There is a shitstorm brewing in the energy markets. Coal, oil, and gas are at multi-year highs. Why is this so?
- Central banks printed too much money, causing inflation in all commodities in general
- Down cycle in previous years due to oversupply led to years of under-investment in new oil wells/ coal mines, and even decommissioning of some assets
- Green pressure causing even more under-investment in new oil wells/ coal mines. The renewable energy invested into is significant, but does not produce enough energy to replace fossil fuels
- Lack of workers. Many workers in these industries are migrants from low income countries who cannot travel now. Many workers from richer countries have moved on to other industries
- Bad weather disrupting supply (flooded mines in China, hurricane in offshore oil fields in USA)
- Bad weather again causing increased demand, first for cooling with aircon during hotter than normal summers, then later for heating in unusually cold winters
- Economic recovery bounced back up faster than expected
- Chinese and Indian power generators tried to time the market, delaying purchases when they thought coal prices were high and would drop. Now that they have run down their inventories and winter is approaching, everyone is suddenly desperate and willing to pay anything to buy more supplies
So there are both short-term and mid-term factors at play. Some things like bad weather will be somewhat recurring. In fact, extreme weather is expected to be more common due to climate change (which is ironically caused by fossil fuels). Prices are likely to moderate after a few months, but will likely remain higher than it was in recent years.
All energy producers, particularly primary energy producers, are going to reap a big harvest. I have invested in both Rex International and Geo Energy. But I am writing about Geo Energy today because they have just released an announcement today with very excellent news. This run up in coal prices is giving Geo Energy a windfall that would flood its coffers with money. Actual coal futures for 2022 are not as high as current prices, but high enough to make Geo energy a compelling investment today.
Cash generation in one year expected to exceed market cap
Many investors will be concerned about the longevity of the coal business. There is good reason to be so. Even Geo Energy’s management have acknowledged that coal is not a long term thing. But while coal is going to end up worthless eventually, it is still needed in the short and mid term. The good news for Geo Energy investors is that we don’t need coal to be relevant in the long term anyway. Based on current prices on the coal futures market, you can recoup your investment and more in just one year.
Looking at the company on a cash basis (will explain why at the end of the post), Geo Energy is projected to have and to generate SGD 722m of cash by end 2022. This is 35% more than the current market cap of SGD 534m. And we are not even considering the future cash flows from 2023 and beyond yet!
Here is the summary of the SGD 722m. Calculations are based on information gathered from Geo Energy’s announcement on 13 Oct 2021.
|USD ‘million||SGD ‘million|
|Net cash at at 10 Oct 2021||62.4||84.4|
|Cash profits for 4Q2021||150||202.8|
|Cash profits for FY2022||322||435.4|
|Total as at end 2022||534.4||722.6|
Net cash at at 10 Oct 2021
Based on announcement dated 13 Oct 2021, Geo Energy has USD62.4m of cash, equivalent to SGD84.4m. There is practically no more debt after the full redemption of the USD bonds.
Cash profits for 4Q2021
The Group is targeting production and sales volume of over 1 million tonnes per month from October to December 2021. At today’s coal prices of USD122 per tonne, the Group already has an average cash profit of over USD50 per tonne. Cash profits per tonne for 4Q2021 is expected to be higher, considering that futures for coal prices for 4Q2021 is averaging USD135 per tonne. But let’s be conservative and use today’s prices for 4Q2021.
1m tonnes x 3 months x cash profit of USD50 per tonne = cash profit USD150m (SGD202.8m) for 4Q2021
Cash profits for FY2022
Geo Energy is able to produce 11.5m tonnes of coal per year, following the recent increase in quota obtained from the Indonesian government. Currently, the M42 Futures Index (4200 GAR coal which is similar to ICI4) on the SGX is showing 2022 prices to average USD100 per tonne. This is lower than today’s coal prices of USD122 per tonne, where the Group has an average cash profit of over USD50 per tonne. Although Geo Energy’s costs are linked to coal prices, lets just be conservative and assume that the ENTIRE price difference will eat into Geo Energy’s cash profits. This will result in a cash profit of USD28 per tonne (My guess is that it cash profits at USD100 per tonne of coal will be around USD40 per tonne, but I will be conservative for this computation).
11.5m tonnes x cash profit of USD28 per tonne = cash profit USD322m (SGD435.4m) for FY2022
A bumper dividend soon?
Geo Energy’s board has a good record of generously sharing profits with minority shareholders. This is quite rare for Indonesian companies. The Chairman has even complained in last year’s annual report about not being able to pay more dividends last FY because of the debt covenants: “As part of our Group’s strategic objectives to deliver value to our shareholders and our commitment to deliver dividends that increase over time in line with growth in earnings, the Company proposes a final dividend of S$0.008 per share, representing a dividend yield of 4.7% based on the closing share price of S$0.17 as at 31 March 2021. If not for the debt covenant restrictions, we would have been able to pay a higher dividend. These restrictions will no longer apply once the US$ Notes are fully repaid upon maturity in 2022. We can then pay a higher dividend based on our dividend policy of at least 30% of the Group’s profit attributable to Owners of the Company.”
Now that the bonds have been fully redeemed, the board is able to pay at least 30% of net profits as dividends. Given that the payout was previously suppressed due to the bond covenants, I think there is a good chance for a bigger payout this year.
- Coal Prices may decrease more than expected
The futures market offers the best prediction of future prices. But it is far from a sure thing. The market’s expectation is for GAR4200 coal to average USD100m per tonne in 2022. But when the time comes, coal prices may be higher or lower than what the market expects it to be now.
- Diversification risk
The CEO has stated that the groups 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. But as of now, we don’t know what these new business will be. Given that coal is not going to be viable in the long term (10 years or so later), diversification is unlikely to be complementary or have any synergies with their current business. Therefore, the current team may face harsher odds in succeeding in the new business. Personally, I prefer that they just distribute all profits back to shareholders, and let us invest the proceeds ourselves.
Some older investors may recall that a few years ago, they did borrow lots of money (the 8% USD bonds that have just been redeemed) without a confirmed acquisition target. The company ended up paying a lot of interest expenses for an acquisition that did not materialise. This indicates that Geo Energy’s management is very aggressive and has a high risk appetite. Its not necessarily a bad thing (high risk, high returns). But it is something that investors should be aware of.
- Personal troubles of management
The Chairman, Charles Antonny Melati, is being charged for drink driving for the second time. The impact on the group if he gets jailed is unclear.
Side note: Why the focus on cash profits, rather than accounting profits
For companies in the resource/ mining sector, the term “cash profits” is mentioned quite often. The main difference between net profit and cash profits is that net profit includes non-cash amortization which are not relevant to today’s investor. The amortization is mainly made up of:
- Depreciation of mine assets. Geo Energy paid millions of dollars to purchase their coal mines years ago. The value of these mines are recorded at the cost paid and are being depreciated as its reserves are mined out.
- The amount spent to remove the jungle, rocks and soil that were above the coal resources was not expensed off, but were capitalized as an asset called “deferred stripping costs”. Accounting wise, this is an appropriate treatment because the value of a mine itself would have increased. This “deferred stripping costs” is then amortized as coal is mined out so that the costs is somewhat shared across all batches of coal throughout the mine’s life.
These non-cash amortization expenses make accounting sense. But to me, these are sunk costs that have been paid for, and I take them as past expenses. To make matters worse, the amortization takes into account the levels of coal reserves, which involves quite a bit of judgmental input. Well, I am buying into the company as it is now. So, I don’t care about the book value of the coal mines, equipment etc. I am only concerned about the net cash on hand now, and the cash that they are making from selling the product less costs of mining.