CONSOL Energy’s CEO, Jimmy Brock, and CONSOL’s CFO, David Khani, join The Stock Podcast to describe the CONSOL investment thesis and the business of mining coal. CONSOL is one of the premier coal producers in the country. Tune in to hear management talk about the outlook for the business, the industry, and one of the most valuable coal assets in North America, the Pennsylvania Mining Complex.
It’s also worth mentioning that, this week’s guests represent two separate public companies. CONSOL Energy, ticker symbol CEIX, and CONSOL Coal Resources, ticker symbol CCR. Similar to what you see in the midstream space, CONSOL Energy is the general partner and sponsor of CCR. CONSOL Energy’s core asset is the Pennsylvania Mining Complex, often referred to as PAMC, and management describes PAMC as the premier coal mining complex in the US. CONSOL also owns a marine terminal on the east coast from which it delivers coal to international markets.
I want to take this opportunity to reemphasize a few of the reasons why I started this podcast. The money management business is changing. Small cap companies like CONSOL and CCR don’t get very much attention from institutional investors. That’s partly because big investors want to see greater liquidity in the shares of the companies they invest in, but it’s also because large investors are increasingly sensitive to the various indexes. Due to its size, CONSOL isn’t super liquid and it’s not a big part of any of the big indices. That said, a significant portion of CONSOL’s shares are owned by ETF providers, which partly exacerbates the liquidity issues.
So, one of the motivations for starting this podcast is directly related to discussions I had with management teams in the midstream space back in 2017. Those management teams were shocked at the poor share price performance for the sector as a whole. Commodity prices were up, volumes were growing, and leverage was declining. However, the number of investors willing to listen to the increasingly positive investment stories from companies in sectors that became a very small part of the index was dwindling. In short, there just wasn’t much investor appetite. Sure, a lot of investors had gotten burned by the distribution cuts, but it seemed then, and still seems today, like a lot of institutional investors have completely forsaken MLPs as investable – not to mention the financial advisors and retail investors that have fled the space.
I think there are a lot of analogies that can be made with the coal industry today. You heard Jimmy Brok and Dave Khani talk about the decline in coal prices, the bankruptcies, and, just the negative investor sentiment for the commodity and the mining sector as a whole. There isn’t a whole lot of investor appetite for coal. So why is that? Well, coal as a fuel source for electric generation has declined substantially over the past decade. Coal demand from the power generation sector peaked in 2007. Back then, almost 1,500 power facilities accounting for more than 310 GWs of coal-fired generation. Today, more than a third of coal-fired power stations have been retired and the total generation capacity has declined by almost 25%.
In case you’re curious, I’m getting these numbers from the EIA, and I’d really encourage you to take a look at their website if you’d like to learn more. The EIA’s website is a gold mine of energy-related data in the US. Additionally, the EIA releases short- and long-term outlooks for energy consumption in the US and, while the agency’s projections can be wrong, the EIA expects domestic coal demand to decline about 8% in 2019, but then remain fairly stable through 2050.
The point is that if you think coal-fired generation is going to completely disappear in the next couple years, CONSOL certainly isn’t a good investment idea for you. But if you’re like me and you think coal-fired generation will continue to make up a part of the generation stack for many years to come, owning some shares of CONSOL could end up being a profitable investment. Especially given the fact that CONSOL is one of, if not the lowest cost producers in the US.
Another compelling aspect of the investment story relates to something Dave said about the company being built to run on maintenance capital over the next 26 years. Just think about that for a second – free cash flow has averaged about $250M over the past 3 years. The present value of a 26-year cash flow stream of $250M discounted at 10% is $2.3B. Compare that to CONSOL’s current enterprise value of 1.7B. Also keep in mind that, I’m ignoring any sort of terminal value for the marine terminal and the 1.6B tons of undeveloped reserves!
Using this approach, I am, of course, ignoring a few risks. I haven’t taken into consideration any of the legacy liabilities. CONSOL’s total legacy liabilities amount to about $1.1B, but the company continues to chip away the liability and the annual cash cost to the company has declined from $139M in 2014 to $73M in 2017. I’m also purposefully ignoring the regulatory risk. MATS was mentioned earlier in the interview. The EPA’s MATS rules were announced in 2011. If you do a quick online search for coal-fired retirements, you’ll see that the vast majority of plant closures have happened since the rules were rolled out. The rule essentially required facilities to add environmental equipment to plants that emitted significant amounts of mercury and other noxious, toxic gases. The equipment isn’t cheap, and given the decline in power prices due to cheap natural gas, many of the owners of these coal-fired plants decided to shut down the facilities.
Before I end, I think it’s worth pointing out one more positive. And for me at least, it’s a significant positive and it’s been a recent theme or trend on this podcast. And that’s management! I was really impressed by Jimmy and Dave, and the way they think about and talk about shareholder returns was very encouraging. More importantly, they’ve acted on their philosophy. Over the past year, they’ve paid down debt and bought back shares. Given the significant cash on the balance sheet, I think 2019 will be a really interesting year from a capital allocation perspective.
