A business with outstanding margins, strong cashflows, good balance sheet, consistent dividends and high barriers to entry combined with an attractive valuation all points towards a potentially excellent buying opportunity. This is what we thought when we first came across Westshore Terminals (WTE CN) - until we started doing a bit more digging.
Westshore Coal Terminal in Canada
Westshore operates a coal terminal in Vancouver, Canada which handled 30mt of metallurgical and thermal coal (~60/40 split) in 2018. It has a dominant position in Canadian coal exports with ~70% market share. However, in a global context, Canadian coal exports are a drop in the ocean, accounting for just 3% of global coal exports. The tyranny of distance places Canada at a cost disadvantage to supply the key demand markets in Asia, meaning higher coal prices are required for Canadian coal exports to make economic sense. Coal prices have been in free fall for the better part of the last two years, and while we do not profess to know what the coal price will do, the global focus on climate change and ESG are headwinds for the coal industry, particularly thermal coal.
Customer concentration at Westshore is very high, with ~60% of volumes attributable to Teck Resources and the remainder largely with a handful of US thermal coal producers. Teck has a 19mtpa take or pay contract with Westshore ending in March 2021. With any business (particularly one with high fixed costs such as Westshore), losing its largest customer could permanently cripple it - this is what could unfold at Westshore. Teck recently struck an agreement with competitor Ridley Terminals to increase its capacity by 3mtpa to 6mtpa with optionality to increase it to 9mtpa. In addition, Teck has a 46% stake in neighbouring Neptune Terminals where it is spending $750-$800m on upgrades to increase its capacity form 12.5mtpa to +18.5mpta (expected completion in early 2021). All up, Teck could move 9-12mt of its current Westshore capacity to alternative ports by 2021. If this displaced volume is not replaced, this would represent a 30-40% drop in volumes for Westshore.
It appears Teck is none too pleased with Westshore, taking the unusual step of singling out the company and criticizing it for logistical and delivery underperformance in multiple public statements. Take for example the excerpt below from Teck's website:
"Steelmaking coal sales volumes for the first Qtr of 2018 are now expected to be approx. 6 million tonnes, in comparison to previous guidance of 6.3 - 6.5 million tonnes. Sales continued to be adversely affected by logistics issues during the quarter, particularly ongoing poor performance at Westshore Terminals"
We suspect the driving force behind Teck's move to reduce its reliance on Westshore is not only performance related but also due to its high charges. While not available in the public domain, we estimate that Westshore charges customers ~$12/t of coal processed. To put this into context, our research shows other coal terminals typically charge 50-80% less! Teck's large CAPEX program on upgrading Neptune Terminals (>$750m) also suggests that the cost-saving is likely to be very significant.
To compound matters, Westshore's largest US thermal coal customer, Cloud Peak Energy went bankrupt in mid 2019. Cloud Peak's assets have since been acquired by a tribal energy company linked to Navajo Nation, however, there is uncertainty about how long these volumes will continue. Tribal President of the Navajo Nation has publicly said it would not financially back bonds of the tribal company saying that it's too risky and plans to move away from coal.
But cant Westshore just find replacement volumes from other customers? We think this will be difficult particularly in the context of declining coal prices. The most promising project in the near term is the Grassy Mountain project in Alberta owned by Gina Rinehart following its acquisition of Riversdale Resources in 2019. Riversdale has paid Westshore reservation fees to hold 4.5mt capacity from 2021, which if it comes to fruition will go some way to replacing lost tonnes from Teck. However, this timetable is highly unlikely to be achieved considering that Grassy Mountain is still in the permitting phase. We expect production is likely to be deferred to at least 2022 or even potentially shelved until coal prices recover. Given the deteriorating economics for the coal industry, it's also unlikely that if production did occur on schedule that the exorbitant margins being paid to Westshore from Teck would be replicated.
Fast forward to 2021, we believe shipments at Westshore will drop materially and remain at lower levels in the medium term. While at the surface Westshore's metrics look good, its earnings could fall by +50% in the near term, triggering a further decline in the share price.
The share price of Westshore Terminals looks to be trending lower...