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Previously employed by a major investment bank. Currently employed by an investment fund.
  • Powering the World's Need for Energy with Coal 0 comments
    Apr 13, 2011 10:05 AM | about stocks: BTU, LLEN, MEE

    Powering the World's Need for Energy with Coal

    Where is the Opportunity? (Peabody Energy Corporation (BTU) vs. L & L Energy, Inc. (LLEN) vs. Massey Energy Co. (MEE))

    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.  American political pundits have long attempted to lead their political bases to align with the thinking that the replacement of coal will be alternative energy sources such as: nuclear, solar, or wind power, but the reality of the situation is that any attempt to significantly reduce coal consumption in the near term will be extremely difficult, given the rapidly expanding industrial giant that is the People’s Republic of China.  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 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.  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 energy.  Following this analysis they quickly procured as many coal mining leases 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 procure leases and land use rights that have since created a market with very limited growth prospects in the United States which in turn has made it very difficult for even the most elite of the US-based coal companies (e.g. Massey Energy Company, Peabody Energy Corp., Consolidated Energy, and Alpha Natural Resources, Inc.) 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.  

    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 year 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 70% 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 well capitalized coal mining companies to acquire smaller or less capitalized players.  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.

    Fundamental Differential

    L&L Energy, Inc. (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.  Its vertically integrated operations include industry leading coal mining, washing and coking facilities.  Though, via its subsidiaries, they have been conducting coal-based operations for over fifteen years, the focus of its current business model is to align its operations and mining practices to mirror those industry standards that have been mandated by the Chinese government for the purpose of consolidating the coal industry.  Over the past 18 months, LLEN has aggressively expanded its own mining operations by continuously acquiring smaller operators, implementing Westernized coal mining standards and rapidly expanding such operations organically through its capital and management capabilities.  LLEN is precisely implementing the goals set out by the governmental policies regarding coal mining consolidation.  Through its acquisitions, LLEN has been able to acquire producing operations (coal mining operations, coal washing operations, coal distribution facilities and coal coking facilities) at very attractive and accretive rates (often less than 3 times current production paid and is paid over a period of three years - effectively bought with own cash flow). We believe the future of LLEN is its export model from the US and potential port blending operations on the ground in China. Entering this market will enable the company to compete and/or partner with the medium to large players in the coal business looking to enter the Chinese marketplace.

    Financially, for the trailing twelve months LLEN has earned approximately $48.3 million in profit, or approximately $1.67 per basic share in earnings.  Similarly, for the trailing twelve months of the 2009 fiscal year, Alpha Natural Resources, Inc., an industry leading US-based mining company with domestic operations in the US, has earned approximately $95.61 million or $0.80 per basic share in earnings.  Additionally, LLEN has also provided guidance that its net income for its 2011 fiscal year will be approximately $1.61 per share, not including any acquisitions that it anticipates closing (of which, it’s anticipated that it will make some significant acquisitions this coming year).  Such growth by LLEN would equate to Alpha Natural Resources (ANR) having to earn $192.9 million this coming year to earn an equivalent per share earnings.

    LLEN is a growing business that is greatly benefiting from the Chinese governments focus on coal consolidation and expansion.  That being said LLEN, even with the Chinese market providing significantly higher coal prices per ton ($120 per ton versus $41 per ton in certain markets), needs to continue to expand its coal reserves to match that of ANR, MEE, WLT, etc.  Upon furthering its expansion we believe we will see the overall discount in P/E multiples dissipate over time as LLEN further progresses its business model worldwide.

    Multiple Differentials

    When looking at market-based metrics, LLEN trades at approximately 3.0 times its trailing twelve month’s earnings, while Walter Energy, Inc. (WLT) and Peabody Energy Corp. (BTU) both trade at approximately 22.0 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 that carries with it enormous upside potential for shareholders over the short, medium and long term horizon.

    Conclusion

    To conclude, it is worth noting that the demand for coal is increasing at a dramatic rate worldwide.  Meeting these demands is going to be difficult and will require a greater number of companies focusing on the logistics of coal delivery as well as overall expansion of production capabilities.  Given L & L Energy's desire to be a global player focusing on production and expansion and the coal import / export market we believe they have significant opportunities ahead of them to generate solid cash flow for its shareholders. We believe that the multiple differential for a company like L & L Energy versus Massey or Peabody is not warranted and we believe that given the opportunities of such businesses, L & L Energy should be trading more in line with its US counterparts.

    Certain editors, staffers and journalists associated with this article have in the past held long positions in ANR, PCX, BTU, LLEN, YZC and WLT.

    Stocks: BTU, LLEN, MEE
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