Disclaimer: I've posted a similar post before on SMR but I thought in the context of the company's announcement to reiterate my view. I bought my initial position in SMR at A$1.01/sh and doubled my investment recently at $0.97 and will continue to increase (double down) my investment if the stock drops below this level, and why I'll only be selling out at A$1.40/sh or higher.
The decision whether to buy or sell here should really be based on how you view the company's future under conservative, downside case price assumptions. Do your own research whether you believe the valuations of supposedly "independent" experts whose bills are paid by SMR and Golden respectively. Of course SMR's expert is going to come out with a high valuation and Golden's paid expert are going to come out with a low valuation. The Board's best interest is to extract the highest possible price for the company under a take-out scenario whilst Golden's would be to buyout the company at the lowest possible price. Likewise I'm going to have a positive view on the company's valuation or else why would I hold it? Golden will likely pick up more shares as existing investors in SMR would have already be up 40% over the past year and 5x over the past two years.
Having said that, if Golden want to take the entire company private they should be paying up. A$0.95 is FAR undervalued in my opinion. There's a reason the register includes Regal and Paradice, two big institutional investors. The kafuffle over whether to use WoodMac's price deck or the broker consensus deck is largely irrelevant, as you're always going to be presenting a range of valuations anyway based on some underlying price. Also the disagreements regarding Isaac Downs is also largely irrelevant. I value it at 0. SMR wouldn't have bought it if they didn't think it was value-accretive. There's no rush to develop Issac Downs anyway. Environmental permitting/final investment decision would still be 2-3 years away at the Isaac Plains CHPP is basically operating at full capacity with Isaac Plains East material anyway.
Why I'm long SMR and why I personally will be rejecting any offer below A$1.40/sh: This is a company that is smashing it out of the park operationally, upgrading FY19 production guidance twice now, and delivering in excess of what they promised. The company is debt free, has a standing working capital facility so the balance sheet is secure, and cash in the bank at 15 January of $31.2m after a partial unwind of the working capital built up over the December quarter. Assume a full unwind of the working capital position built in the quarter and you're looking at indicative cash at bank of A$40m+.
1. Improving product mix: FY19 guidance is now 2.15mtpa product at a 90:10 semi-soft:thermal mix. Last year the sales mix was 63:27 semi-soft/thermal so ignoring movements in the underlying coal price you're already seeing margin expansion from improved product mix.
2. Falling operating costs with significant operational leverage: Moving from Isaac Plains to Isaac Plains East is a game-changer. You're going from 14:1 strip ratio all the way down to <10:1 strip ratio and the benefits can already been seen in the December quarterly. FOB costs per saleable tonne went from A$121/t in 1QFY19 to A$84/t in 2QFY19 and that's with the dragline only been mobilised to Isaac Plains East around Christmas at the end of the quarter. With the drag line now in place cost guidance for FY19 looks extremely comfortable, contingent on whether they decide to front-end more pre-strip. Coming in above cost guidance is also likely to be a positive result rather than negative as it would indicate the company are chasing extra tonnes in a favourable price environment.
3. Under-promising, over-delivering management: They've done almost a million tonnes of saleable product in the first half and they're processing ROM through the plant at an annualised rate of 3.3mtpa in the last quarter. The CHPP was basically running at full capacity last quarter. This is a great result. Production guidance looks extremely comfortable and it looks like they should easily be hitting 2.2mt+ of saleable this year.
4. SMR is a cash box that will produce enormous near-term cash flows: Just do cash flow projections out one year under conservative coal price assumptions: I assume premium low-vol coking coal of US$150/t (a 20-25% discount to spot is trading in the range of US$190-200/t). SMR's semi-soft should achieve at least 65% of this so US$97.5/t. I assume realised thermal at US$80/t (the futures curve has spot Newcastle trading at ~US$90-100/t all through CY19). Assume a 80:20 semi-soft:thermal product mix (far below guidance of 90:10) for an average selling price of US$94/t. Assume a 0.75 US$/A$ and you get A$125/t before royalties. Take off $15 for state and vendor royalties and you get A$110/t. Assume they don't beat production cost guidance of A$84/t and you get a margin of A$26/t. Assume they don't beat FY19 production guidance of 2.15mt nor is there any unwind of built up stockpiles and you get operating cash/Ebitda of A$55m over the next 12 months. Take off $15m for sustaining capex/study work and $20m to fully repay Wotonga South and you're left with free cash flow/cash build of A$20m. SMR's current market cap is A$253m at A$0.96. Take off indicative current cash of ~A$40m and you're left with an indicative EV of A$210m. So under what is in my opinion an absolute worst case scenario: -SMR is trading on a free cash flow yield of ~10% at current valuation; - will have ~A$60m of net cash in the bank after a year; - owns a 3.5mtpa CHPP in the middle of the greatest coking coal geography in the world with locked in port and rail capacity, - and has two potential long-term semi-soft coking coal growth projects that are adjacent to its processing plant.
Ask yourself if you're comfortable owning the stock under this scenario and if you are (which I am, and which Golden/Regal/Paradice likely have also) you should be buying. The replacement value of the CHPP alone would be $100m+.
In reality I believe $140m Ebitda for the next 12 months is conservative, hence SMR is trading at <2x EV/Ebitda and ~50% free cash flow yield, by far one of the cheapest stocks across the entire sector. I wrote earlier in the week that my conservative expectation was a 1c interim dividend and another 2c full year dividend. This was conservative as on my base case estimates SMR could have covered that dividend payment out of free cash flow by 14x. This has proven to be true. The company announced a 3c interim dividend. This stock is a cash-generating machine.
5. SMR is one of the cheapest coal stock globally: Globally WHC/Coronado/Teck/Peabody all trade between ~3.5-4.0x EV/Ebitda. Take a look at this comp table below for proof (this is from 14/1/19). I invested in SMR on the thesis that sooner or later the market will fully recognise the cash flow this company is generating. I invested in Warrior Met Coal (listed on the NYSE: HCC) at US$22.51 for the same reason. HCC has a similar free cash flow yield as SMR, albeit with a more leveraged balance sheet. HCC is now trading at ~US$26.00/sh and is up around 25% over the last two weeks.
Currently SMR trades at forward multiples closer stocks like Bounty and Contura, stocks that have either serious operational issues and/or serious balance sheet issues.Have a look at Bounty's multiple and WHC's multiple and see which you would compare SMR closer to. WHC trades on a 4x forward EV/Ebitda multiple. SMR trades on a forward multiple of less than 2x. Granted SMR has higher operational risk given its single asset/complex operations relative to peers, however you'd argue the operational risk is low given this is open cut dragline/truck and shovel, one of the simplest operations across bulk mining. You're not worried about high CO2 levels underground or a seam roof collapsing on your longwall. This is as simple operationally as it gets.
In one year I can see SMR rerating to trade at 3x EV/Ebitda implying a future share price of ~A$1.40+ and will continue to make the easy decision to increase my position at anything below A$1.00. But this is just how I see the company. Do your own research.
To rebut the main points in Golden's recent 5th Supplementary Bidder's Statement (released 18 January 2019):
1. Buy-back announced three Business Days before Closing Date of Offer -The timing of the proposed on-market buy-back raises obvious questions. Why was it necessary for the board of Stanmore Coal to announce this buy-back just days before the end of the Offer Period?
Golden have a point here really. In my opinion, speaking as a shareholder, SMR's corporate defense of this offer has really been sub-par. It's taken two months for the company to basically act decisively. In hindsight given the company's forward cash flow profile SMR should have announced a buyback immediately after the takeover bid was announced in November to signal to the market how undervalued management think shares are. You could argue that the company's advisors would have expected Golden to raise their initial bid price (as frequently happens) and the company are now reacting to Golden making their "best and final" bid. For those unfamiliar with Australian takeover laws you should read this quick article by Herbert Smith Freehills, one of Australia's leading law firms (https://www.herbertsmithfreehills.com/latest-thinking/how-final-is-a-%E2%80%98best-and-final%E2%80%99-takeover-offer). There is nothing stopping Golden coming back and bidding again for the company at a higher price in 3-6 months.
2. Cash applied to capital management which could be applied to development and exploration. The board of Stanmore Coal advised in Stanmore Coal’s Target’s Statement that Stanmore Coal has a high quality portfolio of development projects and exploration assets. This raises the question as to why the board is nevertheless diverting funds away from asset development to fund capital management initiatives.
This point is stupid. Given the company's cash flow profile SMR can apply cash to capital management AND fund its development and exploration. This is not a company that needs to accelerate development of either Isaac Plains underground or Isaac Plains South. As it should be known they've got at least 5 years of operating life left at Isaac Plains East at full plant capacity. This company has so much optionality with respect to what it does next given the option to either go underground at Isaac Plains (higher upfront capex, lower future operating costs) or develop Wotonga South as a satellite, low strip open cut mine (low capex, higher operating cost) to supplement/replace Isaac Plains East.
3. Buy-back is only for up to 10% of Stanmore Coal and there is no certainty that any particular Shareholder’s shareholding will be bought either at all or in its entirety. Buy-back may be suspended or terminated at any time over the 12 month. Buy-back price is currently unknown and could be below the Offer Price.
This is all true but in reality companies typically cancel buybacks only when they feel the share price has appreciated enough to approach "fair value". This would be a good outcome for shareholders.
4. Directors’ views on the value of Stanmore Coal Shares- Stanmore Coal announced today that the proposed on-market buy-back “demonstrates the board’s strong belief in the underlying value of the Company’s assets...”. Despite such strong beliefs, with the exception of one director who acquired Stanmore Coal shares totalling approximately $6,000, none of the other directors acquired Stanmore Coal Shares through the Dividend Reinvestment Plan approved by Shareholders on 26 October 2018 at the then much lower price of $0.8798 per Stanmore Coal Share.
This is also historically true and is also one of few gripes about this company, that the Board and management have limited skin in the game. Having said that this is a relatively new management team. The Chairman has been on the Board for all of one year. The CEO has been there just over 2 years. The CFO has been here less than 2 years. During this time you can't fault them on what they've achieved. SMR is smashing it out of the park operationally and management have delivered exactly on what they've promised shareholders. Yes not taking up shares in the company's dividend reinvestment program can send the wrong signal to the market however they are not obliged to do so, and you have no idea what their personal situations are. I'd argue their remuneration packages are well aligned to shareholder value creation. I'd also wonder how many people in Australia would opt to take equity in their company over the certainty of a cash bonus if offered the choice from their employer.
5. Rushed timing of announcement of interim dividend ahead of interim earnings: Golden Investments again notes that Stanmore Coal has not released its December half-year financial results, but has nevertheless declared an interim dividend. Without finalised and auditor reviewed half yearly financial accounts, from which such dividends may be paid, Golden Investments questions the necessity for, and prudence of, this declaration of a specific commitment to a specific amount of dividend at this time, especially given that Stanmore Coal had already signalled its general intention to pay interim dividends in its Fourth Supplementary Target’s Statement
This comment is a bit farcical. We are not dealing with a fictional company. The CFO has a set of accounts he would look at daily/weekly/monthly/quarterly. The company knows with reasonable certainty how much cash is in the bank account. It doesn't take an auditor to check how much cash you have in your bank account or what your current financial situation looks like. Yes the timing of the interim dividend announcement is a bit quirky, however I'd argue its a consequence of the situation they find themselves in. It's also another sign that this management team delivers on what they promise shareholders.
6. Competing proposal remains highly unlikely: As noted in Golden Investment’s Third Supplementary Bidder’s Statement, the prospect of a competing offer or proposal emerging at this time is remote. Golden Investment’s considers that the Proposed Corporate Actions indirectly support this view. In effect, Stanmore Coal is using the Shareholders’ own funds to fund the only alternate proposal that the board has been able to make available for Shareholders.
This point is true in that in my opinion a competing bid is unlikely. A bidder for SMR was always (in my opinion) going to be either a coal miner who would improve their asset quality by buying the Isaac Plains assets or a financial sponsor (private equity) who would acquire the company, take it private, harvest cash, and then re-IPO it at a later stage. No other listed Australian coal miners outside of Terracom fit this bill and there is no way Terracom could have bid for SMR given that company's balance sheet. As it so happened a international coal miner (Golden) which produces 20mtpa of low-quality Indonesian thermal joined up with a financial sponsor (Aspect) to bid for SMR. Whilst as a shareholder I would welcome a competing bid I believe it will be highly unlikely to occur. SMR is a growth company that in my opinion was always more likely to acquire other assets rather than be acquired itself.
The other way to look at this whole farcical situation is to realise that Golden made their initial bid almost 2 months ago. SMR is not using shareholder's own funds to fund the competing proposal as shareholders are the ones receiving the dividend and buyback. Golden is actually the one using shareholder's own funds to partially fund their takeover bid! SMR is a cash box. During this time you could imply that the company has produced two thirds of the value created during the December Quarter. SMR produced 641kt of saleable product at an operating margin of A$66/t ($150 average price less $84 cost per tonne produced) so around $42m of operating margin during the quarter. Take off the sustaining and development costs during the quarter of $7m and you’re left with $35m. Take two thirds of $35m and during the time since the original bid SMR has added $23m of value to the balance sheet. Divide by 253m shares and you get a balance sheet that has increased by $0.09/sh in value since the time of the initial bid. Hence you can argue that by not increasing their bid since the initial offer 2 months ago Golden are using shareholder's own funds to partially fund their takeover bid. Just laughable.
Again this is entirely my own opinion, backed up by my own research, for an investment that suits my own personal financial circumstances and is not financial advice. Do your own research.
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