Not that the mining royalties specialist is totally reliant on coal for its income, but it does form a large part of its cash flow, and the share price rise has gone hand-in-hand with strong coal prices.
An investment in coal may not be as sexy as one in lithium or cobalt, but to Julian Treger, Anglo Pacific’s chief executive, it makes a lot of sense.
Mining, he argues, is a perfect way for investors to mix the old with the new: As enthusiasm for the latest fad ebbs and flows there’s always one element of certainty, that the materials for whatever it is that’s being made will have to be mined.
Hence, there’s been a boom in the lithium mining sector in response to hype about electric car batteries, with cobalt slipstreaming along behind. Copper has enjoyed some benefit from this narrative too, as the thinking is that more wiring will be needed in electric vehicles than in petrol-powered ones.
In the case of coal, there’s power generation.
How much power is being used to mine the cryptocurrencies that are sweeping through world markets at the moment? That’s hard to quantify, but it has been notable that a US investor in Atlantic Power Corp (NYSE:AT) has been urging the company to use surplus electricity to mine cryptos, while in China, the authorities are said to have curbed power supply to known cryptocurrency miners.
The 21st-century technological revolution is steam-powered
In the US, much of the power generated for use in Tesla’s electric vehicles actually comes from steam-powered coal stations, an irony not lost on Treger. “These cars are powered by steam, as they were 120 years ago,” he muses.
Perhaps even more significantly for the longer-term, an immense amount of power is used to cool the world’s computers and to keep them cool, and in many countries, particularly outside of Europe, that means coal.
“It’s pretty unfortunate for UK investors that there’s a perception that coal is done for,” says Treger. “But demand continues to grow in absolute terms, although its share is falling.”
That dynamic, though subtle in itself, has had a fairly unsubtle read-through: coal price has been rising. Indeed, in the past 12 months, coal price has outperformed the expectations of many analysts by at least 100%.
The other side of the same coin, though, is, of course, pollution, but paradoxically perhaps, here there is help for coal producers too. That’s because, in China, a key bellwether for the world’s attitudes towards coal mining and pollution, production of the dirtiest coal is being aggressively phased out in favour of the highest quality coal.
This type of coal also commands the highest margin, and those that have it are quids in.
Dirty coal: bad; clean coal: good (or not so bad)
This is true in the case of Anglo Pacific, which derives the bulk of its royalty income from Kestrel, a high-quality clean-coal mine in Australia operated by Rio Tinto.
Anglo Pacific doesn’t hold a royalty over the entire mine, and nor is the quality of the ground over which it does hold its royalty completely consistent, so, three years ago, when Rio wasn’t mining as much of the Anglo royalty area as it is now, and when the coal price was lower, there was less money for Anglo Pacific. It is not surprising that the share price dipped back then and took some time to recover.
Since then, Treger’s been active; he’s raised money and acquired more royalties for the company, in clean coal at Whitehaven’s Narrabri mine, but also in other commodities.
“Coal isn’t going to go away,” he says. “It’s cheaper for the poorer economies of the world. The more thoughtful response isn’t no coal, but cleaner coal.”
Even so, the overall percentage of Anglo Pacific’s portfolio devoted to coal is now smaller, given the overall exposure to uranium, vanadium, gold, copper, silver, cobalt, iron ore and nickel.
“Generally we’ve done one or two transactions per year, but this year I hope we can do three or four,” says Treger.
He’s helped by higher share price, of course, but also by a market that seems open to business, and seems well and truly over the optimistic sky-high valuations that were generated by the last boom.
What type of deal would he like to do, bearing in mind that different markets around the world have had different responses to the new technologies that are emerging?
“Toronto has been a bit subdued,” he says.
“But Australia has been on a lithium, electric vehicle bandwagon for probably about 18 months now. There’s been a bull market for the more speculative mining stocks, but that’s a sort of universe on its own. We try to block out the chatter but other than in the energy space, we’re not seeing yet a very hyped story.”
Cobalt, for example, he thinks is probably nearing the end of its run. The emphasis instead, goes on general, longer-term global economic development.
“Base metals like zinc, copper and nickel could still run. The price of copper bottomed out at US$2.00. It’s now US$3.20 but it could go to US$4.00 or US$5.00 or more. We’ll have to see.”
In that sense, Anglo Pacific stands out from most of its peers, in that it’s not focussed on gold and silver royalties. Instead, this is a royalty company that’s geared to the global economy and advancing technology.
“We as a sector are actually a beneficiary of disruption and there’s an opportunity for us to become the go-to royalty vehicle for the twenty-first century,” Treger believes.
Broker sees plenty of opportunities for more royalty acquisitions
Peel Hunt appears to be coming round to this point of view.
Strong coal prices should give Anglo another year of solid income in 2018, it said.
The broker, which has upgraded the stock to 'add' from 'hold', thinks the current coal price environment could enable management to start acquiring royalties from internal cash resources.
Anglo Pacific currently derives the bulk of its royalty income from Kestrel, a high-quality clean-coal mine in Australia operated by Rio Tinto, but is always on the look-out for more royalties.
“Ongoing coal price strength or royalty acquisitions can each plot a route to a valuation range of 220p-250p, suggesting further upside beyond our revised 160p base case target price,” Peel Hunt said.
Coal prices have already held up better than many expected so far in 2018.
The broker's cash flow estimates plus an undrawn US$40mln credit facility suggests a budget of up to US$135mln for royalty deals in 2018 without the need for the company to issue shares.
At a 10% acquisition yield, this could add 25-40% to the broker's medium-term operating cash flows.
Furthermore, based on the broker's recent meetings with management, it is clear the company has confidence in the deals coming down the pipe.
It did two deals in 2017 but is looking to top that in 2018.
“The overarching trend is for further base metal exposure but, that said, no commodity would be ruled out if the transaction surpasses management’s internal metrics of quality, jurisdiction, and yield. This is particularly the case in the secondary royalty market,” the broker noted.
Royalty income in 2017 rose 90% to £37mln-£37.75mln from the year before, with a further £4.7mln/£5mln to come from uranium operation Denison/McClean.
The broker is forecasting adjusted profit before tax of £33.2mln in 2017, up from £16.8mln in 2016, and sees this rising to £43.2mln in 2018 on the back of a rise in sales to £43.3mln.
The cash generation should not only assist in landing more royalty deals for Anglo but should also underpin Peel Hunt's forecast of an 8.5p dividend in 2018.
Based on Anglo's current share price of around 144p, that would give a dividend yield of 5.9%.