Profiting from coal play despite a murky future
Good old-fashioned coal provided its investors with a windfall last year. The G20 countries may have announced in a joint communiqué last October to declare a halt to financing overseas coal projects.
But that did not stop two Singapore Exchange (SGX) listed coal stocks from posting significant gains last year. Golden Energy and Resources’ (GEAR) share price rose by 80.1% in 2021, and Geo Energy Resources surged 82% in share price alone, excluding dividends. To put this into context, GEAR and Geo Energy outperformed Bitcoin, which rose only 62% in 2021. The Straits Times Index gained a mere 9.8% last year, and the widely followed S&P 500 Index rose 26.9%.
The irony that the Group of 20 (G20) became industrialised because of coal did not escape attention. However, the trend now is to stop financing coal projects despite the fact that the funds that are financing coal projects are probably the ones likely to get a windfall, as banks have committed to stop financing new coal projects.
According to the International Environment Agency (IEA), overall coal demand was set to grow 6% last year, threatening net-zero goals and seen to “rise to record highs in 2022.” Coal power in China was expected to grow by 9% in 2021 and forecasted to grow by 12% in India, S&P Global Platts reported.
Renewable future
Despite the growth, coal companies — like many corporations worldwide — are starting to articulate an environmental, social and governance (ESG) narrative so that they can be more palatable to global funds. Even as coal companies try to figure out how they can pivot to a renewable future, some smart investors are already raking it in.
Last November, GEAR announced that its subsidiary Stanmore Resources will acquire an 80% interest in BHP Mitsui Coal (BMC) for US$1.1 billion ($1.4 billion). This was done through the acquisition of all the shares in Dampier Coal by Stanmore SMC Holdings, GEAR’s newly-incorporated wholly-owned entity.
The acquisition is likely to be financed by a partially underwritten pro rata entitlement offer of ordinary shares in Stanmore, plus a new US$625 million acquisition debt facility and internal sources. The deal is targeted for completion in the middle of this year.
As of June 30 last year, GEAR has a cash balance of around US$100 million. Its projected dividends from its 62.5%-owned Indonesian subsidiary, PT Golden Energy Mines Tbk (GEMS), seeks to meet its US$300 million commitment in Stanmore’s entitlement offer.
One reason GEAR wants to buy BMC is to help itself address ESG concerns. The metallurgical coal dug from BMC’s mines have lower ash, sulphur and phosphorus content, and therefore, less harmful to the environment than the thermal coal now produced
from GEAR’s other mines.
As part of its ESG efforts, the company has laid down a target to have more than half of its revenue and earnings from non-thermal coal. “GEAR’s vision is really to be a globally diversified energy and resources company,” chief investment officer Mark Zhou tells The Edge Singapore.
This decision is a timely one as well, since banks worldwide have slowly tapered off coal financing (particularly with regards to thermal coal) in recent years. For example, on Dec 14 last year, HSBC announced a goal of cutting thermal coal financing exposure by at least 25% by 2025 and a further 50% by 2030.
Diversification
At an extraordinary general meeting held on March 24 last year, GEAR received shareholders’ go-ahead to diversify beyond coal to also precious metals gold and silver. For a good measure, GEAR will also consider base metals including copper, cobalt, zinc, nickel and ferroalloy. Instead of keeping its activities within Indonesia, it will now explore potential investments in Australia, US and Canada.
In a way, GEAR had already made a modest gain investing in gold. Over a period of several months in 2020, GEAR cashed out from shares it held in gold producer Westgold Resources, which was enjoying a lift from the buoyant gold market.
At the same time, GEAR was making a bigger bet on gold. On Jan 15, 2020, via a 50/50 joint venture with EMR Capital, A$100 million was paid upfront for the Ravenswood Gold Mine, with another A$200 million in deferred consideration. Sited within the state of Queensland, this mine as of June 2019 had an estimated resource base of 5.9 million ounces. The acquisition was completed two months later.
Gold mine
Zhou says that these are GEAR’s initial, yet crucial and “intentional” first steps into diversification, so that the company can move up the learning curve. “[The hope is that] one day that we will be able to also run, fully own and operate some of these precious metals ourselves,” he continues, adding that coal and gold cycles complement each other. On one hand, gold is countercyclical to coal. On the other hand, gold and coal producers operate similar business models and so there is a certain level of familiarity.
However, costs of operations might differ between the various areas of activities. “In Australia [where the gold mines are], the all-in sustaining costs will not be as low as that of Indonesia, for example,” adds Zhou. “But again, it’s a different sovereign risk,” he explains, referring to Australia’s AAA sovereign rating. He also adds that Indonesia has a higher risk of illegal mining.
“In such volatile times and markets, diversifying into precious metals such as gold [helps], especially when coal and the rest of the market is down, as it provides a kind of balance.”
Record earnings
Besides GEAR, another Indonesia-based coal miner listed here is Geo Energy Resources. It has taken advantage of the 2021 run in coal prices to cut debt, pay out more dividends, and start buying back shares. It is also trying to find ways to get into the renewable energy business.
On Dec 8 last year, Geo Energy — citing a report from SMG Consultants, its appointed independent qualified person — announced that its two coal mines PT Sungai Danau Jaya and PT Tanah Bumbu Resources, had been accorded a “preferred value” of US$726 million as at Aug 31 that same year.
The valuation is based on a combined coal resource of 101 million tonnes and combined coal reserves of 77.3 million tonnes as at Aug 31last year. It also considers that the concessions of the two mines have been extended to May 29, 2027, and Jan 10, 2028, respectively.
On Oct 10 last year, Geo Energy, assured of its growing cash pile and better earnings visibility, redeemed outstanding debt of some US$63 million, which is part of a US$300 million bond issue carrying a coupon of 8% due 2022. Upon paying its bond-holders, the company’s cash levels dropped from US$120 million, as at Sept 5 last year, to around US$60 million. But in just three months, its cash balance had climbed to US$164 million — and that is after dishing out US$31 million in interim dividends on Nov 29.
Next, Geo Energy — perceiving that its current share price as not an accurate reflection of its actual value — started buying back shares. On Dec 15 last year, it bought back 2.3 million shares at between 31.5 cents and 32 cents. The buybacks continued steadily, with the most recent on Jan 20, with 100,000 shares bought at 33 cents, for a cumulative total of 11.9 million shares.
While global coal prices corrected somewhat following policy intervention by the Chinese government late last year, prices remain at rather lofty levels. As such, Geo Energy is projecting it will still achieve its highest quarterly results for 4QFY2021 ended December last year. The Indonesian benchmark for coal averaged US$132.64 for October and US$79.34 per tonne for November, versus the US$55.95 average between January and September last year. It is also exporting a higher proportion of its production at prices not hampered by domestic market obligations imposed by the Indonesian government.
What next?
Despite the record earnings and positive outlook, Geo Energy is already planning for life beyond just coal mining. CEO Tung Kum Hon also recognises that with better ESG awareness, banks are now more reluctant to fund the coal industry.
He says: “We need to build a business forward… a sustainable business public group [model].” The company is now weighing what it can do within the supply chain of renewable energy, “and from there see how we can further diversify.”
“We are reviewing to optimise our assets portfolio, which may include acquisitions to diversify our business, and divestments to build a larger and more sustainable business for the future,” adds Tung.
For years, Geo Energy was shunned by investors who compelled the company to pay more attention to sustainability in their investment decisions. But Geo Energy is now in a net cash position, with the start of the share buybacks and getting a higher valuation of its mines, which it now has a right to work on up to 2028. Market watchers are wondering if the company could eventually privatise and distribute its cash pile.
Even with the strong gains in 2021, IEA is projecting demand for coal to hit record highs this year. Perhaps that is not a bad time to divest the coal mines and give a hefty dividend to shareholders.