obviously didn't factor in the unfortunate weather Kentucky has experienced this year. Sigh.Murphy's Law strikes again!!
Hopefully as weather improves and permit delays are overcome Jay's extrapolation can be realized.I will post most of his report to refresh shareholders' information.
ProjectedOperating Cash Flows
NAG#1 – Jellico Coal Seam – Production has just begun onthe first coal mine, which is simply named NAG #1. Here production rangingbetween 5,000 and 10,000 tons per month is projected. With coal selling at $56per
ton,and costs at $40 per ton including royalties, this first project shouldgenerate between $80,000 and $160,000 in monthly cash flow, or between $960,000and $1.92 million annually.A 10,000-ton-per-month
operationis the maximum level, with two augers operating full time. Management believesa production level of between 5,000 and 6,000 tons per month is ultraconservative and that production should be closer to the 10,000-ton-per-daylevel than 5,000 tons.
NAG#3 – Jellico Coal Seam + Blue Gem Seam – Underneath theJellico Coal Seam lies the Blue Gem Seam. Blue Gem is an unusually high BTU,low sulfur coal that fetches approximately $100 per ton. Since this is all open-cutmining, to get to the Blue Gem Seam, the Jellico has to be mined first.Production from the Jellico Coal Seam on the #2 Mine brings with it similareconomics as noted above in the NAG #1 Mine. By the end of the first quarter of2010, management expects to begin producing Jellico coal at the rate of 30,000tons per month. With a $16 cash operating margin, the company should addanother $480,000 in monthly cash flow, or $5.76 million annually,from this project.
Aftermining starts from the Jellico Coal Seam, permitting will be sought to beginproducing from the Blue Gem. The hope is that by the third quarter, productionof Blue Gem coal will take place at a rate of approximately 20,000 tons permonth. With Blue Gem coal selling at $100 per month, the profit margin on this productionis around $35 per ton. Multiply that margin by 20,000 tons and you can addanother monthly cash flow of $700,000 per month, or $8.4million annually.
Blue Gem #3 – BlueGem Seam – Production from this high quality resource is expected to begin firstfrom the company’s third mine. And management is expecting production to beginhere by March at the rate of 20,000 tons per 000per month from this project, beginning in March 2010.
Summary of Base Case Cash Flows
Project Q-1 – 2010 Q 2 – 2010 Q-3 – 2010 Q-4-2010 Totals
NAG # 1 – Jellico $360,000 $360,000 $360,000 $360,000 $1,440,000
NAG # 2 – Jellico
$1,440,000 $1,440,000 $1,440,000 $4,320,000
NAG # 2 – Blue Gem 0 0 0 $2,100,000 $2,100,000
NAG # 3 – Blue Gem 0 $2,100,000 $2,100,000 $2,100,000 $6,300,000
Total Operating CF $360,000 $3,900,000 $3,900,000 $6,000,000 $14,160,000
Cash Flow per Share
.003
.036
.036
.555
.131
PE Ratio X 10
.03
.36
.36
.55 $1.31
Wehave tried to err on the side of caution by assuming that if management aimedfor production during any given quarter, we would be assuming actual cash flowsduring the following quarter. We assumed 7,500 tons per month from Jellico #1,which is the median number between production limits projected by the company.
Assumingmanagement is in fact able to produce coal at the rate they have projected andassuming their cost and price estimates hold up, the above targets should behit. In fact, for the longer term, there are many reasons to think the upsidepotential for NAG is considerably more robust that the 10-bagger share pricepotential outlined above. We say that on the basis of the following:
? Coalprices for Jellico coal were based on the current price of $56 per ton.In fact, the futures are projecting a price of $79 per ton by 2012, not becauseof inflation but because of EPA requirements under the Obama Administrationthat shuts down huge amounts of coal production in the U.S. where evermountaintops have to be removed or where valleys have to be filled, in order tocarry out production. Since NAG does not face any of those issues, it stands tobenefit greatly from this legislation, at the expense, of course, of other coalcompanies and of the American people, who will have to pay more for energy as aresult.
? NAGcan produce beyond the first three mines noted above.The company is in the process of preparing to permit for NAG #4 and NAG #5 andexpects to have the ability to produce from those projects in the not toodistant future, to take advantage of higher prices in 2012 when the Obama legislationleads to higher prices.
? DeeperCoal Resources – Lying beneath the Blue Gem is a deeper coal resourcethat management thinks could be in the 100+ million ton range. This deeper coallies some 250 to 350 ft. below the Blue Gem Seam. As NAG continues to drill outthe Jellico and Blue Gem seams, it plans to extend drilling to
deeperlevels, with a goal of establishing a deeper resource. At some point, it hopesthen to attract a larger coal mining company to mine that out and perhapsprovide a royalty to NAG over the longer term.
? Moreacres still being permitted in Kentucky – Atthe present time, management is continuing to expand its acreage in Kentucky, with a view tocontinued expansion beyond the NAG #4 and NAG #5 mines (currently getting readyto permit).
? Coalprojects in West Virginia and Saskatchewan –Longer term, the company has some very
companyhas some very promising coal exploration and development targets in West Virginia and Saskatchewan.At this point in time, management is focusing on its Kentucky projects because those can, and infact are now starting
to,provide operating cash flow. The above-noted points have the potential toincrease cash flows dramatically for NAG both in the near term as well as inthe longer run. For example, a back-of-the-envelope $79 price for Jellico coalwould boost profit margins from $14 to around $45 per ton. That alone wouldallow the company to nearly double annual cash flows, assuming 37,500 tones ofmonthly Jellico coal production. We are assuming a median PE ratio of 10 timescash flow with ranges between 6 and 14 times. Based on prices noted above, anda price-to-cash-flow multiple of 10 times, we think this stock has a shot at becominga “10- bagger” from its current price of
.11. Holding those same cash flowswith a $79 price for Jellico coal would double cash flow and in theory makethis stock a potential “20- bagger.”
DefensiveCoal Should Survive the Kondratieff Winter Depression
Evenduring the darkest depressions, some companies survive. Low-costlife-sustaining products that provide energy, food, and water should exist aslong as human beings remain alive on the planet. With respect to NAG’s assets,in particular, its Blue Gem coal is likely to be a big winner when times getreally tough. I say that because it is an extremely attractive product, beingwhat is called in the industry “compliance coal.” That simply means it is coalthat can be used by power companies without the need for scrubbers. It is highBTU coal (> 13,000) andunusually clean coal, with only 0.7% sulfur. As long as coal is being burned(and it will be for the foreseeable future), this coal product will no doubt bethe most highly demanded coal product. In fact there are only a couple of othercoals of this high BTU and low sulfur content in the world
OtherProperties
Inaddition to coal properties in Saskatchewanand West Virginia, NAG has a copper-gold-molytarget at Louise Lakein British Columbiathat may have some longer-term upside. At this stage, those properties arebackburner projects and the company would do well to farm them out so it getssomething for them as it continues to focus on coal production.
FLEXIBLEMINING CAPABILITY – One important factor that investors should considerabout NAG is that it has set itself up to increase or decrease productionbetween a range of 30,000 tons per month and 60,000 or 70,000 tons per month.This is very important in that NAG should be more able than most coal mining companiesto adjust its output to economic conditions and the price of coal, and thusavoid big losses in hard economic times. At the same time, much as is true withnatural gas, we see a certain level of immunity to the business cycle, giventhe basic need to heat homes in the winter and for electricity in generalduring economic depressions or good times. To the extent coal can retain itsprice during economic downturns because of this basic “must have” factor, wethink a high-quality coal producer with infrastructure in place, as is the casewith NAG’sKentuckyoperation, should be in a position to weather economic declines
OtherProperties
Inaddition to coal properties in Saskatchewanand West Virginia, NAG has a copper-gold-molytarget at Louise Lakein British Columbiathat may have some longer-term upside. At this stage, those properties arebackburner projects and the company would do well to farm them out so it getssomething for them as it continues to focus on coal production.
SUMMARY & CONCLUSION
Forreasons noted above, if NAG can execute its business plans as outlined above,we see very considerable upside potential with limited downside risk for thosewho buy these shares at or around
.10 per share. From a
businessperspective, the company’s downside is very limited, given its high qualityBlue Gem coal deposits and also new regulations to go into effect under theObama EPA. Those laws should ensure demand for NAG’s coal production as manyother projects are shut down and also ensure a higher price for its Jellicocoal because of those supply restrictions. Certainly that is what thelonger-term $74 price for Jellico coal is telling us the market thinks.
Givenmy very bearish market and economic views, recommending purchase of a coalcompany in this environment did not come easy for me. Indeed, inexpensive asthese shares look now, they could get even cheaper if we get the kind ofcataclysmic downturn anticipated in the equity markets and with that the commoditiesmarkets. But assuming the company can generate solid cash flows now and stayout of debt, we think NAG should be a survivor under the worst of circumstances,and for those who can afford to tie up capital for a protracted period of time,this company should richly reward patient investors. Of course this optimism is
basedon a belief that management will succeed in meeting its business plans. Thatthere may be some doubt about that can be seen on two fronts. First, the shareprice is not discounting anything like a multiple of 10 times 2010cash flows noted above. More importantly, the company cannot sign significantlonger-term coal contracts with regional power companies until it proves it candeliver production. Fortunesare made and lost by those who are willing to step out ahead of the crowd. Ifyou think NAG can execute its business plan successfully, then it may pay toadd some of these shares to a diverse longer-term portfolio. Your editor thinksthe odds are better than 50/50 that management will execute its business plans,so we are adding this name into our portfolio reluctantly, given our beliefthat this equity market is very close to a major decline. If you share thatconcern, you may want to exercise caution. On the other hand, some really good productionand cash flow numbers over the next few quarters could cause these shares torise, even in a bad market.