|Shares Out. (in M):||229||P/E||14.5x||10.0x|
|Market Cap (in $M):||9,620||P/FCF||14.5x||10.0x|
|Net Debt (in $M):||3,670||EBIT||1,170||1,600|
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While I usually gravitate away from commodity oriented names, I believe CNX to be an extremely attractive investment at current levels. CNX Energy Inc. is an integrated coal and natural gas business trading at a significant discount to its SOTP. Early 2010, CNX announced a major acquisition of Dominion Recourses’ natural gas business for $3.475B. The transaction was poorly received by market and alienated investors who owned the stock for its attractive coal assets, resulting in over 40% stock underperformance (relative to coal grp) in 2010. As you fast forward to today, things have changed. This acquisition has put CNX in the most desirable shale in the US for natural gas (Marcellus Shale) and provides a free option on a new emerging oil play (Utica Shale). In less than 18 months, the company sold a 50% interest in these two shale plays for $4.0B, more than they paid for the entire business. Our analysis supports a valuation in the mid $50s/share, with $30/share for the company’s natural gas business and $24+ for the coal assets.
|1. Marcellus Valuation:||2. Utica Valuation||3. P1 Valuation|
|Noble JV Deal (08/18)||3,200||Hess JV Deal||593||Total P1 Reserves||3,731|
|% Interest||50.0%||% Interest||50.0%||Less Marcellus||859|
|Implied Undiscounted Value||6,400||Implied Undiscounted Value||1,186||Adj P1 Reserves||2,872|
|Acres in JV (100%)||663,350||Acres in JV (100%)||200,000|
|P/Acre (Undiscounted)||$9,648||P/Acre (Undiscounted)||$5,930||EV/P1||$1.00|
|% Haircut||-26.4%||% Haircut||-24.1%|
|Nat Gas Business:|
|Marcellus Producing + Midstream||219.0|
In August of this year, Chesapeake Energy publicly announced that its 1.25 million acres in the Utica Shale could be worth $15-$20 billion dollars. While the CEO is known to be a very promotional character, any positive developments would clearly be very favorable for CNX. The company’s remaining 50% interest in the Utica Shale could theoretically be worth an additional $1.2-$1.5B if CHK’s public commentary proves correct. If proven out, this would translate to an additional $3.25-$4.50/share above our valuation on the stock. It is also worth noting that Chesapeake has released well results that are supporting of this valuation range. CNX is one of the only companies with any exposure to this emerging play.
Unlike some of the other coal businesses, CNX’s profitability held-up relatively well during the downturn of 2008-2009. This can be attributed to the unique position within the cost curve of CAPP coal. The fact is that in an uncertain market, it is very difficult to accurately predict commodity prices on a go forward basis, but if you can build a thesis that rests on a steep cost curve, one can earn an attractive return even under difficult economic environments. To fact check the valuation, I also looked at the coal assets under a replacement cost based approach. Using approximately $120/ton for a new long wall build, the replacement cost of the assets would indicate roughly $7.4B.
|Thermal Coal Marginal Cost Analysis:|
|Cost Advantage (CAPP Pricing):||$55.00||$60.00||$65.00||$70.00||$75.00|
|Cash Cost Advantage ($45/mt)||$10.00||$15.00||$20.00||$25.00||$30.00|
|Implied Cost Advantage||500||750||1,000||1,250||1,500|
|EBITDA (Thermal Coal)||887||1,137||1,387||1,637||1,887|
|EPS (38% Tax Rate)||$1.35||$2.03||$2.71||$3.38||$4.06|
|(Note - tax rate has historically run in the low 30s)|
|Inc EBITDA at $150 Met||290||290||290||290||290|
|Adj EPS (Unlevered)||$2.18||$2.85||$3.53||$4.20||$4.88|
|Int Expense (Total Co)||235.0||235.0||235.0||235.0||235.0|
|Int Expense (Coal Only)||110.3||110.3||110.3||110.3||110.3|
It is worth noting that the company is about to close on a couple JV deals, thereby significantly changing the capital structure & FCF profile of the company. For the purposes of this analysis, I used the EV, capital structure, & acreage ownership pre-JV transactions. It is relatively easy to adjust the acreage and approach the valuation on a post closing basis, but would require further explaining on the structure of the cap ex commitments of its JV partners. Clearly the above numbers are rather simplistic in nature, but they do a decent job outlining how to think about a normalized/conservative level of cash flows during various market environments. On the met coal side, I am assuming roughly $150/ton, roughly the marginal cost in the industry. While pricing is well above that today ($250/mt), I do not have a strong view as to the sustainability of this pricing L-T.
This management team is acutely focused on shareholder value. While unlikely in the near term, the opportunity does present itself to split up the two businesses in the future. While this may sound contradictory to the actions of this team over the past couple years, it is quite clear the market does not fully recognize the significant value in the assets today. The sell-side analysts are all coal guys and heavily discount the gas business. They are used to valuing assets on earnings & EBITDA rather than reserves in the ground, and NAVs. The company has taken some action to try to mark its gas business to market with two recent JVs, but this has failed to result in fixing what it likely a structural issue (two different classes of investors). We believe such an action would not only prove to unlock shareholder value, but would close a chapter on a very successful series of transactions for this management team.
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