SouthGobi's second quarter impacted by "significant uncertainty"

SouthGobi Resources (TSE:SGQ)(HKSE:1878) posted a sharply lower second quarter profit Monday as sales volume and revenue declined due to the curtailment of mining operations amid a controversial takeover bid for the mining company.

Operations at its Ovoot Tolgoi Mine in Mongolia were "entirely curtailed" at the end of the most recent quarter citing weak market conditions and regulatory issues.

Aluminum Corp of China Ltd., also known as Chalco, plans to buy a 57.6 per cent stake in SouthGobi from Ivanhoe Mines (TSE:IVN), which has triggered anxiety in Mongolia about Chinese ownership of a major resource producer, prompting the passing of a foreign investment law in Mongolia in May.

Mongolia has profited from selling coal, copper and other minerals to China's booming economy, but some in the sparsely populated North Asian nation are uneasy about possible economic domination by their giant neighbour.

Earlier this month, Chalco, the Chinese aluminum giant, said it will extend again its proportional takeover offer for up to 60 per cent of SouthGobi stock by another 30 days. The proposed deal valued at $926 million, or $8.48 per share, has the backing of Ivanhoe, which is SouthGobi’s largest shareholder.

The deal remains subject to all statutory and regulatory approvals, including Canadian and Chinese regulatory approvals, and Chalco shareholder approval.

Sales volume in the latest period declined, the company said, due to the "significant uncertainty" surrounding SouthGobi's business resulting from the proposed proportional takeover bid by Chalco, which resulted in the Mineral Resources Authority of Mongolia announcing a request to suspend exploration and mining activity on certain licenses, various infrastructure constraints in Mongolia, and the softening of inland China coking coal markets toward the end of the second quarter.

For the three months that ended June 30, the Mongolian coal producer recorded a profit of $0.2 million, compared to a net profit of $67.3 million a year ago, and $3.1 million in the first quarter.

In the latest quarter, the company produced 0.27 million tonnes of raw coal with a strip ratio of 4.31 compared to production of 0.87 million tonnes of raw coal a year ago, with a strip ratio of 4.74.

SouthGobi halted its mining activities in the second quarter in a bid to manage coal inventories and to maintain efficient working capital levels. As at quarter end, mining activities had been fully curtailed, and because of this, the miner suspended uncommitted capital and exploration expenditures to preserve financial resources.

The company said it sold 0.16 million tonnes of coal at an average realized selling price of $62.56 per tonne, compared to sales of 1.05 million tonnes of coal at a price of $54.06 per tonne in the second quarter of 2011.

Revenue of $8.4 million was down sharply from $47.3 million a year earlier. The company said customers were reluctant to enter into significant sales contracts due to infrastructure delays, uncertainty with respect to the suspension of mining activities at Ovoot Tolgoi and the continued softening of inland China coking coal markets.

Direct cash costs of product sold, excluding idled mine costs, were $22.57 per tonne compared to $26.77 per tonne a year earlier, as a result of a lower strip ratio and reduced fuel prices.
                
The company noted today that it has not received any "official notification" to suspend exploration and mining activity and "has no reason to believe SouthGobi's licenses are not in good standing."

But SouthGobi cautioned that any official notification received will require a mandatory suspension of operations and could result in the impairment of the company's property, plant and equipment.   

Its total assets at quarter end came in at $846.5 million, and it had $61.6 million in cash and equivalents.

"Although no official notification has been received to date, SouthGobi continues to be impacted by the uncertainty over its licenses. Many government bodies and regulatory authorities in Mongolia are reluctant to provide approvals and permits," the company said in its statement.

Due to the uncertainty, the company said it anticipates its operations will remain fully curtailed in the third quarter and that production volumes, sales volumes and pricing for the full year cannot be estimated.
               
The Ovoot Tolgoi Mine is approximately 40km from China, which is approximately 190 kilometres closer than Tavan Tolgoi coal producers in Mongolia and 7,000 to 10,000 kilometres closer than Australian and North American coking coal producers.

The company is also approximately 50km from existing railway infrastructure, which is approximately one tenth the distance to rail of Tavan Tolgoi coal producers in Mongolia.