(Nov 20): Geo Energy Resources has achieved a big improvement in profitability this year, on increased production at its coal mine in Indonesia as well as higher selling prices. And, production at its second mine could kick off next year. Now, confident that the coal sector is on a steady uptrend, the company is preparing to make some new investments.

“We have seen the worst of the bottom, and we are now going up,” says CEO Tung Kum Hon in an interview with The Edge Singapore. Last month, the company raised US$300 million ($407 million) in a new bond issue. About US$200 million will be used for an acquisition, which may be via some form of joint venture and may take place soon, according to Tung. The rest of the proceeds from the bond issue have been used to redeem an earlier tranche of bonds that matures in January.

“If this company holds US$200 million for a year, paying US$24 million interest on it, it is a very stupid company. You’d expect the company to invest the cash to generate better returns for shareholders,” Tung says. The bonds that Geo Energy has just issued have a coupon of 8% and mature in 2022. They are rated “B2” by Moody’s Investors Service, “B” by Standard and Poor’s Ratings Services and “B+” by Fitch Ratings.

Geo Energy, which went public in 2012, currently generates revenue from only one mine — Sungai Danau Jaya in Kalimantan. It recently acquired another mine adjacent to SDJ called Tanah Bumu Resources (TBR). These two mines have combined coal reserves of 85.2 million tonnes, according to a report by a consultant dated May 19, 2017. The main markets for the company’s coal are China and Southeast Asia.

It was not long after its public listing that Geo Energy sank into the red, though. In fact, the company reported losses for the whole of 2014 and 2015, as coal prices tumbled by half from more than US$50 a tonne. Things started turning around last year. With higher coal prices and increased production at SDJ, the company was back in the black in 2QFY2016. This year, coal prices have continued firming. According to the Indonesian Coal Index, the price of the benchmark 4,200 GAR (gross as received) CV (calorific value) coal was US$44.88 a tonne on Nov 10, up from US$37.25 on Jan 6. That has helped lift Geo Energy’s profitability. For 3QFY2017, the company posted a 16% y-o-y rise in earnings to US$8.6 million, on the back of a 32% y-o-y increase in revenue to US$74.9 million. For the first nine months of the year, earnings were up 344% y-o-y to US$33.2 million, while revenue increased 148% y-o-y to US$223.5 million.

With the release of its 3QFY2017 results, Geo Energy said it would pay an interim dividend of one cent a share. This is on top of the first and final dividend of one cent a share it paid just half a year ago for FY2016.

New mine to start production Geo Energy says it is likely to produce between seven million and eight million tonnes of coal for the whole of 2017. This is actually short of the 10 million tonnes it previously said it was targeting. Tung says the shortfall is due to the delay in completing the acquisition of TBR. The acquisition was only completed in June, a year after the deal was first announced. The company is now working to get TBR into production mode as quickly as possible. This involves clearing the land and bringing in the necessary mining equipment and supporting vehicles. As with SDJ, the operation of TBR will be outsourced to Bukit Makmur Mandiri Utama (Buma), a leading mining contractor, which has a total equipment fleet of 3,000 units.

According to Tung, TBR should begin contributing to Geo Energy’s revenue in 2QFY2018. According to a geological report, which includes a projected production schedule for the next 13 years, TBR may be able to produce three million tonnes of coal in its first year. The report projects production of six million and seven million tonnes for the second and third years respectively.

In the meantime, Geo Energy is still hammering out an offtake agreement for TBR. The existing offtaker for SDJ is Engelhart Commodities Trading Partners, which used to be the commodities trading arm of Brazilian investment bank Grupo BTG Pactual. Spun off in the middle of last year, ECTP has committed to prepayment of US$4 per tonne for SDJ this year. Tung is aiming for a better deal for TBR. “Obviously, we have quite a number of parties interested and we are in discussions. The TBR deal can be better than ECTP’s agreement for SDJ,” he says.

Competition, risks One obvious risk that Geo Energy faces is that the supply of coal could increase dramatically if prices continue to rise. Some market watchers also warn that the cost of renewable energy has declined significantly in recent years, and could soon pose very real competition for traditional fossil fuels.

Tung is unfazed by these concerns, though. The way he sees it, the supply of coal is not going to increase immediately in response to rising prices, because it takes time for idle mines to be brought into production. “You have a paddy field, but when the price of rice goes up, can you increase your rice production right away? Those who haven’t started their mines will need six months’ lead time. By then, the market price would be different,” he says.

At any rate, Geo Energy is competitive in terms of costs, with a strip ratio of just over three times, compared with the median of 6.1 times of its peers, Tung points out. The strip ratio is the amount of overburden that needs to be removed versus the amount of coal that can be extracted. “Different producers make different margins,” he says.

Tung is also sceptical about the idea of renewable energy supplanting traditional fossil fuels within the next 50 years. Solar power, for example, requires not only a significant upfront investment in panels but also a lot of space in order to generate a meaningful amount of electricity. Tung adds that making the solar panels requires copious amounts of raw materials.

Ultimately, the energy needs of the fast-growing economies of Asia will have to be supported by traditional fossil fuels such as coal over the next decade at least. In fact, the most populous countries of Southeast Asia, such as Indonesia, the Philippines and Vietnam, are expected to see their economies grow by at least 5% a year. Even China, which is consciously shifting to renewable energy, still uses coal as a major source of energy. “Just look at China’s industry output: Its PMI [Purchasing Managers’ Index, a measure of manufacturing activity] has gone up. All that needs power,” says Tung.

One other risk that might worry Geo Energy investors is exactly how the company will choose to invest the proceeds of its latest bond issue. In August, the company raised some eyebrows when it said it was mulling an investment in e-commerce. Tung now clarifies that the investment was a corporate social responsibility project. The way he explains it, the Indonesian government was looking for private-sector support and Geo Energy had been asked to consider investing. Tung says even if Geo Energy were to go ahead with the e-commerce project, it will not be a significant investment.

Can the stock go higher? From its all-time low of 9.2 cents on Aug 1, 2016, Geo Energy’s share price has recovered to 26.5 cents on Nov 16. Even at this elevated level, the interim dividend it has declared this year represents a yield of 3.8%. The stock is also still trading at just five times historical earnings.

Tung is unabashed in saying that the market is undervaluing his company. He points out that shares in Golden Energy Resources are trading at more than 20 times historical and almost 10 times forward earnings. “Maybe we should be trading at that value,” he says.

He also emphasises that Geo Energy has a lot of potential to grow its earnings without having to raise any more money. With a cost of production of US$28 a tonne, Geo Energy can easily extract earnings of US$10 per tonne of coal it produces at current coal prices. And, with a projected production volume of 10 million tonnes in 2018, that would translate into US$100 million in potential earnings.

Even at a price-to-earnings ratio of five times, that should put Geo Energy’s market value at US$500 million, or nearly $680 million. At its current share price, the company has a market capitalisation of $352 million. “Should the share price double?” Tung asks. “Does this company need equity funding to do this? No, it has already raised the funding; it is waiting to be deployed,” he adds.

Geo Energy is 25.83% owned by Master Resources International, which is a vehicle owned by various Geo Energy’s directors, including executive chairman Charles Antonny Melati. Melati owns a further direct stake of 14.55%. Renowned commodities bull Jim Rogers, who is also a director, owns 3.4 million shares and has an option to buy two million shares from Melati at 35 cents each over 10 years from 2015. Tung, who joined the company in December 2015, owns 10 million shares, which is equivalent to a 0.75% stake in the company.

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