Edmund Simms's avatar
$26.5m follower assets
Carbon dating—value in Polish coal mining
With little debt, half the market capitalisation in cash, and ample free cash flow, Bogdanka offers an attractive return to those brave enough to venture into the coal mines of Eastern Europe.

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Company: Lubelski Wegiel Bogdanka SA
Ticker: LWB (Warsaw Stock Exchange)
52-week range: zł26-70
Market cap: zł1.3bn ($276m)
Price: zł41
Target: zł69
Upside: +68%
Recommendation: Buy

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Business model
Bogdanka is a Polish coal miner. It extracts coal from its mine near Lublin in South East Poland and sells it to local electricity and heat producers. The company provides almost a third of the coal the country’s commercial generators burn.
Bogdanka has three excavation fields (Bogdanka, Nadrybie and Stefanów) across Lublin Coal Basin with 730mt reserves. It extracts 14mt of coal annually, processing 10mt of it for sale.

Competitive advantages
  1. Poland’s power market depends on local coal: Three-quarters of electricity comes from the black stuff, which is now almost wholly locally sourced after the government banned Russian imports. Before the embargo, Russians supplied 17% of the coal burned.
  2. Source of national pride: Poland is Europe’s second-largest coal producer and uses more of it than anyone else. The industry has the largest union in Poland and is the only one with regulatory clout. “As children, we are taught that coal is our treasure,” says Dr Joanna Maćkowiak-Pandera, the boss of Forum Energii, an energy transition think tank.
  3. Limited new supply: Two years ago, the government struck a deal with the coal union limiting new mine development and phasing out coal by 2049 in exchange for an agreement ensuring all miners got new jobs before closures. The country has 31 mines producing 54mt of hard coal annually, almost all of which is used locally.

Opportunities
  • In-bloc exports: An EU-wide ban on Russian coal means imports to the bloc from other countries have surged—mostly South African. If Polish diggers increase production, exports to other EU countries could increase their top lines. The Dutch, Germans, Danes, French, and Italians are upping coal imports.
  • Priority supplier: Bogdanka is the key supplier of Enea, the company’s two-thirds majority shareholder and Poland’s second largest electricity producer. With a looming energy crisis, Enea will sell more energy to rich neighbours, boosting their top line and feeding through to higher coal demand.
  • Mining licenses: Besides Bogdanka, the company has three other licenses (expiring in 2046, ‘46 and ‘65) for mining coal across the Lublin Basin, covering 2,000mt of extra coal resource. If developed, these will provide more than 9mt per year of additional production.

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Catalysts
  • Contract renegotiation: Supply contracts with Enea are renegotiated periodically, with coal prices set on historical averages. Current annexes cover 2022-'23 and will soon be negotiated for '24. Recent global coal price increases put upward pressure on prices.
  • European Energy Summit: Bosses, politicians, and scientists will meet in the Netherlands in November to discuss the energy transition. By revealing the key role fossil fuels will play in the transition and EU dependence, future regulations will become more transparent, reducing uncertainty.
  • Commodity inflation: If the prices of metals critical to renewable energy continue to rise, public and private investment in the energy transition will dwindle. Stretched public purses and rising interest rates make capital investment here less attractive, cementing coal's medium-term future.

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Key risks
  • Political power struggles: Poland’s refusal to close the Turow coal mine last year irked the EU. At COP26, Poland reversed its commitment to ban coal by 2030 within hours of inking the deal. Miffed global governing bodies, including the EU, might pressure or even sanction Poland to stop them digging and burning.
  • Taxes: Polish companies pay a 19% tax rate, below the 21% average in Europe. Unlike in other wealthy countries, coal companies pay no additional taxes. If these change and Polish emitters are forced to pay up, this will erode cash flows.
  • Russian aggression: If Ukraine falls, the Lublin voivodeship will share a border with hostile Belarussia and Ukrainian-Russia. However unlikely this seems now, an emboldened Russia could look to annex more land.

Valuation
Coal miners are in lawmakers' cross-hairs and have a limited shelf life. Despite the Polish government banning Russian coal, they will find a way to get supply, mostly from local sources. The market will stabilise over the next few years, with prices and profits normalising. But the Paris accord means that Polish coal mining will be gone by 2049, and any resources left after that are worthless.
  • Model
  • Value/share: zł60-79
  • IRR (excl. cash): 15.2%

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Stock Metal Investment's avatar
Interesting, I never looked into natural resources. What is the long, long term plan for the company? As you say, by 2049 their business is gone. Are there plans to diversify into other businesses or just to shut it down in 27 years?
Edmund Simms's avatar
@stonkmetal They don't have a plan past that. They likely believe that coal will remain relevant because they want to expand production and reserves. The company already has 50+ years of proven and viable mining, which would see them through to 2072 at current production levels (10mt per year). There is some clear option value in the mining licenses, undeveloped resources, and excess reserves.

But to be conservative in my valuation, I assumed:
1) Production stays the same as now
2) Any investments they make are value-neutral
3) In 2049, the business shuts down, with the coal reserves having no residual value

Remember that 2049 is 27 years away, and a lot can change in that time. Coal might remain relevant (upside), or the government could subsidise miners to compensate for forced closure (upside). I didn't build either of these scenarios into my model because the price-value gap was already evident.
Stock Metal Investment's avatar
@valuabl Sounds good. Obviously an event 27 years away isn't relevant today, that's just way too far looking out. Still an interesting to think about.
Kiani's avatar
When do you recon the price will start to decline coz of the 2049 emission thingy?
Edmund Simms's avatar
@kiani_koula I have no idea about price movements. But if the stock were priced perfectly and assuming it shuts in 2049 with no residual value, then theoretically, the price would decline linearly from now until the end. All your returns would come from dividends.
StockOpine's avatar
Interesting pick @valuabl. Are there any reasons that justify the deviation of price to the estimated fair value (e.g. war, liquidity of stock, ownership structure and related party transactions)?
Do you mind sharing the discount rate used?
Edmund Simms's avatar
@stockopine I reckon there are three main reasons for undervaluation:
1) Coal is out of fashion.
2) While Eastern European risk premiums have increased following Russia's invasion, they've only increased slightly in Poland—the baby was thrown out with the bathwater. Poland is a NATO and EU member enjoying an A2 credit rating.
3) The company is small ($270m market cap).

I estimated the company's cost of capital to be 11.6% in Polish zloty.
Edmund Simms's avatar
@stockopine It's my pleasure, Opine ✌️
Conor Mac's avatar
This has all the feel of an Edmund pitch, great job man!
Edmund Simms's avatar
@investmenttalk I pray that's a good thing. Thank you, squire
Andy Buchanan's avatar
Am I looking at the correct company? Google says the market cap is $1.36 billion instead of $276 million.

Loved the pitch!

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Edmund Simms's avatar
@andybuchanan That's the correct company. The market cap you see is in Polish zloty, the local currency
Chip Lunderburg's avatar
You mention that Bogdanka's tax rate is 19% which is below the average in Europe. I saw that in your model (thanks for providing that by the way), you continued to use 19% as the base assumption.

If you update that to 21% to be even more conservative, where does that that put your final value per share number?

Thanks for the excellent analysis. Throughly impressed by the idea, opportunity, catalysts, and key risks. I felt like everything I needed to know was right here and it wasn't too long.
Edmund Simms's avatar
@chip_lunderburg Assuming Poland's tax rate moves toward the European average of 21%, the value per share goes from zł69.4 to zł68.9.

I want to highlight that I simulate a range of tax rates in the Monte Carlo simulation, the percentiles of which are displayed at the end of the post. I'm happy to elaborate on this if needed.

Thank you for the kind words
Jonathan's avatar
I'm not super familiar with this space, so excuse the novice question—

If the amount of coal in a mine if fixed, if you increase production, aren't you just depleting the reserves faster? Like, if there are 100 one-dollar bills on the ground, it doesn't matter how fast or slow I pick them up— I will eventually have $100. Why would someone be willing to pay more or less for the coal?
Jonathan's avatar
@jonathanjohnson I re-read your catalysts section and I think the answer might be something akin to— contract renegotiations may result in there being more money on the ground than we thought. (And those contract negotiations would result in a favorable outcome because of the demand for coal at this present time).

Let me know if I'm missing something.
Edmund Simms's avatar
@jonathanjohnson It's not a novice question. Indeed it gets to the heart of valuation.

1) Yes, if the amount of coal is fixed and you mine faster, you deplete the reserves faster. However, money now is worth more than money later. If I can sell $100m of coal now, it's worth more than $1m per year for a century.
2) Bogdanka currently has more than 50 years of coal in the ground at current mining rates. My base case is they mine until 2049 at current levels, and the leftover coal is worthless. This is 27 years of mining left, with 23 years of coal wasted. If they upped their output, they could mine more of that lost coal before 2049.
3) The contract renegotiation could lead to favourable pricing for Bogdanka. Coal prices have erupted over the past year, and these are yet to feed into Bogdanka's financials.

Have I missed something in your question?
Patryk Pioruński's avatar
YouWhat do you think about the following risks? The majority stake is owned by the state and the introduction of a new EU tax?
Patryk Pioruński's avatar
@pi0run123 I am already ignoring the risk of reducing margins that the state may impose to protect the energy sector
Edmund Simms's avatar
@pi0run123 1) The majority stake is owned by Enea, who the Polish government owns just over half of. If you're investing in a Polish coal mine, you're in bed with the Polish government whether or not they own some. It's possible, but unlikely, the government could do something to destroy value here. I have built that country risk into the equity risk premium.
2) The EU could impose a new tax. Tax hikes are a risk every business faces. But even with a higher tax rate, unless brutal, the stock still looks undervalued to me.

Have I missed something?

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