HNRG - Hallador Energy Company

[Fat Pitch]

Hallador Energy Company

[NASDAQ:HNRG]

 

Click to access the Infographic

 

 

http://www.fatpitchinvestments.com/wp-content/uploads/2014/02/Hallador-Place-Setting.png[/url]

 

Here are the 5 major reasons why HNRG is a superior energy company compared to its competitors.

 

1) Strong U.S. demand for Illinois Basin coal - and Hallador's  ability to mine it & sell it cheapest.

2) Non-union labor force; advanced safety - health - & mine maintenance systems.

3) A positive track record and experienced management team that includes 3 prolific venture capitalists. 

4) Strategic placement of coal mine system on major railway systems.

5) Trading at a minor discount + major earnings growth for the next two years.

 

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Hallador Energy Company has ownership in three energy enterprises:

 

100% ownership of Sunrise Coal

50% ownership of Sunrise Energy

45% ownership of Savoy Energy

 

(12/2013) Yearly mining figures: 3.5 million tons of coal and 327,000 barrels of oil.  We also want to note that all coal production has been presold until 2016. We see this as a benefit for HNRG.

 

In mid-2014 the new Bulldog mine will be approved for production. Yearly it will yield 3 million tons of coal - nearly doubling the coal output of HNRG.

 

In mid/late 2015 the Russellville mine will be approved and begin mining operations; which again will increase production another 3 million tons/year.

 

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Location

HNRG corporate offices are located in: Denver, Colorado - all mining operations are located near the Indiana and Illinois southern border .

 

Hallador's 380 non-union coal mining employees coupled with the connectivity of mining operations and coal exporting near major railway infrastructure are two major competitive advantages HNRG has over not only Illinois Basin competitors, but most US coal miners in general.

 

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Stock Metrics

http://www.fatpitchinvestments.com/wp-content/uploads/2014/01/Hallador-Widow-Front.png

 

In the Chart Above… We are looking at price and volume metrics. Our proprietary system indicates strong pricing support at the current trading level. We also want to note that as the dividend schedule repeats and liquidity increases HRNG will continue to elevate itself as an “invest-able” company in the public’s opinion. Increasing Institutional Ownership by sale of insider holdings is currently how this is taking place. While most would consider this strategy “au contraire” in our opinion, it is brilliant. 2 year best case scenario: right off the bat one more occurrence of “insider to institution” sale takes place. Then the Bulldog mine becomes operational – end of 2014 we see the early beginnings of HNRG scaling in earnings. Through 2014 management continues its steady quarterly dividend and public opinion starts setting in that HNRG is worthy of being considered “light conversation” on Wall Street. 2015 comes upon HNRG and the financials start reflecting unexpected earnings gains due to the strategic planning and operational efficiency that management has set in place. Hallador continuing to make strides coupled with the energy industry turning full circle and becoming a sector of interest again for the public markets will continue to promote the demand for HNRG stock.

 

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Superior Operating Margins

 

The industrial commodities markets are usually dominated by the low cost leader. Hallador happens to have the lowest cost coal and highest operation margins of any Illinois Basin coal producer. Most important as scale is reached with the Bulldog and Russellville mines opening, operating margins will likely improve.

 

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Compelling Valuation

Our Discounted Future Cash Flow valuation model indicates a current opportunity to purchase Hallador Energy Shares at 86 cents on the dollar. We forecast intrinsic value to grow at around 17% per year – couple this with the discounted price and you get a forecasted real return of 19.76% per year. Fat Pitch stands by its 3 to 5 year investment horizon and considers its current holding of HNRG to be a first position that will increase with successful completion of projects and milestones.

 

To View the complete File on Hallador Visit:

http://www.fatpitchinvestments.com/company-research/hallador-energy-v1/

 

[Fat Pitch]

Looks like management has entered into an agreement to acquire mining assets from Vectren (http://finance.yahoo.com/news/sunrise-coal-agrees-purchase-vectren-233000165.html)

 

So for ~$300 million they are acquiring about 8.5 million tons of added production with the ability to expand mining operations to their War Eagle reserves without having to commitment $150 million for infrastructure since they can use the Oaktown 2 portal which is the adjacent property. This acquisition will be funded by cash on hand and bank notes so no dilution. Hallador has the option of selling their 45% stake in Savoy for $60 million+ to help fund this acquisition (they invested a couple million in this venture several years ago).

 

Vectren is a utility company that hired 3rd party contractors to mine these assets at a break even proposition. Hallador management believes they can mine these assets much more efficiently and get about $10/ton margins on production. If they succeed, this deal will result in FCF of $90 million/year with mine reserves life of 15 years for a purchase price of ~$300 million… not a bad return on investment. What’s really interesting is that Hallador is trading at an EV of 269 million with their Carlisle mine producing ~$30 million in FCF. 

 

This looks like a great play to arbitrage the price differential between the lower cost Illinois coal basin and higher cost Appalachia coal basin which can be viewed here: http://www.eia.gov/coal/news_markets/

 

If management can obtain the $10/ton margins, they have a low cost philosophy, and achieve $100 million FCF within a year or so then at an EV of $500 million this can become a homerun for investors. Sure the coal industry doesn’t sound sexy as Amazon or Valeant, but 20%+ FCF yields with an unlevered balance sheet and disciplined management is too hard to ignore  ::)

 

Looking forward to hearing other people’s thoughts on this!

[Patmo]

How does the company expect to pay for this project?

[Tim Eriksen]

How does the company expect to pay for this project?

 

As Fat Pitch said: cash on hand, additional debt, and proceeds from Savoy sale.

[Patmo]

He said that's an option. Have they stated what their intentions are? $300mil is a big chunk for a company this size. Even if they would sell Savoy and get $60mil out of it, and use up every last penny of their cash, that still leaves $220mil of debt to raise. The company would go from a very conservative balance sheet to a pretty aggressive one in one fell swoop. 

 

 

[Patmo]

Also I don't really understand the valuation, usually all growth etc is implied in the intrinsinc value as NPV but you give two valuations, an intrinsinc value and then a growth factor on top of it. Do you mean that $1 for .86 is for the normal business, and the extra 17%pa compounding is accretion from the acquisition?

[Fat Pitch]

I wouldn't look too much into the first post. Management is doing a bet the company acquisition on a fire sale purchase. This will significantly increase reserves and almost triple production. Hallador will still have the option of developing the Bulldog mine for another 3.3 million in production for $150 million, but I don't except them to make that investment for quite some time.

 

It is management's intention to monetize their Savoy interest and bet on coal assets in the Illinois coal basin. I spoke with management on the day of the announcement and I was told they have the financing package almost finalized. Yes this is a big acquisition for the company, but the price they are paying with the infrastructure in place makes this less risky from a lender perspective.

 

The big risk here is coal prices. We are seeing a structural demand shift from Appalachia coal to Illinois coal since prices are cheaper with almost the same amount of BTU content per short ton. Illinois coal have higher sulfur content, but the mandatory installation of scrubbers for utility coal plants removes this hurdle.  This shift should put a floor on Illinois coal prices, but we'll see. 

 

[rykelsap]

Do you have an estimate for sustaining capital expenditure requirements on the Oaktown mines? Also do you know the tax status of the assets being acquired? I see that expected cash taxes payable in 2014 are $4.6mm for Hallador prior to the transaction but I am uncertain what the percentage depletion deduction would be for Vectren Fuels. Finally where exactly did the $10/ton margin estimate come from?

Sorry for the barrage of questions but I am a little bit confused by your FCF estimate and FCF yield calculation but admittedly do not know the company or industry very well. Assuming management is able to reduce costs on the acquired assets and achieve a $10/ton margin I see a very quick and dirty FCF estimate as follows:

 

Sunrise Coal EBITDA - $50.0mm

Plus: Oaktown EBITDA (9.5mm tons at $10/ton margin) - $95.0mm

Less: Sunrise Coal Sustaining Capital Expenditures - $15.0mm

Less: Oaktown Sustaining Capital Expenditures (very rough and likely inaccurate estimate) - $35.0mm

Less: Interest Expense (assuming 7% on $100mm of new notes, 3% on $152mm drawn against $165mm facility with rate step-up due to increased leverage for acquisition) - $11.6mm

Less: Income Tax Expense (very rough and likely inaccurate estimate) - $15.0mm

FCFE – $68.4mm

Plus: After-tax Interest Cost - $8.7mm

FCFF - $77.1mm

 

Current Market Capitalization - $356.2mm

Less: Current Cash Position - $19.9mm

Plus: Current Debt Position – $16.0mm

Less: Sale of Savoy (conservative estimate given 1P value) - $60.0mm

Plus: Oaktown acquisition cost (financed with new notes and credit facility) - $296.0mm

Current Enterprise Value - $588.3mm

 

FCFF Yield – 13%

FCFE Yield – 19%

 

Is there anything I am screwing up here? The company seems cheap but perhaps not shockingly so given industry dynamics and management execution risk on cost reductions at Oaktown.

[Fat Pitch]

The $10/ton margin was my form of handicapping the economics of the business. The company expects to see $14+/ton margins at the Carlisle mine. When I called up the company after the announcement  I tossed a 100mm FCF target and I was told I was on the conservative side. There has to be some additional synergies since Oaktown 2 infrastructure is adjacent to WarEagle, or management is being too optimistic?

 

Your FCF estimates mirrors mine assuming $10/ton margin, but that leaves room for upside. I will need to talk to the company again when I get time and hash out the specifics or they may simply update their presentation.

 

The industry dynamics don't look that great, but we are going to be using coal for the next 100 years. I don't see that changing unless we develop commercially viable fusion reactors, but that's a whole another story. I see the Illinois coal basin taking more market share from the coal basins to the east of it. There's a bit of a coal basin boom underway within a sliding coal industry. This is more of a right assets, right time story.

 

[jch548]

Still following HNRG? I had looked them over earlier. I liked the fact they had some growth in the pipeline but couldn't get a feel for what exactly they were up against cost wise to get the new mine going. Then they came out with a purchase that looked interesting but I still had trouble understanding the economics of everything. Not much info on their web site etc.

 

Stock is down with the oil sell off I suppose. Read estimates have been going up.

 

Anything good happening with HNRG these days?

 

 

[Fat Pitch]

Management expects the new mines to have similar economics as their Carlisle mine. I wouldn’t expect the costs to come down until later next year. Spot pricing for Illinois basin coal hasn’t changed either.

 

I only wished they were more aggressive in monetizing their Savoy Energy stake. I’m guessing they are going to hold on to it in this market environment. Going forward all cash flows will be directed towards reducing their bank loans.