Republished from ThumbTackInvestor with permission

SDJ1.16b@ Geo Energy's SDJ mine in Kalimantan. Photo: Company Geo Energy Resources’ FY17Q1 is really interesting. Although I usually take a bottom-up, focused, deep value approach, for Geo Energy, my modus operandi has always been to focus on the macro picture.

This is because it’s obvious that the current and future coal price is by far the main consideration when it comes to Geo Energy.

Geo Energy Resources Investing Thesis – Part I
Geo Energy Resources Investing Thesis -- Part II

In this respect, the markets are pretty forward looking when it comes to Geo Energy.

 US$’m

1QFY17

1QFY16

Change

Revenue

99.3

11.9

735%

Gross profit

25.3

0.3

nm

Profit from continuing ops

14.6

(2.9)

The company delivered on the earnings front.

On paper, it looks pretty damn impressive. Revenue grew 735%, while earnings flipped from being negative a year ago, to a massive US$14.5mil.

Yet the share price dropped the next day.

Now, let me try to illustrate a point here.

On InvestingNote, someone said he bought just prior to the earnings release, because he was expecting stellar results, and he hoped to make a quick (probably small too) profit on this.

I warned then that I’m not so sure that’s going to happen. The problem with this chain of thought is that it’s too simplistic, it’s pretty much level 1 thinking. As a matter of fact, I sold 200,000 shares at $0.32 just prior to the earnings release.

"Currently, I still own 400,000 shares, bought at an average price of $0.157, and upon receiving dividends at the end of May, my average price will be further lowered to $0.147."

-- ThumbTack Investor

My rationale is more macro in nature. But I was expecting the share price to dip after the earnings release, despite expecting good results. I’ve since bought back the 200,000 shares at a lower price, further lowering my average price.

Now, the problem with thinking “ok, results are going to be stellar. I’ll buy before it comes out, and sell after it comes out for a quick profit”, is that EVERYONE knows the results are going to be good! Which is why I said that’s level 1 thinking.

It’ll only work out if you know and everyone doesn’t. Or if everyone expects it to be good, but it turns out to be SUPER good.

Why then did I sell 200,000 shares, and was confident I’d be able to buy back at a lower price?

The macro picture.

The company increased its average selling prices in FY17Q1, from US$38.93/tonne in FY16Q4 to the current US$39.45/tonne.

The slight disappointment is that they moved about 2.2mil tonnes of coal in Q1, vs 2.36mil tonnes of coal the previous quarter. The reason for the slight dip is that seasonally, it’s been raining and that resulted in some days where mining activity had to stop.

That’s not good, but it didn’t just affect Geo Energy. Adaro Energy, the largest (I think, or the 2nd largest) coal miner in Indonesia, also gave the same reason for a flat coal production in Q1.

If that’s the case though, we’ve got a bit of a problem.

Because Q1 is not the period when Kalimantan has the highest rainfall!

529) South Kalimantan weather.jpg

The peak rainfall is usually towards the end of the year, around Q4.

The smaller “peak” each year, coincides with the March, April, May periods. Meaning the rainfall in South Kalimantan (Kalimantan is a big place, the SDJ mine is in the south) increases gradually from Jan to May period, before easing quickly in June, and we’ll have relatively dry days all the way till Nov/Dec when the rainfall jumps to the highest for the year.

So if Q1 rainfall is enough to limit a coal miner’s coal production…. hmmm, won’t Q4 be a problem?

I checked the past records for Q1. Now, I’ve arbitrarily taken 18mm of rainfall as the amount that would disrupt some mining activity for the day.

In Q1, I’ve counted that there are 18 days where the rainfall exceeded 18mm.

In Q2 thus far, and we’re smack in the middle of Q2, we’ve 12 days where the rainfall exceeded 18mm.

So yeah, you can make your own conclusions from this data.

In my opinion, though, the rainfall and its effects on coal production is still not the biggest factor. The biggest factor, is of course, the coal prices that Geo Energy can sell for. I’ve previously described why:

https://www.nextinsight.net/story-archive-mainmenu-60/938-2016/11059-geo-energy-to-buy-or-not-to-buy-overriding-consideration-is-coal-price

And the forward picture in Q2 is not good. Coal prices have been dipping since the start of Q2. Since the start of April, it’s just been dropping relentlessly.

All credits to sxcoal.com:

China Coal Daily Track (May 11)

(2017-05-11 15:16:00)

Thermal coal

Domestic market

China's major coal production bases reported price drops amid increased stocks and waned demand, and thermal coal prices are expected to further decline in the near future. Shaanxi saw a 15-20 yuan/t mine-mouth price drop of thermal coal this week. Coal prices in Shanxi and Inner Mongolia slid some 10 yuan/t and 10-15 yuan/t, respectively. Environmental checks may affect production at coal mines in Shanxi.

In seaborne market, price of the 5,500 Kcal/kg NAR coal was on the decline, with its mainstream offer price at 590-600 yuan/t FOB. Mainstream offer price of the 5,000 Kcal/kg NAR coal -- 515 yuan/t FOB -- was still way lower than cost.

Import market
Few deals were heard concluded, and China may ask power firms to reduce low-grade coal imports, in order to spur
domestic demand and ensure favorable effect of coal capacity cut.


On top of that, China’s NDRC has recently indicated that they’re going to limit the import of low quality coal, the bulk of which comes from Indonesia.

http://www.szdaily.com/content/2017-03/16/content_15669775.htm

http://energy.economictimes.indiatimes.com/news/coal/china-authorities-power-firms-discuss-curbing-low-quality-coal-imports/58610678

Essentially NDRC wants to limit the import of low calorific coal. So what exactly is low quality coal?

NDRC didn’t state clearly, except say that it’s usually “high sulphur content” coal , with high ash levels. These are usually the GAR 3200, GAR 3800 coal from Indonesia.

Geo’s coal characteristics, according to SDJ mine’s JORC report (page 21):

89 % of coal tonnes come within a TS range of 0.1 % to 0.3 % x

94 % of coal tonnes VM is greater than 39 % x

81 % of coal tonnes come within an Ash range of 4 % to 7 % x

89 % of coal tonnes GAR Energy come within a range of 3900 to 4300 Kcal/Kg

I’m not sure if Geo’s coal falls into NDRC’s classification of “low quality”. I suspect not. Geo’s sulphur content is well below the 1% limit that China sets.

Alright, so all that is bad news. Now for the good news.

Summer is coming! Traditionally, China’s power usage shoots up in the hot summer months, as the Chinese crank up their air conditioners. The power plants know this, and they stock up on coal 1-2 months before that. That means sometime towards the end of May – June, utilities would have to increase their buying.

Most coal traders believe that the utilities would have to pick up their buying towards the end of May. Coal price for GAR 4200 coal is currently being offered at US38-39/tonne at most ports.

The other good news, or rather, potential good news, is that the company is guiding that the acquisition of TBR mine will be completed sometime in 2Q. I believe they will announce an offtake agreement together with the acquisition. Now, completion of the acquisition of TBR would likely be a major catalyst for the share price, and right now, this is the main catalyst in my investing thesis.

With TBR acquired,  the management’s guidance of 10mil tonnes of production in FY17 would be more likely to be met. And it’d be a major plus for the management’s strategy of amalgamating both plots of mines (SDJ and TBR sit side by side). Efficacy shoots up, as both mines use the same infrastructure, while total mined volume will rise exponentially.

So let’s go back to the financials and try to look at some tea leaves to predict the future.

Right now, the company just did 2.2mil tonnes of coal at US$39.45/tonne. The company also reported some earnings from coal trading, and from their mine management agreement with their neighbor AJE. I’ve also noted that these extra revenue generators lifted the gross profit margins from the coal mining segment. (Their GPM figures are higher than that of coal mining)

In my DD, I’ve played with the variables: total tonnage moved for FY17, Average selling prices, and the operating costs, to finally derive a range of possible share prices. It’s kinda cumbersome (and monotonous) to type all that out here though, so I’ll just take the lazy way out and assume the company performs the same for all the subsequent 3 quarters for FY17.

This means that assuming Geo Energy moves 8.8mil tonnes of coal in FY17 (they fail to meet their 10mil guidance), at an average price of US$39.45/tonne (ASP for Q1), approximately, we’ll be expecting US$58.54mil in earnings for FY17.

I’m going to loop off a huge 25% chunk from this for a bit of buffer as the coal prices have since dropped from Q1, and also because we are making some projections and these results are unrealized.

That leaves us with US$43.9mil. The current total share base is 1,212,273,113 shares, but I’m going to use 1,329,273,113 shares instead as the company is going to issue 117mil new shares as part payment for their acquisition of TBR.

That means that the projected full year earnings would be 3.3 US cents per share or SG 4.6 cents. Assuming a conservative PE ratio of 10, we have a fair value of 46 cents.

Obviously all this is contingent on many things going their way. There are so many variables, it’s hard to project with certainty. I think currently, the next major thing to look forward to, is the completion of TBR and the announcement of an offtake agreement.


Comments  

0 #3 Tencent 2017-06-01 10:50
Hello JQ, thanks for the insightful post. Just 1 thing to check with you : U said coal price was USD44.68 in Apr and USD45.28 in May. Are these correct ones to cite for GEO's coal? I thought I read somewhere the prices are/were below US$40 per tonne.
Quote
0 #2 jinwen 2017-05-31 19:29
Hi great write up and analysis on Geo Energy!

One thing I noticed was that the company is right regarding January being the highest rainfall period. South Kalimantan is a very large area, and the area which you have set looks to be slightly off where the mine is. The mine is at the Sungai Danau area.

https://en.climate-data.org/location/589820/

This link shows the precipitation data for that area, and q2 is a much drier period, which hopefully the company will be able to extract more and outperform expectations.
Quote
0 #1 JQ 2017-05-29 23:10
Hey, really appreciate your post. It is insightful.

Personally, I believe FY17Q2 will do well. In my opinion, Q2 performance will be based on 2 things, 1) how much coal they can produce and sell 2) Coal price.

1) How much coal can they produce and sell?
I believe they can produce and sell >2.2mil tonnes of coals in Q2, since it is no moonsoon season. I think it is highly probable they can hit the 10mil tonnes of coal this year. The ECTP agreement in FY16, they need to deliver min 4mil tonnes, but ECTP paid 20mil prepayment which means the actual deal is to deliver 5mil coals since prepayment is based on $4/tonne of coal, 20mil/4=5mil tonnes of coal to be delivered. At end Fy16, geo delivered 5.5mil tonnes of coal.

This round, although the agreement states 7mil, their actual deal is 10mil worth of coal as prepayment was USD40mil. Using $4/tonne as prepayment, 40mil/4=10mil tonnes to be delivered. Hence they have the demand for 10mil tonnes already. With the demand in place, can they actually produce 10mil tonnes? I believe they can, since 2.2milx4=8.8mil tonnes from SDJ. In addition, they made an offtake agreement with AJE to get 5mil tonnes of coal from them.

2) Price of Coal for Q2?
The average price for GAR4200 based on "The Directorate General of Mineral, Coal and Geothermal, Ministry of Energy and Mineral Resources, Republic of Indonesia" for 4200 GAR, the average price for Apr 17 is USD44.68 and currently May17 is USD45.28. So with the increased price in Apr and May, there is high likelihood that average selling price will be much higher than Q1Fy17.

So in conclusion with price increased and volume increased due to non-rainy season plus there is secured demand I believe strongly that Q2 will outperform expectations.
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