Canam is in a investment letter its a little long CanAm Coal: On Target to Produce 1 Million Tons in 2013
Calgary based CanAm Coal Corp (TSX-V:
COE) is an active coal producer with four
operating mines in Alabama. Since late-2009, the management team has been executing
a three to five year strategy to increase annual production to between 1-3 million tons
through the acquisition, exploration and development of coal resources. As a result, the
company has experienced extraordinary growth in recent years. In 2011, CanAm's coal
sales multiplied five times, from 48,361 tons in 2010, to 256,221 tons, while, in 2012, it
projects to sell between 450,000-550,000 tons, twice the sales of 2011.
Impressively, the company has sold up to 85% of its estimated production for 2012 in long
term contracts, which generally last a minimum of three years. However, despite these
positive developments, the stock price has remained stagnant, due, in large part, to a lack
of exposure and a tough environment for natural resource stocks, particularly small caps.
Nevertheless, through thick and thin, CanAm's business continues to thrive, which
suggests shares in this undervalued company have strong upward potential when market
conditions improve.
"King Coal"
In a global context, coal is the world's second largest energy source, providing for 30% of
the world's needs, only 5% behind oil, which provides 35%. In recent years, however,
exorbitantly cheap natural gas prices have chipped away at the demand for coal,
particularly as US utilities companies shift to using low cost natural gas. Meanwhile, a
general softening in commodity prices over the last twelve months has also sent coal
prices lower, while President Obama has implemented new EPA regulations that
discourage coal-fired electricity generation, which isn't making life any easier for coal
producers.
These bearish developments-particularly the shift to natural gas-have caused the shares
in many coal companies to fall dramatically in the last year. Nevertheless, despite the glut
in natural gas, there are reasons to be optimistic about investing in coal, particularly in the
long term. Many industry analysts have commented on the fact that current low prices for
natural gas offer little profit to producers, which would suggest that-sooner or later-prices
will need to rise, halting, and, even likely reversing, the shift away from coal. Indeed, it
appears this has already started to happen. Over the last few months, natural gas prices
have rebounded sharply and many analysts expect this trend to continue, particularly if
the US experiences a prolonged spell of cold weather this winter .
Another explanation for current weakness in coal prices is the fact that Chinese imports
are falling. Although consumption for coal continues to increase in China, imports have
declined due to an increase in the country's domestic production. Nevertheless,
as
BusinessWeek reports
, India is expected to buy whatever China leaves on the table. In
fact, demand for coal in India is so strong that plans for $36 billion of new coal-fired power
plants have been halted because of a lack of supply of thermal coal. All to show, the
fundamentals for this market are not simple.
But don't be fooled. Electricity generated from coal is lifting millions of people out of
poverty in both China and India, which account for a significant portion of the world's
population. Think of what it means when China has the third largest reserves of coal in
the world, and it
still needs to import to satisfy demand. The big picture on coal would
suggest that as long as the world continues growing, China and India will continue to
apply heavy pressure on supply, which over time will sustain, and even emphasize, long
term bullish fundamentals.
On the Road to Becoming a Mid-Tier Producer
A large part of CanAm Coal's growth since 2009 can be attributed to the acquisition of two
companies in Alabama, RAC Mining LLC, which operates the Powhatan mine that has the
capacity to produce 140,000-200,000 tons a year, and Birmingham Coal & Coke Inc., of
which CanAm now owns 80% following the exercise of its option, on August 7, 2012. This
has increased its ownership by 30% of three operating mines that have historically
produced an average of 460,000 tons of coal a year. As CanAm is slated to open up
another 3 mines in the coming months, annual run rate production should increase in the
range of 1 million tons per year. All of CanAm's mines use "surface mining" techniques,
meaning they are "open pit" mines, which are more cost-effective and easier to permit.
According to the most recent NI 43-101 report, CanAm currently has 6 million tons of
proven coal reserves, at its producing Birmingham Coal & Coke mines alone. As well, the
company's coal is considered "high quality" from a number of perspectives. Sulfur,
arsenic and mercury content are at the lower end and initial testing has indicated that the
majority of their coals will meet the latest EPA requirements which are to become effective
in 2015. In addition, CanAm's coal does not require washing, which significantly reduces
additional costs stemming from either operating or using a third party washing facility. A
further benefit is the proximity of CanAm's mines to a nearby port, which enables the
company to take advantage of both local and emerging markets at reduced costs for
handling and hauling.
CanAm has strong potential for continued growth through its lease of the massive 22,500
acre Buick Coal Property in Colorado. According to an NI 43-101 report conducted in
2007, the property has an estimated coal deposit of 291 million tons, 188 million tons
indicated and 103 million tons inferred.
Dedicated Management
Through CanAm's shrewd acquisitions, the management team has shown they have the
smarts to take a junior exploring company into production. As well, they seem on track to
realizing their three to five year goal of becoming a mid-tier producer. Concurrently with
their acquisition, they have also expanded their leadership team and have recently added
Scott Bolton as CFO (previously a partner with PricewaterhouseCoopers) and Steve
Somerville as director (previously President of BMO Capital Corporation). The team also
benefits from the experience of the former owners of the Birmingham Coal & Coke mine,
Robert and Thomas Lewis, who remain as officer of Birmingham Coal and Coke, and who
are responsible for the day-to-day operations of all of the Alabama mines. CanAm also
has an impressive board that is chaired by Jonathan Legg, who was National Managing
Director of PricewaterhouseCoopers' advisory practice and also held senior management
positions at The Royal Bank of Canada and Canadian Pacific Railway.
A Producer Selling at the Price of an Explorer
According to Vice Chairman Tim Bergen, CanAm Coal is significantly undervalued relative
to other coal producers. Bergen suggests that this is the result of a market disconnect
between earnings and market cap, stating, based on industry and historical norms, that
the company should be trading at a multiple of 4 to 5 times forward EBITDA, whereas the
Company is trading at around 1 times forward EBITDA. The company's strategy to focus
on "surface mining" has enabled it to avoid permitting difficulties, while its "high quality"
coal and prime location enable it to save costs in ways that other companies might not. As
well, CanAm maintains an option to purchase the final 20% of Birmingham Coal & Coke
Inc., which has been its major source of coal production. The company has manageable
debt, with close to $3 million cash in the bank, and has downside protection with the
substantial majority of its 2012-2015 production locked up in long term contracts. At the
current share price, Can Am Coal seems like a true bargain.