10 reasons to buy a steel-making (coking coal) company, and why it should be Colonial Coal

I’m revisiting this article from two months ago as news on another coking coal company in B.C. Canada caused a major selloff in Colonial Coal’s share price (down 24% on 38x avg. daily trading volume). Is this an epic buying opportunity, or are shareholders going to be bag holders for another year or two?

In the week before Christmas two meaningful events took place in B.C.’s Peace River Coalfield (“PRC”). Glencore’s Sukunka coking coal project was denied an “environmental assessment certificate,” and Teck Resources’ sold its Quintette coking coal project to Conuma {see map below}.

In addition to paying C$120M, Conuma will assume Quintette’s obligations (most notably for reclamation) which are rumored to be C$200M+, and has granted Teck a whopping 25% net profit royalty. As Conuma is an open-pit miner, it might not even touch the vast majority of the coal resources being acquired. If true, it’s paying a hefty premium for < 50M open-pit tonnes.

Does this mean that Conuma is MORE or LESS likely to be an acquirer of one or both of Colonial’s projects? I don’t know, but a PRC coking coal asset that was for sale is no longer on the market. I’m not placing a per tonne valuation on this transaction due to several unknowns.

NOTE: I have no prior or existing relationship with any person or company mentioned, but I do own shares in Colonial Coal (TSX-V: CAD) / (OTCQX: CCARF).

Colonial is a steel-making [coking or metallurgical (met) coal] development company with two 100%-owned projects in one of the world’s premier coking coal regions, the Peace River Coalfield (“PRC“) of B.C. Canada.

Both projects have Preliminary Economic Assessments (“PEAs“) on them. There’s a combined 695 million metric tonnes (“mt“) of high-quality (premium hard & PCI) Measured + Indicated & inferred resources (not reserves). {see risk factors at bottom of article}. [Corporate Presentation].

The projects have been for sale via an investment bank process since 1H 2019. Management maintains that COVID-19 has been a major contributor to the slowness in finding buyers. I believe them.

However, some question the ability of a buyer to get permits, maintain strong First Nation relations, fund regional infrastructure buildouts, etc. Others fear that geopolitics will prevent the Chinese, or companies from other countries, from bidding.

A prominent concern; will “green” hydrogen replace the need for coking coal in the blast furnace phase of the steelmaking process?

NOTE: {Hydrogen’s use in steelmaking remains at pilot scale. It would take a long time to switch to hydrogen on ~1.3 billion tonnes/yr. of blast furnace-derived steel. Also, leakage of hydrogen from exploration, transport, storage & end-use is a serious, unresolved issue}.

If/when demand for seaborne coking coal starts to wane, the best quality coals, (like those from the PRC basin), will be the last to go as they burn cleaner & more efficiently.

For a number of logistical & transportation-related reasons, high-quality seaborne coking coals will remain in demand longer than other coals. Virtually all of the growth in blast furnace demand is coming via the seaborne market, mostly into Asia from Canada, Australia & the U.S.

Please continue reading — 10 reasons to care about coking coal, and especially Colonial Coal.

#10 — Consuming coking coal is a necessary evil. There are no medium-term substitutes that can be deployed on a widespread basis, at reasonable cost.

After decades of trying to reduce the use of coking coal, centuries-old blast furnaces account for roughly two thirds of global steel production.

#9 — Colonial’s valuation is quite attractive. Investors have been waiting years for the Company’s projects to be sold, investor fatigue has set in.

On an EV/resource tonne in the ground basis, Colonial is valued at just US$0.213/tonne [updated 12/22, C$1.05 shr. price]. This compares to a number of historical M&A deals done at US$2.00+/mt.

Inflation this year is the highest since the early 1980s, AND coking coal prices are as strong as they were for most of the previous bull market in 2010-11. These two factors support the potential for a robust EV/tonne valuation.

Chatters on CEO.ca {a Canadian stock dashboard/online community} debate the takeover price, saying it should be US$2-$3+/mt, but even US$1.00/mt would be a +363% premium over the current price of C$1.05/shr. {Dec. 22nd}.

At US$1.50/t it would be a +593 gain, @ US$2.00/t, +824%. I recognize that these outcomes sound too good to be true. However, investor fatigue is a powerful force. {updated 12/22…}

At US$1.00/t, I think there would be several eager bidders, if only to keep the assets out of the hands of competitors. For instance, Teck Resources, Anglo American, Glencore & privately-held Conuma Coal should care as they all have projects and/or existing mines surrounding Colonial.

Note: {update — on 12/21/22 an “environmental assessment permit” for Glencore’s B.C. coking coal mine was denied. This caused the share price of Colonial Coal to fall to C$1.05 in 12/22/22 on 38x avg. daily trading volume (low of the day was C$0.95).

While over 18 (updated 12/22) coal names have soared 100%+, (as much as +451%), Colonial is in the bottom 15% in terms of gains from 52-wk lows, up just 9% (from today’s 52-wk low).

#8 — Dozens of financially strong companies — mostly steel & coal companies from the U.S., India, China, Brazil, Canada, Korea, Japan & Australia — with valuations well into the US$10’s of billions — can afford to buy Colonial’s assets AND fund development to lock-in decades of low-cost supply.

Importantly, potential bidders have dramatically cut debt levels and improved their finances. For example, Teck Resources’ net debt / EBITDA ratio on a trailing 12-month basis is <1.0x, and Steelmaker ArcelorMittal’s leverage is <0.5x.

Australian coal producer Whitehaven Resources is expected to generate a total of C$7.85 billion in EBITDA in 2022-2023, {updated 12/22}, slightly less than its Enterprise Value (“EV“) {market cap + debt – cash} of C$8.3 billion.

#7 — Strong management team, board & advisors. Not only do senior execs & advisors have coal & steel industry expertise and an operations background, they have been active in coking coal M&A. The team has strong contacts in China, India. the U.S. & Australia, and ties with (at least) Anglo, Teck & Glencore.

CEO/Chairman David Austin sold both Western Coal & NEMI at the top of the market in 2010-11. Yet coking coal fundamentals today appear just as strong. Mr. Austin has stated that there are over ten active NDAs in place.

#6 — Coking coal is a tangible, hard asset. Real assets, especially critically important industrial commodities, offer inflation protection. Metals & Mining companies often outperform in inflationary environments and in periods when value investing becomes favored over growth.

#5 — Unlike producing coal companies, Colonial is NOT saddled with; debt, legacy liabilities, elevated pension/healthcare obligations, high reclamation costs, etc. An acquirer of Colonial’s assets should be able to avoid — or better manage — coal-specific issues that existing producers are stuck with.

#4 — Location, location, location. There’s ample regional infrastructure [power, water, rail, roads, west coast ports]. Some infrastructure buildouts will be necessary, but not a huge deal in the overall picture.

Moreover, an acquirer of Colonial’s assets will be able to partner with producers & developers to advance regional infrastructure. Importantly, CEO Austin has agreed to remain involved post-sale to help commercialize the projects.

The PRC is one of the two best coking coal basins on the planet. Only Australia’s Bowen Basin is as good or better. Colonial’s projects are surrounded by Teck, Anglo, Glencore & Conuma.

Conuma could more than double its 4 million tonne/yr. operating rate by acquiring Colonial’s two projects. As of 2020, Conuma’s three mines + one project had a combined 50 million tonnes of proven & probable reserves.

#3 — Colonial’s projects totaling 695 million Measured + Indicated & Inferred tonnes of resources (not reserves) represent a globally-significant endowment. The specs in the PRC region are well understood. PRC coking coal has been shipped to Asia, most notably Japan, for half a century.

#2 — Significant global supply concerns. Russian production of seaborne coking coal will be in decline due to a lack of growth & maintenance capital investment.

Increases in Australian supply is at risk from ongoing weather challenges [climate change], labor shortages, ESG concerns & uncertainty over Chinese/Australian relations.

The U.S. shares some of Australia’s supply challenges (+ railway bottlenecks) and is viewed as a swing producer. Given very high thermal prices due in large part to Russia’s war on Ukraine, a portion of U.S. coking coals are crossing over to the thermal market.

Clearly, Asian blast furnace operators would benefit from locking-in security of supply (and a very low long-term price) by diversifying across as many reliable, long-term sources as possible.

#1 — The economics of Colonial’s projects, as seen in their PEAs, has greatly improved with the substantial increase in coking coal prices from US$160-174/(C$209-$224)/mt in the studies [2010-11], to more like US$225/(C$308)/mt today.

NOTE: {Inflation is running at 40+ year highs, and coking coal prices are strong. Australian coking coal futures out to 12/31/2026 average ~US$240/t, and the current Chinese coking coal futures price is ~US$342/t}. {Updated 12/22}

By my rough calculations, the combined after-tax NPVs are > C$4 billion on higher prices, even allowing for meaningful increases in op-ex & upfront cap-ex.

A buyer at US$1.50/t would be investing a total (including cap-ex) of < C$3 billion spread over the next several years to own over C$4 billion in today’s (after-tax) NPV(5%).

RISK FACTORS — Viable coking coal substitutes like green hydrogen could become available at large-scale & reasonable cost sooner than expected. Perceived permitting/environmental hurdles & geopolitical challenges could preempt bids from key prospective buyers. Currently solid First Nation relationships could diminish. The fact that it’s been > 3.5 years without a reasonable bid means there could certainly be red flags that I’m missing.

CEO Austin and/or his team, advisors/bankers could be overly optimistic [groupthink] on the prospects of selling Colonial’s projects. Colonial stock could be halted for weeks at a time if/when bid(s) come in. Coking coal prices could fall back under US$175/t for an extended period. Trading liquidity in Colonial’s shares is very poor. Even after material delays, the sale or one or both projects could still take many more months. The Company has ~12 months of cash before needing to raise a few million dollars.