Description

International Coal Group

International Coal Group is Wilbur Ross’s new coal company formed when he bought the assets of coal miner Horizon Natural Resources out of bankruptcy. The company trades at a large discount to peers when it should trade at a premium. A unique situation is created here by the trading status of the stock and by the lack of information available.

The stock is currently at $10, with 106mm fully diluted shares this puts the market cap at $1.06bn and they have $105mm of debt on top of that for an EV of $1.16bn. Total reserves are 993mm metric tonnes and production was 15.1mm metric tonnes last year. They achieved an average price of $36.32/tonne in 2003, spot prices are currently in the high 50’s-low 60’s on the Big Sandy Barge contracts.

Bankruptcy projections are for $165mm in EBITDA in ’05 and $175mm in ’06. However, they have not adjusted the projected price for 6.3mm tons of uncommitted coal, and they estimate that this will result in an additional $50mm annual boost to EBITDA in the current environment. So EBITDA should come in around $215mm in ’05 and $225mm in ’06.

This isn’t a complicated idea. ITCL is trading at 5.4x next years EBITDA while comps are trading at around 13x trailing EBITDA and 7x next years estimates. On an earnings basis ITCL is trading at less than 10x next years earnings while comps trade at a forward p/e 15x-16x.

However, these numbers understate the true discount. The union and pension issues change the picture dramatically when they are considered. Out of the universe of comparables(BTU, CNX, MEE, ACI, WLB, FCL, ARLP) only ARLP is non-union and MEE only has a small union component. All the others are heavily unionized. The others also have significant liabilities in the form of workers comp, pension, and environmental liabilities. The size of these liabilities would add between 16% and 104% to the EV of the comps, with 52% being the average. ITCL has no liabilities in this regard apart from a $40mm environmental reclamation liability. If you consider this when calculating EV/EBITDA then comps are trading at about 10.5x EV/’05 EBITDA compared to 5.5x for ITCL. You can’t quantify the union issue in the same way but all else being equal a non-union company should trade at a premium to a unionized company.

And after all is said and done the valuation is supported by cash earnings, which other companies in this industry have a hard time finding.

The long term outlook for coal in the US is also bright with over 100 coal fired power plants in development and there is talk from the gov’t of relying more on coal to cut independence on foreign oil. The US has more Btu equivalent in coal than Saudi Arabia does in oil.

Furthermore, ITCL has low sulphur, high Btu coal – the best there is. Only Massey has a potentially better reserve profile.

What are you buying and who is selling it?

This is a private company. We believe the bank debt holders have received a 100% or greater return since August and have begun to cash out by equitizing their holdings and selling it on the the Pink Sheets. The other issue is that there has been confusion and surprise, even among the brokers selling it, that the stock is legended and comes with restrictions attached. You will probably need a lawyer.

Financial information is not widely available for ITCL. They do not file with the SEC, all our research and analysis has been done using bankruptcy court filings.

Catalyst

-trading at a large discount to peers, when a premium would seem warranted.
-Coal stocks have been screaming and IPOs have been coming to market. Foundation Coal(FCL) is a recent IPO and Alpha Resources has just filed their S-1. Wilbur Ross must see the opportunity as well. We think the lack of information and the fact that this is a private company are the only reasons for the discount but an IPO would remove both of these negatives. A 2nd Wilbur Ross IPO would also be well received after what he did with ISG.
-We don’t know what his plans are but if Wilbur Ross were able to make another great deal like he did with Horizon then that would add value.