Contura Energy (OTCPK:CNTE): An "Alpha" opportunity in the coal sector with 100+% upside
Contura Energy was formed by the creditors of Alpha Natural Resources ("ANR") to acquire the core metallurgical and thermal coal assets from ANR in connection with its restructuring. Per the company's press release "…Contura has acquired all of Alpha's operations and reserves in Northern Appalachia (including the Cumberland mine complex) and the Powder River Basin, along with three Central Appalachian mining complexes (the Nicholas mine complex in Nicholas County, West Virginia, and the McClure and Toms Creek mine complexes in Dickenson and Wise Counties, Virginia). Contura also purchased Alpha's interest in the Dominion Terminal Associates coal export terminal in eastern Virginia." Based on a July forecast provided as part of the acquisition, it is expected that Contura will generate $270 million of EBITDA in 2017, have 10.5 million fully diluted shares outstanding and have net debt of $250 million. Management is led by key executives of ANR and the board will have representation from two key funds that led the restructuring and own the majority of CNTE's equity.
CNTE currently trades on OTC among a small group of distressed and special situations funds that focus on "post-reorg equities." It is expected that Contura will seek a listing on a recognized exchange in the near term, with investors afforded registration rights that can be triggered on February 1, 2017. The company will report third-quarter financial results no later than November 30, its first full quarter as a new public company.
Trading at just 3.3x 2017E EBITDA provided in the restructuring plan, and closer to 2.2x 2017 EBITDA using consensus forward (not spot) commodity assumptions, an investment in Contura represents a compelling asymmetric return opportunity with 100+% upside as mainstream investors discover the story, formal research is launched, updated financial information is made available, and the company lists its shares on a major exchange.
Contura will benefit from a substantial multi-year operational restructuring: During the restructuring management identified and implemented a value enhancement plan designed to reduce costs, improve operational efficiencies and boost profitability. Contura currently has 18 operating mines, down from 61 prior to Alpha Natural Resources entering Chapter 11, 2200 FTE employees vs. over 12,000 in 2012, and SG&A expenses of $28 million as compared to over $210mm in 2012. Contura has three main segments: Northern Appalachian Metallurgical Coal, Northern Appalachian Thermal Coal and Powder River Basin Thermal coal. In October 2015, ANR posted a Preliminary Management Plan review which details each of the operating assets (not all of which were acquired by Contura), actions taken and planned and price/cost/volume assumptions. We have used this document as a check against the CNTE July 2016 forecast and our own modeling assumptions. A copy of the Preliminary Management Plan Review can be found here.
Contura estimates appear very conservative and were prepared prior to the move higher in coal prices: In connection with the acquisition of the ANR assets, Contura provided a forecast in July for 2H 2016 through to 2020. For 2017 EBITDA is forecast to be $270 million, growing to over $300 million in 2019. We have reconciled the forecast against the data in the Preliminary Management Plan Review, primary data sources and conversations with industry participants and feel very confident in the estimates as a conservative base case. For modeling purposes, we are assuming production of 35 to 40mm tons of PRB thermal coal sold at a price of $12.00, 7.5mm tons of NAPP thermal coal sold at a price of $46 and 3.5 to 4.0mm tons of metallurgical coal sold at a price of $90 per ton. A reproduced version of the forecast is provided in the attached PDF and can also be found on their company's preliminary website.
Significant leverage to higher metallurgical and thermal coal prices: Since mid-summer, the spot price of Premium Hard Coking Coal has increased by well over 100%, with the Q4 contract price reportedly being set at $200 per metric tonne and spot prices currently at $220 per tonne. We understand from both industry analysts and executives that Contura's grade of met coal (High Vol A) is currently receiving similar prices due to European demand. While we do not expect spot prices to remain elevated, some analysts are starting to suggest an average 2017 price of $130 to $160 per metric tonne appears reasonable. Applying this commodity forecast range to CNTE's forecast increases EBITDA to a range of $368 to $483 million for 2017.
Current valuation is highly compelling given balance sheet restructuring: Contura was capitalized with $300 million of gross debt, approximately $50 million of unrestricted cash and 10.5 million fully diluted shares outstanding. As shown in the table in the attached PDF, Contura is trading at a material discount to peers and the "tight" capital structure will create outsized impacts on its share price for even small changes in EBITDA and/or valuation multiple.
Highly attractive valuation points to over 100% upside: The closest peer is Arch Coal, which also just emerged from bankruptcy protection and is arguably undervalued given its limited capital markets history and lack of research coverage. Arch is trading at 4.9x forward EBITDA (average of 2 estimates based on two recent research initiations), which would imply $102 per CNTE share using the July conservative management estimates and over $160 per share more current met coal assumptions. A sensitivity of EBITDA and multiples is provided in the attached PDF:
Substantial free cash flow generation will be a further lever to increase shareholder value: With sustaining capital expenditures of approximately $75 million, we estimate that Contura will generate free cash flow of approximately $24 per share, implying a 40% free cash flow yield. With the management team and board aligned, we expect free cash to be used for strictly accretive purposes such as increasing production, repaying existing debt, buying back shares or paying a distribution to shareholders.
Key risks include commodity price volatility, regulatory risk, security liquidity and lack of current financial information (until the end of November).
Disclosure: the author owns the equity of Contura.
Disclosure: I am/we are long CNTE.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.