Thungela Investment Case
July 21, 2021
TGA SJ: 37.19 ZAR
Market Cap: 5.1 BN ZAR ($345MM)
Enterprise Value: 2.1BN ZAR
Price Target: 80 ZAR
Upside: 115%
Resources
Thungela Prospectus – April 2021
Thungela Investor Webcast – May 2021
Thungela Investor Day Transcript – May 2021
Thungela Investor Day Slides – May 2021
Twitter Source for Idea: @DeepValueInv
Other Twitter Source for Idea: @AimingHigher4
https://twitter.com/acosgrove003/status/1412249517550977026
Summary
Thungela Resources is a spin-off of Anglo American which began trading in June 2021. The investment case is simple. It’s crazy cheap (1.5x ‘21 current earnings) and has no debt. I expect the stock to re-rate shortly when it initiates a dividend (when Q2 earnings are announced within 2 weeks). Based on guidance from the company (30% payout ratio), I expect the dividend yield to be ~25% at the current stock price. Peer, Exxaro Resources, trades at a 10.8% yield. As such, I think the stock could double in a hurry.
Where to Buy Shares
The caveat is this stock doesn’t trade in the United States (I think this is part of the reason why the opportunity exists).
You can buy it through Schwab and Fidelity (I used both brokers).
The security trades in London and Johannesburg (South Africa). Volume is good in both places (over 2MM shares traded daily on avg). I’m going to buy it in South Africa because trading volume is slightly higher and the fees are slightly lower.
Here are the costs/commissions as I understand them:
Schwab:
- London:
- 0.6% to buy, 0.1% to sell. Plus commission of 0.75% or $100 (whichever is greater).
- Currency charge is embedded in the fee.
- Johannesburg:
- 0.4% to buy, 0.1% to sell . Plus commission of 0.75% or $100 (whichever is greater).
- Currency charge is embedded in the fee.
Fidelity:
- London:
- 0.50% to buy, 0.0% to sell. 1.0% currency conversion charge. Plus GBP commission (unsure what it is).
- Johannesburg:
- 0.25% to buy, 0.0% to sell. 1.0% currency conversion charge. 225 ZAR ($15) commission.
While these fees seem crazy in a world of zero commissions, I’m happy to pay it given the extreme mispricing.
Background
Anglo American PLC (AAL LN) is a $50BN market cap mining company focused on polished and rough diamonds, copper, platinum and other metals.
In April 2021, it announced that it would spin off its thermal coal business into a new company, Thungela Resources, in an effort to transition away from the most polluting fossil fuels.
Thungela Resources began trading on June 7, 2021 in Johannesburg at 21.90 SAR and is up ~70% in a little over a month.
Nonetheless, the stock is still incredibly cheap and will likely re-rate when a dividend is announced.
Its current market capitalization is ZAR 5.1BN or $345MM.
Business Overview
Thungela is thermal coal business.
Thermal coal or steaming coal is burned for steam to run turbines to generate electricity either to public electricity grids or directly by industry consuming electrical power (such as chemical industries, paper manufacturers, cement industry and brickworks). During power generation the coal is ground to a powder and fired into a boiler to produce steam to drive turbines to produce electricity.
Thungela has 7 coal mines in South Africa as shown below.
54% of production is exported, 37% is consumed internally in South Africa, and 9% is sold to ESKOM (state owned), the largest producer of electricity in Africa.
Thungela expects demand from Asia to drive growth (Bangladesh, Pakistan, and Sri Lanka).
The company believes its mines are on the low end of the global cost curve.
I have no idea if this is true, but if it is, it should provide downside protection if coal prices fall (They are soaring now).
Source: Trading Economics
Coal is the dirtiest power generation source but it’s the cheapest. As such, it’s likely to be used for the next 30-50 years. It’s easy for rich regions (U.S. and Europe) to move away from coal for moral / environmental reasons, but developing economies are going to need it to power their economies.
Here is IEA’s forecast for global electricity generation.
Earnings Outlook, Valuation, and Dividend
At its analyst day, management noted that every $10 increase in the price per ton of coal will increase EBITDA by R2.7BN (talk about operating leverage!).
To be conservative, let’s assume the price of coal is $100/ton (vs. $65/ton last year) in 2021 on average.
This seems reasonable / conservative given the current price of coal. See chart below.
Source: Trading Economics
In this scenario, EBITDA should increase on a full year basis by 3.5 (($100-$65)/$10) * R2.7BN = R9.45N. Last year, the company lost R1.0BN. Add R9.45BN to last year’s results yields R8.45BN in expected EBITDA this year (2021).
What about free cash flow?
As shown below, I estimate the company will generate R4.2BN.
By my estimate, Thungela is trading at 1.2x free cash flow.
While that may seem incredibly cheap, it gets even better.
The company has guided that it will pay out >30% of its adjusted operating free cash flow per year as a dividend.
30% of R4.2BN is R1.26BN or a dividend yield of ~25% at Thungela’s current market cap.
It hasn’t been declared yet but management was very explicit about the dividend during the analyst day. See commentary (including Q&A) below.
When will the dividend be declared?
While I don’t know, I think it’s possible that it will be declared when the company announces Q2 2021 results on August 13, 2021 (based on the above exchange from the analyst day).
A cheap stock can stay cheap for a while. But the dividend declaration (whether in a few weeks or few months) should provide a hard catalyst for shares to re-rate.
While there is no guarantee that the dividend yield will be 20%+, I gain comfort that Citi seems to expect a large dividend too (although I haven’t seen the Citi report). If someone has it, I would love to take a look!
Comps
I think the best comp is a company called Exxaro Resources (EXX SJ), another South African coal company.
It is trading at a TTM dividend yield of 10.8% (40% payout ratio) according to Morningstar.
It’s trading at 3.7x 2021 earnings and an EV/EBITDA multiple of 5.4x.
Source: Market Screener
By my math, Thungela is trading at 0.3x 2021 EBITDA and 1.5x earnings.
I think fair value for Thungela is ~80 ZAR which implies EV/EBITDA and price to earnings multiple of 1.0x and 3.3x, along with a dividend yield of 11.6%.
Downside Protection
Thungela has no debt and was capitalized with 2.5BN ZAR (49% of market cap) at the time of the spin-off.
Further, if coal prices retreat, Anglo American will provide additional financial support to the spin-off. I don’t expect this financial support to materialize given how strong coal prices are, but it does provide another measure of downside protection.
Coal Cost Liabilities
At the time of the spin-off, Boatman Capital Research targeted Thungela with a short report arguing that the company was worthless given its environmental liabilities needed to eventually close down its coal mines.
Boatman Capital closed out its short position profitably, I believe.
I’m not too concerned about these liabilities at this point.
Thungella has 2.9BN ZAR of cash in a trust to meet its environmental liabilities. It also has an additional 3.2BN ZAR of liabilities which it will meet by contributing 188MM ZAR per year (5.5% of outstanding guarantees) as detailed below.
The environmental issues may become an issue years down the road, but I’m not worried about it in the near term given incredibly free cash flow generation and the large expected dividend.
Conclusion
I think Thungela is an extremely attractive near term opportunity that has the potential to double.
Disclaimer/Disclosure
Rich Howe, owner of Stock Spin-off Investing (“SSOI”), doesn’t own Thungela shares but plans to buy some. All expressions of opinion are subject to change without notice. This article is provided for informational purposes. Please do your own due diligence and consult with an investment adviser before buying or selling any stock mentioned on www.stockspinoffinvesting.com.
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