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Allegiance Coal (AHQ) - Accelerated Cashflow and Scalable Production

February 23 2021, 19:43 GMT

Allegiance Coal

  • ASX: AHQ
  • Shares Outstanding: 866.1M
  • Share price AUD$0.10 (19.02.2021)
  • Market Cap: AUD$82M

Allegiance Coal is listed on the Australian Securities Exchange (ASX:AHQ). Its investment focus is advanced, near production, or producing steelmaking coal projects in countries with low political risk. Allegiance is also committed to the development of sustainable working relationships with indigenous peoples and the wider community with whom the company is engaged in relation to its projects.

We met with Mark Gray, Managing Director of Allegiance Coal for an overview of the company and their projects and plans going forward.

Company Overview 

Allegiance Coal is an ASX-listed company focused on developing and operating Metallurgical Coal mines, also known as Steelmaking or Coking Coal Mines. They are strong believers in the long-term demand for blast furnace steel.

All About Coal: Types, Uses, & Perception at Market 

Mark Gray is personally a strong believer in the immediate, medium and long-term demand for blast furnace Steel. Supply is constrained as during the last commodity downturn, a lot of the major coking Coal producers held back on significant capex programs. It takes 10-15 years to get a mine into production, thus, supply is constrained and demand is good. India is slowly but surely going through a significant industrialization process. China's demand for coking Coal remains strong, they are a net importer, notwithstanding how much Coal they produce. The macro-economic dynamics tell a good story, and at the end of the day, you need Steel to make wind turbine energy, solar panels, electric cars, long-term storage battery units. It goes hand-in-hand with renewable energy.

Some people are confused by the difference between thermal Coal, which is for energy requirements, and metallurgical (met) Coal, or coking Coal, or Steelmaking Coal, which has industrial usage. If you are making Steel, you need met Coal and that confusion is causing problems with environmentalists and retail investors alike.

There is a lack of knowledge about the difference between thermal Coal and metallurgical Coal and their uses. Thermal Coal is use to create power / electricity, and Met Coal is used in the blast furnace Steel industry. You can, of course, put met Coal into a power station, it's like rocket fuel for a power station, but you can't do the reverse; you cannot put thermal Coal into a coking oven and a blast furnace. They have different chemical and metallurgical properties. Met Coal still has ash and sulphur, as does thermal Coal, but in the coking process of metallurgical Coal, are where those impurities are extracted in the coke oven so that when one puts pure Coke, pure carbon, into a blast furnace, a lot of those polluting properties have been removed.

Team Experience & Background 

Mark Gray has been in the industry for 18 years involved in running, originating and promoting mining companies, in particular Coal, but his first career was in M&A law. In New Zealand he spent some time working for a magic circle firm in London and investment Banking in London as well. In the late 1990s he embarked upon a career change, and ended up in the mining industry and came to own an underground Coal mining services company in Australia, along with 2 of his partners. He learnt a lot about mining and running mining companies and about the Coal business and he now appreciates how important and critical Steel-making Coal is to the world, to the industrialization of the world and to the role it has to play in renewable energy as well.

The Macro & Geopolitics: Supply/Demand & Pricing

China is a net importer of Met Coal, and we are aware of the conflict between Australia, the world's largest producer of coking Coal, and China, the world's largest consumer. But people who understand the market and the basic fundamentals of supply-demand in the sector are not turned off at all by the conflict between Australia and China. Within the last couple of weeks, the world order in terms of Coal pricing and how it's priced, has returned after an odd scenario in the early months of January, when it became well understood that China had imposed a ban on Australian Coal, amongst other things.

Current demand is actually driven by India. India is slowly but surely working its way into an industrialisation programme. India is now the largest importer of seaborne metallurgical Coal, followed by China, who is still a net importer, notwithstanding the enormous amount of domestic production.

The world order of pricing of metallurgical Coal is all against a benchmark Coal, or a benchmark set of Coals, out of the Galilee Basin in Queensland. There are mines there, namely Peak Downs, Riverside and some others that set the pricing for all metallurgical Coal on the seaborne market. Certainly during the month of January, the benchmark was trading at a significant discount to other metallurgical Coals: Canadian and US in particular, but world order has returned and the benchmark, the Premium Low Vol hard-coking Coal from Australia, is now again setting the price.

The US High-Vol A, a hard-coking Coal, trades very closely to Premium Low Vol, or to benchmark. Over the last 7-years, the discount has been something in the order of 2-4%, and at times High Vol traded at a premium to benchmark. US Coal historically, certainly the High Vol A Coal, is aligned very closely to premium mobile, so it's not as though the US had a period of high prices. Instead, the premium Low Vol, because of the Chinese-Australian conflict, depreciated very quickly for a very short period of time. However, US High Vol A is an excellent Coal, highly sought after by the steel mills, and a premium is paid for it.

We saw in the US an 8% reduction in last year's numbers. The US is historically a high-cost producer on the seaborne market. 320Mt of Metallurgical Coal hits the seaborne market every year. Australia accounts for about 60-65% of that, followed by the US with 15%, and Canada 10%. Then there's the rest of the world. The US unfortunately, for several reasons, is one of the highest-cost producers in that market. They are at the top end of the cost curve, and we often refer to the US as a swing supplier: prices are up, they come online, they get back into production very quickly. When prices decline, they disappear.  What we saw was a reduction in US exports of met Coal that was directly related to the drop in the benchmark price during Covid.

We also noticed that blast furnaces in Europe are firing up again which has got to be good for demand and pricing. The European steel mills idled many of their blast furnaces during Covid, and so did India. But they're back firing up, they are looking for Coal and there's not a lot on the seaborne market. With the decline in US production, there's a hole on the supply side and Europe is desperate for Coal at the moment. They're having to export it from Australia because, of course, Australia can’t export to China. They have to pay a big premium to get that Coal all the way around The Cape and into Europe.

Allegiance Coal Assets: What Have They Got?

Allegiance Coal has the Canadian Tenas project in Northwest British Columbia which is a green-fields project, but very close to permitting. Last year they completed the acquisition of an idled Coal mine in southeast Colorado with a very large resource base which is the asset which they are working very hard to return to production. The target date is May/June 2021.Allegiance Coal (AHQ) - Accelerated Cashflow and Scalable Production

The New Elk project in Southeast Colorado is a big resource, certainly by US standards. The mine itself has 670Mt of Coal resource, the vast majority of which is in the measured and indicated category. It's a very high level of resourced definition. Allegiance Coal undertook a Feasibility Study in relation to one of the Coal seams last year and converted about 45Mt of that resource into saleable Coal reserves. It is a substantial resource base with a solid reserve to start mining with that asset.Allegiance Coal (AHQ) - Accelerated Cashflow and Scalable Production

The coal is loaded onto a vessel in the Gulf of Mexico and the Feasibility Study indicated that they could load a vessel in one of the Coal terminals in Houston for something in the order of USD$75/t. Alternatively, it can go by rail a little bit further to the Coal ports in New Orleans, for the price of around USD$80/t. In terms of cash costs, these are very low cash costs on the seaborne market. It certainly puts the mine in the lowest half of the cost curve for seaborne metallurgical Coal, and on the tip of the lowest-cost quartile. 

The product that they will be exporting in the coming year will be very close to on-specification High Vol A, so it's at a premium. High Vol A Coal today is trading around USD$150/t and they’ll be hoping to get something very close to that price with their first shipments.

Preparation for Production: Securing Financing 

New Elk is permitted and fully constructed. This mine was built in 1951. It operated for 30-years producing 30Mt of coking Coal supplied to a blast furnace which existed in Southern Colorado for over 100-years, and also supplied coking Coal to a blast furnace in California. It's a constructed mine. If the mine was built today, it would cost USD$200M. The start-up capital requirement for Allegiance Coal today is USD$13.5M.

The management team has mobilized and is on-site now. The Chief Operating Officer has moved there with this family and they have engaged their production manager and their general manager for non-production activities which are the 2 key executive positions on the mine. They are currently refurbishing the mine equipment on-site and need to buy some extra pieces of equipment and need a small upgrade on the wash plant, but it will all be done by the end of March. On the sales side, the sales and marketing agent is in Brisbane, Australia and is engaged with the Steel mills globally so they are starting to build an order book. 

Allegiance Coal raised USD$7.5M back in November and they are using that cash to do the equipment and mine refurbishment and they will need more money to continue that capex programme.

They are very advanced and are in discussions and due diligence with a New York debt fund for a USD$15M project finance facility. Technical due diligence is largely completed and the independent technical mining consultants felt that the mine plan was robust in terms of opex costs and capex production assumptions. The debt fund is now moving into legal and financial due diligence. If they are successful in securing that funding, that will be the greater part of the capital requirement secured, which they hope will be finalised by mid to late March.

Their market cap is around USD$80M and their share price has been fairly flat over the course of the last year and they want to do it in the most undiluted way possible for their shareholders and Mark Gray himself is quite a significant shareholder with over 3.5%. 

The Coal quality is well understood and it aligns very nicely with High Vol A Coking Coal on the seaborne market. It's highly sought after and it's in demand, particularly in the current environment. Off-take financing will not be a condition precedent to the funding. This is typical project finance, so the debt fund will be their senior secured creditor. They are looking at a 3-year term. A 12-month interest holiday and start repaying debt over the last 2-years.  

Once the market knows that Allegiance Coal has secured this debt facility, they will see the pathway through to production and it is then that the company will be re-rated as a consequence of that to reflect the true value of the company. The opportunity is clear if they can deliver all of those things in the sequence and timing that they predict. 

Coal: Opportunity VS Sentiment 

There are some very strong supporters with the big investors and the retail sector continuing to invest in companies like Allegiance Coal in the met-Coal sector despite negative sentiment regarding the coal industry. Historically, Coal companies were looking to take the retained earnings, to make acquisitions and grow the company. They were focused on capital growth, on share price accretion, but less focused on the fundamental plan of a good return for shareholders. The strategy of Allegiance Coal is to generate strong news and to focus on organic growth. They have a good resource base, with 2 projects and the New Elk is a very significant resource base with organic growth potential from that asset rather than having to go out and acquire other assets. They are keen to get strong earnings and pay returns to their shareholders.

Business Plan, Strategy & Timing

Allegiance Coal is not going after any M&A. We understand the timing of New Elk. With the BC asset though, they’re very close to filing an environmental assessment certificate. That activates an 180-day review period with the regulators in British Columbia, and leads to a 40-day decision period by the Ministry of Environment, Energy and Mines. Hopefully by October/November this year, they'll have their environmental certificate for that project. That asset is not far from being permitted to be into production and they are planning possible construction in mid-2022, first Coal in 2023 which would add very nicely to their production at New Elk, and an incremental increase in production from one of their assets.Allegiance Coal (AHQ) - Accelerated Cashflow and Scalable Production

ESG Component: Changing Perception of Coal

Allegiance Coal needs their EIA to be approved, but also needs to get the locals on board and get permission from First Nations communities. Mark Gray has lived in the area for 3 years which he feels is the best way for the company to engage with the community. He moved there when they commenced the pre-application phase of the environmental assessment process in British Columbia. There are isolated pockets of opposition, and that is acknowledged and accepted, but overall, the local community is hugely accepting of the project. There must be no danger to the water in the rivers and the fish, which will come down to science and engineering. If they can't satisfy the BC regulators and the local First Nations group, then they will not get their environmental assessment certificate. It comes down to the ability of the team to develop a mine design which has minimal impact on not only water and fish habitats, but all the other environmental components.  

Allegiance Coal is 3-4 months away from production. They have a big resource base, a big reserve base and a good asset with good Coal quality. They will be producing by the end of the year in excess of 1.5Mt annualised. The company is in a strong position and they think they have the management team to execute their strategy. 

We are looking forward to hearing how they get on. It sounds like there's a succession of announcements that they will be making over the next few months so will keep an eye on the news from Allegiance Coal. 

To find out more, go to Allegiance Coal's Website.


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