Description

CONSOL Energy (CEIX) $37.87

CONSOL Energy (CEIX) represents the coal assets of the legacy CONSOL business with the E&P assets being renamed CNX Resources (CNX). The separation was accomplished by a 1:8 spinoff distribution of CEIX from CNX on November 29, 2017.

CONSOL Energy presents a compelling investment opportunity because it is a high-quality collection of assets run by a capable management team in a highly out-of-favor industry. As such, perceived risk is far greater than probable realistic outcomes.

The Company controls three coal mines in southwestern Pennsylvania. These coal mines are notable for three factors:

·         Low-cost producers

·         High-quality coal in terms of high btu content and low sulfur content

·         Geographically well situated on two rail lines and in proximity to eastern customers

Coal will eventually be discontinued as an energy source, and not because the planet will run out of coal reserves. Coal currently supplies 30% of US electrical power, down from 50% a decade ago. While another 10% diminution is likely in the next decade, it will take another 10-15 years before the US is not using coal to generate electricity. However, the low-cost operation of these assets and their geographically desirable location ensures that they will be some of the last mines operating.

In addition, management has created value by carefully selecting its customers. Specifically, they target high quality power plant operators in the eastern US that are accessible by rail. Like the CONSOL mines supplying them, these operators will have some of the last plants running because of their efficiency and relatively strong environmental standing.

In the meantime, the developing world is increasing its coal consumption. While China is trying to reduce the expansion of coal-fired electrical plants, India is building new plants. A growing amount of US coal will enter the export market and CONSOL is uniquely positioned by owning a 200 shipping terminal in Baltimore that offers low cost transport to Asian, European and North American markets.

World coal industry capital expenditures peaked at $17.7b in 2011 and have fallen sharply to $6.0b in 2016. Minimal new coal supply is coming to market. In addition, CONSOL expects that it can run its existing mines at full capacity for their remaining useful lives of 26 years at only maintenance levels of capital expenditures because of prior investments of $1.4b over the last decade.

The limited amount of new supply coming online, combined with the decrease in supply as high-cost mines shut due to falling demand should result in a more favorable pricing environment going forward.

Management is experienced and committed to de-levering the balance sheet which stands at a reasonable 2.1x net debt/EBITDA. Given a terminal value of zero, de-levering the balance sheet will be necessary to maintain equity value. Management incentives are driven by free cash flow generation, leverage targets and share price. On December 18^th, CONSOL announced a $50MM share and note repurchase authorization. In addition, there is a cash flow sweep on the term notes.

An additional unique lever that CONSOL has is that they created a MLP structure CONSOL Coal Resources LP (CCR), which represents 25% interest in the Pennsylvania mining complex. CONSOL has economic control of 90% via its 75% direct ownership plus LP unit ownership and 100% of the GP units. This structure allows for additional financial flexibility as CEIX can drop down assets into the LP and use the LP as a financing vehicle. Additionally, CEIX can monetize the LP units it owns directly.

Currently, CCR has a market cap of $415MM and an enterprise value of $666MM, representing 25% economic interest in the Pennsylvania Mining Complex (PAMC). This implies an enterprise value of $2,666MM for the PAMC and $2,399 for CEIX’s 90% economic interest in the PAMC.

To substantiate that number, assuming production for the next twenty years at current levels and pricing with a zero terminal value and a discount rate of 15% gives a value of $2,128 for CEIX’s 90% economic interest in the PAMC. There is likely upside to both production and pricing.

EBITDA was $363MM in 2016 and $357 LTM. Maintenance capex is around $50MM. 2017 capex should be around $100MM due to the spin.

In addition to the PAMC, CEIX owns the 200 acre shipping terminal in Baltimore outright. This asset generates very little cash flow but is likely worth $100MM and could be monetized in a sale-leaseback, or developed further to increase returns.

Finally, CEIX owns an additional 1.6 billion tons of coal reserves. Assuming a very low value of $0.25/ton, this asset represents another $400MM in assets that could be monetized.

In total, this yields $2,628MM - $2,899MM in enterprise value. Less $919 in pro-forma debt at the spinoff, yields an equity value of $1,709MM - $1,980MM, which on 28MM shares outstanding equates to $61.04 - $70.71 or  61% – 87% above current prices.

Pension, non-retirement and environmental liabilities are $1.2b and the service cost of $85MM/yr has been included in cash flow so I haven’t added the liabilities to debt.

In summary, CEIX is a very well positioned, high quality asset run by an experienced management team that is properly incented and should benefit from some industry tailwinds and has multiple levers to extract value.

Catalyst

favorable pricing environment, de-leveraging, utilization of LP and monetization of other assets