Disposal and Strategy Update

For immediate release                                                                                      1 September 2014

 

HARGREAVES SERVICES PLC

("Hargreaves" or the "Group")

 

Announcement of Disposal of Imperial Tankers and Strategy Update

 

 

Hargreaves Services plc (AIM: HSP), the UK's leading supplier of solid fuels and bulk material logistics, announces the disposal of the Group's wholly owned subsidiary, Imperial Tankers Limited ("Imperial"), to Suttons Transport Group for a cash consideration of £26.9m, further details of which are given below.  This disposal is a first step in implementing a new strategy to focus the Group on its core strengths, simplify operations and ensure the business is optimally placed to respond to changes in market conditions.

Hargreaves has successfully developed its position as the UK's leading coal production, trading and distribution company. The Group's current activities comprise:

·      the UK's largest independent coal and coke sourcing and trading operation;

·      the largest portfolio of surface coal mines in the UK;

·      a leading industrial services operation, providing materials handling and related services to coal fired power stations and the steel industry; and 

·      a successful coke trading business in Germany, operating as an associated company.

Disposal of Imperial Tankers

Imperial has been part of the Group since it was acquired in 2007 for a total consideration of £6.3m. The tanker operation has grown steadily under the Group's ownership and has been consistently profitable. However it currently offers limited synergies with other Group operations and now falls outside the Group's core activities. Imperial generated profit after tax of approximately £1.6m on revenue of £29.7m during the year ended 31 May 2014. EBITDA in the year ending 31 May 2014 was approximately £4m. The business unit will be sold inclusive of cash balances of £1.6m and £2.7m of asset finance debt, resulting in an effective enterprise value and reduction in overall net debt of £28.1m. The book value of Imperial Tankers in the Group accounts was approximately £9.5m.

Commenting on the disposal, Gordon Banham, CEO of Hargreaves, said: "Imperial Tankers is a quality business and I would like to commend and thank the staff and management for their hard work and commitment in developing Imperial into one of the strongest tanker brands in the country. The very favourable valuation reflects the quality of the business and strong recent growth. I am pleased that the business has been sold to a high calibre operator who is seeking to invest in expansion and is well placed to drive synergies from the business, which the Hargreaves Group is unable to access. This is a good outcome both for the Group and for the management and employees of Imperial Tankers. Following the disposal we will be left with the  fleet of dry bulk vehicles. This will remain a key part of the Group to drive synergies with our trading and production activities."

Strategy Update

Following the disposal of Imperial Tankers, the Board will continue its review of the operations and strategy of the Group to ensure that it is optimally placed to deliver shareholder value. The review will seek to identify and validate opportunities to simplify group structure, increase operational focus and liberate fixed and working capital.

The strategy review has been prompted by recent, emerging and potential changes in the markets in which the Group operates. This focus on market trends and conditions will assist the Board in maximising the quality of future earnings by exiting profit streams that are deemed to represent the lowest risk-weighted returns and weakest prospects for sustainable long term growth whilst strengthening the Group's longer-term position in its core markets.

As the review progresses and the outcome of the current strategic initiatives take shape, the Board will consider the optimal capital structure and distribution policy for the Group, ensuring that they are properly aligned to the long term expectations and requirements of both shareholders and the Group. With regard to the capital that is liberated by the review, consideration will be given to reducing debt, distributing it to shareholders or re-investing it in the business. Any re-investment would be focussed on attractive and value enhancing projects related to the Group's core business activities.

The Group will continue to carefully grow its international services business, building on its recent contract wins with China Light and Power and its increased credentials and experience in the steel sector.  The Group does not expect to need to deploy significant capital to support this initiative. 

In terms of any other investment opportunity or requirement, the Group's short and medium priority will continue to be focused on securing and under-pinning the core UK coal trading, production and distribution businesses. The Group has expended significant time and effort to date and continues to actively search for and examine opportunities to acquire more direct control over significant outlets for its coal, by contract or acquisition. Long term coal supply contracts underpin our coal production and coal trading operations by providing greater long term visibility over coal off-take. As outlined below, the term of coal supply contracts from generators is continuing to shorten.

If no appropriate investment opportunities are identified then the Board is currently minded to pursue a strategy of running the UK operation to maximise cash returns with a view to distributing these to stakeholders.

With regard to market conditions, the Board continues to assess and monitor developments in the UK coal markets and movements in international coal prices.

The future dynamics of the UK coal markets

The drive towards renewable energy and the reduction of CO₂ emissions continues to present uncertainty about the quantity of coal that will continue to be burned by power generators to satisfy UK energy market demands. Although recent substantial and unexpected falls in short term gas prices have significantly reduced current coal burn and despite the imposition of carbon taxes and the upcoming impact of the Industrial Emissions Directive, the Board remains of the opinion that coal will continue to be an important constituent of the UK energy mix for many years to come. Indigenous coal will continue to be an important element of this mix. Current data indicates that the UK coal market, principally led by the demand of power generators, will remain of sufficient size to support comfortably the Group's plans for its UK coal production and distribution businesses for many years to come.  The Board remains confident that Hargreaves can add value and generate profit from this market.

In the nearer term however, increasing uncertainty around Government policy, the weakness in international coal prices and current volatility in gas prices, and hence coal burn, are leading UK generators to delay purchase contracts or source coal on shorter term contracts. This reduces revenue visibility in the Energy & Commodities Division and creates longer-term challenges for the Production Division, where substantial contract visibility is required to underpin longer term investment decisions in the Group's surface mining activities. 

Other changes are also affecting the supply and demand for coal products. Uncertainty still exists over the future of the operations of the former UK Coal PLC, both in terms of the deep and surface mines, whilst proposed changes in Irish government policy could also reduce demand for domestic coals.

International coal price

Recent significant falls in the international coal price have been compounded by a strengthening of sterling against the US dollar. The effect of this has been to reduce the sterling price of thermal coal in the UK. The Board remains of the opinion that current price levels are artificially low and expects some recovery in the foreseeable future. However, at its current level the coal price presents near term challenges to investment in and the development of the Production Division's surface mining operations.

Since raising equity in April 2013 to acquire the surface mining assets of Scottish Coal Company Limited and Aardvark (TMC) Limited, the sterling price of coal, as measured by the API 2 Index, has fallen from around £55 per tonne to £46 currently. These surface assets were acquired at prices that represent good long term value for the Group and the Group remains committed to the development of surface mining opportunities in the UK and building on its strong pipeline of sites.

To date, for existing sites, the impact of the falling coal price has been minimised by hedging or fixing the price of the coal that was planned to be extracted. In the longer term, for new and future sites, the challenge of low coal prices can be partially mitigated through re-designing mining schemes to focus on the lower-ratio coals, reducing production costs but also reducing the total amount of coal that can be extracted. Whilst this will reduce absolute production levels it will assist in protecting the profitability of the coal that is produced. The Group will only commence operations at new sites if the output can be fixed or hedged at an economic level.

The surface mining pipeline is a core strategic asset and store of long term value for the Group and indigenous coal will continue to be an important fuel for UK power generation. The strength of the Group's position in surface mining leaves it uniquely-placed to capitalise on any future upturn in coal prices and coal fired power generation.

Further Potential Simplification Opportunities

In assessing the Group's wider activities, the Board has identified a number of additional areas where it sees opportunity to release and redeploy capital.

The Group produces and trades coke through its Monckton coke plant. As we have previously reported, coke markets and pricing have been very volatile and this continues to hamper Monckton's activities. Difficulties in the financial and commercial position of some producers and customers are adding to the challenging trading conditions. The Group has always recognised the importance of balancing risk with maximising return on capital employed and is aware of the high levels of working capital already invested at Monckton and in its wider coke trading activities.  We remain committed to minimising operational risk wherever possible, by avoiding significant open contractual positions. Against this background, the Board will, in the coming weeks, review whether Monckton can achieve sufficient contractual certainty in current market conditions to justify the level of working capital deployed to support the operation. The Group will also look for opportunities to cut working capital levels in its German associate by reducing trading levels until normal market conditions resume.

The Group views its UK coal trading businesses as a core part of the Group and highly synergistic with its coal production activities. Although there will continue to be a key focus on developing production, trading and distribution activities in the UK, the Group does recognise that coal trading poses very intensive working capital demands. Opportunities will be sought to focus trading activities on core streams where the Group is best placed to add value, optimise its return on capital and maximise synergies and profits from its thermal and speciality coal markets. To achieve this focus, we currently envisage reducing bulk trading volumes by around 1.5m tonnes per annum and reducing working capital accordingly. A key focus of the Group will be to protect our market share and margins from the supply of coal into the specialty markets.

Other non-core activities are also under review, including the tyre crumbing operation, the joint venture with MIR Trade in Europe and the Rocpower operation. Notice has already been given to our joint venture partners to seek to wind down the activities of MIR Trade joint venture in an orderly fashion. The Group has recently received early stage interest from a third party in the acquisition of Rocpower's Commonside Lane facility and grid connection. In light of the decision to streamline the Group, the Board is assessing the merits of a potential disposal.

The Board expects this set of initiatives to liberate substantial cash resources, which will be available to enhance returns for shareholders, either by reinvestment in the Group's core markets or in pursuit of complementary alternative opportunities or by some form of capital distribution. The reduction in trading volumes would be expected to contribute to a net positive working capital inflow in the current financial year with further benefit in the following year. If a decision is subsequently taken to close Monckton in this financial year that would be expected to be significantly cash positive and would create an additional working capital inflow over the current and proceeding financial year.

The Board will update the market further on the review process at the time of its final results on 9 September 2014. The Company does not expect to make any key decisions before that date and welcomes the opportunity to engage with shareholders following publication of results.

On 30 May 2014, Hargreaves released a period-end trading update for the year ended 31 May 2014. Since that announcement, there has been no material change to the underlying trading outcome for the year ended 31 May 2014. Net debt at the financial year-end was approximately £69m. Following the decision to consider disposing of Rocpower's core asset, the Board is continuing to evaluate the carrying value of the Rocpower assets on the Group balance sheet. The Company will publish final results for the 2014 financial year on 9 September 2014.

Commenting on the review Gordon Banham, CEO of Hargreaves, said: "The global and UK coal markets are going through a period of significant change and challenge which has led us to review both the market and strategic landscape and to move quickly to address potential threats and challenges in our core UK market. We remain of the view however that the coal market in the UK still offers the Group significant longer term opportunities, when the market settles back into a more normalised state."

Hargreaves Services	Tel: 0191 373 4485
Gordon Banham, CEO
Iain Cockburn, Finance Director
Buchanan	Tel: 020 7466 5000
Mark Court / Fiona Henson / Sophie Cowles
N+1 Singer (Nomad & Joint Broker)	Tel: 0207 496 3000
Sandy Fraser / Nick Owen
Jefferies Hoare Govett (Joint Broker)	Tel: 020 7029 8000
Sara Hale / Harry Nicholas