$5.75 CAD 52-Week Hi: $7.21 Low: $0.30
All Amounts in USD, as the product is priced in USD.
Earnings Per Share (Fiscal Year March 31) P/E Multiple
2004A 2005E 2006E 2007E 2004A 2005E 2006E 2007E
($.02) $0.16 $0.98 $1.15 NM 28.8X 4.7X 4.0X
Gross Margin/tonne FY 2006E: $65.00 Operating Profit/tonne FY 2006E: $57.00
2006E EBITDA/Interest Expense: over 30X Public Float: Approx. 30 million shares
Shares Outstanding: 68 million Market Capitalization: $313 million
Peabody Energy (BTU-NYSE) for comparison (2004 4Q US Mining Operations)
Gross Margin/tonne: $4.36
Operating Profit/tonne: $1.62
Pine Valley Mining (PVM) is a metallurgical coal producer with operations based in Northeastern British Columbia, Canada. For further detail regarding the Company’s operations please refer to our previous report at microcapvalue.com or the Company’s web site at pinevalleycoal.com.
Pine Valley has recently completed the transition from a development stage exploration company to a significant metallurgical coal producer. In January, PVM announced that it had completed Phase I of construction that brought monthly production from about 45,000 metric tonnes per month (540,000 tonnes per year) to a level of 110,000 tonnes/month (1.3 million TPY). The Company expects Phase II of construction is to be completed in June, bringing monthly production to 167,000 tonnes per month (2.0 million TPY). Based on a 15% discount (historical) to recent settlements of hard coking coal (Fording, FDG-NYSE, announced last week that they would be selling their hard coking coal for $125/tonne), PCI prices should be in the area of $100/tonne for the Coal Year beginning April 1 of this year.
The Company believes that total capital expenditures through June 2005 will be approximately $22.5 million based on the most recent Company press release in late December. The Company has raised approximately $17 million to date through debt financing and warrant exercise. The remainder should be funded from internally generated cash flow. Overall, we expect PVM to be debt free by the end of calendar 2005. PVM could be paying dividends perhaps as early as the calendar 4Q of this year. An annual dividend of 15-20 cents per share USD should be readily supportable even at half the current coal prices.
We don’t expect things to proceed without some glitches along the way. All mining operations are subject to the whims of Mother Nature and other unforeseen problems. It is absolutely remarkable that a 2 million TPY metallurgical coal mine could be put into production with such a relatively small amount of capital. This is primarily due to the location of the Mine, which had all major infrastructure in place prior to start-up. Most coal production operations of this size require between $100 and $200 million+ in capital expenditures with the attendant debt burden and/or equity dilution.
PVM reported an operating profit for the calendar 3Q 2004, with only one month in production. This is quiet an achievement. Most mines don’t make profits for many months after start up; some don’t attain profitability for years. Graham Mac Kenzie, CEO, a seasoned mine manager, has done an excellent job. He is a tireless worker, intent on making the Mine operate at peak efficiency. We expect the Company to hire more seasoned professionals to beef up Management. PVM should be listed on the Senior Toronto Stock Exchange before the end of this quarter. The current Directors are mostly holdovers from the period before mining operations began and contribute very little. The Company is also very weak in its investor relations efforts. This has helped to create the current opportunity on a price-to-fundamentals basis. Based on our forecasts, the Company should post return-on-average equity and assets in excess of 100% during FY 2006.
The new Chairman, Jeffrey Fehn, seems to be a very good businessman and is intent on bringing in the necessary talent on both the Management and Director levels. Barring any major problems, PVM is, and should continue to be, a money making machine due to its position as the, if not one of, the lowest cost metallurgical coal producers in the world. Some “experts” believe that the current economic boom in China, which has driven commodity markets worldwide, may soften along with the world economy over the shorter term. We tend to agree with this assessment but over the longer term we believe that higher energy prices in general are here to stay. Even with diminished growth rates in China, secular trend-driven aggregate energy demand should remain strong. Coal, even met coal, is energy. Worldwide, we consume about 97% of productive oil capacity, which seems to be fine with everybody. Someone could “slip on a banana peal” and we would be in deficit.
Based on our EPS estimate for FY 2006, and a conservative P/E multiple of 12-15X, a stock price in the area of $12-15 by Fall 2005 is well within reason. However, with the superior margins, production growth and a debt free balance sheet expected by year-end, PVM could enjoy a higher multiple. Although the stock has seen spectacular gains over the last year, the risk profile of PVM has been coincidently reduced as most of the major hurdles facing the Company have been overcome.
Most mining companies and analysts focus on EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization a.k.a. cash flow) because they have made large capital investments and carry large debt burdens, and they don’t post strong net income. Therefore, I (interest expense) and DA (depreciation, depletion and amortization) are large and therefore tend to inflate the commonly used definition of cash flow relative to earnings. Effective tax rates tend to be reduced accordingly. A Company such as PVM, with relatively low nominal levels of assets (capital investment) and debt (probably extinguished by year end) tend to have low interest expense, depreciation and amortization expense and higher effective tax rates. Peabody Energy (BTU-NYSE) has reported negative tax rates since 2001.They report taxes as a benefit. All of us wish we could say our taxes are a benefit. They reported about $300 million in profits over the period. Over $100 million in taxes were deferred. (If you ever wondered what deferred taxes on the balance sheet were; they are the cumulative difference between taxes for financial reporting purposes and taxes for tax reporting purposes). Companies do keep two sets of books as a matter of course. Such is the wizardry of modern accounting.
Author’s Note: I remember analyzing IBM a couple years back and finding that IBM’s book value per share had actually declined about 70% from 1995 to 2002 while they were reporting all these fantastic earnings. Total reported common shareholder equity increased only 4.4% over the period. Some say, “That is because they are more of a service company rather than a capital goods company”. Well, that said; what happened to the cash? It seems it went to share buybacks, that went into option exercises for Management, which re-introduced new shares to the market, which means it all went into Management’s pockets. Maybe that is it, but in any event it sure looks fishy to me. This may be one of the greatest pieces of financial engineering in history. Others may say, “the largest heist (although technically legal) in history”. No wonder the CEO left to write books about how he turned around IBM. These days all the CEO’s extol the virtues of share buybacks, no double taxation, market support, blah, blah, blah rather than paying higher dividends. The reality is that it supports their option cash outs. Remember, only actual shareholders have the right to dividends.
Trying to read today’s financial statements, even for experienced professionals, is a minefield. For example, BTU reported earnings per share for 2003 of $1.73 cents per share in their press release excluding items, yet there was zero pre-tax operating income, according to their Annual Report. It is absolutely amazing how they exclude things that hamper reported earnings and include them when they enhance earnings and all the Wall Street “analysts” obediently comply. No one seems to feel that negative taxes (added to income) should be excluded. Accounting charges are all there for a reason, whether they are office supplies or charges for extinguishments of debt, or cumulative effects of accounting changes. These items previously benefited earnings, now they are being repaid. Without proper accounting, there is absolutely no way of judging any company’s performance. “Earnings Quality” depends on it.
Based on unaudited earnings reported on their web site for 2004 BTU “earned” $2.75 per share. BUT, if you take their own reported pre-tax earnings and tax them at the 34% statutory tax rate, something “old time analysts” used to do (and we do here in our EPS projections for PVM) you get around $1.59 per share. The PE ratio based on “fully-taxed earnings” goes from the popularly reported 31.2X to 54.2X. If you use Enterprise Value (shares outstanding x share price= market capitalization + [long term liabilities], rather than market capitalization alone) it becomes 92.7X earnings. You have to take long-term liabilities into account, which in this case includes pension liabilities. In the meantime, insiders busily sell shares. There must be hundreds of Form 4 filings since last Spring. In stark contrast, to our knowledge, current insiders at PVM have never sold any shares, only bought them. It always amazed me that they would have some guy on CNBC talking about some guys in “Joe’s Paint Company” selling, but never talk about the innumerable sales by insiders in all the popular “names”. Insider sales relative to purchases recently have exceeded levels of late 1999, this should tell people something.
PVM should have virtually zero long-term liabilities by year-end 2005. (I’d hate to see the P/E for Ford, based on Enterprise Value. That is why the P/E seems so low). Back to BTU, their reported average sale price per ton for 2004 was $15.80 per ton. To be fair, 61% of there 2004 production was from low BTU (British Thermal Units) coal from the Western US, selling for around $10 per ton. PVM should be selling their coal for around $100 per tonne. A metric tonne is 1.1 short tons. Therefore, direct comparison is $110 per ton.
BTU’s pre-tax operating profit per ton skyrocketed over 100% between the first and last quarter of 2004, from $0.71/ton to $1.48/ton. PVM should make well over $52 per ton (short ton) for direct comparison. That right, over 35X the pre-tax operating profit per ton. There is literally no comparison on a margin basis. Note: All in Canadian corporate taxes should be in the 31% area. The statutory US corporate tax rate is 34%.
[We would rather have a smaller, high margin business, there are less moving parts. Unfortunately, people always get hung up on size rather than quality, after all Enron was going to take over the world, Calpine was going to light up the Earth].
They might as well be in two different businesses. Put a different way, their approximately 200 million tons produced during 2004 is equal to about 5.7 million tons profit-wise for PVM. At 2 million TPY (2.2 million short tons per year), PVM should make about 38% of the operating profit of BTU. Therefore, it should be worth 38% of Peabody market cap of $5.6 billion or $2.12 billion or over $31. Based on Enterprise Value for Peabody of $5.6 + $3.6= $9.2 or PVM would sell at $51 a share. Obviously, either BTU is very overvalued or PVM is very much undervalued. We believe it is a little or a lot of both. PVM is also new and untested where BTU has stood the test of time and is the biggest coal producer in the world. Margins should again improve substantially for BTU during 2005, as long-term contracts are replaced with new contracts that better reflect market prices.
In any event, PVMCF seems very much undervalued at $4.60 per share USD, $5.75 per share CAD.
Using standard conventional comparative analysis regarding PVM is very difficult due to the fact that there are so few publicly traded coal companies in general, and metallurgical coal companies in particular. They span several countries, different accounting conventions, several currencies, and even different systems of weights and measures. On top of that, coal qualities vary substantially.
One valuation metric that always comes into play (or should) is profitability. PVM is extremely profitable at current prices and merely very profitable at even half the current coal prices. The contract prices for the next coal year beginning April 1, 2005, which coincides with the Company’s fiscal year, are expected to be in the $100/metric tonne range. Profits should clean up the balance sheet completely by year-end and thus make PVM readily capable of weathering any downturn in prices. At 50% of current coal prices, most producers would only be marginally profitable with many becoming unprofitable. PVM would still earn good profits, perhaps 25-30 cents USD per share. Free cash flow levels at this level of profitability would still support a dividend with PVM in a debt free position. This reduces coal price risk considerably. Earnings should grow along with production even in static to slightly down coal price environment. We believe that given sustained prices in this area, PVM is capable of increasing annual production beyond the 2 million TPY rate currently projected by June. The property should be able to support production in the 3 million TPY range, this possibility is not included in our estimate for fiscal 2007. At 2 million TPY, proven reserves in the less than 4:1 strip ratio area are sustainable for at least eight years. Most mature metallurgical coal producers are in the 8:1+ strip ratio range. At those ratios, PVM’s overall reserves are probably in the 30-50 million tonne range. Based on current prices, there is probably recoverable coal in the 100 million tonne range. No one has booked reserves at current prices. Reserves are a function of price. For instance, there is about one ton of gold in a cubic mile of ordinary seawater. Unfortunately it would probably take gold prices in the order of $100,000 per ounce to make extraction economic.
PVM has some currency hedges in place, not on an investment basis, but for producer hedging purposes only, according to Management. The Company may also study the feasibility of a power plant on site, something that was explored by PVM in the 2001-02 timeframe. The coal is suitable for a PC (pulverized coal) power plant according to a pre-feasibility report by Bechtel, a major engineering/construction company, which prepared the report. The main power lines running from a major hydro dam in Northern BC, bisect the Property. These lines run to Vancouver and on to the Columbia Hub, a major electricity distribution point in Washington State, for power deliveries to California. BC Hydro, the Government-owned utility, has recently decided that it needs new electricity sources.
Peabody (BTU) has pursued this strategy with success in the US. Peabody announced their plan to build a power plant after PVM announced their intentions in the area in 2001. A power plant would give the Company a defensive nature. Steel making, is inherently a cyclic business. Steel companies and therefore met coal producers command high P/E multiples at the beginning of economic cycles and lower P/E multiples at the perceived peak in economic cycles. A power plant would smooth this relationship, as electricity consumption is historically relatively immune to economic downturns. The last thing people stop buying is utilities.
PVM may also study the possibility of building a coking plant on site. US steel companies would be a likely joint venture partners, and being the final refined product, prices are currently in the $3-400/tonne range. Volumes would be much smaller and therefore transportation costs, which account for roughly half of the delivered cost of PVM’s coal, would be reduced. Mac Arthur Coal (MCC-ASX), a major PCI producer in Australia, which has had transportation challenges, is currently conducting a feasibility study to build a coke plant in Queensland, adjacent to the Bowen Basin, one of the world’s richest sources of coking coal. Surplus heat will be used to generate electricity, basically a cogeneration application. A similar plant in BC would be a major plus for PVM. (By the way, Mac Arthur Coal has higher strip ratios, about 7.5:1 at its largest (Coppabella) mine, and thus higher production costs than PVM. PVM is undervalued relative to MCC). A coke plant would both produce a higher valued product and potentially electricity. This makes it doubly attractive and probably the way for PVM to go, in our estimation.
Once the 2 million TPY rate is attained and debt is paid down, PVM will be a lean, mean profit machine for many years to come. Internally generated cash flow should easily provide maintenance costs and expansion capital.
Over the last few years the market has been a very strange animal. I have been in the markets for almost 22 years, since I became an analyst with Merrill Lynch in 1983. Markets go up and down (mostly up) in unison for no reason. Today all averages rallied at almost exactly 1:00 PM EST. This is purely a function of program buying, since the averages are mostly composed of different companies. I see this type of action as a desperate attempt by the powers that be, to keep this crazy, “wealth-based” economy going. There is no savings, and the US is exporting assets, capital and businesses at alarming rates. I’ve noticed that real estate agents are celebrated like stockbrokers were celebrated in 1999. Everyone has a real estate deal cooking, like they all had their great stocks in 1999.
Insiders are selling like crazy. Although the mainstream has hardly noticed, the “market” is in about the same place it was in 1998. Inflation adjusted returns have been negative over the last six or seven years, yet everyone believes the “market is doing fine”. I read the other day; in a column regarding mutual funds, that such and such large cap fund had “five-year compound returns of minus 2 percent which put it in the 98th percentile”. Believe it or not, I used to sell any stock that was trading over 20X trailing earnings (except very special situations like PVM). Now they all trade there.
The whole stock market thing and particularly the real
estate thing I liken to a set of dominos. Once one of the people turns around
and says, “I want to sell, not buy”, everyone in front of them will say “what
do you mean, I need you to buy my deal so I can buy the next bigger deal”. Then
one by one, they will turn around and sell. There will be a 1000 people and
only 100 chairs, most will simply fall on the floor as they did with stocks in
2000. It will be the double-whammy with stocks and the first whack in real
estate. These daze people believe anything that happened even five years ago
was ancient history. I read an article
in the NY Times awhile back, written in 1936. As I recall, it basically said that
despite the Dow Jones being down 80% since 1929, you would have still done
better than real estate, which was down 85%. In general, the only sector that
did well in the 30’s was commodities. Homestake Mining’s dividend in the
late 1930’s exceeded their stock price in the early 1930’s.
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The analysis contained herein is for informational
purposes only. It is not any offer to buy or sell any security. The information
contained herein is believed to be accurate but its accuracy is not guaranteed.
Thomas B. O’Brien, the author of this report, was previously CEO of Pine Valley
Mining for a period of 11 months in 2000-2001 following the death of Orville
Gillespie, the founder of Pine Valley Mining and its predecessor companies. He
holds a BA in Geology, worked and was trained by Phillips Petroleum Company and
an MBA in Finance. He holds approximately 2.3 million common shares of Pine
Valley Mining. Affiliates of Mr. O’Brien hold large positions in the common
stock of Pine Valley Mining. Mr. O’Brien is not an officer, director or insider
of Pine Valley Mining. Pine Valley Mining did not compensate Mr. O’Brien in any
way, for the preparation of the report. This is not a complete analysis of any
company or industry. God bless Orville Gillespie, without his tireless work,
Pine Valley Mining would not exist Thanks.
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