Coal Idea from Marcelo Lima (Heller House)

Special Value Investing Congress Notes for the Irregulars

Marcelo Lima says that the reports of coal’s death are making people miss a bargain-priced coal company that’s

Governments are all projecting that coal consumption grows into the foreseeable future. This is a UK company, where coal consumption has been declining … but coal imports have been growing in that country because the mines have been shut. Only three underground coal mines in UK now, from 170 in 1979, so they’re importing it for the still large portion of the electricity generation business that’s coal-fired.

Hargreaves Services (HSP in London) is a coal merchant — they produce it, transport it (started as a trucking company that rolled up a bunch of smaller truckers), process it, sell it, etc. They are not a commodity speculator, they hedge fuel costs and pre-sell the coal on their balance sheet. They’ve diversified into more value-added services, including managing coal handling at major ports, running a coking operation, etc., so trucking is now a very small part of the company. The biggest profit generation is from their surface mining and from the port/coal processing operations.

The market cap is about $400 million, interest expense and dividend are easily covered by earnings — the stock has done very well since 2005 IPO, reaching 1200 pence last Spring and got growth company valuations for the early years and solid 12X earnings as recently as last year.

They’ve paid dividends for seven years, growing them annually and covering the dividend easily. The company has long-term management that owns about 10% of the company and doesn’t want to overpay for acquisitions — so far they’ve paid multiples of 6X operating profits, on average, in the dozen or so companies they’ve bought in the past decade. They’ve also been opportunistic, renewing their trucking fleet to lower costs by buying up purchase contracts from companies that were suffering in 2009 and buying into a bankrupt Scottish surface mine just this year. They did not see earnings drop during the recession, though revenues dipped slightly (coal prices went down) — profits have been steady because of their long term contracts — 22% compounded growth rate in earnings over the past three years.

So why are they cheap?

Lima thinks the stock is cheap because the market believes that coal is disappearing due to natural gas, that Hargreaves is in declining commodity markets, and coal mining is high risk ...

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