Finding Opportunity In China's Energy Revolution

by: ValueGrowth

Over the past eighteen months the worldwide coal industry has undergone a significant and explosive transformation, one that has many industry experts and investors asking themselves where coal fits into the worldwide energy equation. Many American political pundits have long attempted to steer their political bases toward the thinking that the replacement of coal will be alternative energy sources such as nuclear, solar, or wind power. However, the reality of the situation is that any attempt to significantly reduce coal consumption in the near term will be extremely difficult fundamentally, especially given the rapidly expanding industrial giant that is the People’s Republic of China as well as the overall economic concerns that are taking place domestically. Over the past ten years China has moved from a socialistic economy to one that is more in line with the booming capitalistic structure found in the United States during the American industrial revolution. And as a result of the Chinese government’s ongoing push for privatization, the country is rapidly morphing from a third-world country to a developing nation with an identifiable middle class on the verge of explosive industrial growth and a seemingly unquenchable thirst for energy.

United States Market

The United States has been a developed nation since its emergence from the industrial revolution when individuals such as the Rockefellers began to monopolize the various coal producing regions in the United States, which was enabled by the support of the U.S. government. Through their monopolistic methods, these entrepreneurs were able to identify that the lowest common denominator in America’s quest for growth fell to its need for affordable energy. Following this analysis, they quickly procured as many coal mining leases (or coal properties) as they possibly could in order to ensure that they could monopolize the coal industry and the industrial power that these leases yielded. These early entrepreneurs were able to get at the ground level and secure leases and land use rights that have since created a market with very limited growth prospects in the United States; this in turn has made it very difficult for even the most elite of the US-based coal companies (e.g. Peabody Energy Corp. (BTU), Consolidated Energy, and Alpha Natural Resources, Inc. (ANR)) to return meaningful growth in earnings per share back to their investors. These companies are constantly struggling to show consistent growth through aggressive acquisitions; their primary form of year-over-year EPS growth hinges on the simple hope that coal prices will continually appreciate, primarily from the demand of the emerging markets such as China. We have recently witnessed Peabody and other U.S. producers making a major push into Asia, with developments such as Peabody’s winning bid on the Tavan Tolgoi coal deposit in Mongolia.

Chinese Market

In stark contrast to the U.S. coal market, the Chinese coal mining industry is a developing market that has shown rapid growth over the last ten years. Most notably, during the last few years China has officially claimed the title as the “leading consumer of energy in the world.” This is a direct result of the emergence of a sustainable and growing middle class in China. Demand for energy in China (of which at least 75% of that energy comes from coal consumption) has resulted in the need of more than one new coal-fired power plant built every week to meet the current domestic demand, with no let-up in sight. In recognizing the exponential growth in energy, the Chinese government has encouraged (and sometimes forced) an increase in coal production to meet the insatiable demand. This has resulted in a very favorable environment for consolidation of coal mining operations, whereby the government has created policies that encourage coal mining companies to acquire smaller or less capitalized players, expand safety procedures and further mechanize such operations. To further illustrate their support, not only are they creating favorable negotiating environments, but the Guizhou government (a provincial government in China) has stated that they are enabling such consolidation by providing up to 70% of the acquisition price to fund such acquisitions. This, in the mind of the government, accomplishes two goals: (1) increase the production to meet the country’s growing energy needs and (2) enhances the country’s safety and mining standards through better infrastructure and capital investment, thereby attempting to mimic US mining standards as much as possible.

Positioned to Exploit Such Opportunities

L&L Energy, Inc. (NASDAQ:LLEN) is a U.S.-based coal company run by U.S. citizens and a U.S. Board of Directors of excellent pedigree with its principal operations located in the People’s Republic of China. From a mining, due diligence and acquisition perspective they are led by the experience of Syd Peng, who has been involved in the company for well over a year as an advisory board member and now as a member of the Board of Directors. Given the size of LLEN, their public presence and the location of their existing operations, the Guizhou government, including their Vice Governor - Sun GuoQiang, has shown their encouragement to LLEN and has helped to set expectations accordingly with regards to such expansion. The provincial government has begun to provide details regarding their definition of “support” and what it could mean for the consolidators in the region, with the announcement that they have instructed three major banks in the region to provide up to 70% financing during the consolidation process.

As mentioned above, the Rockefellers sought such an opportunity in the U.S. during our energy revolution and we believe many players in China, such as L&L Energy will do the same in the current environment in China.

Multiple Differentials

When looking at U.S. market-based metrics, LLEN trades at approximately 3.0 times its trailing twelve month’s earnings, while Walter Energy, Inc. (NYSE:WLT) and Peabody Energy Corp. both trade at approximately 15.0 times their trailing twelve month’s earnings. Given the current dynamics of these companies, we believe that the drastic discount at which LLEN is currently trading is an oversight by the marketplace due to the cloud that currently hangs over Chinese operators. For individuals with a local presence that creates an opportunity for enormous upside potential over the short, medium and long term horizon.

When looking at Asian market-based metrics, the differential is even more extreme. Gansu Jingyuan Coal Ind & Elec Power Co., which mines 2.5 million tons of coal per year, possesses a market valuation of $2.95 billion on the Shenzen exchange. LLEN has stated that the government has aspirations for them to be a 3.0 to 10.0 million ton-per-year player in the region over the next three years and has stated publicly their commitment to help them get there. Currently, when all their mines go back into production, they will be around 1.0 million tons, but actively seeking sizable acquisitions, with strong management teams, that can put them well above 2.5 million tons in the near term. This differential creates a very attractive scenario of LLEN to consider a duel listing on an Asian exchange or a primary listing on an Asian exchange, which they mentioned they are looking into on their latest earnings call.


To conclude, we believe we may be witnessing an interesting development in the latest energy revolution in the second largest economy in the world, and the best capitalized. We believe that BTU (with some operations in northern China), Asian listed players (in southern and northern China) and LLEN (in southern China) are all well situated to benefit from such movements and we look forward to holding a well balanced portfolio of domestic and international coal stocks to benefit from the dramatic events unfolding over the next three years.

Disclosure: I am long PCX, LLEN, BTU, YZC. Certain editors, staffers and journalists associated with this article have in the past and currently hold a long position in BTU, LLEN, PCX and YZC.