Valuation Model: Geo Energy NPV, Comps Analysis Indicate Recoveries of 80-99%, Fair Value Range of $45M to $95M; Credit Support Underpinned by $200M of Balance Sheet Cash; Could Change With M&A Outcomes

Relevant Documents:
Tearsheet
Excel (with updated valuation analysis) on Reorg Analysis Page
$300mil 8% ‘22 Senior Notes Covenant Brief
2018 Independent Expert’s Report (SMG Consultants)

Further to Reorg’s initial tearsheet on Geo Energy Resources Limited (“Geo”), we have carried out a valuation analysis on the Indonesian coal miner’s existing operations. Through an income approach based on project level cash flows and multiples approach based on peer comparables, we estimated that the existing producing assets are likely to be worth $45 million to $95 million, depending on a range of coal price assumptions. Further, due to Geo’s substantial cash balance of $199.6 million, the $300 million 8% ‘22 Senior Notes should see recovery from the high 60s onwards even with a fairly challenging set of coal price assumptions. That said, the company has communicated its intent towards significant acquisition opportunities and depending on the asset acquired and the consideration paid, the fair value range of the senior notes could change.

To be conservative, Reorg’s analysis only attributes value to Geo’s producing coal mines, Sungai Danau Jaya (SDJ) and Tanah Bumbu Resources (TBR) and does not include the two other inactive mines. The Bumi Enggang Khatulistiwa (BEK) project that is currently being put under care and maintenance is likely to be worth little at current coal prices given its coal has low calorific values, relatively high ash content and a relatively high mining strip ratio. No value is attributed to the exploratory and undeveloped Surya Tambang Tolido (STT) concession, which was acquired in 2016 for $2 million.

To sensitise valuation inputs and operating drivers, please access Reorg’s excel model HERE under the “Drivers & Assumptions” tab.

For the purpose of this exercise, Geo’s prospective acquisitions are considered to be cash neutral (neither value accretive nor destructive) for the time being until more asset-level details are disclosed.

The implied recoveries for the stated valuation range are:

Income Approach

The income approach utilises various unit operating cost inputs from Geo’s 2018 independent expert report prepared by SMG Consultants. Pit-to-port cost drivers make up more than half of unit operating costs; in particular, waste mining cost makes up about a third of the operating cost but Geo’s relatively low average strip ratio of 3.3x is helpful in keeping costs competitive when compared to peers.

In arriving at a base case scenario, a set of consensus pricing forecast that incorporated pricing views from 17 contributors for the Newcastle thermal coal benchmark, as compiled by KPMG in Aug. 2019, was considered. The median strip pricing is then discounted by 52.5% to arrive at an indicative average selling price (ASP) for the 4,200kcal GAR coal that Geo markets through its off-takers. Over the past 9.5 years, 4,200kcal coal has traded at roughly 50% to 55% average discount to the Newcastle benchmark. The following chart uses 6,500kcal GAR coal as a proxy for the Newcastle benchmark:

Using the above assumptions against a 15% discount rate - Reorg reaches a base case net present value (NPV) of $43.9 million:


Notwithstanding a broad set of assumptions, it is not unreasonable to arrive at a fairly conservative valuation range of around $45 million to $95 million, implying recoveries of 81% to 98% for the $300mil 8% ‘22 Senior Notes compared with current levels of 73.3/73.9. From the base case estimate of $43.9 million, the implied recovery is 81.1%. Even if NPV estimates halve, the senior notes are still likely to see recoveries of around 75% because of the large excess cash balance on the company’s balance sheet- this is close to where the bonds are trading at.

The implied recoveries for the stated valuation range are illustrated below:

As of June 30, 2019, Geo has $199.6 million of cash (around $175 million if pro forma effects are given to the recently announced $25 million proposed acquisition of Titan Global Energy (TGE)), largely carried over from the $300 million 8% ‘22 Senior Notes’s issuance in 2017, out of which Geo is likely to deploy a significant portion towards acquisition opportunities. Please refer to Geo’s tearsheet for more details on the prospective acquisition targets.

In the event that Geo’s prospective acquisition turns out to be capital destructive (perhaps due to prolonged weak coal prices or unforeseen high operating costs) or if it overpays for assets, the recovery rate of the $300mil 8% ‘22 Senior Notes could be significantly lower. As of Oct. 23, 2019, the notes are quoted at 73.3/ 73.9- implying credit investors’ bearish views toward Geo and they are perhaps mostly looking towards its excess pro forma cash balance of around $175 million as the main source of credit support.

While Geo considers inorganic growth opportunities, it could yet table a meaningful tender offer to noteholders if a sizable transaction, excluding the proposed Titan deal, does not transpire and its $300mil 8% ‘22 Senior Notes continue to trade down. Management has neither confirmed nor denied the possibility of a tender offer, although industry sources that Reorg has spoken to indicate that it is increasingly challenging to acquire a significant coal mining asset (barring a distressed sale) that could see a similarly attractive near-term return as a tender offer, even at a premium over recent trading prices. This is especially so after taking the notes’ 8% annual coupon into account.

As another point of comparison, sell-side analysts have estimated 9%-12% return on invested capital over the next two to three years for Adaro - a large-cap, bluechip vertically-integrated Indonesian coal miner that has a stronger profitability profile than Geo.

When sensitised against various capital cost discount rates and benchmark discount rates against the Newcastle thermal coal benchmark, the notes have the following implied recoveries under the assumptions of the modelled cost structure:

Peer Comparable Approach

Reorg also provides a peer comparables analysis as a sense check to the income approach. We use a multiples comparable approach in which an enterprise value (EV) per reserve ton and EV/ EBITDA have also been considered:

Given that Geo’s mine life is relatively short, the EV/ EBITDA metric might be a less applicable approach especially considering the peers above tend to have a significantly longer estimated mine life. Assuming the lower end of the range at 1.9x, the implied EV of Geo would be around $68 million.

From a reserves perspective, although Geo’s SDJ/ TBR mines enjoy some of the lowest cash costs (~5th percentile) amongst peers on an energy-adjusted basis, according to the company, the coal produced from those mines tend to have lower energy content with relatively low ash and sulfur content. Given the smaller operations and reduced economies of scale, the median multiple of $1.51 per reserve ton was adopted to imply an enterprise value of $96.4 million by the end of 2019. This would be on the higher end of the estimate indicated in the earlier income approach, implying an almost par recovery at 98.6% for the $300mil 8% ‘22 Senior Notes.

Given that coal prices have generally trended down in 2019 as compared to 2018, Geo’s upcoming 2019 JORC-compliant reserves report is likely to show a smaller reserve size.

It should be noted that Geo completed the acquisition of 98.73% in TBR in June 2017 with a headline consideration of $90 million made up of $37 million in cash, $13 million in Geo shares and the assignment of $40 million worth of trade and other receivables. This implied a valuation of $2.15/ reserve ton or around 42% higher than the median multiple indicated above. Coal produced from Geo’s TBR and SDJ mines has similar specifications.

The company’s proposed acquisition of the TGE assets implies a valuation of $0.57 per reserve ton and appears to be a favourable deal for the company such that Geo could have booked a bargain purchase gain on a pro forma basis. The associated coal assets have a higher blended calorific value of around 4,550kcal/kg GAR but comes with a relatively higher ash content while sulphur content remains comparable.

Seaborne Thermal Coal Sector & Outlook

From the above analysis, it can be seen that Geo’s enterprise value is most affected by seaborne thermal coal prices. Therefore, we attempt to provide an overview of the thermal coal market below.

According to Platts, Indonesia remains the world’s largest exporter of seaborne thermal coal. The country has around 40% of the seaborne thermal coal market share, followed by Australia with around 20%. These two countries dominate the Pacific Basin trade and primarily cater to the import demand of China, India, Europe, Japan, South Korea and Taiwan, in order of importance. These countries make up about 80% of total seaborne thermal coal demand, with China and India taking up around 35%.

Indonesia is the dominant low-rank coal supplier while Australia tends to export higher-ranked coal. Indonesia’s top five countries of export in 2018 are the following:


China and India soaked up around 58% of Indonesia’s seaborne thermal coal exports in 2018. 81% of Geo’s 2018 revenues are made up of exports to China and mainly to utility companies that blend Geo’s coal with domestic supplies for use in coal-fired power plants due to the lower ash and sulphur content found in the company’s coal. The blending is necessary for Geo’s end-customers to comply with environmental regulations. At the same time, the low ash characteristic is helpful towards reducing unwanted byproduct build-up in boilers and tends to improve thermal efficiency and reduce maintenance costs.

In the short-term, coal prices could see some support as China conducts a series of domestic coal mine inspections, potentially tightening supplies, ahead of its National Day event on Oct. 1. However, coal inventory at various key Chinese ports appears to still be on the higher side as concerns on import quotas remain.

Over the medium-term, China’s accelerating coal mine approvals as seen in 2019 could potentially increase domestic supply and dampen global pricing.

While thermal coal is likely to remain as a primary energy source for global power generation, various market participants are of the view that coal demand is likely to suffer structural decline over the long-term for some of the following key reasons:

• Financing constraints against coal-related businesses


• Natural gas increasingly replacing coal’s share of power generation, especially in China


• Clean energy from renewable sources becoming increasingly affordable

According to the IEEFA, more than 100 globally significant financial institutions have developed formal thermal coal mining and coal-fired power plant restriction policies. Reorg’s on-the-ground research with various industry stakeholders in Indonesia also indicates that various coal-related projects are finding it increasingly challenging to seek financing, likely resulting in a higher cost of capital for such businesses and reduced prospective supply of coal production/ related power generation capacities. Already the global planned coal power capacity in pre-construction status has declined dramatically:


Regarding natural gas, Caixin cited a research report by CNPC Economics and Technology Research Institute that Chinese demand is expected to grow strongly to 2035. The research indicated that natural gas will grow from 8% of China’s total non-renewable energy mix to 14% in about 15 years’ time as the country seeks to replace coal with a cleaner source of fuel. Across various consumption sectors, China’s natural gas demand is expected to grow strongly:


As for renewables, the levelised cost of electricity (LCOE) for wind and solar have come down significantly and are expected to further trend down:


If the above forecasts beyond 2018 are accurate, these sources of renewable power could be extremely competitive with fossil fuels in certain countries, including those in Asia, and could increasingly displace coal and reduce seaborne thermal demand..

As an example, the Indian States of Chhattisgarh and Gujarat have recently indicated that they will not be building new coal power plants and could be looking to solar power instead to meet increased power demand.

The above structural factors are only meant to provide an overview of some of the key trends that may lead to a long-term decline of seaborne thermal coal prices and represents a single viewpoint.