geological conditions.”  HLB has begun negotiations over a couple of different means by which it can salvage some value from the site, but it’s too early to estimate any numbers.

Financial Statement Comments

The year-to-date loss reflects the $17mm Crossville debacle.  It is likely that the company will record a comparable gain on the PRC transaction in the 4th quarter.
HLB’s only debt was a $4.7 loan from Anglo Coal that has been forgiven as part of the formation of PRC.
The company’s option plan is quite modest.  Annual grants have been about 1% of shares outstanding.


HLB’s ability to attract top quality partners (AES and Anglo) is the best indication of the competence of HLB’s management.  It appears that the market has punished HLB for the Crossville debacle without giving appropriate credit for PRC and Wapiti.  The company president, David Slater, is easy to reach and comfortable discussing all details of the company’s business.

But wait, that’s not all!

HLB has more little nuggets of potential future value. 
v     The Quinsam mine has enough resource that its production could grow to 2.5mm tonnes per year.  That might require another $15mmof capex.
v     HLB retained a 1% royalty on the projects it contributed to PRC; it’s not clear when those will be developed and how big they will be, but at some point the royalty could easily provide $1-3mm of annual free cash flow to HLB. 
v     HLB has an option to purchase 10% of the Wapiti power plant from AES.  HLB doesn’t have the money to make the purchase, but maybe something will develop in the future.  With permits and long-term contract the plant will be a valuable asset. 
v     HLB has another significant met coal resource at Bingay Creek in British Columbia.  There’s no development on the horizon, but maybe something will develop in the future
v     HLB has also acquired coalbed methane development rights on Vancouver Island.


1) Exhaustion of year-end selling
2) Awareness of Peace River Coal
3) Wapiti project permitting
4) 2007 Growth and Profitability at Quinsam and PRC
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