There is money to be made in this "dying" industry
There is money to be made in this "dying" industry
I’m a big contrarian investor at heart. I love the “hated” and “dying” industries. Those melting ice cubes that slowly lose revenue every quarter. The black sheep of Wall Street.
Recently I have been looking into industries that have environmental, social or governance (“ESG”) risk. You tend to find some interesting opportunities in these industries. Hated and disregarded. Companies that spit off cash flow but trade at basement level valuations due to the perceived notion that they are “bad” for society in some form or another.
My recent interest in these “bad” industries has lead me to research the coal industry.
For newbies, there are two types of coal:
Thermal coal: used in electricity generation
Metallurgical (“met”) coal: used in the production of steel
Both thermal and met coal get bad reps as they are pollutant to the environment in some form of another. In addition, there is a social factor as well given black lung disease, coal mine explosions, and an entire host of problems that occur when the large coal companies leave these small southern towns that have been the main employer for decades.
To make matters worse, outside of the not so great social and environmental issues, the coal industry is the epitome of the boom and bust. Bankruptcies. Total loss of capital. Restructuring. Rinse, wash, repeat. The entire industry is littered with lost investor capital to the wind. Billions have been made, and billions have been lost.
This ESG risk combined with the lack of investor capital has lead me down the path of researching and investing in coal names. So far, my entire focus as been on the met side.
As stated before, met coal is used in the production of steel. BHP provides a great overview how met coal is used in the steel making process:
Met coal is heated above 1,000ºC in a coking oven to create coke – a hard, porous lump.
The coke is then added to a blast furnace with iron ore. Hot air and PCI are introduced, creating a flame temperature over 2,000ºC.
The burning coal and coke produces carbon monoxide, which, along with the high temperature, converts the iron ore into a liquid.
This molten ‘pig iron’ is transported to a steel shop, where impurities are removed and alloys are added to make steel.
Currently there is no technology available to make steel at a large scale without the use of met coal. So if you want steel you need met coal. Unlike thermal coal which is used in the production of energy, there is multiple viable replacements. So no matter your political or social views, if you are a steel user, you are also a met coal user.
Why am I investing in the met coal industry? A few different reasons.
The demand for steel is extremely strong. Steel producers are running close to full capacity and everything they are making is getting gobbled up.
The strong demand for steel has lead to historically low levels of steel inventories and record pricing. Every piece of steel getting made is also getting sold. When you go an entire year without producing steel then magically turn the switch back on, record levels of demand combined with record pricing occur. This is happening in multiple industries across the world right now.
One of the best ways to get a boost to your country as a politician is to pass infrastructure bills. The United States passed a $550 billion infrastructure bill. India’s steel demand is forecasted to increase exponentially through 2025. And a host of other countries are spending their way out of this pandemic. Demand for steel should continue to remain strong outside of any global recession or another pandemic.
The increase in spending across the world has lead to analysts predicting we are entering a new commodity super cycle. Goldman Sachs recently put out a research note stating that we are entering a new commodity super cycle that could last years. Going green, Goldman Sachs contends, “has the potential to create a capex cycle on par with the emerging markets-driven cycle of the 2000s”.
The advent of a future commodity super cycle has caused met coal pricing to doubled (or more depending on the type) from the January 2021 lows. Pricing continues to increase everyday off the back of strong steel demand, record low inventories and a tight supply chain.
Despite the increase in pricing, met coal producers are still trading at basement level valuations (30-50% forward free cash flow yields) due to the ESG concerns highlighted above, along with the boom and bust history investors in these companies have endured throughout the years.
But with pricing having more than doubled, these met coal producers are on pace to post record revenues and profits in the coming quarters and years. Indeed, most of these companies are so gun shy from the previous commodity boom and bust cycles that all cash flow generated will be used to deleverage balance sheets, providing investors more long-term terminal value.
In fact, if pricing holds at the current level (most of these producers think it continues to increase heading into the back half of 2021) these companies will generate enough cash to pay off their debts entirely in less than a year. This phenomenon has already been seen with the steel producers which has lead to record level stock prices.
But what makes this most interesting is the lack of investor capital in the space. Investors have been burnt too many times in the coal space. Billions have been lost and the cost of capital has increased. In addition, new ESG concerns have forced many of these companies to struggle to get outside funding for new capital projects. So despite the saying that high pricing is cured by high pricing, it appears as if it may be different this time around. Thus, the lack of capital in the space, combined with debt and legacy liabilities is forcing coal companies to focus on balance sheet moves instead of investing in new projects and bringing on additional production.
So, the increased demand for steel (which appears to be a multiyear cycle), combined with basement level valuations, higher met coal pricing and lack of investor capital has piqued my interest to start investing in the coal industry. Because if I am directionally right, there is potential to make a significant amount of money as operating leverage kicks in, leverage ratios come down and cash flow is ultimately generated and used in shareholder type returns.
I have begun to advantage of this “commodity super cycle” by purchasing met coal miners that Wall Street seems to be totally ignoring.
I wrote a research report in June of a small met coal miner that is already up over 50% from where I called it a buy. The profits I made from this miner were then reinvested back into another miner.
This new miner that was recently highlighted to subscribers appears to have asymmetric upside to downside ratios. There is a significant amount of debt and other legacy liabilities on this company’s balance sheet so any directionally correct bet could result in considerable upside.
In addition, if pricing holds for the next three months production volumes will be locked in at record pricing that could make the company debt free by year end 2022.
The future for this company looks bright. I have made this miner a “top position” in my portfolio and will continue to buy more shares on any weakness in the market price.
If my thesis is correct, I think the stock price will re-rate to the $40-50/share range over the next 6-12 months and if pricing is indeed locked in at current rates, notwithstanding any operational issues (this is mining), the share price could go to $100/share by the end of 2022.
Get instant access to this new research note and access to all of my previous investment research for only $10/month.
Feel free to reach out if you become a subscriber and you realize the service is not for you within 30 days and you will get a full refund. No questions asked.
The Alpha Letter cares about accessibility. If the paid tier poses an unreasonable financial burden please reply and we can offer free trials or an aggressive discount (especially if you are young, between jobs, or a student). Learn more about The Alpha Letter Premium here or hit reply with any questions.
Disclaimer: The publisher does not guarantee the accuracy or completeness of the information provided in this page. All statements and expressions herein are the sole opinion of the author or paid advertiser.
Alpha Letter is a publisher of financial information, not an investment advisor. We do not provide personalized or individualized investment advice or information that is tailored to the needs of any particular recipient.
THE INFORMATION CONTAINED ON THIS WEBSITE IS NOT AND SHOULD NOT BE CONSTRUED AS INVESTMENT ADVICE, AND DOES NOT PURPORT TO BE AND DOES NOT EXPRESS ANY OPINION AS TO THE PRICE AT WHICH THE SECURITIES OF ANY COMPANY MAY TRADE AT ANY TIME. THE INFORMATION AND OPINIONS PROVIDED HEREIN SHOULD NOT BE TAKEN AS SPECIFIC ADVICE ON THE MERITS OF ANY INVESTMENT DECISION. INVESTORS SHOULD MAKE THEIR OWN INVESTIGATION AND DECISIONS REGARDING THE PROSPECTS OF ANY COMPANY DISCUSSED HEREIN BASED ON SUCH INVESTORS’ OWN REVIEW OF PUBLICLY AVAILABLE INFORMATION AND SHOULD NOT RELY ON THE INFORMATION CONTAINED HEREIN.
No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer or the solicitation of an offer to buy or sell the securities or financial instruments mentioned.
Any projections, market outlooks or estimates herein are forward looking statements and are inherently unreliable. They are based upon certain assumptions and should not be construed to be indicative of the actual events that will occur. Other events that were not taken into account may occur and may significantly affect the returns or performance of the securities discussed herein. The information provided herein is based on matters as they exist as of the date of preparation and not as of any future date, and the publisher undertakes no obligation to correct, update or revise the information in this document or to otherwise provide any additional material.
The publisher, its affiliates, and clients of the a publisher or its affiliates may currently have long or short positions in the securities of the companies mentioned herein, or may have such a position in the future (and therefore may profit from fluctuations in the trading price of the securities). To the extent such persons do have such positions, there is no guarantee that such persons will maintain such positions.
Neither the publisher nor any of its affiliates accepts any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of the information contained herein.
By using the Site or any affiliated social media account, you are indicating your consent and agreement to this disclaimer and our terms of use. Unauthorized reproduction of this newsletter or its contents by photocopy, facsimile or any other means is illegal and punishable by law.
For Full Terms of Use Click HERE. For the Privacy Policy Click HERE.
alphaletter.co (“Alpha”) is a website owned and operated by Substack. Alpha is paid fees by the companies that make investment offerings on this website. Be aware that payment of these fees may put Alpha in a conflict of interest with the investor. By accessing this website or any page thereof, you agree to be bound by the Terms of Use and Privacy Policy, in effect at the time you access this website or any page thereof. The Terms of Use and Privacy Policy may be amended from time to time. Nothing on this website shall constitute an offer to sell, or a solicitation of an offer to buy or subscribe for, any securities to any person in any jurisdiction where such an offer or solicitation is against the law or to anyone to whom it is unlawful to make such offer or solicitation. Alpha is not an underwriter, broker-dealer, Title III crowdfunding portal or a valuation service and does not engage in any activities requiring any such registration. Alpha does not provide advice on investments or structure transactions. Offerings made under Regulation A under the U.S. Securities Act of 1933, as amended (the "Securities Act") are available to U.S. investors who are “accredited investors” as defined by Rule 501 of Regulation D under the Securities Act well as non-accredited investors, who are subject to certain investment limitations as set forth in Regulation A under the Securities Act. In order to invest in Regulation A offerings, investors may be asked to fill out a certification and provide necessary documentation as proof of your income and/or net worth to verify that you are qualified to invest in offerings posted on this website. All securities listed on this site are being offered by, and all information included on this site is the responsibility of, the applicable issuer of such securities. Alpha does not verify the adequacy, accuracy or completeness of any information. Neither Alpha nor any of its officers, directors, agents and employees makes any warranty, express or implied, of any kind whatsoever related to the adequacy, accuracy, valuations of securities or completeness of any information on this site or the use of information on this site. Neither Alpha nor any of its directors, officers, employees, representatives, affiliates or agents shall have any liability whatsoever arising from any error or incompleteness of fact, or lack of care in the preparation of, any of the materials posted on this website. Investing in securities, especially those issued by start-up companies, involves substantial risk. investors should be able to bear the loss of their entire investment and should make their own determination of whether or not to make any investment based on their own independent evaluation and analysis