Coal runnings: Anglo Pacific turning the page

Coal is hot right now. Prices are stratospheric as demand for thermal coal has far outstripped supply. The current price exceeds the average over the past decade, and even metallurgical coal has come along for the ride as buyers look for any exposure they can get.

For evidence of the windfall profits now filling producers’ coffers, investors need look no further than the shares of Thungela (TGA), up over 500 per cent since it was spun out of Anglo American (AAL) last year. Glencore (GLEN) is also reaping the rewards of being the last major to fully embrace the pariah fossil fuel, having gone against the divestment tide and maintaining that it was the best owner of thermal coal assets.

Governments have also woken up to the rapid ascent in prices from under $100 (£82) to over $400 a tonne. One of the world’s key coal mining areas, Queensland, has already brought in tax regime changes to take advantage of surging benchmark prices, although the Australian state’s government went for a progressive price-based increase rather than a higher profit tax, as the UK has introduced for North Sea oil and gas producers.

Nonetheless, opposition to the new royalty regime has been consistent. “The near-tripling of top-end royalties has worsened what was already one of the world’s highest coal royalty regimes, threatening investment and jobs in the state,” commented BHP (BHP) chief executive Mike Henry in the group’s recent FY2022 production statement. Helpfully, the average price received of coal more than tripled in that period versus the prior year, to A$524 (£300) a tonne.

On 1 July, Queensland’s take rose to 20 per cent for prices above A$175 a tonne; 30 per cent for prices above A$225 a tonne and 40 per cent for prices above A$300 a tonne. Previously, the royalty topped out at 15 per cent of anything above $150 a tonne.

For investors in BHP and the other major miners operating in the state, this will dent divisional profits but should prove a much smaller knock to sky-high group-wide profit margins. While Thungela and other coal-only miners are enjoying a sugar rush that will fade as the world moves away from thermal coal, the recycling of windfall coal profits into the commodities of tomorrow looks like a smart long-term trade.

What then?

Enter Anglo Pacific Group (APF), holder of a royalty covering production from the Kestrel mine in Queensland, which since 2018 has been owned by a joint venture between EMR Capital and Adaro Energy. The state’s new rule book is set to plonk a massive pile of cash on the London-listed royalty and streaming company’s balance sheet, given it has essentially the same rights as the Queensland government. Right now, this equates to a take of around A$160 for every tonne of coal mined on Anglo’s royalty lands, based on the current spot price of A$570.

Coal prices had already supercharged revenue at Anglo Pacific before the new rates came in on 1 July. And, even though Kestrel is a metallurgical coal mine. The company smashed expectations for portfolio contributions from its various streams and related revenues in a six-month trading update released last week. The June quarter revenue from Kestrel alone was $37mn, more than double Peel Hunt’s $17mn forecast. Handily, a strong cobalt price also drove non-coal revenue growth. Overall, Anglo Pacific beat its record 2021 revenues in just six months.

For a company that already had the stated aim of funnelling coal royalty earnings into investments in metals needed for the energy transition, such as nickel, copper and cobalt, this early outperformance is a big help. But with investors revising down short-term global growth forecasts and seemingly more focused on falling copper and nickel prices than a surging coal market, Anglo Pacific’s share price is 19 per cent down on April’s high.

This seems somewhat short-sighted. Broker Liberum forecasts that metallurgical coal will trade strongly for at least another two years, putting its 2022 average at $399 a tonne, and then $281 a tonne in 2023 and $249 the year after. To the cash cow that is Kestrel, we can add improving diversification and a royalty model that escapes the operational or geopolitical risks of mining, while maintaining exposure to strong metals prices.

Royalties are usually sold off before a mine reaches production or when a producer needs a quick influx of capital and doesn’t want to load up with more debt. Last year’s purchase of the Voisey’s Bay cobalt stream (similar to a royalty but only the buyer signs up for a share of production rather than sales) from Vale (BR:VALE3) was along these lines. This $205mn deal is already paying for itself, as income from the stream hit $7mn in the three months to June as cobalt prices remained high.

The other highlight from the second quarter was the drop in net debt to $21mn against RBC Capital Markets’ estimate of $44mn.

Here’s the deal

The royalties business is about dealmaking, and managing cash flows. Kestrel has delivered plenty for Anglo Pacific and its shareholders, and Voisey’s Bay is already contributing well. 

Other examples of winners in the sector include Trident Royalties (TRR), which last year bought a 4.8 per cent stake in future revenues from the Thacker Pass lithium project in the US, shortly before the owner vastly increased the estimated scope of the mine. Some arrangements don’t go down so well with producers’ investors: SolGold (SOLG) shareholders were furious when it sold 1 per cent of future revenues to Canadian royalty giant Franco Nevada (CN:FNV) for $100mn in 2020. 

The issue Anglo Pacific has faced in recent years is the need to replace Kestrel, as the operator of the mine will eventually move on from the area covered by the royalty, expected by 2026. New chief executive Marc Bishop Lafleche, who replaced long-time boss Julian Treger earlier this year, has said this is already done, through a recently-inked $185mn deal to take on four royalties. 

Two of these are for the West Musgrave and Santo Domingo projects, copper and nickel in Australia and copper in Chile, respectively. The seller is South32 (S32), which is taking $48mn in cash and the rest in shares, so will become Anglo Pacific's biggest shareholder with a 17 per cent stake. 

“This deal transforms our portfolio,” Bishop Lafleche told Investors’ Chronicle last month. 

Of course, it’s not a straight swap between Kestrel and the two new royalties. The mines are some way off generating income, and until they do Anglo Pacific will be sitting on the sidelines hoping the owners of West Musgrave (OZ Minerals) and Santo Domingo (Capstone Copper) can get the assets into production. Peel Hunt analyst Tim Huff is confident the deal would be positive for Anglo Pacific. “These two assets alone should not only fully replace Kestrel, but also bring the base level of royalty contributions to Anglo Pacific up to $100mn, a significant jump from our current estimate of $50mn to $60mn,” he said when the deal was announced. 

The company’s balance sheet and current very high revenue (as compared to previous years) means the $48mn cash portion of the $185mn price is well covered, while the $205mn that went to Vale was covered by debt (now largely paid off) and an equity raise. There is also still some dry powder: the company said last week it had added a $50mn accordion feature to an existing $150mn loan for future purchases. Bishop Lafleche said a royalty or stream on a producing mine would likely be the next target. 

Crest or trough? 

Analysts expect 2022 to be a high point for Anglo Pacific revenues and profits. The consensus forecast is for revenue of $170mn this year, and because it doesn’t actually carry the costs of mining the metals itself, cash profit of $156mn. The latter is more than double last year’s $71mn record. Peel Hunt also forecasts a baseline dividend of 7p per share for the next few years, although on current form – and amid a bright outlook for commodities prices generally – we would expect distributions (or buybacks) to rise.

This is a set-and-forget company to hold for the long erm. Management is working to make sure investors understand today’s coal and cobalt prices won’t last much longer – “these record levels of income are not expected to be sustained in the second half of the year”, Bishop Lafleche said last week – but this is a moment when the company is reaping the rewards of the high coal price and funnelling that cash into dividend-providing assets for the years ahead.