TGIF Series 2 #7 The reincarnation of a deadly resource
Welcome to the latest edition of The Great Investment Frontier (TGIF) report.
So far in this series we’ve documented the largest infrastructure project the world has ever seen, why it’s being built and a few ways to profit. If you’ve missed our recommendations, catch up by clicking here and here.
Growing demand for dirty energy
Infrastructure and energy go together like soy sauce and dim sum dumplings – one without the other would be a disappointment.
Likewise, as China gives the ancient Silk Road an infrastructure face-lift through the One Belt, One Road initiative (OBOR), cars, trains, planes, ships and factories will grow in number, and so will demand for energy.
Much to the chagrin of environmentalists, coal will be a key source of power in planned OBOR projects.
OBOR Coal Projects
Although China and other major powers pay lip service to clean power, the fact remains that coal is the cheapest and most accessible form of energy.
With 460 million people in Asia lacking access to electricity, demand for cheap energy will trump concerns about climate change and local air pollution.
Seeing the needs of poor countries as an opportunity to expand, China has already started to fund several coal projects.
One OBOR project, the China-Pakistan Economic Corridor – will involve lots of investment in coal.
Of the US$46 billion that will be invested into the project, around US$37 billion will be used for various energy projects, particularly coal-fired plants.
Beneath Pakistan lies more than 185.5bn tons of coal – sufficient to generate 100,000 megawatts (MW) of electricity for 30 years. The government plans to add 10,400 MW of electricity at a cost of US$15.5 billion by 2018.
The “Thar Coal Mining and Energy Project” is one OBOR project that will address the country’s energy deficiency.
Financed by Chinese banks and the Asia Infrastructure Investment Bank (AIIB), the mine will likely extract more than 175 billion tons of coal from the Thar Desert.
There are at least 7 other multi-million dollar coal-fired power plants under construction along the China-Pakistan Economic Corridor.
But Pakistan’s coal projects are likely to only meet domestic needs. Other OBOR countries remain energy deficient and equally vast coal projects are underway in these areas.
How to profit from coal under an OBOR regime
Adaro Energy Tbk (Indonesia Stock Exchange; ticker ADRO) is an Indonesia-based company engaged in integrated coal mining through its subsidiaries. It does mining, barging, ship loading, dredging, port services, marketing and power generation.
It also produces thermal coal from its mining sites located in Kalimantan Selatan, Indonesia.
Sound business fundamentals
With 24 years of operating experience, Adaro has a proven track record of sustainable coal production and is one of Indonesia’s largest suppliers of high quality coal from its sizeable reserve base.
The company recently entered into an agreement to purchase 75 percent of the US$120 million Indomet Coal Project. Leading global resource company, BHP Billiton, is a project partner.
The project has access to 1.27 billion tons of metallurgical coal resources, accounting for up to 80 percent of Indonesia’s coal production.
By 2032, Adaro plans to add about 20 gigawatts (GW) of energy in response to Indonesia’s push to add almost 35 GW of coal-fired capacity by the end of 2025.
Domestic energy demand accounted for the largest portion of the company’s revenue stream, but it has strong sales in OBOR countries like China and Malaysia, as well as in India and Japan.
Global supply shortages from China’s coal production cuts in 2017 have propped up prices worldwide. As a result, Adaro saw its profit margin increase from 20.24 percent in 2015 to 27.15 percent in 2016, as you can see below.
Adaro’s operating earnings before interest, tax, depreciation and amortization (eBITDA) margin is stellar and has a proven capability to adapt to difficult market conditions.
The company’s operational eBITDA margin in 2016 increased up to 36.5 percent, reﬂecting the strength of earnings and the resilience of their business model.
Part of OBOR
Adaro also has a 34 percent stake in one OBOR project in Indonesia, the Central Java Power Plant (CJPP) in Batang.
The project is a 2,000 MW greenfield coal-fired power plant, making it Indonesia’s largest power plant to be built for power shortages. Construction began in 2016 and it should start operating in 2018.
In total, the project is expected to cost between US$4 and US$5 billion. The World Bank and the Japanese Bank for International Cooperation will finance the project.
Adaro will face few export challenges, thanks to a host of new transportation routes being built, courtesy of OBOR.
In the coming years, 24 new strategic ports, 15 new airports, 2,650km of new roads, a 42 GW electric power plant, bus transit system in 29 cities, and 2,159km of inter-city railways will be built in Indonesia.
All these points mean Adaro will likely be a good inclusion in anyone’s portfolio for the foreseeable future.
With thousands of OBOR contracts worldwide and an equally high number of ways to “play” the project, expect another great recommendation from us next week.