Description

Thesis summary: In a world of cheap commodity names, Geo Energy Resources, an Indonesian thermal coal miner, may be the most egregiously mispriced security of the lot. At 33.5c SGD it trades not just at <1x EV/EBITDA and 1.5x P/E on run-rate earnings but more importantly at 2.5x trough EV/EBITDA, assuming thermal coal prices immediately crash back to the lows, from 2022 - despite having 7-8 years of mine life left, coal prices still very elevated; half the market cap in cash today with zero debt; a new buyback in place for a bunch of the shares; and a dividend policy that suggests a 20% yield on 4th quarter earnings alone is quite likely forthcoming. By any reasonable or unreasonable DCF valuation (ie punitive), the equity is worth anywhere from a near-double to a near-triple. Management is in it to win it, with ~55% of the company controlled by insiders, who have recently repaid all debt and made their capital allocation priorities clear by instituting a buyback for 10% of the company (and ~25% of the float).

This opportunity exists because 'Indonesian coal miner' is a very dirty phrase in the investment world; this entity was formerly quite levered; the business model and cost profile of the assets improved immeasurably once they moved to outsourced mining using a contractor two years ago; and Indonesian family-controlled companies have a bad historical reputation (though there is no legacy hair on this security, that I can see). On the other hand, they have been assiduous stewards of capital lately; the entity is listed in Singapore, and is reasonably liquid ($3-5mm ADV); and they are most certainly aligned given the insider ownership.

I believe there is a decent chance you get ~15-20% of your capital back out of 4Q earnings; another 20%+ dividend next year; and the company buying in 10% of the share through 2022, meaning you could well get a 50%+ return of capital through buybacks and dividends alone. This all assumes coal prices far lower than current as will be discussed.

This is a simple idea so the write-up will be brief. Happy to answer any follow-ups in the Q&A.

Background: Geo Energy Resources, listed on the SGX, owns 2 Indonesian thermal coal mines (ICI4 is the benchmark grade, its quite low quality), and produces 11-12mt a year from a 77mt confirmed reserve base (100mt total resources) that suggests a ~7+ year remaining mine life (though it could be longer and probably will be as they explore and develop other tenements beyond the two operational today). 60% of revenues go to China; 20% to Indonesia, domestically (a quarter of production, at capped prices); and the rest goes to Korea. Geo receives the ICI4 benchmark (minus some discount, I believe 10% or so but it is not entirely clear) on the export tons (75% of production) and the capped local (DMO) set price on the 25% of production that is consumed domestically. The export market is where most all the profits are made and in this regards they are the mercy of seaborne mid-grade thermal pricing, so if you are bearish thermal coal this probably isn't for you.

They have been printing cash hand over fist lately, as you can imagine, but the most important thing to realize is that even at trough coal pricing (mid-$20s ICI4) through COVID the company was generating positive EBITDA ('cash profit' as defined by the company is essentially EBITDA):

Whilst the business obviously demonstrates positive operating leverage like other miners, since they moved to an outsourced mining model from the beginning of 2020 (Buma conducts the mining at their two mines under a profit sharing agreement linked to ICI4), costs have moved in quite a linear fashion related to market pricing - with cash profits being preserved at very low pricing per the above. In fact if we run a regression of all the reported pricing and cash costs reported quarterly since 1Q'20, along with the disclosed profitability of the business under 'max' ($150/t) and 'min' ($25/t) pricing scenarios (something the co disclosed in their latest presentation), we can create the below chart which demonstrates this linear relationship:

Because the profit-sharing agreement with their contractor allows them to still earn reasonable returns at very low prices, the business is actually much less risky today than it was historically. This informs the outcomes in a simple DCF (to be discussed shortly).

Where we are now: Geo has already disclosed that Q4 will be a record quarter, and that mid-Dec net cash is $164mm - half the market cap, AFTER repaying all debt and the interim dividend (3c per share out of 4.4c net income last quarter). Using the disclosures from the company (ASP, revenues in Oct and Nov, tons sold etc) along with the linear relationship above to derive cash costs, I think they will earn ~$145mm in EBITDA in 4Q alone - basically half the end-3Q EV, in a single quarter - and will generate 9-10c SGD in EPS. last quarter they paid out 70% of EPS as dividends, so they could clearly pay out most of this huge windfall, but even if its a lower number at say 60%, thats a 5.5-6c yield, or 16-18% of the current stock price simply from Q4 alone. Given cash disclosures thus far this would still likely leave the company with >$100mm of net cash on the balance sheet...

In other words even if we assume coal prices go straight back to the trough next year (say $25/t for ICI4) they would still be generating $70mm+ of EBITDA against a $180mm EV (today, mid-Dec - likely a good deal lower at year end). This is of course ridiculous given January (1mt probably) is likely already sold at similar levels and coal prices are going back up. But it demonstrates that this stock is quite different than other 'peak peak' commodity names, it is not trading at a reasonable multiple of normalized earnings, it is still trading at a ridiculous multiple of normalized earnings whilst there is no indication earnings will normalize soon.

Capital allocation: As previously mentioned Geo Management have been pretty strong stewards of shareholder capital lately. They shrewdly bought back half the USD denominated debt ($60m++ face), last year during COVID, generating >$30mm in excess profits (a large number against a small market cap at the time). Since repaying the balance of the debt in October they have upped the payout ratio (as mentioned to near 70% from 3Q earnings) - something debt covenants previously precluded. Then, the other day, they instituted their first buyback, suggesting they'll buy up to 10% of the company's shares - but really 20-25% of the float, given insiders own near 60% of the company - via an on-market buyback over time. To be fair, they have also mentioned 'diversifying' via M&A into non-coal assets - a risk, if they start empire building, to be sure - but since those pronouncements all they have done is talk about how undervalued their stock is and instituted a big buyback. So let's see.

Valuation: Given the short life nature of the asset we should probably use a DCF. Here, it doesn't really matter what you plug in, you are going to get a level far far higher than the current quote. If you assume ICI4 goes to  $55 next year (futures curve), $45 from 2023 and stays there (worse than the futures market) for the next 7 years of production; and use a 15% DR (this is Indonesia), you get a value for the equity around 80c SGD. If you take prices back to $30/t  in 2023 (ie not far off the lows) and use a simillarly punitive DR, you get a value of 62c. If you take prices to $25/t from 2022 (ie, immediately) AND keep the DR at 15% - you still get a valuation in the low 40s. 

Management had a valuation done by some 'experts', who concluded the mine assets as of end-August were worth $726mm USD - ie, ~70c per share. The company has since generated a huge amount of excess cash (from higher prices) since then, which is why a DCF run now on similar assumptions (which look conservative to me on costs, etc, anyhow) generates a valuation north of 80c. Again, still multiples of where we trade.

A simpler approach is to simply assess where we trade in EV/EBITDA or P/E or dividend yield terms at various realized prices (assuming the cost relationship holds). Here is what it looks like in 2022 at various ASPs:

I have no idea what coal prices are going to do, but if you're telling me they can go back to the stone cold COVID lows and I still get a 5% div yield (and the buyback) on top of a likely 15-20% capital return from 4Q - and more likely I get another 20%+ yield and the stock is really at 1-2x P/E - I like that setup. 

Reputational 'hair' and why its so cheap: the company is essentially controlled by Charles Melati (largest stockholder). Melati is an entrepreneur who previously worked in property and other industries like plastics; it is not entirely clear to me how he got his start in coal mining (this article has an interview with him, it doesn't really explain much other than he 'noticed a gap in the power market' and started some JVs with existing miners. He appears unaffiliated with any of the major families in the coal mining business in Indonesia (the Bakires, Bumi) or other conglomerates that dominate sections of the economy. As discussed, capital allocation and governance has been reasonable and quite good by indonesian standards - but all these companies are tarred with the same brush by foreign investors after the Widjajas screwed over foreign creditors at Asian Pulp & Paper post the Asian financial crisis. More recently, Indonesia has been an extremely difficult jurisdiction for foreigners to extract value (in distressed situations), so keep that in mind. Still, this is not a distressed situation; and insiders own almost 60% of the equity; and, I don't think Melati has any links to some of the bad actors historically. For what it's worth Jim Rogers - yes, that Jim Rogers - is on the board, and owns a few million (token) shares in the company.

Catalyst

huge Q4 div

huge Q4 earnings

ongoing buybacks tightening the float

time