SINGAPORE (June 19): The Covid-19 outbreak has caused already soft coal prices to weaken further as demand for energy drops. With prices now hovering at around US$53 ($73.88) per tonnne, coal producers face further strain. “Coal prices are obviously dependent on demand-supply dynamics,” Geo Energy Resources CEO Tung Kum Hon told The Edge Singapore in a recent interview. While he is betting on coal prices moving over US$30 per tonne in 2021, it may take some time before prices recover to 2018 levels of US$45 per tonne.
Given this “depressed market” condition, Geo Energy’s priority is to keep a tight rein on its costs. It has trimmed its production costs from US$30.24 per tonne in 1QFY2019 ended March to US$26.86 per in 1QFY2020, as it cut back production and paid lower rates to its contractors. Tung says the coal industry is seeing shorter cycles and coupled with the Covid-19 fallout, Geo Energy needs “a new level of flexibility and responsiveness” in managing costs.
Deal failure, new acquisitions
On Sept 23 last year, Geo Energy announced plans to acquire a 51% stake in two producing coal mines held by PT Titan Global Energy in South Sumatra for US$25 million. These two mines had reportedly been in production since 2012, and in 2018, produced 3.8 million tonnes. The addition of these two mines on top of Geo Energy’s existing assets means the company’s total production would increase from five to seven million tonnes per year. It would also increase its total proven coal reserves from 78 million tonnes to about 122 million tonnes as at end-June 2019.
But on April 1, Geo Energy said the deal was off. Tung explains that the two coal mines were part of collateral offered by the vendor Titan Group and that the bank refused to give the go-ahead. Around this time, the Covid-19 outbreak worsened, which weakened coal prices and affected valuations and Geo Energy could not put together another deal right away. Tung says he remains keen to make an acquisition within the next two years. “We have to look at what are the risks and returns in a situation like this. If we are able to leverage and seize opportunities, there will be a great value for shareholders,” Tung says.
Notes conundrum
The aborted acquisition has not merely stymied Geo Energy’s growth but it has also affected the company’s balance sheet. Back in 2017, Geo Energy — via its subsidiary Geo Coal International (GCI) — raised US$300 million in debt to build up a war chest for acquisitions, and by extension, grow its earnings. Fixed rate senior notes at a coupon rate of 8%, due in 2022, were issued. This issue was three times subscribed.
Under terms of the issue, either Geo Energy or GCI are required to make an offer to purchase all the outstanding notes come April 2021, in the event that the company does not meet a certain level of coal reserves of 80 million tonnes. It does not meet this requirement now. Along the way, Geo Energy has bought back some of the debt from some noteholders, at prices ranging from as high as 67.6% of par value in early December 2019, to the recent lows of 41% and 43% in March and April this year. As a result, the issue has been reduced to US$154 million.
On May 21, via a consent solicitation exercise, GCI offered to buy back the outstanding debt by paying just US$430, plus interests, for every US$1,000 in principal amount. The company had also put forward looser conditions for them to approve.
Geo Energy wanted this “additional financial flexibility” given the “challenging market conditions”. In turn, it is a chance for noteholders to “gain liquidity” that might not otherwise be available to them. The company said it launched this exercise because some noteholders asked. The company also said that it explored borrowing from banks but as collateral would be required, the noteholders would end up behind the banks in the queue of creditors.
Given the steep discount to par value, the offer was rebuffed by most noteholders. As at June 4, just US$20.9 million of the $154 million principal amount outstanding had been validly tendered. A minimum of 75% consent was needed. The company confirmed on June 5 that the proposal was rebuffed and thus the conditions of the issue will thus remain.
Analysts were not surprised. “Noteholders are being asked to accept prices that are at a deep discount to the par value of the initial note price,” says Moody’s Investors Service analyst Maisam Hasnain. He warns noteholders that by rejecting this offer, they run the risk of facing “more onerous terms” in a few months’ time if the company’s credit profile deteriorates and Geo Energy repeats the exercise.
When Geo Energy introduced the offer in May, it had sounded a similar warning. “There can be no assurance that the company will be able to offer the same prices to holders in the future, should these uncertainties continue to persist and have a negative impact on the group’s underlying operational and financial condition.”
For now, Geo Energy is pushing ahead to undertake more intensive exploration in its two existing mines. Citing a study by SMG Consultants, the total proved and probable reserves may increase by 29 million tonnes. Geo Energy might then be able to make a smaller acquisition to meet the minimum reserves requirement.
Liquidity a concern
Ratings agencies did not look too kindly at Geo Energy’s consent solicitation. Moody’s Hasnain, citing the US$146 million of the notes repurchased between December 2019 and April 2020 at the significant discount of up to more than half, a “distressed exchange”.
On the other hand, Fitch Ratings responded by downgrading the long-term issuer default ratings of both Geo Energy and GCI to C from CC. Fitch analyst Geetika Gupta tells The Edge Singapore Geo Energy’s liquidity after the transaction will decline given the current coal prices and level of demand. “Today [the company’s liquidity] is still fine, but it’s quite weak and it’s deteriorating over time,” she says.
For 1QFY2020 ended March, Geo Energy reversed out of the red with earnings of US$31.3 million from losses of US$8.7 million a year ago. This came on the back of a 34% increase in revenue for the quarter to US$87.8 million from US$65.7 million last year due to higher volumes and average selling prices.
Gupta says that while Geo Energy’s 1QFY2020 results were not impacted, the effect will show up from 2QFY2020. Among the seven Indonesian coal miners under Fitch’s coverage, Geo Energy has the weakest cash position and thus a thin cushion. “If coal prices were to fall by a further one or two dollars, it will affect a lot of its operations,” says Gupta.
Tung maintains that his cash cost is lower than other miners, which means Geo Energy can still make a profit selling to off-takers such as Macquarie and Trafigura even if others cannot. “We are now in a better position to negotiate on the price with other people, and the pricing is more cost effective or price effective compared to what we had previously,” he says.
Gupta also notes that if prices remain low, the bigger competitors to Geo Energy can choose to dig only at mines that cost them less to do so, and idle the more expensive operating areas. With just 65 million tonnes from its two mines, Geo Energy has less of such flexibility. “If coal prices fall further, it will be difficult for Geo Energy to continue to operate as it does not have either the liquidity situation or alternative funding sources to sustain itself,” she adds. If coal prices falling below US$25 per tonne would mean Geo Energy has to start “burning cash” or suspending operations, says Gupta.
Tung agrees that while the company’s in a stable financial position, if prices should drop and remain at US$24, he will consider suspending part of the operations. “It’s about how we manage our production in line with coal prices,” says Tung. “We cannot stop production totally, because we would have missed the opportunity totally when coal prices pick up again,” he adds. In general, investors have given energy stocks a chilly reception, including Geo Energy. Tung believes that they are wrong and that Geo Energy’s share price, which remains unchanged year to date, is “undervalued”.
At its June 17 closing price of 12.1 cents, Geo Energy is at a significant discount of 24% off its book value of 15.81 cents per share; and a P/E ratio of 3.8 times based on 1QFY2020 earnings of 3.19 cents per share. “Not many people understand our sector, and what’s most important is what’s reflected in the company’s bottom line,” says Tung.
