top of page

How to make money on ugly coal mining company

Our student made an analysis of coal mining company Thungela based in Africa and made 3X his investments in 1 year

Thungela Resources emerged as an independent entity from Anglo American in June 2021. The investment proposition is straightforward: it's remarkably inexpensive, with a valuation at just 1.5 times its 2021 earnings, carries no debt, and is poised to deliver substantial returns to its shareholders. Based on the current coal prices, it appears to generate approximately 916 million SAR in monthly free cash flow, equivalent to 14% of its market capitalization. Although we may need to wait until the end of the year, the catalyst for its value appreciation is the introduction of dividends, in line with the company's stated 30% payout ratio. This should translate to an estimated dividend yield of around 16% at its current stock price, or potentially higher. A comparable South African company, Exxaro Resources, is trading at a significantly higher multiple of 5.1 times its 2021 EBITDA. If Thungela Resources were to be valued similarly to Exxaro, its worth would be significantly higher, far exceeding its current price of 51.

Background Anglo American PLC (AAL LN) is a mining corporation with a market capitalization of $50 billion, primarily engaged in the production of polished and rough diamonds, copper, platinum, and other metals. In April 2021, Anglo American announced its intention to separate its thermal coal division into a new entity, Thungela Resources, as part of its strategy to shift away from environmentally damaging fossil fuels. Thungela Resources started trading on June 7, 2021, in Johannesburg at 21.90 SAR per share and has witnessed a remarkable 100% increase in value over the past couple of months. Nevertheless, the stock remains significantly undervalued and is likely to see an increase in its market rating when a dividend announcement is made. Currently, Thungela Resources has a market capitalization of ZAR 7.0 billion, equivalent to $471 million.

Business Overview Thungela operates in the thermal coal sector, which is used for electricity generation. Thermal coal is burned to produce steam, which in turn drives turbines to generate electricity for various applications, such as public electricity grids or industrial sectors requiring electrical power, including chemical industries, paper manufacturers, the cement industry, and brickworks. Thungela possesses seven coal mines in South Africa. Approximately 54% of its production is exported, 37% is consumed within South Africa, and 9% is sold to ESKOM, the state-owned electricity producer in Africa. Thungela anticipates increasing demand from Asian countries such as Bangladesh, Pakistan, and Sri Lanka. The company believes its mines are positioned at the lower end of the global cost curve, potentially safeguarding its performance even in the event of declining coal prices.

Economic Rationale Coal is recognized as a highly carbon-intensive energy source, but it remains one of the most cost-effective options for power generation. Developing economies, in particular, will continue to rely on coal for their energy needs in the coming decades, while more affluent regions like the U.S. and Europe are transitioning away from coal for ethical and environmental reasons.

Earnings, Valuation, and Dividend Thungela's management disclosed at its analyst day that every $10 increase in coal prices per ton would boost its EBITDA by R2.7 billion. In the first half of the year, Thungela reported EBITDA of 1.9 billion R. Assuming an average coal price of $110/ton in the second half of 2021, second-half EBITDA is projected to be approximately R6.1 billion. Adding this to the first-half EBITDA of R1.9 billion, Thungela is on track to achieve R8.0 billion. As for free cash flow, an estimate suggests the company is capable of generating R4.2 billion, with potential for this estimate to be conservative given the current coal prices. Notably, Thungela is trading at just 1.8 times this conservative 2021 FCF estimate. The company has indicated its intention to distribute over 30% of its adjusted operating free cash flow annually as dividends. This would equate to 30% of R4.2 billion, or R1.26 billion, resulting in an estimated dividend yield of around 25% at Thungela's present market capitalization. While the dividend hasn't been officially declared yet, the management has been clear about their commitment to it during their analyst day.

Dividend Declaration Timeline The expected timeline for the dividend declaration is likely to coincide with Thungela's annual results announcement in February. It is a strategy consistent with Anglo American, its parent company, which disclosed its annual results on February 25, 2021.

Comparative Analysis A fair point of comparison could be made with Exxaro Resources (EXX SJ), another South African coal firm, and New Hope Corporation (NHC), an Australian coal company. Exxaro trades at 5.1 times its 2021 EBITDA, while New Hope trades at 4.8 times the same metric. Assuming that Thungela should be valued in line with New Hope at 4.8 times its 2021 EBITDA, it suggests that Thungela's fair value should be around 125.50 ZAR per share, far surpassing its current price of 51. Even if one disagrees with this valuation methodology and chooses to apply a discount, it's evident that Thungela remains undervalued, especially considering the consensus EBITDA estimates for Thungela may be significantly underestimated.

Risk Mitigation Thungela's financial position is robust. It is debt-free and was endowed with 2.5 billion ZAR (equivalent to 49% of its market capitalization) upon its spin-off. Additionally, in just 23 days in June, it bolstered its balance sheet with an additional 500 million ZAR in cash. Moreover, in the event of a coal price decline, Anglo American, its parent company, has the potential to provide further financial support to Thungela, although the likelihood of this occurring appears low given the current strength of coal prices.

Environmental Liabilities At the time of its spin-off, Boatman Capital Research expressed concerns about Thungela's environmental liabilities, contending that the company's obligations for mine closure and environmental remediation rendered it essentially worthless. However, Thungela holds 2.9 billion ZAR in a trust to cover its environmental liabilities and has allocated an additional 3.2 billion ZAR to meet these obligations over time. This accounts for a small percentage of its outstanding guarantees. While environmental issues could become more significant in the future, they do not pose an immediate concern, given Thungela's strong free cash flow generation and the substantial expected dividend.

Conclusion In summary, it is advisable to consider purchasing Thungela Resources based on its compelling value proposition and potential for substantial shareholder returns.

bottom of page