Allegiance Coal (ASX: AHQ) - Hitting Revenues Targets and Scaling Up

Allegiance Coal Limited is a listed Australian company focused on seaborne met coal mine development and operations, with operating mines in southeast Colorado, central Alabama, as well as a development project in northwest British Columbia. Allegiance is committed to the development of sustainable working relationships with indigenous people and the wider community.

Matt Gordon caught up with Mark Gray, Chairman and Managing Director, Allegiance Coal. Mr. Gray is the founder at Telkwa Coal Limited (a wholly-owned subsidiary of Allegiance Coal) and is responsible for securing the farm-in rights to the Telkwa metallurgical coal project in September 2014. He is a corporate lawyer with over 3 decades of transactional experience working with Herbert Smith in London, as a Partner with Bell Gully in New Zealand, and as a Director at Barclays de Zoette Wedd, an investment bank in London. For the past 12 years, Mark has worked as an Advisor and Company Executive for mining companies including underground coal in Australia, open-pit mining in Africa, and in the exploration and development projects for several minerals. 

Company Overview

Allegiance Coal Limited is engaged in the acquisition and exploration of coal tenements. The company was founded in 2011 and is headquartered in New South Wales, Australia. New Elk Coal Company, LLC, Allegiance Coal USA Limited, Telkwa Coal Ltd, and Mineral & Coal Investments Pty. Ltd. are the company’s subsidiaries. The company’s major assets include the Tenas Project in northwest British Columbia, the New Elk Mine in southeast Colorado,  the Black Warrior Mine, and the Short Creek Underground Mine in Birmingham, Alabama.

Allegiance Coal has 2 producing mines in the US, along with 2 development projects, one in the US, the other in British Columbia. The company is focused on the production of metallurgical coal for the seaborne steel market. 

The Coal Industry

Despite being slightly out of favour in the market due to the growing focus on renewable and sustainable energy sources, the coal sector has observed notable growth in recent times. There is a distinction between thermal coal that is used for power generation and coking coal which is for blast furnace steel production. Allegiance Coal is focused on metallurgical coal, also known as coking coal. 

The coking coal market has seen fantastic prices in recent times and demand continues to remain strong. India is the biggest importer of seaborne coking coal. Due to the pandemic, Europe saw a 70% cut in steel production, however, the demand has started to rise once again. The idle blast furnaces are getting back into operation and the demand for coking coal continues to grow. 

Although there is a distinction between the previous boom in the coal market. This is because there has been a lack of capital investment by major resource houses since 2013. This year marked the decline of the sector, leading to a severe lack of forward supply. Traditionally, companies including BHP, Rio Tinto, and Anglo American would launch a new project that would supply the market with additional 10Mt-20Mt coal annually to fulfil the market demands However, this is no longer the case and the new supply is now coming from the junior sector. 

The gap between the supply and demand in the coal sector has had a huge influence on pricing from a macroeconomic perspective. The sector remains strong and has the opportunity to generate strong revenue and significant profits. 

As the need for ESG (Environmental, Social, and Governance) norms grow, there needs to be a clear distinction between thermal coal and steel-making coal. These two types of coal are often confused despite having starkly different use-cases. In fact, one of the investment banks that was highly active in the resources and coal sector is no longer interested in coal. 

While thermal coal is used for heating and is commonly associated with environmental pollution, the coking coal used in steelmaking is crucial for infrastructure development that includes aeroplanes, cars, housing, and shipping. At present, the demand for coking coal in the short, medium, and long-term is strong. The constrained supply is an added factor that positively influences the demand, especially in the long term.

Over the past 12 months, the company has enjoyed extraordinary prices for coking coal. In fact, the prices have been the highest they’ve been in the history of seaborne coking coal. This provides the company an opportunity to generate fantastic profits. Though it’s unclear at this point whether the prices will sustain in the future, it is expected that pricing will stay robust due to the macroeconomics, strong demand, and limited supply. 

Coal analysts anticipate that there might be a decline in prices to a marginal cost of production. The price would need to sit at or above this marginal cost in order to survive. On the debt side, there are growing challenges due to ongoing ESG concerns. To attain debt financing, companies have to look at private equity houses and credit funds, which are available, but at a greater expense. Meanwhile, the equity capital markets in the coal sector continue to be strong. 

Cash Position

In Q4 2021, Allegiance Coal was expecting to generate $25M in revenue. However, as one of the vessels was loaded 2 weeks late, the company was able to generate $8M. The company made $32M in revenue and to be delivered in Q1 2022. 

Notably, the company has observed a significant jump in revenue ever since it acquired additional assets. For comparison, it generated $1.7M in September last year which grew to $8M in December. And in January this year, the company will generate over $30M in revenue. 

Allegiance Coal expects to continue generating cash for the foreseeable future through its production pipeline. It is currently focused on cost optimization in order to capture higher margins and profits. In 2022, Allegiance Coal has an annualised sales production guidance for 1.6Mt saleable coal. The company expects a 3-month delay in achieving these numbers. This is because during December last year, the company was focused on realigning its underground layout. The company optimised its 2 mines to provide more efficient short, medium, and long-term production. 

Building the Workforce

Allegiance Coal has worked extensively towards building and expanding its workforce. It observed a stagnant growth at about 50 underground operators for a 3-4 month period. The company also saw an increase in the onboarding and relieving of employees during this period.

The departure of employees was caused due to a host of factors, including accommodation. At the New Elk mine located in southern Colorado, there was limited accommodation and the majority of the employees were housed in motels. This wasn’t sustainable in the medium to long term. During this period, the company was able to increase its portfolio of houses and leased properties in the area. 

Currently, the company has 50 properties under its control. This has allowed Allegiance Coal to move the majority of its workforce out of motels and into comfortable housing within the region. 

There was an influx of new workers in January. This has led to an increase in the number of employees housed in motels. However, the company has a pipeline of more properties that will be available over the next few weeks. This will enable the company to house the new employees in comfortable accommodations. 

Since Christmas last year, Allegiance Coal has been able to grow its underground production workforce from 45 to 75. This has enabled the company to operate 2 underground production units through the day and night shifts. This comes out to a total of 4 shifts per 24-hour period. This will directly lead to an increase in production at the New Elk mine in the first quarter, particularly for the realignment of the company’s underground mine plan. The New Elk mine is expected to make a significant contribution to the company’s revenue this quarter. 

Targets 2022 and Beyond

Allegiance Coal was able to ramp up production at its Black Warrior asset. This asset was an existing business generating revenue. The company is looking to triple its production this quarter with the same fixed costs. This will enable the company to substantially increase the generated revenue from Black Warrior. 

Previously, the company was selling coal at $80/t in the domestic thermal market. Now, it is selling the supply on the seaborne coking coal market with prices in excess of $250/t. 

The operations at the New Elk mine are also ramping up. By mid-2022, New Elk is expected to become cash flow positive. The New Elk mine is a sizable asset that needs a large workforce to operate. The asset features a big wash plant, along with a large infrastructure that can produce up to 1Mt-2Mt annually. Once the company is able to increase the scale of the operation, it can drive the unit cost down, generating good margins. The company expects to achieve this by the end of Q2 2022. 

Allegiance Coal plans to update its production guidance within the next 2 weeks. It is looking forward to the progress at the New Elk mine, following the increase in the workforce. The company has endured a lot of challenges operating through covid in January. It now has a limited number of covid positive cases in its workforce. 

As additional workers join the company, Allegiance Coal expects a significant productivity improvement in February. The company’s EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortisation) guidance is planned for Q3 2022. 

The company is looking to achieve steady-state production. It is considering Black Warrior as a premium asset. The company has a 20,000t trial sample for a large European Steel mill which is to be loaded next week. Upon a successful trial, the company will be able to achieve much higher pricing of $390/ton. It is important to note that this pricing is discounted. The company can achieve benchmark pricing following a successful trial. The company is confident in the quality of its coking coal. It has conducted a large coke oven test on the material. This higher-quality coking coal is expected to command index-based pricing sooner or later. 

Notably, Allegiance Coal has seen a jump of $0.10 in its share price over a 12 month period. It is important to note that the EBITDA multiples of coal companies trade significantly lower than other resource companies. Once the retained earnings are in place, the company has plans to start paying dividends. 

The company isn’t looking for additional acquisitions in the future. It has a strong portfolio of assets. The Black Warrior mine has started generating strong revenue. The New Elk mine is halfway through the start-up phase and has an excellent runway for Q1 2022. 

The Short Creek underground asset is a world-class tier-1 property that is ideal for mid-hard coking coal. This asset is expected to have a relatively modest CapEx (Capital Expenditure). Allegiance Coal intends to bring the Short Creek asset into production in the second half of 2023. The company also has a strong asset in British Columbia. It has an excellent portfolio with low-to-modest capital demands. The company is focusing on building retained earnings and paying dividends. 

‍To find out more, go to the Allegiance Coal website