“Wisdom is learning what to overlook”
– William James
“…a fiery growth engine, the kind of business we like to own: one that doesn’t require enormous sums of cash to generate annuity-like cash flow”
– Sardar Biglari
For part 2 (part 1 can be found here.) of the ongoing review of the high quality assets backing Sandstorm Metals and Energy Ltd (CVE:SND) streaming portfolio, I want to turn our attention to Sandstorm’s flagship Metallurgical Coal assets. I’ve chosen to follow up with the met coal deals primarily because I think that they offer yet another powerful illustration of the fact that SND’s highly attractive streaming assets can be purchased at a price that is by any rational measure completely out of proportion to economic reality, and almost certainly unsustainable assuming pretty much any future scenario where the world doesn’t actually end.
So, without further ado let me introduce you to NovaDx and its low cost, long-lived high quality metallurgical coal play(s), the Rosa and Rex No. 1 mines. Like with nearly all of SND’s streaming assets, the potential to increase value above and beyond the initial 2013 reserve/production estimates is substantial (to say the least) and the potential for a true moonshot type of homerun when all is said and done is very, very real. Of course, I would do a disservice to not mention that SND shareholders at current prices are quite literally paying nothing for this high probability, heads I win, tails I don’t lose call option on high quality silicon based met coal, so definitely keep that in mind as we go.
My hope is this latest rational walk will highlight the above reality and in the process, provide the breadcrumbs that ultimately persuade other bargain hunting investors to really roll up their analytical sleeves so to speak and do the work necessary to get to know these assets, their respective competitive/cost positions, the guys running the show, and last but not least, to come to a firm conviction as far as what is, and is not, an appropriate valuation after weighing all of those factors. While I’m not certain of many things, I am certain that the price implied expectations are one thing, but reality here is another – and so I think the real rewards (as always) will accrue to those that can tell the difference and position themselves accordingly.
So lets get to it.
Thoughts on the Silicon Metallurgical Coal Market
Before I begin I want to note that I’ve chosen to focus on the silicon coal aspect of this story as opposed to met coal utilized in the coking and activated carbon markets, primarily because the vast majority of the potential value creation here resides in the continued development of SND’s Rex No. 1 stream and the high quality silicon coal it produces. For those who aren’t familiar with silicon coal and its uses, silicon is a key input in silicon metal and hence by extension in thousands of industrial and consumer products unrelated to steel production – typically within the chemicals and aluminum industries. So I think its crucial to understand this nuance, as NDX – and SND by extension – and its Rex No. 1 mine is well positioned to capitalize on the anticipated growth and widening supply/demand imbalance of silicon coal over time.
Keep in mind that demand for Silicon metals is a secular growth story that is both firmly intact and driven by a confluence of global macro “mega trends.” These “mega trends” make silicon coal in a somewhat unique amongst the coal family, given it possesses multiple sources of end market demand. Much like the difference between silver and gold, silicon coal’s supply/demand dynamics are driven by multiple uses in more a more varied set of end markets. The takeaway is that pricing isn’t solely reliant on the relentless shift of China’s rise as the economic center of gravity as far as the consumption of met coal is concerned. This is an important and salient point to understand as far as thinking about the value of these streams long-term to SND and the associated supply/demand dynamics (and hence pricing) of the silicon coal that is produced. Granted, concerns over the pace of growth in China, the European financial crisis and the strength of the U.S. recovery have caused downward pressure on steel demand. Yet, even with these short-term concerns, U.S. coke plants are running near capacity and global steel mill percentage utilization remains in the mid-70s. With seaborne metallurgical coal demand expected to grow by more than 170 million tonnes to 428 million tonnes by 2020 (which is nearly 70 percent higher than the 2011 level) clearly the long-term fundamentals are still in tact.
So given most investors I’ve talked to seem to have a good understanding of the issues and dynamics of the seaborne market, they aren’t as aware of silicon coals other industrial uses/underlying drivers and thats a big part of this story. Consider silicon coals role in the production of silicon metal, which is the key component in the production of silicon chips and therefore everyday electronics. The increasingly global focus on renewable energy & energy conservation is another big piece of this puzzle that is expected to continue to benefit silicon producers and their bottom line.
For example, the use of silicon metal in aluminium alloys makes it both stronger and lighter. As a result, silicon metal is a key component in the aluminum that is being increasingly used in the automotive industry in order to replace heavier cast iron components. The benefits of this transition are obvious, as it allows car and other vehicle manufacturers to garner weight reductions. This leads to less fuel consumption and increased efficiencies and hence benefits the environment by both reducing greenhouse gas emissions and conserving fossil fuels. This is a trend thats here to stay.
Other drivers of the increasing demand for Silicon Metal (and hence silicon based coal) come from (1) the solar power industry – as solar panels are made from silicon, which use the sun’s energy to produce domestic and industrial electricity and (2) silicon based polymers – which are used as alternatives to hydrocarbon based products and appear in many other every day staples such as lubricants, greases, resins, skin and hair products. So while this is not meant in any way to be a comprehensive overview of the end markets and/or the underlying supply/demand equation that should support silicon coal pricing, I did wanted briefly discuss the issue in order to highlight that numerous secular tailwinds are supporting the value of SND’s Rex No. 1 assets long-term. Taken together the tailwinds here are VERY powerful, not entirely dependent on Chinese consumption, and unlikely to relent long-term for obvious reasons, so the fundamental underlying reality governing the supply/demand imbalance of silicon coal appears here to stay and I think its reasonable to expect a stable to rising price over time.
In sum then, who knows what pricing will look like over the next year or two or how much met coal China will need to export in the meantime. I certainly