Sunday, November 30, 2014

Indonesian Thermal Coal (part 2) - the Asian coal market

The thermal coal market is harder to understand than I imagined.  Demand should be predictable - after you build a power station, you know how much coal you can shovel into it for the next 30 years. And if many coal miner's costs are above the market price, then production must contract, and there will be an eventual recovery when a new wave of demand picks up.  But its not that simple.

Seaborne trade is dependent a few big customers.  In 2013, China was responsible for about 30% of Asian coal imports, followed by Japan and India at around 15% each, and Korea at 12% (from BREE - p55).  But even though China is the worlds largest importer, only about 8% of its thermal coal is imported.   So graphs like this, showing China's coal imports steadily rising year after year are misleading,
when you consider that China's thermal coal production was off the chart at 3024 mt in 2013.   The imports are only at the margins.  A small change in demand or supply could reduce or stop imports. Or even lead to China exporting coal again.

The reason for that China imports is that bad railway infrastructure makes it expensive to carry the coal to the coastal cities.  This makes it the same to ship Indonesian coal to them:

 (Source: Adaro - p11)

So Indonesia's low cost advantage is also only at the margins.  They can only sell coal to the China's coastal cities, not to the western provinces.  And improvements in train size or railway infrastructure may make it possible for coastal cities to buy from local mines instead.  There are also plans to build power stations near the mines inland and transmit power to coastal cities.

The next largest buyer, Japan, is easier as they don't produce any coal themselves.  They are expected to reduce coal imports from 142mt to 127mt in 2019 as  they restart nuclear reactors and  (p51).  They have 4.8GW of coal fired stations scheduled to start next decade, which may add 10mt.  This report gives more optimistic estimates.

India is widely expected to replace China as a leading importer of coal.  But, like China, India has large reserves of coal.  Unlike China, they cannot mine them fast enough - their state owned coal company has missed targets for the past 6 years.  It is politics, not economics that will determine if their coal industry can be consolidated enough to improve efficiency, if foreigners can invest, and if required railways and power transmission can be built.

South Korea is next: additions of 12GW in 2015/16 expect to add 25-30mt coal per annum.

I expect ASEAN to grow coal consumption dramatically.  From around 70-90mt of imports now, to 210-279mt mt in 2035 in 2 scenarios (pp124-125).  Makes sense, as some of these countries do not have full electricity coverage yet, and coal is the cheapest and most reliable option.  Adaro expects ASEAN consumption (not just imports) to rise from 214mt in 2013 to 600m in 2035.

Worldwide, growth in coal use is undergoing structural slowdown:
  • Coal use has declined, due to cheap natural gas in the US
  • The US and China have agreed to reduce their greenhouse gas emissions.  China agreed to cap emissions by 2030.  They also released plans to cap coal consumption at 4.2bn tons by 2020.  I am surprised, I thought there was no way they would do it. They have also implemented local carbon trading schemes, mostly in coastal areas, in preparation for a nationwide scheme, possibly in 2016.


Thermal coal is trading below its marginal cash-cost in the cycle.  Credit Suisse says that "when there is oversupply of a commodity, typically 40% falls below the cash cost."  They say that 40-50% of thermal coal production is currently below cash cost.

Thermal coal is expensive to transport, thus seaborne coal is a small part of the thermal coal trade.  The cost curve shown in my first post is only for seaborne thermal coal only (graph B4).

I can't tell if long-term overall Asian thermal coal usage will rise or fall.  You can construct plausible scenarios either way.

Even though we are probably at the low point in the cycle, I won't look at Indonesian thermal coal because:
  • China and India may use their own coal
  • There is a structural decline in coal growth.  So the next up cycle may be smaller.
  • Potential changes in regulations make it risky for Indonesian coal companies.
  • Commodity down cycles are usually very long.   Newcastle coal fell from 1995 to 2003.  Due to the above risks, I would not be comfortable holding an Indonesian coal company for another 4 years while waiting for a payoff.
I could be wrong, and there are plausible scenarios where coal usage rises, especially in South East Asia, which would benefit Indonesia's exports.  If I was going to buy, my first picks would be Adaro and Bukit Asam.  But the long term picture is too hard to predict.

Wednesday, November 19, 2014


Baiju is the most popular drink in China, and Moutai is the highest premium brand of Baiju.  It has a long, storied history.  Each bottle takes 5 years to produce.  It is only produced at a specific location (p6).

In China there was a Baiju Bubble, which popped in 2012:

I don't know if Kweichow Moutai itself benefited from the previous high prices, or if their distributors did.

The bubble was pricked by Beijing's anti-corruption drive.  Moutai had previously focused on selling to government officials (or those who were hosting them).  They are now trying to switch to the consumer market, by:
There are many brands of baiju in China.  Diageo, LVMH and Pernod have acquired their own brands.

The risks are:
  • Young people in China may not take to baiju, being used to foreign brands of whiskey or vodka in nightspots instead.
  • This is purely a domestic China play.  Its unlikely that foreigners will take to it - "tastes like paint thinner and feels like a lobotomy".
  • As a China Company, its numbers may be fake.
  • China food quality: the company had a contamination scandal in 2012,over plasticizers in the bottles.  They did not handle it well.
  • How are they managing to lower prices, increase volume and move into the consumer market without affecting quality?
The numbers look excellent.  I didn't read the financial statements myself, but got the numbers from Morningstar, who, surprisingly, cover it (subscription needed).  Profit margins (after taxes) have been over 44% for the past 5 years.  Gross margins are over ninety percent.  Net cash has risen steadily over the past five years - I estimate it to be around 15% of the market cap, at 165yuan/share.  Perhaps they are also in the business of printing money.

The PE based on the last 4 quarters is just under 13 (@ 165 yuan/share).  Even though I prefer Diageo, which has a larger variety of products and is more international, Moutai looks better at this valuation.

Bought 900 shares at CNY 163.3 on 17th Nov 2014.  Total cost was SGD 31594.  Held in my DBS Vickers acct.

Sunday, November 16, 2014

Indonesian Thermal Coal

In one of his books, Aswath Damodaran mentioned a strategy for investing in cyclical commodity companies. When the commodity price is low, below the marginal cash cost of production, buy the lowest cost producer, who will survive and benefit once the commodity price recovers after the more expensive players are forced out of the market.

Newcastle (Australia) coal has dropped 50% since 2011:

(Source - indexmundi)

Futures have it between USD 63 now and USD 72 in 2020.

A google for thermal "coal cost curve" beings up this chart (from mid 2013), showing many players above the current price.

More googling shows Indonesia being the 2nd lowest cost producer, after South Africa (See here) (See p8).  A more recent chart (p24):

This is worth looking at further.

Quick Notes on the Thermal Coal Industry

Thermal coal pricing is regional, due to high transportation costs.  Coal often costs several times more to transport than it does to mine.  Cost to transport to port (for export) is the largest component of production costs.  Therefore, mines by the sea have much lower costs.

The simple 2011 map below gives rough costs for shipping coal.  Indonesia has the cheapest costs to China and India:

(Source: Nomura p11)

This one is more recent and detailed (source - Accenture p14):

We can see that Kalimantan has the lowest shipping costs to India, Japan and China.  The price differences between the importers (Qingdao, Japan) and exporters (Australia, Indonesia)  is maybe 10-15% once shipping costs are added.  A small change at the margins can have a large effect.

In the US, coal has been slowly replaced by Natural gas due to the fracking boom (p10) (more graphs here).  I don't think this will happen in South East Asia, as LNG is expensive to ship, and many regions here are so poor that they don't have reliable electricity.

Even though Australian producers are losing money, they are forced to continue production by long-term take-or-pay contracts.
It is expected that Chinese imports will decline over the next few years:
Mongolia is a producer of coking coal, but it is probably uneconomical to produce thermal coal there, with production costs estimated "in the order of $10-$30/tonne" with the same costs being incurred for freight into China.

Indonesia has a policy to replace diesel with coal for electricity generation.  They expect to double thermal coal consumption over the next 8 years.  This may not be good, as the government has tried to interfere with the coal industry:
The thermal coal market is quite fragmented.  Glencore is by far the largest player.  It probably controlled 50% of South African exports before its merger with Xstrata in 2013.  In 2010, it had 28% of the seaborne thermal coal market, plus Xtrata's 9%.  Glencore will be responsible for half the new coal coming onto the market in the next year.  They have been accused of trying to flood the market to remove competitors.

As with any market, no one can predict future coal prices.  Prices may be low until the 2020s, due to Glencore flooding the market and Australian mines being forced to produce.  I can't see a catalyst for coal prices to increase...but if I could, then so would everyone else.  Have to be willing to buy before everyone sees the light at the end of the tunnel.

The uncertainty introduced by the Indonesian government's ever changing rules may make me take a smaller position.

What to look for in a Coal Company

  • Low debt, to survive the cycle.
  • Low production costs:
    • Short distance to port (pit-to-port)
    • Low stripping ratio
  • Reserves: long mine life.
  • Are they selling coal on the open market, or at a hedged price?  Selling coal at a price higher price hedged years ago can make the company seem more profitable than it is.
  • Operating leverage: especially high fixed costs for transportation.

Sunday, November 2, 2014

Apple watch

Apple's new watch:
  • The watch does not fit under a shirt sleeve, so cant be a dress watch.
What can you do with it?
  • See incoming messages or calls on your wrist.
  • Open hotel doors and act as a boarding pass.
  • Use ApplePay.
  • Provide turn-by-turn walking directions.  And it could be done silently, by buzzing your wrist.
  • You can place your finger on the watch and send your heartbeat to someone.  Not very useful.
  • Fitness tracking: calorie counting steps moved - pretty standard stuff.

Why would you use it for?  We're not sure, there's no real reason for its existence yet.  Maybe:
  • The watch buzzing on your wrist may prevent phantom phone calls.  (I get this when I'm on call).
  • Can it remind you of things?  If you're going outside and its raining (bring an umbrella), or if you're passing buy a shop and need to buy something.
  • It can wake you up in the morning.  And not your wife.
  • It gives you directions to walk around town without bumping into people because you're looking at your phone.
At the moment, its main use is to stop you looking at your phone so much.  Cut a lot of little annoyances out of your life.

Will this overturn the watch industry?  The threat is not from the Apple Watch itself, but from the continuous innovation (or copying) that this may start.  Someone may write a killer app that makes enough people buy it.  The Apple watch may eventually replace the iPhone.   No matter how timeless, elegant or expensive a wristwatch is, if enough people get used to glancing at and feeling feedback from their smart watches, it becomes a necessity.  Like a smartphone today.

And for pricing, Apple has taken aim at the luxury watch market. It's prices start at $349 for the sports watch.  A stainless steel watch is also being released, and a 18K solid gold (not plated) one.  The last will probably cost over 5K.

Watches have a long history, and are now the only piece of jewelry a man can wear.  But you can only wear one watch at a time.  We need to wait and see if there is a compelling enough reason for mass adoption of smart watches.  Right now, I give it a 50/50 chance. The mechanical watch industry may die in 10 years.

Buying shares in Swatch or Richemont now may be like buying Nokia or Blackberry in 2007.  Even though Swatch is cheap at less than 14X earnings, its too risky. Too bad: I really liked these companies, but have to scratch them off my buy list.