$Geo Energy Res(RE4.SI) As a part-time-wannabe-analyst-without-a-blog on Geo from the desk of my home, this is my report.
The business model of Geo is very simple and easy to understand, with good business climate currently, and a strong balance sheet, income statement, cash flow, dividend payout and good management (what's there not to love?). That is why I am a strong proponent of this company and sometimes a little too enthusiastic.
Their main business model is holding the coal mines as an asset, in which they hire a mining contractor (BUMA), to mine the coal and sell it to an off taker (ECTP for SDJ mine). No capital expenditure required to mine the coal, with a mining specialist doing the job for you. Guaranteed sales with low credit risk due to the offtake agreement with the giant commodity partner as well. BUMA is paid per tonne based on a variable fee, depending on the coal prices. Higher coal price, they are paid more. However, Geo will still stand to make more profits as they sell for even more than the marginal increase in payment to BUMA (i.e. if they pay $1 more to BUMA per tonne, their selling price increases by more than $1). With a business model like that, it is also very easy to scale. Geo has just announced the US300M notes, which will allow them to acquire more mines and deploy this same business model, just like a photocopying machine.
At such a rate of coal production, they only have about 100m tonnes of proven and probable reserves and so people feel that they will run out of coal in a few years. This will not be an issue as they are still acquiring more mines to take advantage of the uptrend in coal prices, boosting reserves. Also, this uptrend in coal prices may last a few years, but it won’t last forever. So why get concerned about whether they have 1B in reserves or 100m in reserves when what is important is what you PRODUCE and SELL, not how much coal you have? 1B in reserves but if you can only produce 12m tonnes annually, then that is all you are going to earn. This company is valued at US265m market cap with a discounted future cash flow of more than US$600M. You can argue that this is dependent on coal price and all, but I think the margin of safety here is wide enough to rest your worries.
Currently, they have 2 mines, SDJ and TBR. At max annual production, SDJ can produce about 10 million tonnes for them, and TBR 5 million tonnes. This year, they were targeting to hit 8 million for SDJ, 2 million for TBR, hence the 10 million projection. However, due to TBR acquisition finalising later than expected, TBR’s output would probably be less than 2 million. However, SDJ’s output is still on track for 8 million. So if you are wondering if their production will be more than 8 million, 8 + anything is more than 8 million (math). Their contract with the mining contractor will also mean that there will be penalties if production falls short, hence 8 million is very likely. Going forward, with an annual max output of 15 million, what do you think their likely annual production will be? 12-14 million tonnes does not sound too far-fetched to me.
Offtake agreement concerns
ECTP is currently offtaking for SDJ, and they will announce the offtaker for TBR in due time (with certainty). Offtake agreement will ensure sales for their production, and mitigation of credit risk as they do not have to deal with individual small buyers.
In the last year, they made 2.2 cents per share and paid out 1 cent per share. Do you think they are likely to pay one dividend and then stop paying for future years? This year, when they make 7-8 cents per share, do you think paying out 1 cent per share is doable? Do you think there is room for an increase in dividend? (Probably) What are the implications for yield if they increase their dividend at current share prices? (Up) And so what will happen to their share price? (Up).
Indonesian domestic coal demand
Concerns about Indonesia making coal miners shunt production for the domestic coal market would not apply to Geo, as they do not have the agreement with the Indonesian government to produce coal for them, unlike Golden Energy. Hence they are able to mine and freely export their coal to foreign, more lucrative markets aka China. But the Indonesian coal market in my view still serves as a good support for coal demand in the future.
Competitive advantage due to type of coal
Coal is black and contains sulphur, but not all coal are equal. The coal that Geo produces is higher in quality with lower sulphur content, and to me this is their competitive advantage over other coal miners especially from China. GAR4200 is sought after by China, and they will always need it to mix with the locally mined coal in order to meet the governmental environment standards for power plant emissions (PCP turning treehugger these days). Coal still remains one of the cheapest forms of energy, and I doubt China even with its tree-hugging initiatives will completely abolish use of coal for electricity anytime soon. Since they will need low sulphur content to mix, the demand for Geo’s coal will always be there.
In terms of ability to ride out cyclical waves, they are one of the lowest companies on the cash cost curve, meaning that if coal prices fall, many other coal miners will be in the red before they are affected. Also, don’t forget that their cash cost will fall (slightly) together with coal prices due to their pricing structure agreed with mining contractor BUMA. They have a solid balance sheet as well. If they were able to ride out the last one without such a robust business structure, I think now they are stronger than ever.
Stock Price Targets
This is the part in which most people are interested in, but I think should not be the focus of company analysis. It is the same as asking how high is the sky. There is the discounted cash flow projection (>600m) given by the company, which would imply a stock price in excess of 65 cents. Then there is the easy one I like, which is EPS x P/E. A good rule of thumb I use for P/E would be to compare it to the growth rate of the company. Actually Geo's revenue and profits have been growing at some ridiculous rates in the last year because it is a turnaround story. But let's place a reasonable growth rate of 15% for the foreseeable future going forward. A P/E of 15, multiplied by this year's earnings of 7-8 cents (even if only 6 cents), you can do the math. Okay, let's say you are very pessimistic about this company for whatever reason, and you only award it a P/E of 7.5 (half of growth rate). That's around $0.50? That is my own fair value for the company TODAY. Moving forward, again, their earnings WILL grow with the increased rate of production (and hopefully with coal prices as a tailwind). Will the share price be more than 0.50? (Yes). Might we see P/E expansion due to the growth rate? (Maybe- fast growing companies tend to get a higher P/E). This leads to an exponential increase in the share price. Can you imagine if the earnings grew from here, and the P/E expanded at the same time? I think a dollar is not an outrageous forecast in the longer term. Is holding this for 3 years that hard? The CEO has said in interviews that his goal is to make Geo a US1 billion market cap company. I don't think he is saying that for fun. If Geo is worth SGD 1.35 billion, what is the corresponding share price?
To me, the biggest issue that most people have with such "high" price targets is because they keep comparing it with the CURRENT share price. Well, it is called "UNDERVALUED" for a reason and so we need to take advantage of it in order to gain. They find it unbelievable that a stock priced at 0.29 can ever attain $1.00. I have reframed this in my mind to see it in this way: Assuming Geo is ALREADY trading at fair value of 11x P/E and 5 cents earnings, so 0.55. And someone puts out a price target of $1.00. Will you think it is far-fetched? (Probably not) And then, in a more extreme example, if the stock is currently OVERPRICED and trading at 2.00 today, and someone says it can go to 2.20, will you think it is far-fetched? (Probably not) But I think that the second example would be far-fetched to me, even though it is not a big increase over the last market quotation, because we should always judge a company's worth by its fundamentals and business rather than it's last done stock price. Always remember that its stock market success is limited by its business fundamentals and not it's current stock price today.
With current coal prices hitting new highs and moving into 4Q (which means even higher production) for Geo, I am excited for their 2017 results next February. Of all the concerns I have read about this production volume issue and that offtake agreement, I really hope you guys can see that they are non-issues. Coal price is the biggest challenge moving forward, but that is greatly supported by demand factors. In putting together this report, I have realised that all the individual investor needs to do is to take a good look at their investor presentation, and you will be wondering why you aren’t buying more.