A Fool goes mining for deep value in the coal sector.
Despite its outdated image, coal is still just as important as oil when it comes to keeping the wheels of industry and commerce rolling. Here in the UK, 30% of electricity is generated using coal-fired plants, and in the USA -- the world's second-biggest coal consumer -- almost 40% of electricity is still coal fired.
In emerging economies like China and India, the proportions -- and the sheer volumes -- are greater still.
Solid as a BRIC
Despite the slight slowdown in China's economic growth, electricity generation rose by 7% in 2011 and steel production also rose strongly; both of these are heavily dependent on coal. China's domestic coal production is not expected to keep pace with demand over the next few years, resulting in increased imports.
It's a similar story in India, where coal-fired power generation rose by 9% in 2011. Estimates suggest that 90GW of coal-fired power generation is due to come online in India and China alone this year, resulting in demand for an additional 300m tonnes of coal.
Profiting from coal
Two UK companies that have made impressive profits from coal are Drax Group (LSE: DRX) and Hargreaves Services (LSE: HSP), both of which I looked at earlier this year. Today I would like to look at some of the other opportunities in the coal market -- one of which is close to home but has a potential twist in its tail.
The biggest of today's threesome by far is Bumi plc (LSE: BUMI), a FTSE 250-listed Indonesian coal miner. The company owns a number of coal mines in Indonesia and exports 85% of its production, mostly to China and India, two of the world's largest coal importers.
Bumi's shares have fallen by 60% over the last year, despite a fairly decent set of results and a $600m cash pile. Its current £1.3bn market capitalisation puts it at a discount of about 30% to its tangible assets and it mined 85m tonnes of coal in 2011, up 9% on 2010.
The problem with Bumi is its debt, which is part of a wider leverage problem being experienced by the main shareholders in Bumi, Indonesia's Bakrie Group. Although Bumi's net debt is a manageable $222m, the net debt at its largest subsidiary, PT Bumi, was $4.4bn at the end of 2011, overshadowing PT Bumi's revenues of $3.5bn for the 10 months to December 2011.
Reducing the overall debt burden and lowering its cost of capital is Bumi's main priority and it expects to make good progress on this in 2012, reducing PT Bumi's debt burden by starting to repay a $1.3bn loan from the China Investment Corporation and refinancing a further China-backed loan, from the China Development Bank. If Bumi can get on top of its debts, it should be a profitable and sustainable business, with good growth potential.
UK Coal (LSE: UKC) published its full-year results last week and, when I first looked at them, I was struck by the apparent good value on offer.
Following four years of losses and the announcement in March that it might have to close its problematic Daw Mill mine, UK Coal had returned to profit, delivering a pre-tax profit of £58m, considerably better than forecast. This left the company trading at about 30% of its net asset value of £146m, which includes a £280m property portfolio.
There were still problems with debt (£139m) and a pension deficit (£430m) to resolve, but a planned restructuring and the unrealised value of the property portfolio seemed to offer a potential route out of this problem, providing an attractive value proposition.
The problem is that since then, UK Coal's share price has gone ballistic, rising by 90% to 23.5p from its pre-results level of 12.5p, an all-time low reached after the announcement of its problems at Daw Mill. Prior to this, it was trading fairly stably at 30p; meaning that it is still 20% cheaper than it was in March.
My concern is that the reaction to UK Coal's return to profits has been overdone and may end up undergoing a further correction when investors realise that some problems remain.
UK Coal is proposing to spin off its £280m property portfolio into a separate company, along with some of its debt and pension liabilities. Its banks have yet to approve this but further equity fundraising might also be required and this solution leaves an unclear picture of the resulting net asset value of the coal business.
I'm now more cautious on UK Coal and would be inclined to wait for things to settle down before making any move.
Atlantic Coal (LSE: ATC) is an AIM-listed American coal miner, which operates the Stockton Colliery in Pennsylvania. It sells its coal locally and is experiencing strong demand and rising prices for its high quality anthracite coal.
Last year was a year of below-expectation growth and teething troubles, but this year production has really taken off -- up 12% in Q1 compared to Q1 2011 -- and Atlantic has finished the delayed commissioning of a rail link that will give it access to a further one million tonnes of previously unworkable reserves.
Although Atlantic Coal's share price has already risen from a low of 0.3p to 0.47p, I think it is likely to rise further this year as production scales up and the company reaps the rewards of strong local demand for its coal.
Mining is dangerous
All of the companies mentioned above -- from £1.3bn Bumi to £17m Atlantic -- carry a fair level of risk. Things may not go to plan or they may get worse before they get better. For my money, UK Coal has become the most risky following the near doubling of its share price in the space of three trading days.
If any of these interest you, I would suggest you look into the facts and figures thoroughly for yourself before making any decisions – these ideas are no more than a starting point for in-depth research.
David Kuo challenged his Motley Fool analysts to pinpoint the attractive sectors of 2012 -- and they delivered! Discover the industries they selected in this new Motley Fool guide -- "Top Sectors Of 2012" -- while it's still free!
Further investment opportunities:
> Roland does not own any share mentioned in this article.