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24-11-2017, 09:35 AM
1) The issue is not about the size of GER's inventory relative to peers. GER has about 80 million tonnes of coal. At the rate it is currently producing -- about 8 million a year -- it will take 10 years for them to sell this inventory. Fewer years if they're faster of course. But the exposure to spot market prices is undoubtedly in years. This is the risk. Very few business will allow themselves to be exposed to spot market prices for this long. Not to mention the highly volatile commodities market. The fact that there are peers in the industry that is similarly exposed to the spot market does not pardon GER. Some simple calculation will illustrate this risk.
From its latest quarterly, GER has revenue of US$75m and PBT of US$11.7m. Assuming that its production volume and expenses remain the same, a 30% rise in coal spot price will see its revenue rise 30% to about US$98m, and PBT rising to US$34.2m. Conversely, a 30% fall in coal spot price will see its revenue fall 30% to US$52.5m and PBT falling to -US$10.8m. Assuming coal has a bad year and this result is duplicated throughout the year, the PBT for the entire year will be -US$43.2m. And let us not forget its increased finance cost of US$10m from the increase in US$125m 8% of notes. Which brings the PBT to our hypothetical situation of a bad coal year to about -US$53m. This assumes GER has not yet made additional acquisitions of mines with the money raised from the notes; which will invariably cause PBT losses to be much higher than US$60m, since more coal will be sold for below cost. How many of such years can GER withstand before it is no longer able to refinance, or before it runs out of liquidity?
2) The issue is also not about whose financing costs are lower. It is the fact the financing costs are high, and the company's capital structure has a high proportion of debt. GER currently has US$73m of notes against US$160m of equity, debt/equity is 45%. Taking into account the increase of US$125m in notes, total debt will be about US$200m, bringing debt/equity to 125%. If coal prices fall, the mines on GER's book will not be worth as much as it states. And the huge losses from a falling coal price will also eat away equity; the debt/equity ratio will be much higher than 125%. In such a hypothetical situation, how will GER be able to refinance its notes? If no one is willing to lend and GER does not have the money to repay, note holders will seize all assets. Will shareholders not lose everything?
I am not saying that coal price is going to fall, or GER is surely going bust. I am highlighting the risk of what may happen should the coal market experience a bad year. It may be good, or bad, I don't know. Such business models are not new, and the fallout from poor market prices has happened time and again. Some only recently; commodities trading, shipping, fishing, oil and gas. They all share the same characteristic of expensive financing, high debt, and over exposure of selling prices to market forces.
Whether these risks are real or imaginary is up to investors to decide for themselves.
From its latest quarterly, GER has revenue of US$75m and PBT of US$11.7m. Assuming that its production volume and expenses remain the same, a 30% rise in coal spot price will see its revenue rise 30% to about US$98m, and PBT rising to US$34.2m. Conversely, a 30% fall in coal spot price will see its revenue fall 30% to US$52.5m and PBT falling to -US$10.8m. Assuming coal has a bad year and this result is duplicated throughout the year, the PBT for the entire year will be -US$43.2m. And let us not forget its increased finance cost of US$10m from the increase in US$125m 8% of notes. Which brings the PBT to our hypothetical situation of a bad coal year to about -US$53m. This assumes GER has not yet made additional acquisitions of mines with the money raised from the notes; which will invariably cause PBT losses to be much higher than US$60m, since more coal will be sold for below cost. How many of such years can GER withstand before it is no longer able to refinance, or before it runs out of liquidity?
2) The issue is also not about whose financing costs are lower. It is the fact the financing costs are high, and the company's capital structure has a high proportion of debt. GER currently has US$73m of notes against US$160m of equity, debt/equity is 45%. Taking into account the increase of US$125m in notes, total debt will be about US$200m, bringing debt/equity to 125%. If coal prices fall, the mines on GER's book will not be worth as much as it states. And the huge losses from a falling coal price will also eat away equity; the debt/equity ratio will be much higher than 125%. In such a hypothetical situation, how will GER be able to refinance its notes? If no one is willing to lend and GER does not have the money to repay, note holders will seize all assets. Will shareholders not lose everything?
I am not saying that coal price is going to fall, or GER is surely going bust. I am highlighting the risk of what may happen should the coal market experience a bad year. It may be good, or bad, I don't know. Such business models are not new, and the fallout from poor market prices has happened time and again. Some only recently; commodities trading, shipping, fishing, oil and gas. They all share the same characteristic of expensive financing, high debt, and over exposure of selling prices to market forces.
Whether these risks are real or imaginary is up to investors to decide for themselves.