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Are Aurizon shareholders exposed to unacceptable risk?

Retail investors should be wary of investing in Aurizon (ASX: AZJ) because it is exposed to the risk of a major coal project failing to eventuate. Aurizon has a $3 billion deal with GVK Hancock to buy a 51% interest in Hancock Infrastructure and construct a new rail network servicing Queensland’s Bowen and Galilee basins. However, the success of the investment relies on new coal mines becoming productive.

Unfortunately for Aurizon, the market for coal is far from buoyant. The CEO of New Hope Corporation (ASX: NHC), Robert Neale, recently said that he thinks conditions will be tough for the Australian coal industry for at least a couple more years. New Hope certainly seems to be the most prudent of the miners, and will be well placed to strike if weaker competitors, such as Whitehaven Coal (ASX: WHC), are brought to their knees.

When the coal price drops, as it has, prudent companies delay or cancel greenfield projects. This is relevant to Aurizon because the company is planning to spend around $3 billion on infrastructure that will service new coal projects. Of particular importance are GVK Hancock’s Alpha and Alpha West projects, which would be a major customer of the proposed rail network.

A widely cited report by the US-based Institute for Energy Economics and Financial Analysis found that “GVK simply cannot afford to participate in the Alpha project due to its plummeting stock price, over-leverage and poor track record.” This report was commissioned by Greenpeace, one of a multitude of environmental groups who target marginal coal developments with the aim of causing financial pain for backers. The report is backed up by both evidence and market sentiment.

The share price of Whitehaven is one example of what the market thinks about developing new and marginal reserves in the current climate. Whitehaven stock has fallen from a ludicrous $6.74 to the current level of about $1.50 over the last few years, and the price is down over 30% since I warned investors to avoid the stock in July.

Below is the five-year share price chart for GVK Power and Infrastructure, the company that has committed to invest $10 billion in the GVK Hancock projects, on which Aurizon depends. As you can see, the market has lost confidence in the company, which is currently committed to building 16 different greenfield projects around the world.

GVK 5-year Share Price Chart from Yahoo Finance

GVK 5-year Share Price Chart from Yahoo Finance

At the recent AGM, the Chairman of Aurizon, John Prescott was asked, “If GVK does default on its loans, and the railway assets become essentially stranded, making a $3 billion investment worthless… will the QCA force Aurizon to pass the loss directly on to shareholders?” The QCA is the Queensland Competition Authority, the body that essentially regulates the price Aurizon can charge for haulage.

Foolish takeaway

Prescott’s immediate answer was silence, for an agonizing 45 seconds. His first words were “I’ve been conferring with my colleagues, I’m not sure I understand the question.” He then went on to say “we have had a fair bit of experience mitigating such risks, in other projects, and I don’t see us going ahead with a project unless we are satisfied that the risks are appropriate.” If I were a shareholder, that wouldn’t exactly reassure me. There are far safer infrastructure companies available on the ASX.

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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article

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