Going Against the Fear Curve: Dan Chu on the Coal Market

Investors in search of a coal industry expert could certainly do worse than Dan Chu. He’s the managing director of mergers and acquisitions at Deutsche Bank (NYSE:DB) in New York, and has spent the last 25 years of his life facilitating major transactions, mostly within the coal space. 

At the 2014 Coal Association of Canada Conference and Trade Show, held in Vancouver from September 10 to 12, Chu shared his views on the coal market and tried to answer the question “is now the time to invest?” While stressing that his specialty is making the market rather than timing it — he is an investment banker and not an analyst, after all — he offered some valuable observations and suggested that going against the grain might be a good approach to consider.

The fear curve

“The last time it was the right time to be investing in coal was probably in the late 2000s and early 2010 era,” Chu said. He noted that large institutional investors like BlackRock (NYSE:BLK) and Fidelity went from owning very few shares in coal to “dominating the share registers of most large coal companies.” At the same time, “the sector funds couldn’t get enough exposure.”

Furthermore, companies like Rio Tinto (NYSE:RIO,ASX:RIO,LSE:RIO), Vale (NYSE:VALE) and Cliffs Natural Resources (NYSE:CLF) were all busy acquiring coal projects.

It certainly seemed that everyone was busy securing a stake in the coal market at that time, giving coal “the focus of the sharpest minds and the biggest wallets.” Overall, the industry was enjoying cost curves that “reflected the sum of all our hopes.”

However, as coal investors know too well, the market turned, and the price curve changed its mood. Today, it “reflects the sum of all our fears,” the banker said, noting that momentum funds have left the sector, while large institutional funds no longer hold large positions. “They are trying to slowly decrease the exposure they have in coal companies,” he said.

Going against the grain

In Chu’s opinion, those looking at that “fear curve” to make investment decisions today will definitely be left sitting on the sidelines. “Very few people are brave enough to be able to look at that and say ‘I have a different view,'” he admitted.

However, he referenced the opinions of several others at the conference, suggesting that the outlook for coal might not be so bad after all. According to Chu, some say that the global demand for coal is still growing, and that “while China is taking a short pause, there is hope that India may be reawakening.”

What’s more, the banker believes that the current oversupply of coal is slowly but surely being “worked through” the system, with temporarily idled mines shutting permanently and previous investment in additional capacity having stopped “roughly three years ago.”

Company success

Chu said the collective wisdom of the market might suggest that “the time to invest is not now; [in fact] it’s two years from now.” However, he was able to come up with three examples of those who have succeeded in bucking that trend.

“I’ll give you another perspective,” he said. “It might help illustrate why this might be the time to invest in coal.”

First, Chu cited the success of Bob Murray of privately held Murray Energy. He purchased five longwall coal mines in West Virginia from Consol Energy (NYSE:CNX) in late 2013. The market wasn’t friendly, and Consol was searching for a buyer for months without any luck. However, when Murray heard the mines were available, he decided on the purchase “within 10 minutes,” then negotiated, executed and completed the transaction within two months. “He financed the cash component with all debt, and this transaction doubled the size of his company,” Chu said, also noting that since the closing, debt holders who supported the move are “enjoying a 20-percent return on their investment.”

Next, the banker pointed to the recent acquisition of PBS Coals by Corsa Coal (TSXV:CSO). Corby Robertson, who owns a majority interest in Corsa, has normally stayed away from operating coal companies, but when he heard that Russia’s Severstal (MCX:CHMF) was selling its US met coal operations, the entrepreneur acted quickly.

The transaction was secured within months and announced in July. Certainly, the buy was a good move for the company — shares of Corsa gained 27 percent the day of the announcement, and Chu pointed out that between the announcement and closing of the acquisition, “the collective improvement in the share price of Corsa was in excess of the purchase price of the target that [Corby] had acquired.”

Lastly, he pointed to Keith Alessi, CEO of Westmoreland Coal (NASDAQ:WLB), who announced the acquisition of Sherrit International’s (TSX:S) coal properties on Christmas Eve of 2013. That was definitely “not the best of times to think about making investments in coal,” said Chu, but Alessi is known for “being an out-of-box thinker,” and his creativity and persistence were rewarded in this case.

Going against weak market conditions, Westmoreland made huge gains the day of the announcement. “I think it was about 50 percent,” Chu recalled, noting that the company’s share price has since doubled and tripled.

The takeaway

To be sure, the investment banker admitted, those examples are anomalies; however, he stressed that “[n]either Bob, nor Corby nor Keith were gripped by the fear curve.”

Of course, investing is an exhaustive process, and most wise investors conduct careful due diligence rather than buying stocks on a lark. However, trusting one’s own research rather than following general trends can sometimes be the key to a great investment.

It’s that entrepreneurial spirit that Chu believes will carry coal forward, and the banker finished by stating that he hopes to have more similar stories to share in the next six months.

Securities Disclosure: I, Teresa Matich, hold no direct investment interest in any company mentioned in this article.