China has waged a campaign against high coal prices. This swift and powerful campaign has caused turmoil in the coal futures market, and is consequential to investors of coal companies like Geo Energy.
I expect 3Q21 results to be released in a few weeks time, where management will also give their views on the current and future outlook of the market. But in this period of high volatility, a few weeks is a long time. While other investors are panicking, it is timely for us to take a step back and re-look at what is going on in the market, and reassess the value that Geo Energy’s stock holds.
Coal prices have tumbled from “unreasonable” highs
In late September 2021, facing an electricity crisis, the Chinese government declared that they would pay “any price” to buy more coal. This declaration caused prices to skyrocket. Speculators in China were bidding up coal futures contracts. Physical coal traders started hoarding coal. The price increase were exacerbated because traders were suppressing supply further to, in some sense, extort the the government and power plants to pay an exorbitant “any price”.
To be sure, there is a shortage of coal worldwide. Indian cities are also facing power cuts. Coal, oil & gas prices have all gone up. But at least some of the price increases of coal in October 2021 were caused by these speculators. China consumes and produces about half of the world’s coal. It is also a communist country. So, it has decided to use its power to crack down on what they consider to be “unreasonable” price increases with some of the measures listed below. This has successfully caused the futures markets to plunge. Spot prices have fallen also, but to a smaller extent.
- Commanding China coal companies (which are mostly government linked companies) to produce more coal. We can expect a surplus of coal in global markets in the future because of this
- Commanding China coal companies to sell coal at low prices that are independent of the market price
- Cracking down on “illegal” coal storage facilities. These facilities were allegedly used to hoard coal to create an artificial shortage and drive prices up. No one knows how much coal are stored at these facilities. But technically, the coal in these facilities can be considered as part of China’s stockpiles (though unofficial). I see this development simply as a drawdown on stockpiles
- Cracking down on the futures market through higher fees and restricting information flow
Crackdown on information relating to coal
I think the most difficult part of this crackdown is the crackdown on information. There is very little reliable sources for market to price coal now. Data providers in China are publishing outdated or perhaps even wrong prices. In fact, because the propaganda department is involved, we will not know the true demand and supply situation in China now. If there are reports of supply bottlenecks due to weather or accidents, it might not be allowed to be published in the news. Things like the reported production quantities, levels of existing stockpiles etc will be in doubt. So I think the coal futures market in China and elsewhere are a lot less reliable as a predictor of future prices due to the crackdown on information.
Geo Energy: Not as undervalued as before, but still undervalued
The current slump in coal prices was quick and dramatic. Surely, the prospects of Geo Energy has been negatively affected. But I don’t think it is a disaster for Geo Energy. It will have a smaller and shorter windfall. But it is a windfall nonetheless that the market doesn’t seem to appreciate well enough.
Despite the slump, coal prices are still considered high. A more normal price would be USD30-40 per tonne. In fact, when Geo Energy bought the SDJ and TBR mines (almost all of Geo’s production are at these 2 mines) in 2014 to 2016, prices were only USD30-35 per tonne. So recent prices of above USD100 per tonne are really quite mind-blowingly high. It won’t last for long, but it is enough to earn the company many many years worth of profits.
Let’s also not forget that in July 2021, with average ICI4 at USD64.88, Geo Energy made profits of USD18.6 million and EBITDA of USD26.5 million. As at the the time of writing, ICI4 prices are at USD133.90. Suppose that ICI4 prices fall by 50% to USD64.88 and remain at that level for 1 year. Cash profits for that 1 year alone would be SGD 429.3m, exceeding enterprise value (market cap – net cash) of SGD 382m at a share price of SGD0.33.
If ICI4 prices fall by 65% to USD47.78, it would still have a enterprise value to cash profit ratio of less than 2.
The above estimates are conservative if we consider that the futures for ICI4 are indicating higher prices for the next year at least. Though the futures market are less robust now because of the crackdown on information, I am confident that 3Q21 will be fantastic (my own estimates is around USD65m profits and USD90m EBITDA), and 4Q21will probably exceed it.
Operational progress since 1H2021
Geo Energy has set about some plans going forward from its 1H2021 presentation slides. These goals are very much in line with what investors want. Let’s take stock of their progress with reference to the the slide below:
- On 20 Sep 2021, Geo Energy announced that it has received approval for the increase of Rencana Kerja Anggaran Biaya (“RKAB”) (Work Plan and Budget) production quota for the SDJ and TBR coal mines for 2021 from 10 million tonnes to 11.5 million tonnes. Done
- On 13 October 2021, Geo Energy announced that it has redeemed all US$60m of outstanding bonds. They have generated so much cash that even after redeeming all the bonds, they still have US$62.4m of cash left over. Done
- On the reviewing and valuation of assets for possible divestments, No news yet
On diversification into the renewables supply chain, Geo Energy’s CEO also said in the 13 Oct announcement that the group seeks to “expand our revenue streams by way of potential joint ventures, trading and value accretive acquisitions that are self-funding”. This sounds like they already have a target identified. Interestingly, the CEO has mentioned looking at nickel and cobalt mining in an interview published by The Edge on 5 Jul 2021. In progress - There has been no share buybacks in 2021. No news yet
So far so good. Geo Energy has done what it said it expects to do. It is only the items that it said it “may” consider that we don’t really have news yet.
My wish list going forward
1. Share buy-backs
At current prices, Geo Energy is trading at a very low forward P/E. It is even cheaper if we consider that Enterprise Value (market cap less net cash) to forward cash profits is less than 1.
2. Special dividend
Due to the unforeseen super high coal prices in recent months, Geo Energy has made a windfall that they probably did not expect. These supernormal profits in excess of capital needs could be passed on to shareholders in a one-off special dividend.
3. Update on diversification plans
As discussed above in the section on current progress, I think Geo Energy is targeting the acquisition of nickel/ cobalt mines. But this is just based on my inferences from reading the CEO’s interviews. I know that they may not be able to share so much info until things are really firmed up. But any additional information will be welcomed. Perhaps an estimate of the total investment amount that they are looking at?
4. Divestment of BEK and STT mines
One area that I am really hoping for action in is the divestments of assets. Most coal companies believe in the long term profitability of coal and are building up decades of reserves in their mines. Geo Energy stands out in that their management is clear eyed about wanting to transition away from coal. The cash cows (SDJ and TBR mines) will be mined out in about 7-10 years and they want to use the cash generated to get into the renewables business. I have stated in my previous post that I prefer for them to just return all the cash to shareholders. But if they are not doing so, then the diversification into the renewables supply chain is way better than investing in more coal mines or spending a fortune in developing the BEK and STT mines.
With the prices of coal still high, this is a good time to sell away the BEK and STT mines. These mines are huge and have a lot of unexplored potential reserves. Geo Energy is currently mining again at BEK and doing some exploration at STT. I hope that these activities will help boost the valuation of BEK and STT, and that they would be divested at a good price soon. This is entirely possible, given the fact that the importance of geographical diversification of energy sourcing has become so clear in recent months. Freakish weather like the floods in China are unlikely to hit two countries many miles apart at the same time. Perhaps some Chinese coal companies might be interested to diversify geographically and buy these mines?
To be clear, BEK and STT are not going to be worth much. STT was bought for only USD2m in 2016. It is is not worth much because it is in the pre-production stage with minimal exploration done. Furthermore, for coal mines, a lot of its value is also tied up into the infrastructure that the owners has to invest in to transport the coal. This is not done yet for STT. As for BEK, it is already a producing mine, with infrastructure paid for and built up long ago before Geo Energy’s IPO. It should be worth more, but given that its coal is of a lower grade than TBR and SDJ, my very rough guess is that it could be sold for about USD10m? Anyway, the proceeds of divestments is not going to be that significant. Of more significance is the fact that they will free up spare cash instead of spending millions to develop these coal mines.
DISCLAIMER: As of 28 October 2021, I own shares of Geo Energy
A Wandering Elephant 