(Sept 30): When Geo Energy Resources raised US$300 million in a bond issue in 2017, it was gearing up to buy additional assets. The interest rate of 8% a year on the bond — a hefty US$24 million a year — was something the Indonesia-based, Singapore-listed coal miner was willing pay, as it believed it was poised to acquire assets that could give it better returns.
For nearly two years, investors have been waiting for Geo Energy to make a big move — and now, one might be just round the corner. When the company announced its 2Q2019 earnings on Aug 14, it said it was doing due diligence on a producing coal mine in East Kalimantan, and that it expected to submit a binding offer by end-August. In an Aug 30 update, the company said it had submitted a revised non-binding proposal, and that if the deal was to take place, it would represent a “very substantial” acquisition.
Then, before more details on this big acquisition were announced, the company said it was making another acquisition. On Sept 23, Geo Energy said it would spend US$25 million ($34.5 million) to buy a 51% stake in two producing coal mines — Bara Anugrah Sejahtera and Banjarsari Pribumi — in South Sumatra.
Tung Kum Hon, CEO of Geo Energy, tells The Edge Singapore in an interview on Sept 26 that the potentially bigger deal is still pending approval from the seller’s shareholders and that the deadline has been pushed back to October.
To be sure, in the past two years, the company has been actively looking for assets to acquire, but those that were shortlisted did not make the cut eventually. “Although there were many assets, we will not consider those that do not have the ability to ramp up or improve our overall operational metrics,” says Tung.
From Kalimantan to Sumatra
With the acquisition announced on Sept 23, Geo Energy will expand its production location to Sumatra. It has been operating in Kalimantan so far. South Sumatra, says Tung, has one of the largest coal reserves in the country, and the company plans to be more active there. “It’s fair to say that [South Sumatra] is one of the new focus areas for the company now, and we are definitely on the lookout for more acquisitions there,” he adds.
According to Tung, this latest acquisition, when completed, will improve the company’s top and bottom lines. The two mines are licensed to produce until May 7, 2029. They have estimated coal reserves of 50 million tonnes and the coal output has a relatively high average calorific value of 4,770 kcal/kg, which commands better prices.
Both mines have been in production since 2012. Last year, they produced a total of 3.8 million tonnes. For the first six months of 2019, production increased to 2.3 million tonnes. Geo Energy plans to increase production to between five million and seven million tonnes a year. For 2018, Geo Energy, from its four existing mines, produced a total of 7.9 million tonnes — short of the output of eight million to nine million tonnes set for the year. For 2Q2019, it produced 1.4 million tonnes.
KGI analyst Joel Ng, the only brokerage analyst with active coverage on Geo Energy, is somewhat sceptical about the deal. At US$25 million, the purchase price translates into just US$0.57 a tonne. Coal sells for around US$35 a tonne. Owing to macroeconomic uncertainties, including weaker demand from key market China, Ng is not too excited about the outlook of the coal mining industry either.
“It sounds too good to be true, especially since [the mines] produce high-quality coal,” says Ng, who has kept his “neutral” call and price target of 14 cents on the stock.
According to Tung, one reason the company bought assets in Sumatra instead of concentrating on Kalimantan is to diversify its geographical risks. For all its wealth of natural resources, Indonesia, unfortunately, is prone to sporadic natural disasters. In June, the company was forced to cut back production in its existing mines in Kalimantan because of heavy rain. “By spreading out our operations instead of limiting ourselves to one area, business is unlikely to be severely disrupted in the event of a major incident,” he explains.
However, geographical diversification comes at the price of operational efficiency. If the mines are closer to one another, they can share equipment for production and logistics, for example. KGI analyst Ng is not too worried about the operating efficiencies. The inefficiencies are marginal and should not be a cause for concern, he believes. “In terms of logistics, the effect is small, as the coal will be shipped to local power stations,” he says.
Diversifying from China
Commodity companies know their fortunes are inextricably tied to global market demand for what they produce — there is only so much extra margin an efficient producer can eke out. “It is often hard to predict the performance of companies in the commodity market, as it is based on external factors that are out of the company’s hands. Today, these factors include a slowing economy and oil prices,” says Ng.
As a result, coal, just like other kinds of commodities, has seen plenty of fluctuations in prices. Prices in the past year have dropped in tandem with the weaker global economy. According to the Indonesian Coal Index, in 2Q2018, the average price for 4,200 GAR coal was US$44.84 a tonne. It dropped to as low as US$35.49 in 1Q2019 before recovering slightly to US$37.56 in 2Q2019.
For 2Q ended June 30, Geo Energy reported revenue of US$51.9 million, down 38% y-o-y, as heavy rain in June led to lower production volumes, on top of lower average selling prices. Earnings in the same period were US$830,000, a 90% drop from US$8.47 million in the year-earlier period.
The lower earnings have weighed down the company’s share price, which has fallen 11.3% year to date to close at 15 cents on Sept 26. At this level, the company is valued at 9.81 times historical earnings and 0.95 times its net asset value of 15.72 cents as at June 30. It has a market value of $208.5 million. By contrast, the share price of Golden Energy and Resources, another Indonesian coal miner listed here, has declined 26.36% year to date, closing at 16 cents on Sept 26. It is valued at 16.34 times its earnings and 0.736 times its NAV of 15.73 US cents as at June 30.
While a slowing world economy has trimmed energy consumption, thereby affecting coal prices, the fossil fuel industry is under additional pressure. Many governments and companies, partly in response to environmentally conscious consumers, are pushing for the use of renewable energy such as solar and wind energy.
From Tung’s perspective, however, coal remains the most economical source of energy and he does not see alternatives overtaking its usage in the near term. He claims that wind farm owners and operators need at least 10 years to recoup their initial investments, and solar energy is not as efficient in generating power. “A lot of focus today is on coal — the new power gem,” he says.
For Geo Energy, China is the singlelargest market, but with the country’s economy slowing down, Tung is actively trying to develop other markets, specifically, India and Indonesia, where further industrialisation is taking place. “I anticipate that Indonesia will be the next China or India in about five to six years,” he says.
