coal mine or gold mine

Good read on guj parent company

Mudar Patherya / Mumbai July 23, 2007
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Gujarat NRE Coke is available at a deep discount considering the value of its recently acquired coal mines in Australia.

In June 2007, even as investors were writing out cheques for the DLF issue with the resigned air of ‘Of course, we are not going to be allotted anything but what the hell’, investors in the first international IPO by an Indian company – India NRE Minerals in Australia - were allotted every single share they asked for. For a number of reasons.

People understand real estate, but don’t understand coking coal. People can appraise what is above the ground, but are less likely to put their money into what is below it.

And this reflects the failure of a management – parent Gujarat NRE Coke – to communicate the reality of its business (most analysts don’t even know the difference between coking coal and thermal coal!).

I say this with regret; Gujarat NRE Coke is to my mind a fascinating showpiece of new age Indian entrepreneurship. Extensively invested, considerably under-researched, dismissively misunderstood.

For years, Gujarat NRE Coke was a simple convertor of coking coal (not thermal coal!) into low ash metallurgical coal.

It made the best of a commodity business: enhanced capacity in good years, enhanced capacity in bad years (in 1999, it did so even when the price of coking coal was higher than met coke!) and the result was that by the early part of 2004, Gujarat NRE Coke was the largest merchant manufacturer of met coke in India - its nearest Indian competitor has 55 per cent of its installed capacity – and possibly one of the lowest cost producers in the world. Period.

Good time to go vertical, right? That’s when Gujarat NRE went lateral instead. It went to Australia and bought a coking coal mine instead. Then some time later another mine. Then a stake in a New Zealand coking coal company. And a few months ago, yet another mine in Australia, this time from BHP Billiton, the biggest in the business in the world.

Three direct mine ownerships and one stake. When not a single Indian company has any direct or indirect ownerships in coking coal mines outside India.

Megalomania? Before I answer, consider this: Coking coal is the primary input in the production of coke; coke is the primary fuel in the blast furnace; coke serves the role of a chemical reducing agent in hot metal production; coke serves as a structural material to support the deep bed of coke/ iron oxide/ limestone that makes up much of the furnace volume. Ergo, coke quality directly enhances steel manufacturing competitiveness and production.

This is why the subject is relevant for India: Because even though India has large reserves of non-coking coal (thermal), there is a prospective coking coal famine worrying CFOs of steel companies.

Here are the numbers: The National Steel Policy 2005 indicates that India should be producing 100 million tonne of steel by 2019-2020. This will require 70 million tonne of coking coal (assuming that 60 per cent of all new capacity will be commissioned through the blast furnace route).

At that time, India will not be able generate more than 10.5 million tonne of coking coal from within. The rest? Imported.

The future comes soon enough, warned Einstein. Only as recent as in 2005, India projected 65 million tonne of steel-making capacity by 2010-11; within two years, the government had revised the figure to 80 million tonne.

The government had sagely anticipated 7.3 per cent growth in steel production while formulating the National Steel Policy; production jumped by 10.1 per cent.

So what makes Gujarat NRE a superior steel proxy than steel companies? The fact that the company (through its subsidiaries) is integrated from coking coal to met coke. The fact that it has scale. The fact that the demand for both its products is assured. The fact that there is relatively low competition. The fact that there are no industry entrants.

The fact that in good coking coal but weak met coke markets it can market its resource and go easy on met coke; in weak coking coal but strong met coke markets it can go full throttle on met coke; in good coking coal and good coke markets it can leverage its value chain and make money hands over fist; in weak coking coal and weak met coke markets it can still report higher than industry margins.

So for all those who think of GNRE and say ‘Ah, met coke’, here’s an identity challenge.

Think resource company instead. And for all those who are the cat’s whiskers at valuations, here’s a bigger challenge: appraise this mining-cum-product company. Try. GNRE expects to progressively scale its annual coking coal mine output from 1 million TPA to 6 million TPA by 2012; at peak, its mines will be able to provide 100 per cent of the resource needs of its met coke plants; the cost of mining coal is probably no more than $ 45 a tonne and the stuff sells for more than twice the amount; when it begins to bring in the rich coking from New Zealand from 2008 onwards, it could facilitate the manufacture of low ash (10 per cent) met coke fetching $100 a tonne higher than the 12.5 per cent variety; in five years, GNRE expects to emerge as the fifth largest coking coal mine owner in Australia.

So much for P&L stuff. I have a completely different valuation take. GNRE estimates that its coking coal mines possess reserves enough to last 100 years; the in situ valuation of these mines has been placed at 900 million Australian dollars.

Considering that GNRE possesses a market capitalisation (based on existing equity) of no more than Rs 1500 crore, it implies that if you had the money to buy out the company you would get the world’s most competitive met coke producer free and also nearly Rs 1200 cr as an early bird incentive. It must be Christmas already.