1. The general malaise in the mining sector - so we need to be either looking for long term upside or exceptional stories that break the mould.
2. The sell of stocks for tax reasons - because people want to realise their losses in the current year
3. The low commodity prices across the board.
So the question is - where to start. Well, the first stock which has appeal to us is Bandanna Energy (BND.ASX). As of today, they have fallen to a stock price of 10c; which is within 3% of their all-time low of 9.7c. This makes this 'psychological level' a strong support, so today we bought a lot of them.
There aew several appealing elements to this company:
1. Enormous cash backing - They have $108mil in cash, and their market capitalisation is $52million at 10c. The implication is that their cash holdings are worth 20c/share, or that they are trading half of their cash backing. That's just crazy because it also ignores the value of their project; it makes them a compelling takeover target, or opens the prospect of a capital return or share buy-back. Any of them outcomes would at least push the company's share price to 15-20c range, so depending on the option, it makes you wonder why it has not happened. Not, you don't usually issue shares and then have a special capital return, but you might have a share buy-back to raise the price. The question is whether the executive team thinks the current low price will be sustained. Certainly the cash is needed given the size of investment.
2. Project in Qld - They have a pretty decent coal project in Qld near Emerald, surrounded by other coal mines, and close to rail infrastructure.
3. Prospective buyer - They have a Korean power utility on their share register. Typically Asian power utilities have taken stakes in coal companies in order to secure the marketing rights to coal. In this market, there is no reason to expect a project to proceed, or a power shortage to exist. This requires some understanding of the Korean utility market, which I don't have...which you might like to investigate. Any developments here however offers long-term upside.
4. Low coal prices - they will eventually recover. The appeal of Australia is access to capesize shiploading facilities, proximity to Asia, good quality coal, and the reliability of its law. This has been called into question recently with the Rudd-Gillard governments introducing huge tax imposts on the sector; making Australia look like a pretty sordid 'graft economy'. Anyway, they have gone, but coal prices remain low. For some perspective here, take a look at this chart, and consider this a contrarian buy opportunity.
5. Demand side - There is destined to be strong demand still for coal given that security of supply considerations remain. In fact, you might wonder if Germany is forced to re-open old coal-fired power stations given that it could struggle for gas supplies from Russia. I'm not sure if these plants have been mothballed. It is more probable that nothing will become of the issue. The more trusted outcome is simply more coal demand from China, India, Korea. I'm expecting China to continue investing in domestic infrastructure, to expand the size of its domestic economy. This will boost domestic demand, and that will mean more coal and gas. Some of this will come from Mongolia. Indonesia is increasingly struggling to supply more export-grade coal to Asia, so Australia is well-placed, but it needs competitive cost structures.
6. Problems to be solved. The coal industry is struggling in Queensland from a number of problems which I would expect to be resolved in due course. These hurdles will permit a number of projects to proceed; foremost those with cash, who are able to sustain exploration, or which are at an advanced stage. The problems are:
a. High labour costs - The Australian Labor Party has effectively priced a lot of Australia's potential and existing miners out of business with a $18/hr minimum wage. This is not the nominal wage rate in the mines, but it effectively pushes all wages up to $35-40/hour because people don't want to work in the outback. The fact that people can earn a good '$18/hr' lifestyle wage on the coast means they are not so keen to work in the bush. You have to pay $35-40. Abbott will probably lower the threshold to $15.
b. Carbon tax - I think this legislation is highly controversial to remove, but it deserves to go, but I suspect Abbott will want to adopt some form of charge upon carbon, but I think he will seek another way to do it, with say a compulsory level after the first 5 years of mining.
c. Queensland Rail Rates - The Queensland government holds a monopoly over railways in their state. The problem is that existing rail rates were negotiated at far higher levels. The problem is that coal prices have dropped markedly. Now, maybe QR considers itself as a business, whether a monopoly or not, but the implication is that contract prices are very high. The question is - do rail shippers sell more coal at these prices, or do they attempt to negotiate lower rates for incremental increases in production when they finally get some more customers. Certainly high rail rates are an impediment to further investment, so I'm expecting a concession by the Queensland government when they realise that they are competing with the Chinese government, which is prepared to subsidise coal deliveries from Mongolia. This would of course be good news for new projects as well.
d. Resource Rent Tax - I twould expect the Abbott government to drop the Mineral Resource Rent Tax, and replace it with some type of public resource tax. They will of course have to negotiate or reconcilate that type of tax with the states, which already charge a royalty, and with the prospect of Liberal governments across Australia, that becomes easier. There would I expect be efforts to harmonise these taxes.
There is one issue that bothers me. The Springsure Creek project has approval. Given the company's cash reserves and their familiarity with the region, I wonder if they will acquire a neighboring company, Acacia Coal (AJC.ASX). The reason is the 7-11Mtpa of coal is a lot of capacity to add to the market, and their sponsoring utility is not going to want all of its supply from a single mine. I wonder whether BND will acquire Acacia for access to open-cut ore, as a short term precursor to full UG longwall production. Acacia's project is also well-advanced, and Acacia has access to the same rail infrastructure. Acacia has an open-cut project which better serves as an incremental project. Acacia is struggling to raise cash in this environment; their cash requirements are a modest $50 million, and it would make sense at least to better utilise the company's cash. Acacia Coal has 900 million shares on issue at 1.1c, and thus a market capitalisation of just $10 million; with $4.2 million in cash.
In times of low coal prices; we look for rationalisations of capacity. These companies seem well-suited. They are close together, they have strategically common interests, and one presents short term upside (but no cash), whilst the other presents enourmous production potential (but no incremental fit for current subdued coal market). Both companies stand to benefit from restructuring of costs in the Queensland coal industry. The coal industry is powerful in Queensland politics. I am expecting both a state and federal concession on costs to rekindle the Australian coal industry, as Mongolia has made a similar concession in 2012 after 'they pulled a Rudd'. I hope that catchphrase 'catches on'.
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