Why are there Windmills on their Homepage?: Ramaco Resources $METC $METCB

Coal, the new whale oil. Part III

Hello and welcome back to “Coal, the new whale oil.”  For a quick refresher on the macro thesis, feel free to check out the first in the series.  

In summary, I am bullish on metallurgical coal for export markets, and both Peabody Energy (BTU) and Warrior Met Coal (HCC) have metallurgical coal expansion projects under production.

There is another metallurgical coal small cap company still building out their capacity, Ramaco Resources (METC).  You may have heard of them from the modern legend of the fund manager who took a chance buying an old coal mine in Wyoming for $2 million, and discovering a $37 billion rare earth element deposit underneath it.

https://www.mining-technology.com/news/rare-earth-discovery-in-us-values-coal-mine-at-37bn/

Ramaco Resources is an interesting company, 5.8% owned by the founder and CEO, Richard Atkins, incentives should be well aligned.  And, his background at JP Morgan has led to development capex strategy and share classes that should be attractive to investors, although the current share price belies this strategy.

Regarding capex, growth strategies are paced out in order to maintain free cash flow growth after capex.  If only Vermillion Energy (VET) and New Fortress Energy (NFE) would follow in Atkin’s footsteps.  Despite 2023 having less EBITDA than 2022 due to falling coal prices, capex was reduced to give the investor a growing free cash flow investment.  

Richard Atkins also created an interesting share structure for METC by spinning off some very stable royalty, infrastructure income, and intellectual property streams into a separate entity, METCB.  For investors particularly interested in income, METCB has a current dividend yield of 8.62% compared to METC’s 5.42%.  So there is a way to participate for both income investors and growth investors.  

The market capitalization of the combined METC and METCB share classes is a bit over $575 million.  For comparison, Warrior Met Coal (HCC) is trading at a market capitalization of $3.1 billion.  METC is guiding toward ending 2024 with a 5 million ton annual run rate, and on their way to 7 million tons of annual production in the medium term.  HCC is currently at a 7.6 million ton annual run rate, on their way to a 12 million ton run rate in a few years.  This implies about a 3x upside in share price for METC just to trade at the same valuation as HCC.  And the rare earth element asset and future development is currently valued by the market at zero. 

The most recent cash costs for METC are $108 per ton of metallurgical coal, with management spending capex on efficiencies to get this number below $100 as soon as possible.  This cash cost of production should put them in the 1st quartile as a relatively low cost producer.  

Regarding the rare earth element deposit of legend, an extensive core drilling and chemical analysis program is underway, as well as analysis and design of the optimal processing facility.  A pilot rare earth processing facility will be started in 2025, and brought into production in 2026.  While small, the pilot is designed to generate products for sale immediately upon completion.

Rare earth elements are outside of my competency, but when I can get exposure to them as a free lottery ticket when I buy an already undervalued business, it seems like a pretty good deal to me.  With China banning exports of Gallium, and METC’s rare earth reserves being 9.3% Gallium, I am cautiously optimistic for someone completely outside of their expertise.  But to get the rare earths for free on a dramatically undervalued metallurgical coal producers is a fun lottery ticket.

Of course extracting the rare earths would take an enormous amount of capex.  But I am contented by management’s prioritization of free cash flow growth over growth capex so far.

Management is guiding for 2024 full year capex at around $60 million, with $20 million of that for growth, and $40 million for maintenance.  Not bad for a company that will increase production by 1 million tons of coking coal this year.

Depending on metallurgical coal prices, METC will be able to generate $400 million to $600 million of annual EBITDA. At Enterprise Value / EBITDA ratios of 5x, METC could generate a 6x return in a few years. And that does not include either the possibility of dramatically higher metallurgical coal prices due to reduced supply as investment banks turn their backs on coal, or any benefit from the eventual production of rare earth elements.

Ramaco Resources appears to be a very well run company that pays attention to delivering results for shareholders, and is trading at a fraction of the multiples of their peers despite the recent announcement that China is stimulating their economy with the lowest interest rate in their modern history, 2%.  The balance sheet is clean, growth projects on time and under budget, and the embedded lottery ticket is enticing.  I am adding METC to my portfolio, replacing one third of my exposure of both BTU and HCC.