A happy early Christmas to you, dear readers. For those of you on the Nice list, as an early present we have a diversified resource conglomerate. For the Naughty list, well, you should know what’s coming. Please, come in and read on.
NACCO Industries, Inc. is the public holding company for the North American Coal Corporation. The company is listed in many online resources as a coal miner, materials handler, specialty kitchen appliance manufacturer, and royalty collection stream, and it reports unconsolidated earnings along with gross profits. Not only environmentally unfriendly, but also confusing, disparate, and tough to value. And yet, this phenomenon of imperfect information is an excellent way to gain an edge on the markets, as the surface inaccuracy, confusion, and environmental taboo can create inefficiencies, mispricings, and buying opportunities. And coal mining, make no joke, is a rough business, so if you can remain profitable here that might be saying something. We hope to begin clearing some of that up here.
History
The Cleveland & Western Coal Company began as a coal brokerage in 1913 and purchased its first underground mines in Ohio in 1916. It became the North American Coal Corporation in 1925 and over the next fifty years grew throughout Ohio, Pennsylvania, West Virginia, North Dakota, and Texas, and listed on the NYSE. The company began large-scale surface mining, its core business, in the 1980’s.
The advent of leveraged buyouts and syndicated lending groups in the 1980s and ‘90s drove a private equity merger-and-acquisition frenzy in the 1980’s and 1990’s[1]. North American Coal diversified into materials handling in 1985, reorganized as NACCO as a multi-industry holding company in 1986, got into kitchen appliances in 1988, and created its North American Mining segment with limestone mining in Florida in 1994. NACCO grew to be the largest lignite coal producer in the US in 2000, to total 2008 revenue of $3.7bn, before spinning out its $1.8bn-revenue materials handling business, Hyster-Yale Materials Handling (NYSE:HY), in 2012, roughly half the business.
NACCO generated $140mm in revenue in 2019, roughly two-thirds of which was coal mining-related contract fees, followed by limestone mining and resource extraction royalty fees. As of 9/30/2020, the company operated at eight coal mines. Per the latest 10-Q, the company is paid a management fee per ton of coal or heating unit (MMBTu) delivered. In the NAM segment, the company generates fixed price and management fee contract structures from limestone quarries in Florida, with a recent $3.5mm investment into lithium mining in northern Nevada. Its final segment of business, minerals management, develops the company’s Ohio, Louisiana, Mississippi, Pennsylvania, Alabama, and North Dakota oil and gas reserves, collecting royalties for leases from third parties. These reserves were acquired as a result of the company’s historical coal operations, and NACCO sells customers the rights to explore, produce, and sell natural resources on their property.[2] The company has operations in the below areas of the several States:
JC Butler, NACCO’s current CEO, has been working with NACCO in some capacity since 1995 and became CEO in 2015. Mr. Butler has done a good job managing the tough fossil fuel business: beginning with the spinoff of the housewares business[3] in 2017, NACCO began honing in on its core competency of resource extraction and full service customer management. It expanded its service offering by adding a wetland mitigation banking[4] business to the product portfolio. Lithium Nevada will pay Sawtooth Mining, LLC, a management fee per ton of lithium delivered over the 20-year contract.
Industry
The largest global application of coal is in the industrial space, where 60 quadrillion BTus were consumed in 2018 for utilities’ power generation and steel and cement production. Global coal production in 2018 was 7.7Bn tons, with total estimated coal reserves to be roughly 1.1 trillion. The US is estimated to have 23% of the world’s in-ground coal reserves or roughly 250bn tons, the most of any single country in the world, and produce roughly 700mm tons annually. Overall western production has declined due to regulations and political ill-will toward the dirty fossil fuel. Meanwhile, the Chinese have grown to be the dominant overall producer, from 2.5bn tons in 2007 to 3.5bn in 2018, roughly 40% growth from 2007-18 and currently five times the size of the US market.
23% of US utility electricity, NACCO’s end market, comes from coal. Its customers are primarily power companies on a management fee contract basis. Within that market, NACCO ranks sixth among major producers with 5% market share, compared to its largest competitor, Peabody Energy (NYSE:BTU), approximately four times larger than NACCO with 20% market share. This weaker market position is offset somewhat by its recent expansion into lithium mining, a high-demand market for battery producers.
With significant alternatives for power weakening demand for coal, increasing regulation in western countries, and growing Chinese production, the industry environment is a sure source of risk if NACCO’s customers decide to change their method of power production. Some fault lines have already been spotted, with contracts beginning to unwind.
Valuation
NACCO is currently restructuring many contracts and stalling or selling mines, which Inverness expects will squeeze margins going forward as the company restructures. Some investors might not like exposing their portfolios to coal and risk the potential a) pollution created by their company and b) likely negative profitability impact of new regulations handed down from on high.[5] Social taboos in today’s Western markets have driven fear of coal, limiting demand, investment, and enthusiasm for coal stocks. So why bother?
Prior to coronavirus, NC had reached a high of $65/share, or market cap of $350mm, in October 2019. But likely due to the coronavirus panic, contract restructurings and cancellations, the cheap price of oil, and simply coal and other fossil fuels viewed as out of favor with broader social trends, the market viewed the company as half as valuable as it was in 2019, to the tune of a 50% decline to ~$180mm by today’s calculations, and is now trading around $26. Volume has also trailed off following the spinoffs, and total shareholders today amount to roughly 700 Class A and 140 Class B holders (2019).
Today, the market is valuing NACCO at roughly 3-4x EV/EBITDA, a very cheap price by middle market standards for such a longstanding business, let alone one pivoting to expand into new end markets. Financially, the company is already a nice apple to pluck – $97mm of cash, 2019 EBITDA of $58mm (41% margin nearly unheard of), stock repurchase program, limited debt, 2.8% dividend yield, 3.0x cash to debt, no net leverage, and 2.9x assets to liabilities.
While coal may have put the stock in its current predicament, the NAM segment is NACCO’s primary growth engine, both in terms of catalyzing share value and growing revenue. Lithium will be in ever-higher demand around the world as the Western world leads the transition to electric- and battery-powered vehicles and energy storage demand grows. Management has streamlined the business and seems well aware of coal’s scarlet letter, taking steps to diversify revenue streams. And Inverness likes when companies have $100mm in cash just lying around, paying a dividend.
Inverness Holdings has no interest in any securities mentioned herein.
Sources: BTU and NC 10-Ks, US Energy Information Association, BP Statistical Review of World Energy 2020, https://im-mining.com/2019/09/25/nacco-subsidiary-sawtooth-gets-mining-contract-thacker-pass-lithium-operation-nevada/
[1] Check out Barbarians at the Gate by Bryan Burrough and John Helyar. Great read.
[3] Hamilton Beach Brands (NYSE:HBB)
[4] A quite wild wild west form of ecological management to offset effects of mining or pollution. Perhaps a business for you ESG-oriented investors out there.
[5] Jargon: “stroke-of-the-pen risk” – proposals like the Green New Deal and European green vehicle mandates and limitations on burning of fossil fuels