ENDOCOAL LIMITED (ASX: EOC) 8 February 2011

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1 Endocoal Limited (ASX: EOC) is an Australian coal exploration and development company, focused on the Bowen Basin, Queensland where it has one of the largest landholdings. Company Data ASX Code EOC Share Price ($) 0.40 Shares on Issue (m) Options (m) 16.9 Other (m) 7.0 Market Cap (fully diluted, $m) 57.0 Financials ($m) Cash (est) 10 Debt Nil Resources *(Mt) Inderi (Indicated) 15.5 Inderi (Inferred) 11.3 Meteor Downs (inferred) 14.4 Total 41.2 *All Thermal Coal Board Alan Broome Rodney Austin Lex Hanson Phil McCarthy Gavin Solomon Top Shareholders Non-Executive Chairman Managing Director Citi Man Investments Ltd 14.3% Cookshill Investment Pty Ltd 13.5% Indus Capital Partners 8.8% Stemcor Australia Pty Ltd 6.0% Share price performance $0.70 $0.65 $0.60 $0.55 $0.50 $0.45 $0.40 $0.35 $0.30 Volume Price Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Millions 7 Analyst Basil Burmeister Senior Research Analyst bb@helmsec.com.au Helmsec Global Securities RECOMMENDATION: SPECULATIVE BUY The Endocoal share price has significantly underperformed the coal sector since listing in April We believe that this is at least partly due to the relatively modest resource of 41.2Mt established to date. While the company has commenced scoping studies, we do not believe that either capital or operating costs estimates have reached the point where meaningful discounted cash flow analysis can be attempted. The EV to resource valuation of $1.11 per tonne is above the $0.70 weighted average of Helmsec s basket of Australian coal explorers (see page 6). This could change if a maiden resource in excess of 50Mt (the lower end of the company s exploration target) at Rockwood and modest increases at Orion Downs are announced by mid-year. Based on a potential market re-rating resulting from a significant resource increase, we consider Endocoal a Speculative Buy. KEY POINTS Exploration drilling is expected to recommence in March/April. The programme will set out to: increase the resources at Orion Downs by a modest amount, as well as converting resources from the inferred to indicated category, improving the status of the resource base establish an inferred resource at the Rockwood Project, which currently has a 50-80Mt resource target for the northern area with potential for a similar target in the south scout drilling at Orion Downs, Essex, Expedition Creek and Talwood Assuming drilling commences in April, the company expects to announce a resource upgrade at both the Meteor Downs and Inderi Projects at Orion Downs in June 2011, as well as a maiden resource at Rockwood. The resource upgrade at Orion Downs is expected to be in the order of 10-15Mt. The company is targeting a combined total of around 50Mt of inferred resources at Orion Downs. Cash balance of approximately $10m means the exploration programme is fully-funded for at least the next 12 months. In parallel with the exploration programme, the company is advancing the draft feasibility studies of the Orion Downs underground and Meteor Downs open pit operations. KEY RISKS The company s 2011 drilling programme may fail to deliver a significant resource increase. The company does not currently have a firm port allocation although there is a strong likelihood that other potential producers may not be able to meet their quotas. Whilst the company is in discussions with banks, development remains subject to finance. High short/medium term minimum exploration commitments at the majority of the company s Exploration Permits for Coal (EPCs) means there is some risk of cut-back in tenement size. Disclaimer and disclosure of interest are displayed on last page. Page 1

2 BACKGROUND The company listed on the ASX in April 2010, raising $17m through an IPO, issuing 28.3m shares at $0.60 per share. The company has one of the largest landholdings in the Bowen Basin Queensland, including 10 tenements across ~5,000km 2. All projects are 100% owned by Endocoal. All tenements are within close proximity to key infrastructure, including railways to coal terminals. Location of the company s tenements is shown below. Source: Endocoal Limited The company s initial exploration targets were the Orion Downs tenements (Southwest Bowen Basin targeting thermal coal) and the Rockwood tenement (Central Bowen Basin, targeting coking coal). The initial drilling programme at Orion Downs commenced in August Multiple coal intersections identified export-quality thermal coal and identified two areas of particular interest: the Meteor Downs South prospect in the south and the Inderi prospect in the south east. Drilling programmes in 2010 resulted in the release of a maiden JORC resource for Inderi on 28 July 2010, with a maiden resource for Meteor Downs South announced on 25 November The company thus fulfilled one of its main IPO aims to delineate a JORC resource on at least one project by 2H To date, the company s resource base is a modest 41.2Mt at two prospects, which appears to have disappointed the market. Endocoal has, however, approached exploration and development on a slightly different pod concept. The company is targeting a 20-30Mt reserve per pod, each pod producing 2-3Mt per annum with two or more producing pods per tenement. The advantage is that production could be achieved in shorter time Disclaimer and disclosure of interest are displayed on last page. Page 2

3 frames, with lower start-up costs and infrastructure requirements than larger products. It remains to be seen whether this concept will be embraced by the markets. The recent flooding in the Bowen Basin will have little effect on Endocoal s 2011 exploration programme as no drilling had been planned for the wet season (January to March). ORION DOWNS The Orion Downs EPC, which covers an area of 1,027 km 2, lies to the east of Yanzhou Coal Mining Company s Minerva and Athena operations (79Mt and 560Mt of thermal coal resources respectively), south of Bandanna Energy s Arturus and Springsure Creek projects (511Mt thermal coal resource) and west of Xstrata s Rolleston mine (600Mt resource and 9Mtpa thermal coal production). The Rangal Coal Measures are being targeted. The Dawson Highway transects the tenement which also lies within close proximity to the direct rail link to the port of Gladstone. In 2010, Endocoal announced maiden JORC resources at two prospects: 26.8Mt (% indicated) at the Inderi Project and 14.4Mt at the Meteor Downs South Project. Drilling in 2011 is expected to boost the status of the resource as well as increase the overall resources by 10-15Mt. In addition, a 30-day programme of scout drilling will target other potential areas of interest. Inderi Project More than 5,500m of drilling have been completed at Inderi since the company listed on the ASX in April From a total of 29 boreholes drilled, 19 holes intersected coal, with seam thickness ranging from 3.9m to 5.4m. Coal quality is similar to that being mined at Rolleston; the low ash/sulphur content indicates that coal is unlikely to be processed through a washing plant. Coal Quality C Seam D Seam CV (Kcal/kg) 6,233 6,025 Ash (1) 9.5% 8.0% Inherent Moisture (1) 9.9% 11.2% Sulphur (1) 0.42% 0.43% *Air-dried basis On 28 July 2010, the company announced a maiden JORC resource of 26.8Mt, comprising 15.5Mt indicated and 11.3Mt inferred resource. The bulk (~83%) is Bandanna Formation D Seam. The company is currently in the process of signing up contractors for the next drilling season, expected to begin in late March or early April, as well as liasing with landowners. The purpose of the programme is step out drilling to the north and to more closely delineate coal quality in the area currently excluded from the resource base due to an intrusion in the seam. A resource upgrade is expected by June, provided the drilling is able to start by the beginning of April. Due to the presence of a dolerite capping and the depth of the coal seams, extraction would be by underground means. Bord and pillar mining, with an estimated 70% mining recovery, is currently being considered. Disclaimer and disclosure of interest are displayed on last page. Page 3

4 Meteor Downs South Drilling commenced in June 2010 along the tenement perimeter abutting the Xstrata mining lease area. In late November, the company announced a maiden JORC inferred resource of 14.4Mt, with an average seam thickness of 7.2m and maximum thickness of 9.7m, at depths between 11m and 70m. The seam is continuous, with little apparent faulting and no basalt cap. Coal qualities are typical of the Rangal Coal Measures low-ash export quality thermal coal with low to moderate sulphur content. While both the C and D seams of the Rangal Coal Measures were identified, only the D Seam has been included in the resource estimate. The relatively shallow intersections should allow for the development of a modest truck/shovel open pit operation with order of magnitude stripping ratios expected to be around 5:1. A 30-day drilling programme is expected to start in April. In-fill drilling is expected to improve the resource status from inferred to indicated, while step-out drilling in the north (where the SR is low) and the south west should provide a very modest (10-25%) increase in overall resource tonnage. The upgraded resource is expected to be available by June ROCKWOOD The Rockwood EPC, covering an area of 99 km 2, is located in the Central Bowen Basin, approximately 40km east of the BHP Billiton Mitsubishi Alliance Saraji mine and immediately east of McArthur Cola Limited s Wilunga and Codrilla Projects. The Oaky Creek Rail Line of the Goonyella Rail System is approximately 55km northwest of the tenements, with a total distance of approximately 200km by rail to the Dalrymple Bay Coal Terminal. The rail infrastructure and road access services a number of operations including the Peak Downs, Saraji and Norwich Park mines operated by the BHP Billiton Mitsubishi Alliance. A maiden drilling programme was conducted in 4Q 2009 where five open holes and two core holes were drilled and intersected coal seams between 0.3m and 5m thick. However, the coal seams appeared to be part of the Fort Cooper Coal Measures, lying above the German Creek Coal Measures. Drilling recommenced in mid-september Three open holes, drilled along the projected anticline of the Rangal or Moranbah Coal Measures, intersected coal seams. Hole RKD 008 intersected a 5.0m seam at 262m while RKD009 exhibited a cumulative coal thickness of 21.3m including a 6.2m seam commencing at 29.3m depth. Hole RKD 010 intersected a series of coal seams between 62m and 286m with a cumulative thickness of 26.5m. Quality analysis on core from diamond drill hole RKD 009HC on the 6.2m seam indicated a potential low-volatile PCI product, with a theoretical yield of 60% and ash levels of approximately 12%. Analysis of the other seams intersected through RKD 009HC is currently underway. Drilling in the northern area is expected to recommence in March. A 35-day campaign, on a 24-hour shift basis, is currently planned. A maiden resource is expected to be delineated by June The company has indicated an exploration target of between 50Mt and 80Mt for the northern area. Our back-ofenvelope calculations suggest an exploration target of around 35Mt, based on an average coal thickness of 5m. Considering that two of the drill holes produced cumulative intersections in excess of 20m, the potential tonnage could be considerably higher an exploration target of 50-80Mt does therefore not appear to be unreasonable. Continuity of individual seams will be the key. It should be remembered that the coal seams appear to be reasonably steep dipping and that the resource to reserve conversion rate may therefore be adversely impacted. Open-hole drilling has also been undertaken in the southern section of the Rockwood tenement, intersecting a 7m coal seam at a depth of 198m (RKD 012). Geophysical logging is planned to confirm the thickness of this Disclaimer and disclosure of interest are displayed on last page. Page 4

5 intersection. Further exploration is planned for 2011 to assess the structural continuity of this southern area, including further open-holes and geophysical logging. Low level, closely spaced airborne magnetic surveys are expected to begin within the next few weeks. Together with mini SOSIE seismic and ground gravity surveys previously undertaken, this should further assist in the determination of structure and seam stratigraphy. OTHER PROJECTS In addition to Orion Downs and Rockwood, the company has a further 8 exploration tenements in the Bowen Basin. During 2011, scout drilling is expected to commence at: Essex, where 8-10 holes are expected to be drilled over a 45-day period. Coking and PCI coal is being targeted on the 204 km 2 EPC. Expedition Peak, where again the company is expecting to drill 8-10 holes over a 30-day period, targeting both thermal and coking coal on the 129 km 2 tenement. Talwood, in the north, where drilling is expected to start in May and continue for a 180-day period. The company also has two large EPCs in the southern Bowen Basin (Cedars, 1,020km 2 and Barfield, 564km 2 both targeting thermal coal), another large EPC in the northern Bowen Basin (Sullivan Creek, 1,020km 2 prospective for thermal and coking coal), a small tenement called Nebo (78km 2 ) in the north east targeting PCI and coking coal and Springton Duaringa east of Blackwater, where coking and PCI coal is being targeted on the 761km 2 tenement. Furthermore, Endocoal has registered approximately 2,800 km2 (more than 50% of the total landholding) within 6 of its tenements under in-situ gasification projects for future Underground Coal Gasification (UCG) applications. This is a technical process involving the injection of oxidants into deep non-mined coal seams to convert coal into syngas, which is then brought to the surface for power generation and gas usage. UCG strategy will be considered if coal seams are identified at depths below 200m. DEVELOPMENT In parallel with the exploration programme, Endocoal is currently evaluating the development options at Orion Downs. A request for tenders for contract mining by bord and pillar has been sent out to two of the leading contractors in this field and responses are expected within the next three weeks. Basic mine plans are being compiled and a draft feasibility is due for completion by the end of February. The company expects to lodge an MLA by June. It is anticipated that costly full EIS studies will be avoided if the underground and open pit operations have individual capacities of less than 2Mtpa. In-house preliminary estimates of capital costs for the development of an underground mine at Inderi and an open cut operation at Meteor Downs South (including road and rail links) are in the $100m to $150m range for fully owner-operated projects, with the prospect of reducing this substantially through open cut contract mining. First pass cash costs, including transport to the port, are estimated at around $68/t for the underground operation. The company is currently in discussion with several banks and Navigator Project Finance as it moves towards a bankable feasibility study (BFS). Under the current timetable, Endocoal is unlikely to be in production before late 2013/early It presently does not have rail or port access for any potential coal production at this time. The company is currently in discussion with Queensland infrastructure providers to ascertain that the Abbot Point Coal Terminal is committed Disclaimer and disclosure of interest are displayed on last page. Page 5

6 to X80 and X110 expansion, which would allow third party access and that Queensland Rail is proceeding with the Northern Missing Rail Link to permit third party access to Abbot Point. Planning for Wiggins Island Stage 2 (at the port of Gladstone) is underway and Endocoal has registered as a participant. There is also some discussion on a possible third terminal at Mackay, which is only 70kms further from the Orion Downs Project than Gladstone (420kms). VALUATION Both internal and external capital and operating costs for an underground mine at Inderi and an open pit mine at Meteor Downs South are ongoing, but a DCF valuation based on current assumptions is considered to be premature. One of the measures used to value coal exploration companies is enterprise value (EV) per resource tonne. With an EV of around $47m, Endocoal s EV/resource tonne is around $1.11, well above Helmsec s $0.70/tonne weighted average for a basket of ASX-listed coal exploration companies (listed below). However, an increase of between 60Mt and 95Mt by August (based on possible increases of 10-15Mt at Orion Downs and a maiden resource of 50Mt-80Mt at Rockwood) would reduce the EV/t to between $0.34 and $0.46, which could trigger a re-rating of the stock. Options/ Mkt Total EV/Total Company Shares Other Price Cap Cash Debt EV Resource Resource Location (m) (m) ($) ($m) ($m) ($m) ($m) (Mt) ($/tonne) EOC Endocoal Limited Bowen Basin, Qld REY Rey Resources Ltd Canning Basin, WA CWK Coalworks Ltd Western NSW SMR Stanmore Coal Ltd Bowen/Surat, Qld CLR Carabella Resources Ltd Bowen/Mulgidgie, Qld HUN Hunnu Coal Limited Mongolia NCR Nucoal Resources Hunter Valley, NSW AKM Aspire Mining Ltd Mongolia CPL Coalspur Mines Ltd , ,276 1, Canada Total/Average 3,007 4, Source: Company Reports Notes: 1. Share prices as at 2 Feb Market cap is fully diluted 3. Cash as at 31 Dec (or est) Caution should be exercised when this measure is used, as the denominator may be higher value metallurgical coal or lower value thermal coal or combinations of the two. In addition, this measure does not take into account such factors as the proximity to infrastructure (or lack thereof), depth to coal seams, coal quality, likely capital and operating costs or country/sovereign risk. Disclaimer and disclosure of interest are displayed on last page. Page 6

7 BOARD The company has a very experienced Board. Chairman Alan Broome has been associated with various aspects of the coal mining industry for many years, while Managing Director Rod Austin has had previous experience as a CEO for a company operating a total of six coal mines. Independent directors Lex Hansen and Phil McCarthy bring a wealth of geological and mining experience respectively, while Gavin Solomon s legal and corporate advisory experience rounds out a highly experienced team. Further details are provided below. Alan Broome Non-Executive Chairman Metallurgist with more than 20 years experience in the Secondary Metals Industry and 15 years experience in the Mining Industry. Previously Managing Director of Australian Coal Industry Research Laboratory (ACIRL) and AMPControl Pty Ltd. Currently director and/or chairman of Solid Energy Ltd, Micromine Pty Ltd, Buccaneer Energy Ltd, CRL Energy Ltd (NZ), Inbye Mining Services Ltd, Workpac Group Ltd, Acumine Ltd, Quadrem Ltd and Nimrodel Resources Ltd. Rodney Austin Managing Director More than 20 years management experience in finance and the resource industries, including CEO of Oceanic Coal which operated six coal mines in the Hunter Valley and Queensland, exporting thermal and semi-soft coking coal to Korea, Taiwan and China. Previously a NSW Coal Association and Mining Council Executive board member and Chairman of the NSW Mining Council Planning and Environmental Committee. He is a former Deputy Managing Director of James Capel Australia (HSBC). Lex Hansen Coal geologist with 30 years experience, including Utah Coal in the Bowen Basin in the seventies. Ex-director of HSBC Corporate Finance (Mining). Currently a director of Heemskirk Consolidated Ltd, Core Resources Ltd and Platinum Australia Ltd. Phil McCarthy CEO and Managing Director of Powercoal Pty Ltd from 1990 to 2000 (prior to acquisition by Centenial Coal). Previous to this, he held various positions, including Managing Director, with Newcom Collieries Ltd. Former director of Jellinbah Resources Pty Ltd (Bowen Basin open-cut mines) and Chairman of Strata Engineering Pty Ltd (private geological engineering). Gavin Solomon Corporate advisory and legal background, currently Managing Director of Helmsec Global Capital Limited. Disclaimer and disclosure of interest are displayed on last page. Page 7

8 Disclaimer and disclosure of interest This document (Report) is issued by Helmsec Global Securities Limited ( Helmsec ), a subsidiary and authorised representative of Helmsec Global Capital Limited (HGCL), Australian Financial Services Licence No This Report is intended solely for the use by wholesale/institutional clients within the meaning of section 761G of the Corporations Act 2001 (Cth) (Act), sophisticated investors pursuant to Section 708(8) of the Act, professional investors pursuant to Section 708(11) of the Act and/or otherwise persons to whom a disclosure document is not otherwise required to be given under Chapter 6D of the Act. To the extent that any recommendations or statements of opinion made by Helmsec in this Report constitute financial product advice, they constitute general financial product advice only and do not constitute personal financial product advice in any manner whatsoever. Accordingly, any such recommendations or statements do not take into account the investment objectives, financial situation, taxation requirements and/or the particular needs of any recipient. Before subscribing for securities in the Company named in the Report (the Company), you should consider, with the assistance of your independent financial and legal advisers, whether the potential investment is appropriate in light of your particular investment needs, objectives and financial circumstances. Any recommendations or statements of opinion contained in this Report are based on assumptions made by Helmsec. These assumptions may or may not eventuate and accordingly, any such recommendations or statements of opinion may prove to be incorrect. This Report has been distributed in confidence and may not be reproduced or disclosed to any other person without the prior written consent of Helmsec. The information contained in this Report has been prepared by Helmsec with due care but no representation or warranty whatsoever is made, express or implied, in relation to the accuracy and/or completeness of this information. This Report is based on information obtained from sources believed to be reliable and Helmsec has made every effort to ensure the information in this Report is accurate however Helmsec does not make any representation and/or warranty that any information in this report is accurate, reliable, complete and/or up to date. Except for any liability which cannot be excluded, Helmsec disclaims all liability for any error or inaccuracy in, or omission from the information contained in this Report or any loss or damage suffered, directly or indirectly by the reader or any other person as a consequence of relying upon the information. Helmsec, HGCL and their Directors, employees, agents and consultants accept no obligation or liability whatsoever to correct and/or update any information and/or opinions in this Report. Opinions expressed are subject to change without notice and only accurately reflect the opinions of Helmsec at the time of writing this report. Helmsec and its Directors, employees, agents and consultants accept no liability whatsoever for any direct, indirect, consequential and/or other loss arising from any use of this Report and/or further communication in relation to this Report. The historical information in this Report is, or is based upon, information that has been released to the general market. Helmsec has not been paid by the Company to produce this document. HGCL has acted as lead manager in relation to the Company s IPO in April HGCL has an ongoing mandate for corporate advisory services with the Company. Helmsec received fees from the Company for the IPO and the provision of corporate advisory services. HGCL may, in the future, be appointed by the Company to act as corporate advisor and/or as lead manager in relation to any future placement of securities in the Company. HGCL is likely to receive fees and securities in the Company if so appointed. Each recipient of this Report acknowledges that Helmsec, HGCL their Directors, employees, authorised representatives, consultants, associates, related entities and/or family members may have interests in the securities of the Company. If you require further information in relation to the parties referred to above and their interest(s) in the Company please contact Helmsec. Disclaimer and disclosure of interest are displayed on last page. Page 8