Forget iron ore - Met coal is up 208% in 5 months, and this is the stock we're buying

Romano Sala Tenna

Katana Asset Management

At the beginning of May this year, coking coal was trading below US$120/tonne. As at COB 21/9, contracts were exchanging hands at US$390 per tonne. When we throw in the exchange rate of $0.73, this equates to an all-time record price of $A534 per tonne.

Yet this extraordinary price rise in the space of less than 5 months has largely gone unnoticed. This in the main part is likely due to the collapse in the iron ore price, which has dominated news headlines. There has also been some rather one sided commentary around China boycotting Australian coal purchases. Both of these have negatively impacted sentiment and displaced attention from the underlying commodity strength.

Of course, prices at $US390 per tonne are likely to be as unsustainable as they were at US$120 per tonne. But every day they remain here is an incredible windfall for the handful of existing producers. For example, the average capsize ship is around 150,000 tonnes. If we assume simplistically that the average cost of production is $A100 per tonne, then even at $US300 per tonne, every met-coal cargo that departs an Australian port is likely to generate in the vicinity of $A46m profit.

Of course the key question is where we see the long term met-coal price settling. As we’ve seen with iron ore, only tomorrow’s historians will know. But what the current spike has demonstrated, is that the market is a lot tighter than anyone had anticipated. And the increasing scrutiny on ESG, means that new mines are less likely, will take longer, cost more and likely be built in less favorable jurisdictions.

Over the past two years, the met-coal price was range bound between US$120 and $US160 per tonne. But in the years preceding that, it rarely traded below US$160/tonne and was range bound with an upper limit of $US240 per tonne, and the occasional spike through US$300/tonne. Moving forward, we see the seaborne market as being tighter than it has been historically. A price of US$180/tonne would therefore seem reasonable.

In terms of how ASX-focused investors can gain exposure to this burgeoning price, that question is much easier to answer. Coronado Global Resources Inc. (ASX Code CRN) is the only dedicated metallurgical coal producer of any size. We have recently updated our model for FY22e, and the numbers are compelling.

Based on an average price of $US180 per tonne (remember the current spot price is bordering on $US390 per tonne), Coronado will generate earnings per share (EPS) of 23.9c. This places it on a PER of 3.8x the current share price, representing a discount of ~56% to the materials sector and ~78% discount to the ASX 200.

There are no certainties in investing, and resource stocks represent another level of volatility again. But the potential upside is substantial should the underlying commodity price hold anywhere near 50% of the current level.

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The information contained in this article is provided to each recipient on the following basis: this article has been produced by Katana Asset Management (KAM). This article does not purport to contain any information that the recipient may require to evaluate KAM’s performance KAM is the holder of Australian Financial Services License No: 288412. none of KAM, Katana Capital Ltd, their respective directors, officers, employees advisers or representatives (collectively the representatives of the company/license) make any representation or warranty, express or implied, as to the accuracy, reliability or completeness of the information contained in this article and nothing contained in this article is, or shall be relied upon as a promise of representation, whether as to the past or the future. except insofar as liability under any law cannot be excluded, the Beneficiaries shall have no liability arising in respect of the information contained in or not contained in this article. statements in this article are made as of the date of this article unless otherwise stated. this is a general article only and it is not a recommendation and there is no consideration of the personal circumstances of any person;under no circumstances should this be taken as financial advice.

1 stock mentioned

Romano  Sala Tenna
Portfolio Manager
Katana Asset Management

Katana Asset Management was founded in September 2003 as a boutique investment management firm. Katana employs an all opportunity investment mandate being style, sector and market cap agnostic.

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