Thursday, 4 November 2010 Solid Energy

Solid Potential

Our initial valuation of Solid Energy is around $1.6bn as an estimated Investment Recommendation: n/a secondary market trading value for a listed entity. The bulk of this is Share Price: unlisted represented by existing operations, but about a third of our valuation Risk Assessment: Medium is an estimate of the discounted value which the market might apply to Solid Energy’s New Energy growth options. Financial Summary Coal operations – the value base NZX Code: n/a Solid Energy’s current value is primarily made up of its existing coal Issued Shares: 60.9m operations, along with planned extensions. Renewable fuels (wood NZX50 Index Weighting: n/a Market Cap (@ valuation): $1573m pellets and biodiesel) make up only a very small part of the current Average Daily Turnover: n/a value. Our DCF valuation of the company’s current operations and Forsyth Barr Research DCF Valuation: $25.83 planned extensions, net of debt, is around $1.2bn. Most of that NAV: $7.28 value resides in the company’s South Island operations which 12 Month Low - High: n/a supply higher-grade coal to mainly export markets. Share Price: N/A New Energy growth options In future, Solid Energy’s planned New Energy projects have the potential to create very signifi cant upside. However, we note that equity markets elsewhere have been reluctant to ascribe much value to many of these projects (except coal seam gas). Some of them, particularly coal to urea and coal to diesel, involve substantial capital expenditure in the billions of dollars. We have treated these projects as early stage potential upside, and (somewhat arbitrarily) have allowed 20% of a simplifi ed DCF for each project as a contribution to our overall valuation. Year to 30 June 09A 10A 11F 12F Reported Profi t ($m) 111.1 67.8 77.6 108.7 Normalised Profi t ($m) 137.8 61.5 77.6 108.7 Valuation Normalised EPS 226c 101c 127c 179c Our DCF valuation for Solid Energy is $1.7bn, but shares listed on Normalised EPS Growth 293% -55% 26% 40.1% the NZX have traded historically at an average 5%–10% discount to EV/EBITDA 4.4x 12.4x 9.0x 7.1x our DCF valuations, and we have therefore applied a 7.5% average EV/EBIT 5.1x 18.1x 12.9x 10.1x listed market discount which reduces our estimate of market value Normalised P/E 11.4x 25.6x 20.3x 14.5x to $1.6bn. We note that our DCF valuation is very sensitive to small P/E Relative 88% 177% 158% 119% changes in assumptions, particularly on coal prices, which suggests DPS 98.3c 88.7c 32.8c 32.8c that the market might apply a larger discount than the 7.5% average % Imputation 100% 100% 100% 100% fi gure that we have applied. Gross Div Yield 5.4% 4.9% 1.8% 1.8% Cash Div Yield 3.8% 3.4% 1.3% 1.3% Comparable company multiples of earnings and book value would suggest a similar value, although with a wide range of about $1bn to Interest Cover 33.3x 8.0x 6.7x 8.3x $2.5bn. A resource-based valuation excluding Solid Energy’s lignite Debt to (Debt + Equity) 6.4% 17.0% 18.6% 18.8% resources and based on sector average value-to-resource ratios Debt to EBITDA 0.1x 1.5x 1.3x 1.1x ROE 31.8% 13.9% 16.0% 18.9% would be similar, although including all of Solid Energy’s resources would suggest a higher range of approximately $3bn–$4.5bn. Company Background Solid Energy is New Zealand’s largest coal producer, providing coking coal to the NZ steel industry and world markets, and thermal coal for electricity Valuation View generation and other domestic consumption. Solid Energy also has We value Solid Energy at $1.6bn, or around $26 per existing biofuel and wood pellet operations, and plans substantial investment in new energy projects including mining and conversion of Southland lignite share. $1.2bn of this is attributable to the existing operations, to briquettes, urea and diesel, coal seam gas extraction and underground and the rest to the discounted potential of Solid Energy’s coal gasifi cation. planned New Energy developments. The key to value growth will be the success or otherwise of these projects which have Analyst the potential to at least double the value of the company. Guy Hallwright (+64 9 368 0006) [email protected]

This is a private communication to Forsyth Barr clients and is not for reproduction, public circulation or the use of any third party (whether in whole or in part) without the prior written consent of Forsyth Barr Limited.

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 1 1 Company Background Coal Operations

Overview Rotowaro Mine Solid Energy New Zealand Limited (Solid Energy) is a state- Rotowaro Coalfi eld and the Rotowaro Opencast Mine are owned enterprise (SOE), which operates as a commercial located 10 kilometres west of Huntly township in the Waikato. company but is wholly owned by the New Zealand The coalfi eld was fi rst mined in 1915 and opencast mining Government. began in 1958 near the former Township pit. The majority Solid Energy extracts, processes, markets and distributes of Rotowaro coal goes by overland conveyor to Genesis more than 4 million tonnes of coal each year from its Energy’s Huntly Power Station and by train to New Zealand seven underground and opencast mines around Huntly Steel’s Glenbrook Mill, near Auckland. The remainder of coal in the Waikato, Greymouth, Westport and Reefton on extracted from Rotowaro supplies the North Island industrial the West Coast and Ohai in Southland. More than half of and home heating markets. Annual production of around 1.5 Solid Energy’s annual output is sold for export to major million tonnes mainly comes from the many different coal international customers who value the special low ash seams in the Awaroa 4 pit. qualities of its coals, particularly in steel production as well Huntly East Underground Mine as the manufacture of carbon fi bre, activated carbon and silicon metal. India is Solid Energy’s largest export market, Huntly East Underground Mine is located north of Huntly followed by Japan. township. The mine entries and surface facilities are on the east side of the Waikato River, while all current mine Domestically, Solid Energy supplies coal to New Zealand development and coal extraction takes place on the west Steel Limited’s Glenbrook Mill near Auckland and is a major side. Underground roadways extend 150 metres beneath the supplier of thermal coal to the Huntly Power Station. The river to connect the two areas. Coal is loaded directly onto major industries of dairying, cement making, timber and a branch railway at the mine, which connects to the nearby meat processing also use its coal as an energy resource. main truck line. In production since 1978, Huntly’s single As well as operating existing mines, Solid Energy is coal seam is 8–20 metres thick and lies 150–400 metres responsible for the rehabilitation of a number of former mine deep. Nearly all of the approximately 400,000 tonnes of sites across New Zealand. annual production from the mine is sold to New Zealand Over the next 20 years Solid Energy’s production is estimated Steel’s nearby Glenbrook plant. to be about 100 million tonnes, which will require major ongoing investment in the development and expansion of Stockton Opencast Mine new and existing mines. Solid Energy’s Stockton opencast mine is the largest mining operation in New Zealand and is located high on a plateau in History the Buller coalfi eld, north of Westport on the West Coast of In 1987, with the establishment of SOEs, Coal Corporation the South Island. Most of the approximately 1.5–2.0 million of New Zealand was incorporated as a private company. It tonnes of annual production from the mine is exported for purchased a large part of the business of State Coal Mines, use by Asia’s leading steel mills and coke makers. which had run for many years under Crown ownership. In The mine directly employs around 550 people who are 1996 Coalcorp, as it had become, was rebranded Solid now employed through an alliance with Downer EDI (since Energy New Zealand Limited. September 2009). Production for FY10 was below budget, but the mine is now on track to meet budgeted production of 1.8 million tonnes in FY11.

Chart 1. Coal Sales (m tonnes)

Source: Solid Energy

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 2 Spring Creek Underground Mine Solid Energy plans to develop projects to convert lignite to Spring Creek Underground Mine is in the Seven Mile Valley, briquettes, urea (fertiliser) and fuel (diesel). Of these, Solid north of Greymouth on the West Coast of the South Island. Energy’s plans for the latter two will require signifi cant capital Solid Energy operates this mine in a joint venture with Cargill. expenditure, indicatively around $1.5bn–$3 bn for the urea The coal is transported by rail to the port of Lyttelton on the project and around $5 bn for the diesel project. east coast of New Zealand for shipment to international Coal Seam Gas markets. More than half of the around 500,000 tonnes of annual production is exported to both steel makers and Solid Energy is developing reserve estimates for coal seam thermal markets. Spring Creek is still operating below gas in the Waikato, Taranaki and the West Coast of the breakeven, although targeted FY11 production of 675,000 South Island. Coal seam gas typically comprises less than tonnes should make it cash positive, but production of 2% carbon dioxide and about 95% methane, and produces around 800,000 tonnes per annum is needed to make an less greenhouse gas emissions than conventional natural acceptable return. gas, which can contain up to 50% carbon dioxide. Coal seam gas already provides 15% of the USA’s gas supply and close New Vale Opencast Mine to 90% in Queensland. Solid Energy’s exploration is most The New Vale Mine is on the Waimumu lignite coal fi eld advanced in the Waikato, where test wells have yielded high in Eastern Southland. The mine produces approximately quality gas containing 98% methane and only 1% carbon 250,000 tonnes of coal a year, supplying local industry, dioxide. including Fonterra’s nearby Edendale Dairy factory. Underground Coal Gasifi cation Renewable energy operations In July 2010, Solid Energy lodged an application for resource consents to build, commission, and operate a $22m Underground Coal Gasifi cation (UCG) pilot plant in the Wood pellet fuel Waikato by 2011. Growth of Solid Energy’s Nature’s Flame fuel business The UCG process gasifi es coal very deep underground, accelerated rapidly with the completion of the $34m fi rst producing synthetic gas (syngas) that can be used to either stage of the Taupo wood pellet plant in October 2009. generate electricity or produce pure hydrogen to make a Following a number of trial shipments to Europe and Asia, range of high-value products such as methanol, synthetic the plant’s fi rst major export order – 6,700 tonnes to transport fuel, fertilisers or waxes, plastics and detergents. assist European thermal power plant operators to reduce The UCG pilot will convert up to 30,000 tonnes of coal into emissions – was shipped from the Port of Napier in March syngas and operate for up to two years on private property 2010. A second shipment, scheduled for October 2010, was within Solid Energy’s Huntly West Coal Mining Licence. Work brought forward by a month and doubled to 16,500 tonnes. will begin when consents are granted. These shipments are part of an initial 3-year, $15m supply agreement which is now being expanded to accommodate greater tonnages. Domestic residential sales remain fl at. 2 FY10 Result and FY11 Outlook

Biodiesel FY10 Result Review Biodiesel New Zealand produces a diesel fuel from used Table 1. FY10 Result Review vegetable oil collected throughout the country. The resulting fuel has operational and maintenance advantages over Year to 30 Jun $m FY09 FY10 Chg mineral diesel and is mainly supplied to fl eet operators. The Total Revenue 979.5 689.8 -29.6% operation has a plant in Christchurch and an oilseed storage Total Costs 617.2 553.7 -10.3% and processing plant at Rolleston. Development was scaled Total EBITDA 362.3 136.2 -62.4% back in 2009 due to unfavourable conditions but there Depreciation & Amortisation 49.0 46.6 are signs of improving demand and the business aims to EBIT 312.6 93.2 -70.2% increase output to around 60 million litres in the next 4–5 FX gains -102.5 30.3 years. Net interest -9.4 -11.7 EBT 200.7 111.8 -44.3% Future potential projects Tax 54.5 44.0 NPAT 146.2 67.8 -53.6% Southland Lignites Minority Interests -0.3 0.0 More than 3 billion tonnes of lignite lies in the three coalfi elds Equity Earnings -8.8 -6.3 Solid Energy targeted some years ago in Eastern Southland. Reported Profi t (pre abn) 137.8 61.5 -55.3% Abnormal items -26.7 6.3 Lignites in Southland are a nationally signifi cant resource REPORTED PROFIT 111.1 67.8 -38.9% that can support a number of large-scale high-value development projects, representing major opportunities regionally and nationally. FY10 saw a substantial reduction in sales on FY09, with revenues down -30%, but against a pcp which saw record The high moisture and low energy content of lignite means coal prices. Solid Energy’s larger mines all struggled to make that after mining, processing is needed to increase energy production targets, with export and domestic sales volumes content and create high-value products for New Zealand down around -5%, and average achieved prices were down markets and potentially for export. Solid Energy plans to use -13% on FY09 in USD and -25% in NZD, with the average a suite of technologies to produce a range of higher-value exchange rate up from around 60c in FY09 to 70c in FY10. products to maximise the value of these lignites.

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 3 While costs were down -10%, the reduction in volumes and Table 4. Margin Analysis prices produced a massive -70% drop in EBIT, although FX impacts reduced the pretax decline to -44%. Year to 30 Jun NZ$m FY08 FY09 FY10 FY11F FY12F FY13F Coal revenues 505 942 652 917 858 935 Solid Energy has implemented a number of productivity and Coal costs 370 504 448 467 470 481 production initiatives over the last 18 months which should Tonnes sold (m) 4.41 4.2 3.8 4.7 4.0 3.9 improve future performance. Costs per tonne sold 84 119 117 99 117 123 These include improved performance at Stockton due to Coal gross profi t 135 438 204 450 388 454 initiatives put in place by the joint venture with Downer EDI Coal gross margin 26.7% 46.5% 31.4% 49.1% 45.2% 48.6% which operates the mine, organisational changes at Spring Renewables revenues 11 11 18 34 56 71 Creek, and improved development rates in the Huntly East Renewables direct costs 13 9 20 16 25 56 northern extension along with the planned introduction of Renewables gross profi t-22-2183116 improved roster arrangements at the mine. At Rotowaro an Renewables gross margin -18.2% 18.2% -11.1% 52.4% 55.5% 22.2% ongoing dispute with the operator over performance may Other costs (net of other income) 49 78 66 273 171 182 lead to a change of contractor when the contract expires in Overall EBITDA 84 362 136 195 247 288 late 2011. Overall EBITDA margin 15.3% 37.0% 19.7% 20.1% 26.5% 28.0% Offsetting these, the introduction of carbon pricing from July 2010 will increase costs, and while these can be passed in a given year. For example, if a mine is being extended on to domestic consumers they cannot be passed on to overburden removal will increase costs which will fall again international customers, who can source coal from countries as the new area becomes fully productive. Separate cost with no emissions regime in place. data for each mine, or at least separate data for the North Island and South Island mining operations would improve FY11 outlook predictability but due to commercial sensitivities this data We expect FY11 to be a better year for Solid Energy, with has not been available. sales volumes budgeted to rise from 3.8 million tonnes to However, as Table 4 shows, we expect improved coal margins 4.7 million tonnes and prices looking stronger thus far in in FY11 after lower pricing impacted FY10. Future years USD, although a further rise in the NZD could offset some will be highly dependent on the coking coal price path, but of the gain. should be modestly assisted by an increasing contribution Table 2 below summarises our FY11 forecast. from the renewable energy businesses. Table 2. FY11 Forecast A large increase in distribution, selling & other costs (including carbon costs) is expected by the company in FY11, Year to 30 Jun $m FY10 FY11 Chg but these are expected to fall back somewhat in FY12. At Total Revenue 689.8 969.6 40.6% EBITDA margin level we expect modest improvement in FY11 Total Costs 553.7 775.0 40.0% but more substantial improvement in following years. Total EBITDA 136.2 194.6 43% Depreciation & Amortisation 46.6 58.7 3 Valuation EBIT 93.2 135.9 46% FX gains 30.3 0.0 Solid Energy’s current value is primarily made up of the Net interest -11.7 -20.3 existing coal operations, along with planned extensions. EBT 111.8 115.6 3% Renewable fuels (wood pellets and biodiesel) make up only a Tax 44.0 34.7 very small part of the current value. In future, the planned New Energy projects have the potential to create very signifi cant NPAT 67.8 80.9 19% upside. However, we note that equity markets elsewhere Minority Interests 0.0 0.0 have been reluctant to ascribe much value to many of these Equity Earnings -6.3 -3.3 projects. The exception would be coal seam gas, where there Reported Profi t (pre abn) 61.5 77.6 26% are a number of players in the Australian market. However, Abnormal items 6.3 0.0 Solid Energy’s project is further from completion than many REPORTED PROFIT 67.8 77.6 14% of these, and there are signifi cant questions over costs and Five-year forecasts utilisation – in general costs are high, including treatment of water waste, making these projects only viable if they are Our 5-year forecasts for Solid Energy are set out in Table 3 sited close to a power station user or for conversion to LNG. on page 5. We have treated these projects as early stage potential Our forecasts are based on Solid Energy’s budgeted upside, and (somewhat arbitrarily) have allowed 20% of production and capital expenditure numbers and our own a simplifi ed DCF for each project as a contribution to our coal price assumptions (see next section). They include overall valuation. Solid Energy itself uses a more sensitive planned expansions of existing coalfi elds and renewables discount factor matrix, set out as follows: businesses, but do not include New Energy projects: lignite to pellets, urea and diesel, coal seam gas and underground Table 5. Discount Factor Matrix coal gasifi cation. Risk/discount factors Cost Likelihood Overall Table 4 gives our expectations for coal and renewables (PAG) accuracy of success factor margins, and overall EBITDA margin. We only have access PAG1 concept stage 50% 20% 10% to aggregated coal production cost data, which leaves us PAG2 67% 40% 27% reliant on company guidance as to annual cost fl uctuations. PAG3 75% 60% 45% Production costs per tonne can vary signifi cantly depending PAG4 85% 75% 64% PAG5 feasibility study 90% 90% 81% on how much overburden removal and similar work is involved PAG6 investment 100% 95% 95%

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 4 Table 3. Solid Energy 5-Year Forecasts

Profi t & Loss FY09A FY10A FY11F FY12F FY13F FY14F FY15F Revenues Coal 942 652 917 858 935 939 995 Wood pellets 8 9 14 30 30 48 52 Biodiesel 391927417884 Total Sales 953 670 951 914 1,006 1,065 1,130 Services to joint entity 5444445 Other income 22 16 15 15 16 16 17 Total Revenue 980 690 970 933 1,027 1,086 1,152

Coal production costs 504 448 467 470 481 470 487 Exploration & evaluation 7888899 Renewables operating costs 920162556106113 Admin costs 66 65 266 164 175 182 191 Other costs 31 14 18 19 19 20 20 Total Costs 617 554 775 686 739 786 821

EBITDA 362 136 195 247 288 300 331 Depreciation 19 23 29 35 49 51 57 EBITA 343 113 166 212 239 248 274 Amortisation of mine assets 30 24 30 38 49 53 52 Operating EBIT 313 90 136 174 190 195 222 Other income net of other expenses -1400000 Total EBIT 313 93 136 174 190 195 222

FX Gain (Loss) -1023000000 Net Interest -9 -12 -20 -21 -21 -18 -9 Pretax 201 112 116 153 169 177 213 Tax 54 44 35 43 47 50 60 Effective tax rate 23.6% 32.4% 30.0% 28.0% 28.0% 28.0% 28.0%

NPAT 146 68 81 110 122 128 153 Minority Interests 0000000 Equity Earnings -9 -6 -3 -1 1 3 5 Pre-abnormal Profi t 138 62 78 109 122 130 158 Abnormal items -27600000 REPORTED PROFIT 111 68 78 109 122 130 158

Dividend paid 59.9 54.0 20.0 20.0 20.0 20.0 20.0 Dividend payout ratio 43.5% 87.7% 25.8% 18.4% 16.3% 15.3% 12.7% Imputation credits 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Cashfl ows EBITDA 362 136 195 247 288 300 331 Other Cash Income 0000000 Interest Paid 1 -4 -20 -21 -21 -18 -9 Tax Paid -49 -24 -35 -43 -47 -50 -60 Working Capital Movmts -167 -22 -15 18 1 -7 -8 Operating Cashfl ow 147 86 124 202 221 225 254 Capital Expenditure -119 -177 -147 -212 -244 -68 -118 Acquisitions 0-800000 Dividends Paid -60 -54 -20 -20 -20 -20 -20 Other 0000000 Funding (Required)/Available -32 -153 -43 -30 -43 137 116

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 5 Solid Energy internal valuation Chart 4. Coal Prices (US$/tonne) Solid Energy’s current view of project values is as shown in the following two charts. 300 Hard coking Thermal The company’s view on value is driven by very aggressive 250 coal price assumptions, and is higher than our assessment of how the equity market might value the company. 200

Chart 2. Company Valuation by Project Stage 150 100% 100 90% 2,228 736

80% 50 3,494 70% 0 60% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

50% 748 (% of NPV used) 40%

30% 387 Sources: ABARE, Bloomberg, IRESS 20% 175 115 576 10% We note that while coal prices go through major swings and

0% recent prices have been very strong, there has been a fairly Resource PAG 1 PAG 2 PAG 3 PAG 4 PAG 5 PAG 6 Op Admin modest real growth trend over the last 100 years – see below. Projects at early development stages are heavily discounted, as per the following company chart. Chart 5. Long-Term Real Coal Price Index

Chart 3. Segment Analysis as at 30 June 2010 ($bn)

4.5 574 50 28 535 4.0 65 3,494 3.5 281 773 3.0

2.5 2,314

2.0 ($bn) 1.5

1.0

0.5

- South Island North Island Renewable Coal Seam Lignite UCG New Energy - Corporate Solid Energy Sources: Global Financial Data, IMF, RBA Energy Gas Conversion Other

Source: Both charts sourced from Solid Energy However the coal price strength in recent years has been We note that our valuation uses a much more conservative driven by the emergence of rapid demand growth from coal price path assumption than the company does, as well developing countries, especially China and to a lesser extent as a simpler discount for new energy projects, hence our India, since the early 2000s. While generation capacity valuation is just over half the company’s internal valuation increases have driven demand for thermal coal, much of this (at enterprise value level). coal is internally sourced, and the more relevant portion of this demand to Solid Energy is metallurgical or coking coal Coking coal prices demand, which is met in part by internationally traded coal, Coking coal was priced between about US$40 and US$60/ mostly from Australia. tonne over the 30 years between 1974 and 2005. In FY06 Coking coal is used in steelmaking and is in turn driven by the price jumped to $127/tonne, then drifted back to $114 steel demand. Chart 6 shows global steel production since in FY07 and $96 in FY08, before leaping to a record US$300/ 1980. tonne in FY09 and falling back in FY10. Opinions on the long- run path are now divided, with some forecasters expecting prices for coal (and other forms of energy) to remain very strong into the foreseeable future, primarily driven by developing world demand, and others expecting a slide back to around US$140-US$160/tonne in the longer run.

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 6 Chart 6. Global Steel Production Coking coal prices depend on the intersection of demand and supply. Demand has been very strong (up to 2008), but 1600 India there has been a delayed supply response. This has been 1400 China partly due to the lags in bringing new capacity onstream, but RoW also to infrastructure constraints in Australia. 1200 Australian exports account for around 60% of globally 1000 traded coking coal – see Chart 8 below. Between 2007 and 2009 Australia experienced signifi cant supply issues due 800 to constrained port and rail capacity, and to mine fl ooding.

600 However a major programme of capacity expansion is now under way, with port capacity expansions of 100Mtpa in NSW 400 and 26Mtpa in Queensland due for completion this year, and a further 120Mtpa planned by 2015. The increased port 200 capacity is being supported by upgrades to rail infrastructure

0 including the Goonyella to Abbot Point Expansion and the 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010F Surat Basin Rail major projects.

Source: World Steel Association Chart 8. International Coking Coal Trade (mt)

400 The dip in steel production in 2008 and 2009 is now Aust exports Other exports 350 rebounding, with growth projected to be 13.1% in 2010, slowing to 5.3% in 2011, although steel demand in the 300 developed economies in 2011 will still be well below the 250 pre-crisis peak level. While developed world demand is recovering slowly, most of the recent growth has been driven 200 by China, but evidence is emerging of substantial recent 150 overbuilding, and the World Steel Association expects that demand will slow in the last part of 2010 due to the Chinese 100 government’s effort to cool down the real estate sector and 50 ongoing steel production control. In 2011 Chinese demand growth is expected to slow further, with a weakening real 0 2014F 2015F 2006 2007 2008 2009 2010F 2011F 2012F 2013F 2004 2005 estate sector and the phasing out of stimulus packages. Chart 7 below gives a regression of steel demand against global GDP growth. It suggests steel demand growth is likely to average around 4.5%–5% if global growth averages 3.5%– Source: ABARE, Forsyth Barr estimates 4%. However, as Chart 6 shows, the recent data has been much stronger as the developing world became the growth New mines are also coming into production, with planned driver, and we believe the line may have tilted upwards coking coal production increases of nearly 60Mtpa in towards the upper grouping of points around the 5% GDP Australia between 2010 and 2013 (ABARE) and a further growth line. This might suggest stronger steel demand 25Mtpa over the following three years. Production is also growth of around 7% at the same global GDP growth levels. rising strongly in China, Russia and Mongolia, and steel plants are improving their effi ciency and increasing the use of pulverised coal injection, with the greatest blast furnace Chart 7. Global GDP and Steel Demand productivity improvements expected in China. This suggests that expectations of a very strong coking coal price path may be over-optimistic, with high prices since 2009 having their expected effect on supply, albeit with a delay. There remains a very substantial global resource, although there is a shift to higher-cost mines as demand increases. Nevertheless the strength of demand and increasing marginal costs suggest that hard coking coal prices may remain considerably higher than historic averages. Our $1.7bn DCF valuation assumes the coking coal price remains around US$200/tonne in FY11, rising to US$225/ tonne by FY14 and then grows at 1% per annum in real terms. The USDNZD path is also signifi cant to our valuation. In general, we would expect coal prices to be stronger if the USD was weaker. Our DCF valuation assumes that the NZD will average around US73c in FY11, falling back to US70c by Source: Angus Maddison, IMF, WSA, First River FY14 and remaining at that level.

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 7 DCF valuation Our assumptions for semi-hard and semi-soft coking coal are driven off our hard coking coal price, at 85% and 70% of the Table 6. Summary of DCF Valuation HCC price respectively. Our domestic coal price assumption in the longer term is 85% of the export thermal coal price in NZ$bn NZD. Value of operations 1,199 Table 8. Coal Price Assumptions Plus discounted future projects 687 Firm value 1,886 Real Plus investments 19 FY09A FY10A FY11F FY12F grwth Less net debt -205 Prices USD Less dividends since bal date 0 Export Hard Coking Coal US $/t $225 $177 $200 $210 1% DCF value of equity 1,701 Export Semi-Soft Coking Coal US $/t $187 $137 $140 $147 1% No of shares (m) 60.9 Export Thermal Coal US $/t $63 $70 $95 $100 1% Valuation per share $27.93 Domestic Coal US $/t $64 $76 $86 $93 1%

Valuation sensitivity Our cost of capital assumptions are set out below. We have The table below gives our DCF valuations for Solid Energy used a weighted average cost of capital of 10%. We note that at a range of coal and exchange rate assumptions. The coal this is in agreement with the company’s internal usage of an price in the table is the price assumed by FY14, after which 8% real WACC. it is assumed to grow at 1% in real terms. The NZDUSD rate We have used 0.8 as an unlevered asset beta. The range is a fl at rate assumption from FY14. from the comparable companies in Table 11 was wide, The table highlights the signifi cant impact on our valuation of varying from around 0.2 to around 2.0, over periods from varying assumptions for these two variables. 6 months daily to two years weekly. A further complication is that several of the companies are early-stage and that Table 9. Valuation Sensitivities gearing levels have fl uctuated widely, with a number having FY14 coking substantial equity issues, which makes de-levering equity NZDUSD exchange rate coal price betas diffi cult over longer periods. Excluding early-stage companies not yet producing, the average is somewhere (USD/t) 0.60 0.65 0.70 0.75 0.80 between 0.7 and 1.1. 300 4.3 4.1 3.9 3.8 3.7 250 2.7 2.6 2.4 2.3 2.3 Because de-levering is problematic we also looked at 225 1.9 1.8 1.7 1.6 1.5 (geared) equity betas over 2-5 years. These display a similar 200 1.2 1.0 1.0 0.9 0.8 range, with the average just over 1.0 (excluding early-stage 150 0.0 0.0 0.0 0.0 0.0 companies not yet producing). Solid Energy has a well- established production base and we would expect its beta to Multiple valuations be towards the lower end of the range, and while it is hard to Comparable company data for Australasian coal miners is be defi nitive we believe our selection of an asset beta of 0.8 given in Table 11, and implied valuations for Solid Energy are (equity beta of 1.0 assuming a 25% target debt:equity ratio) given in Chart 9, based on comparable company multiples of is reasonable. stated resources, book values, EBITDA and profi t after tax. We have used our standard assumptions of a 6% risk-free Comparable company earnings and book value multiples rate (a 10-year average rather than the current rate) and a tend to suggest similar value ranges for Solid Energy, 7% post-tax market risk premium. Our WACC formulation is although there is a wide range of multiples across the sector. the standard Brennan-Lally version which takes account of imputation. A resource multiple valuation would suggest a higher value range, but a large proportion of Solid Energy’s measured resource is lower-value lignite; if we exclude lignite from Table 7. Forbar WACC Assumptions Solid Energy’s resources, the resource-based valuation falls broadly intro line with the earnings and book value based Parameters valuations – shown as the second bar from the top in Chart Risk Free Rate 6.0% 9. Market Risk Premium 7.0% We have not shown a reserve-based valuation in Chart 9, Gearing 25% but this would suggest a very low value, as relatively little of Asset Beta 0.8 Solid Energy’s quoted resource is represented by proven and Equity Beta 1.0 probable reserves. Cost of Equity 11.2% Debt Premium 1.25% The multiple ranges we have used in Chart 9 are taken from Table 11, and are shown in Table 10. We exclude the Cost of Debt 7.25% early-stage companies Pike River and Riversdale from the WACC 10.0% earnings multiple ranges, and the resource-based valuations also exclude Gloucester and Whitehaven, both of which have been involved in corporate activity and are acquiring reserves not yet refl ected in published fi gures. Enterprise values are adjusted for capital raisings since balance date in the case of Gloucester and Riversdale.

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 8 Table 10. Multiple Valuations Chart 9. Summary of Valuation Methodologies

Valn at Resources Multiple Multiple of: Low High Average avg $bn Resources 1.5 2.5 2.0 3.9 Resources ex Lignite 1.5 5.1 2.7 1.2 Resources ex Lignite Book Value 1.2 5.7 3.2 1.4 EBITDA 5.9 16.0 8.9 1.5 Earnings 9.5 27.8 17.0 1.3 Book Value Multiple Valuation conclusion EDITDA Multiple In general, we fi nd shares listed on the NZX tend to trade at around a 5–10% discount to our DCF valuations on average PE Multiple over time – see Chart 10 below which tracks the market average discount to Forsyth Barr DCF valuations. DCF Valuation Different companies tend to trade at different average discounts to their DCF valuations, ranging from approximately 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 zero to 30%. For example, Pike River Coal has traded since (NZ$bn) listing at an 18% discount to its DCF valuation on average, but it is a start-up operation and has encountered a number Chart 10. Market Average Discount to Forsyth Barr DCF of setbacks in its pre-production phase. Valuations

Since we do not know where Solid Energy might fi t into the 5% range of discounts seen across the market, we have applied 0% a 7.5% approximate market average discount to our DCF -5% valuation, which would reduce our $1.7bn DCF valuation to -10% $1.6bn. -15%

Bringing all of the valuation methodologies together, we -20% value Solid Energy at around $1.6bn or around $26 per -25% share. This sits in the middle of the earnings multiple, price- -30% to-book and DCF valuation ranges – see Chart 9. -35% From an investor’s perspective, the key will be the -40% Jan07 Jan08 Jan09 Jan10 Jan03 Jan04 Jan05 Jan06 attractiveness and credibility of Solid Energy’s growth options.

Table 11. Coal Company Multiples

NZ$ EV/ NZ$ EV/ Price/ Market PE PE EV/EBITDA EV/EBITDA Resources Reserves Book Value Company Code Currency Price Cap (m) Fcst 1 Fcst 2 Fcst1 Fcst2 Actual Actual Actual Solid Energy n/a NZD 25.83 1,573 20.3x 14.5x 9.1x 7.2x 0.9x 35.3x 3.5x Minus lignites 3.5x 43.5x Pike River Coal PRC NZ NZD 1.18 482 173.2x 11.2x 24.1x 5.2x na 8.3x 1.8x Centennial Coal Co CEY AU AUD 6.13 2,422 16.0x 12.6x 7.9x 6.7x 1.5x 8.4x 3.2x Coal & Allied Industries CNA AU AUD 112.00 9,697 16.0x 11.3x 10.3x 6.6x 2.5x 8.2x 5.7x Gloucester Coal Ltd GCL AU AUD 9.89 1,389 15.3x 9.9x 7.5x 4.5x 3.9x 32.1x 5.0x Gujarat NRE Coking Coal GNM AU AUD 0.62 552 9.5x 4.4x 6.2x 3.3x 1.5x 8.8x 1.2x MacArthur Coal Ltd MCC AU AUD 12.49 3,653 13.0x 10.3x 8.2x 6.7x 2.4x 24.1x 2.8x New Hope Corp Ltd NHC AU AUD 5.15 4,276 20.9x 19.1x 5.9x 5.5x 2.1x 4.1x 1.9x Riversdale Mining Ltd RIV AU AUD 10.76 2,540 137.9x 37.9x 90.6x 17.3x 47.9x 169.3x 4.5x Whitehaven Coal Ltd WHC AU AUD 6.14 3,031 27.8x 14.6x 16.0x 9.0x 5.1x 12.4x 3.0x Compco Median: 16.0x 11.9x 9.3x 6.7x 1.9x 8.2x 3.1x Compco Data Source: Bloomberg Consensus Descriptions of coal companies in Table 11 Pike River Coal: PRC is developing an underground coal mining operation near Greymouth in New Zealand. PRC plans to extract nearly 18 million tonnes of premium hard coking coal. Centennial Coal Co: CEY is a thermal and coking coal producer with operations in the Western and Southern Coalfi elds of NSW and in central Queensland. CEY exports its product throughout the world. Coal & Allied Industries: CAN operates underground coal mines and open cut mines at Hunter Valley and Mount Thorley (both in NSW) along with related coal preparation. CAN export its product to Japan, Asia and Europe. Gloucester Coal: GCL mines and explores coal throughout eastern Australia. GCL, through the Stratford Joint Venture, produces coking coal and thermal coal for use in the production of steel. Gujarat NRE Coking Coal: GNM mines coal in Australia and produces low ash metallurgical coke in India. MacArthur Coal: MCC is a coal mining, production and exploration company operating in Australia. MCC’s projects include the Coppabella Coal Mine and the Moorvale project in the Bowen. New Hope Corp: NHC is a thermal coal production company based in Australia. NHC also has interests in logistics and infrastructure operations in Australia. Riversdale Mining: RIV is a mineral exploration and production company focusing on anthracite mining operations in the Vryheid district of South Africa through the Company’s Riversdale Project. Whitehaven Coal: WHC mines and sells metallurgical and thermal coals to the global steel, power generation, and metallurgical industries.

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 9 FY10 Revenue Breakdown Profi t and Loss and Balance Sheet

Year to 30 June 2009A 2010A 2011F 2012F 2013F Renewables Other 3% Total Revenue 979.5 689.8 969.6 933.5 1026.6 3% Other coal Total Costs 617.2 553.7 775.0 686.0 738.7 4% EBITDA 362.3 136.2 194.6 247.5 287.9 Depreciation & Amortisation 49.0 46.6 58.7 73.7 97.9 EBIT 312.6 93.2 135.9 173.8 189.9 Domestic Net Interest -9.4 -11.7 -20.3 -21.0 -21.0 coal Export coal EBT 200.7 111.8 115.6 152.8 169.0 33% 57% Tax 54.5 44.0 34.7 42.8 47.3 NPAT 146.2 67.8 80.9 110.0 121.7 Minority Interests -0.3 0.0 0.0 0.0 0.0 Equity Earnings -8.8 -6.3 -3.3 -1.3 0.7 Rep Profi t (pre abn) 137.8 61.5 77.6 108.7 122.4 Key Drivers Abnormal items -26.7 6.3 0.0 0.0 0.0 REPORTED PROFIT 111.1 67.8 77.6 108.7 122.4 Year to 30 June 2009A 2010A 2011F 2012F 2013F plus amortisation adjustment 0.0 0.0 0.0 0.0 0.0 Export coal production less abnormal -26.7 6.3 0.0 0.0 0.0 mt 2.0 1.7 2.5 2.2 2.4 Domestic coal less full tax/other 0.0 0.0 0.0 0.0 0.0 production mt 2.2 2.1 2.2 1.8 1.5 NORMALISED PROFIT 137.8 61.5 77.6 108.7 122.4 Hard coking coal price CASH FLOW USD/t 225 177 200 210 218 EBITDA 362.3 136.2 194.6 247.5 287.9 Semi-soft coking coal price USD/t 187 137 140 147 152 Working Capital (inc) / dec -166.9 -21.9 -15.2 18.0 1.1 Export coal price Interest & Tax Paid -48.2 -28.2 -55.0 -63.8 -68.3 NZD/t 338 231 239 257 285 Other 0 0000 Domestic coal price NZD/t 106 108 118 129 131 Operating Cash Flow 147.2 86.1 124.4 201.7 220.7 NZDUSD 0.607 0.703 0.730 0.720 0.710 Capital Expenditure -118.9 -176.7 -147.0 -212.0 -244.0 Acquisitions 0.0 -7.9 0.0 0.0 0.0 Divestments 1.6 1.9 0.0 0.0 0.0 Divisional Breakdown Dividends Paid -59.9 -54.0 -20.0 -20.0 -20.0 Other 0.0 0.0 0.0 0.0 0.0 Year to 30 June $m 2009A 2010A 2011F 2012F 2013F Funding Available (required) -30.0 -150.6 -42.6 -30.3 -43.3 Export coal revenues 684 394 603 567 678 Equity Raised (returned) 0.0 0.0 0.0 0.0 0.0 Domestic coal revs 232 229 259 235 200 Other coal revenues 26 29 55 56 57 Change in Net Debt 30.0 150.6 42.6 30.3 43.3 Nature's Flame revs 8 9 14 30 30 BALANCE SHEET Biodiesel revenues 3 9 19 27 41 Working Capital 90.8 128.1 143.2 125.2 124.1 Other revenues 27 20 19 20 20 Plant & Property 275.6 394.4 439.2 510.0 583.4 Total revenue 980 690 970 933 1,027 Mine Assets 157.3 173.0 216.5 284.0 356.7 Other Assets/inv. 181.1 197.1 174.6 174.6 174.6 Total Assets 704.8 892.5 973.5 1093.8 1238.8 Net Debt 53.9 204.8 247.4 277.7 321.0 Other Liabilities 217.0 244.3 240.4 240.4 240.4 Shareholder's Funds 433.9 443.4 485.7 575.7 677.4 Minority Interests 0.0 0.0 0.0 0.0 0.0 Total Liabilities/SHF 704.8 892.5 973.5 1093.8 1238.8

Valuation Key Ratios $m Year to 30 June 2009A 2010A 2011F 2012F 2013F Value of Operations 1,200 Total Sales Growth 84.7% -29.7% 41.9% -3.9% 10.1% PV of Future Projects 687 Total EBIT growth 649.0% -70.2% 45.9% 27.9% 9.3% Total Firm Value 1,887 Reported Profi t Growth 216.6% -38.9% 14.4% 40.1% 12.5% Plus investments 19 Normalised Profi t Growth 292.6% -55.3% 26.1% 40.1% 12.5% Less Net Debt -205 Gearing 11.1% 31.6% 33.7% 32.5% 32.2% Value of Equity 1,701 Du Pont Ratio Analysis Shares (m) 60.9 A. EBIT/Sales (Margins) 31.9% 13.5% 14.0% 18.6% 18.5% Dividends since bal date $0.00 B. Sales/Assets (Asset utilisation) 1.4 0.8 1.0 0.9 0.8 DCF Valuation $27.93 C. 1- Norm Profi t/EBT (Tax burden) 31.4% 45.0% 32.9% 28.8% 27.6% Key Assumptions Normalised ROA = A*B*(1-C) 30.4% 5.7% 9.4% 11.3% 11.1% Cost of Equity 11.2% D. 1- EBT/EBIT (Interest burden) 35.8% -20.0% 15.0% 12.1% 11.0% Weighted Avg Cost of Capital 10.0% E. Assets/Equity (Leverage ratio) 162.4% 201.3% 200.4% 190.0% 182.9% Terminal growth 2.0% Norm'd ROE = ROA*(1-D)*E 31.8% 13.9% 16.0% 18.9% 18.1%

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 10 Disclosure: The comments in this publication are for general information purposes only. This publication is not intended to constitute investment advice under the Securities Markets Act 1988. If you wish to receive specifi c investment advice, please contact your Investment Advisor. Forsyth Barr Limited and its related companies (and their respective offi cers, agents and employees) may own or have an interest in securities or other products referred to in this publication, and may be directors or offi cers of, or provide investment banking services to, the issuer of those securities or products, and may receive fees for acting in any such capacity in relation to that issuer. Further, they may buy or sell securities as principal or agent, and as such may undertake transactions that are not consistent with any recommendations contained in this publication. Forsyth Barr Limited and its related companies (and their respective offi cers, agents and employees) confi rms no inducement has been accepted from the researched/recommended entity, whether pecuniary or otherwise, in connection with making any recommendation contained in this publication or on our website. Analyst Disclosure Statement: In preparing this publication the analyst(s) may or may not have a threshold interest in the securities mentioned in this publication. A threshold interest is defi ned as being a holder of more than $50,000 or 1% of the securities on issue, whichever is the lesser. In preparing this publication non-fi nancial assistance may have been provided by the entity being researched. A disclosure statement is available on request and is free of charge. Disclaimer: This publication has been prepared in good faith based on information obtained from sources believed to be reliable and accurate. However, that information has not been independently verifi ed or investigated by Forsyth Barr Limited. Accordingly, Forsyth Barr Limited: (a) does not make any representation or warranty (express or implied) that the information is accurate, complete or current; and (b) excludes and disclaims (to the maximum extent permitted by law) any liability for any loss which may be incurred by any person as a result of that information being inaccurate or incomplete in any way or for any reason. The information, analyses and recommendations contained in this publication are confi dential to the intended recipients and are statements of opinion only. They have been prepared for general information purposes and whilst every care has been taken in their preparation, no warranty or representation is given (express or implied) as to their accuracy or completeness. Nothing in this publication should be construed as a solicitation to buy or sell any security or other product, or to engage in or refrain from doing so or engaging in any other transaction. This publication should not be used as a substitute for specifi c advice. This publication is intended to provide general securities advice only, and has been prepared without taking account of your objectives, fi nancial situation or needs, and therefore prior to acting on any information, analysis or recommendation contained in this publication, you should seek advice from your usual Investment Advisor. Forsyth Barr Limited and its related companies (and their respective offi cers, agents and employees) will not be liable for any loss whatsoever suffered by any person relying upon any such information, analysis or recommendation. This publication is not intended to be distributed or made available to any person in any jurisdiction where doing so would constitute a breach of any applicable laws or regulations.

Forsyth Barr Research Solid Energy • Solid Potential Thursday, 4 November 2010 11