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The Outlook of Coal Stocks: Update

Two months ago, more precisely in the first week of October, I noticed the price of coal, in this case the benchmark coal price of Newcastle Australia, which previously was falling down to US$ 53 each ton in the beginning of 2016, it began to rerise to US$ 72. After I had considered some analytical reasons, I inferred the rise might continue in the long term, and as a result I chose one among the coal stocks that according to me was a great stock, it was Harum Energy (HRUM), its price was 1,050 (you may reread the analysis here).

Later, it was true that the coal price continued to climb up, but no one would expect if its increase was fast, that today the coal price of Newcastle has hit the psychological level of US$ 100 by a ton! The results were predictable: Since early October, the coal stocks skyrocketed to hundreds of percent in a matter of weeks, even though they had risen much before (the coal stocks had already increased since the beginning of 2016, but the transaction volume only significant enough after October). As an illustration it’s HRUM, its highest price was 2,640, then it has increased to 300% YTD, but HRUM was not the only one, because most coal stocks have climbed to hundreds of percent since the beginning of the year.  When JCI has reached its peak in October as the euphoria of tax amnesty reduced, but the market was not lethargic as the investors had a new toy: The commodity stocks, mainly coal.

But as usual, when a certain stock or sector had an increase then some investors might have bought the stock at a low price earlier, but other investors might buy the stock at a high price, the problem was we could not expect a stock to keep climbing up every day, but there must be a downturn. And it happened to the coal stocks, in the latest two weeks some coal stocks, although it’s not all, have started to fall. If you have bought the stocks since the October, or earlier, you would have secured your place. But what if you bought the stocks late? So, if that was the case then we have to review the outlook for coal sector again and here we go! 

First, the price of Newcastle coal reaches the US$ 100 a ton, it is higher than the coal company has ever predicted. What I remember was, in April 2016, United Tractors (UNTR)’s management said the coal price at US$ 50’s each ton was low, and for the next five years (it started from 2016) the coal price would rise to around US$ 52 – 72 each ton. The report from the management of HRUM also predicted the same thing, the coal price in the future would be stable around US$ 75 each ton. And the latest one, when the management of Bumi Resources (BUMI) made a deal to end its liability issue with the creditors, one of the assumption points used was the coal price, although it might rise and fall in the short term, but it would not go down lower than US$ 70 each ton.

But none of three companies mentioned above said if the coal price would be stable at level US$ 100 by ton. But if the coal price had risen or fallen to any position, including reaching US$ 100 each ton as for now, then it would have been adjusted and become stable at US$ 70 – 75 each ton, or at least it was the prediction from the company. But it might be different: When the management said if the coal price would be stable at US$ 70 – 75 each ton, it was not a prediction, but the lowest assumption they expected to occur, if the price of coal were low as in the past time, the production volume would be cut to reduce the coal supply on the market (and indeed that was what UNTR and the rest had done in 2015 – 2016). But if the coal price had risen to US$ 70 by ton, the higher the better, the production volume would have been increased again.

However, it doesn’t mean the coal price would keep rising, and the problem is the recent condition is different with the ones in 2011, it skyrocketed to US$ 142 each ton because of increasing demand from China which had high economic growth, but for now it has started to (and still) slow down. When the coal price was rising quickly, near two times in months, the possible reason was the technical rebound after it had long downtrend for five years (since 2011), the rebound showed the long-term downtrend had ended, but to rise to what it was in 2011 then it needs time, it may not take to five years, but it is not as fast two last months.

Then except if it has positive sentiment coming either from China, Japan, or domestic, I think that sooner or later the coal price will fall for a while, but it won’t drop below US$ 50’s, but US$ 70 is maximized. Then it may climb up slowly but in a certain pace, but it will not as fast as it moved two months ago, but it may become stable/stagnant on a certain level. When the price is ‘confirmed’ to go above US$ 70 by ton onwards, then BUMI and the others will increase their coal production volume so it will increase the coal supply on the market, and eventually it will make the coal price stuck on a certain level.

Second, if it’s true that the coal price will fall in the future, the overheated stocks will also drop. Why do I say overheated? Because some of the coal stocks were cheap, let’s say if its PBV is 1 time or less, but recently they are already more expensive than some blue chips.

As the coal price is unlikely to fall below US$ 50’s per ton, HRUM and others will not fall into their bottom positions in early 2016. The cooling down phase will occur until April 2017, when the companies publish their financial statements of Quarter I 2017, if the results are great then the coal stocks have the fundamental reason to go up once again.

Not an euphoria yet

Last, third, the main question is, what is the fair valuation of the coal stocks? We need to review their records in 2011, when the sector was at its greatest period: In 2011, I remembered, the lowest PBV of a coal stock was about 4 times. The coal stocks were regarded very expensive, they were more costly than the consumer goods stocks, because the investors valued equity based on the proven reserves owned by the enterprises. If PT A had equity of Rp1 trillion but its market capitalization was only Rp5 trillion (PBV 5 times), but it was still valued as cheap, because PT A had coal reserves at a trillion tons which if it had dug the reserves and sold all the coals, then it would have got profit at tens of trillions! Then once again if PT A had a market capitalization which was five times bigger than its equity, it was still cheap, because the equity did not count the ‘equity’ in the form of coal that had been proven underground, but it had not been turned into money. Some companies were considered to have huge coal reserves (compared with their annual production volume), their stocks were valued at PBV 7, 9, to 11 times. 

(but indeed, the most basic mistake the analysts recommended about coal stock was they thought the current selling price, it was US$ 140’s each ton, would be stable at that level and would never fall)

Okay, it was in 2011. But how do they perform now? Well, although the coal stocks skyrocketed, the highest PBV only reaches three times (the share of PTBA), but it is already higher than the most stocks’ valuations at IDX, which become cheap recently as IHSG gets sluggish. And if you compare coal companies performances up to Quarter III 2016, where their incomes and net profits have not improved and their ROE’s are low, it is obvious the current value of coal stocks is not cheap anymore. If the coal price starts to consolidate, the coal stocks will drop for a while to find their balance spots.

But when the consolidation/cooling down phase ends, the coal stocks will rise again, and this time their risings will be based on the results of their financial statement’s performances at the beginning of 2017 (they will not go up together anymore because of the increased coal price). As an illustration, I possessed two coal stocks in 2011 which skyrocketed: Resource Alam Indonesia (KKGI), it rose from 1,700’s to 8,000’s, and Garda Tujuh Buana (GTBO), from 100’s to 1,500’s and it was still rising to 5,000’s in 2012 (sadly, I had sold GTBO far before it rose to 5,000).

And.. did you know why those two could skyrocket? Well, it was simple, because those two stocks reported annualized ROE to 60 percent! Or it’s far higher than most of the coal stocks. Plus, when the big coal stocks such as BUMI and Adaro Energy (ADRO) had been valued at PBV 4 times, the PBVs of KKGI and GTBO, based on their unincreasing prices (KKGI was at 1,000’s, meanwhile GTBO was at 100’s), were only less than two times, which probably because they were labelled as small stocks so that people rarely paid attention to them, and noticed them only after they had extraordinary financial reports.

If you think the increase of coal stocks in recent months were great, then you has never had GTBO

So, trust me, it does not matter if a stock rises a lot or the opposite happens that it drops a lot in a short period, but finally people will look at their financial statements, and its stock valuation. Then our task is simple: On April 2017, focus yourself on analyzing financial statements of all coal enterprises, find the one which has the best performance, and the cheapest stock! Then buy it for mid or long-term.

Then what should I do if I have already had a coal stock? Well, it does not matter if you bought it earlier then you may gain profit, or you got it late then you are stuck, but if you have a vision of the future, at least in April 2017, then there is no reason for you to sell it in a hurry. Because even if the coal price drops, but not go below US$ 70 a ton then the coal companies will still increase their volume production, and it means their incomes with net profits, and profitabilities will be ‘huge’ again, though not as huge as they were in 2011, but ROE projection at 20 – 25% in 2017 for a healthy coal company is sensible, and it will be a good reason to value the stock at PBV 2 – 3 times, or even higher.

Then, last, you have to remember in 2011, everybody valued coal stocks based on the reserves owned by the companies. But for now, as far as I know there was no single analyst who mentioned ‘the coal reserves’, in which it meant the coal sector had not reached its euphoria peak. If you want the most recent illustration, in the early to mid 2013, the construction stocks skyrocketed to a point which the analysts said that PBV 4 – 5 for Adhi Karya (ADHI) was fair, considering the business had a long-term construction agreement at trillions Rupiah that had not reflected on its equity (ADHI was at level 4,000. Let us see in what position ADHI now?). Construction agreement we discussed here was similar with coal reserves.

The conclusion is, when people become unrealistic when they estimate a stock or sectoral valuation, that’s when the euphoria occurs, and the stocks may fall later. But the euphoria has not hit the coal sector so far, as the valuation of the coal sector is not that high yet. And that means, with an assumption that you still have the chance to hold the coal stocks for at least mid period (from 3 to 12 months onwards, or longer), then the opportunity is still there!

Original article was written (in Indonesian Language) in November 28, 2016. For inquiries, please contact the author by email teguh.idx@gmail.com

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