Coal stock M&A action heats up

PORTFOLIO POINT: As small coal companies get together, they become big enough to show up on the radar of international miners. Here are some likely contenders.

'Build it, and the bids will come’ has emerged as the unofficial motto of the Australian coal industry, with a flurry of mergers and takeovers likely to continue thanks to continued strength in demand for electricity and steel.

Whitehaven Coal’s proposed acquisition of Aston Resources to create a $5 billion business is an example of how one bid could lead to another, with the merged entity likely to attract an international mining group, whereas on their own neither company was attractive to a global miner or coal buyer.

Speculation about a move on the merged Whitehaven/Aston started within hours of the deal being announced, triggering interest in what other mergers might be possible to create Australian coal companies of substance – and takeover appeal.

Small and emerging producers such as Stanmore, Carabella, MetroCoal, Coalspur, and Cockatoo are potential merger partners to create a business where size matters given the economies of scale and transport economics associated with all bulk commodities such as coal and iron ore.

-Coal contenders
Company	ASX	Market cap ($)	Close 16/12 ($)	12-month high ($)	12-month low ($)	P/E
Stanmore Coal	SMR	96.7m	0.76	1.53	0.675	-42.2
Carabella Resources	CLR	154.5m	1.27	3.01	0.075	-19.7
MetroCoal	MTE	120.1m	0.575	1	0.27	-38.9
Cockatoo Coal	COK	396.3m	0.395	0.565	0.31	-27.9
Coalspur Mines	CPL	976.9m	1.68	2.38	1.2	-45.5

If more mergers/takeovers follow, and all of the small stocks mentioned have been included in earlier lists of suggested coal investments (Back to black being the most recent) then they will follow a steady stream of earlier acquisitions which has denuded the ASX of mid-tier coal stocks.

Peabody Energy’s $5 billion acquisition of Macarthur Coal removed one of the last independent Australian coal stocks; while New Hope Corporation, also valued at close to $5 billion, is actively seeking takeover bids – as had Whitehaven before its proposed merger with Aston.

Other deals that have removed listed coal stocks include Rio Tinto’s takeover of Riversdale, and Noble Group’s seizing of effective control of Gloucester Coal, and likely move to bid for minority shareholders who retain a 35% stake in the stock.

Takeover activity has left the lion’s share of Australian coal mining in the hands of a few big, diversified miners such as BHP Billiton and Rio Tinto, or international miners such as Peabody, Anglo American and Xstrata.

However, demand for coal remains strong despite doubts about future global economic growth, with two factors ensuring continue high levels of demand for coal: the slow development of renewable sources of energy, and the slowdown in building nuclear power stations after the Fukushima accident in Japan earlier this year.

Even the rise of natural gas in its many forms (conventional, and unconventional as coal-seam methane and shale gas) has failed to put a dent in the ongoing role of coal.

It is demand, and the high price for thermal (electricity-producing) coal of more than $100 a tonne, and metallurgical (steel producing) coal of more than $200 a tonne, that is underpinning the corporate activity for a fuel, which is sometimes treated as politically incorrect in the climate change debate but for which the world is yet to find a replacement – and might not do so for decades.

Over the past two weeks, as the Whitehaven/Aston deal was being unveiled, two major reports on future energy demand highlighted the role for coal – just as the latest round of United Nations organised climate change talks drifted to an inconclusive finale in the South African city of Durban.

The inability of industry to develop alternatives to coal as a generator of low-cost, base-load power, and to act as an essential fuel and catalyst in the production of steel, means that the future for coal is as bright today as it has ever been.

Regular readers of Eureka Report will not need reminding of this trend, with a number of reports over the past two years highlighting the strength of the coal market. The three most recent articles were on November 7 (see Suddenly, coal looks cheap), October 19 (Back to black), and September 21 (Betting on black).

The performance of stocks listed in those earlier reports has been mixed, trending down, though the fall in value of the full suggested portfolio has been restricted to 3% since September 21 whereas the overall market, as measured by the ASX All Ordinaries and Metals indices, has fallen by 7.5%.

For the coal stocks to fall at half the rate of the rest of the market offers cold comfort for investors, but it does indicate the higher-than-average interest in coal miners.

That will continue, with the latest reports by the Australian government’s energy forecasting arm, the Bureau of Resource and Energy Economics (BREE), and the global oil major, ExxonMobil, supporting the case for coal.

The BREE report highlighted the increasing use of gas to produce electricity in Australia and the potential decline in the use of coal, but left open future opportunities for coal as gas prices rise.

Under a low gas-price scenario, coal’s share of Australian electricity production could fall from 74% to 36% in 2035. However, with high gas prices, coal’s share of the electricity generation market could remain around 52%.

The rise of gas as a fuel of the future, and theoretical interim step in a world that uses more renewable power sources such as wind and solar, was echoed in the ExxonMobil document, which looked at global energy demand out to 2040.

Like the BREE report, the ExxonMobil analysis saw a strong increase in the use of gas, and a decline in the market share held by coal, with 2025 seen as the peak year for coal consumption as a share of the total world energy market.

However, coal will retain a long-term share of the energy market, even as gas use rises and renewables pick up an increasing proportion of demand.

By 2040, the three primary fossil fuels – coal, oil and gas – will still account for an estimated 80% of global energy demand, with renewables such as wind and solar lifting their share of the total market from 3% to 7%.

For investors, both the BREE and ExxonMobil reports demonstrate that coal will remain an essential fuel for at least the next 30 years – somewhat longer than most investment horizons.

• To read the ExxonMobil report, click here.