Those who read this blog regularly know that accounts I manage own shares of NACCO (NC). For details on why I like the stock and why I think it’s not the right stock for most investors to hold – listen to:
The company put out its annual letter to shareholders this past week.
This blog post is not going to be about NACCO specifically, but about a more general situation. Most coal miners have a different business model than NACCO. The CEO does a good job of explaining the company’s “management fee” (as he calls it) type business in that letter to shareholders.
This presents a problem for investors trying to analyze the stock. On the one hand, it is a coal miner. Its future is tied to the power plants it serves continuing to burn coal as fuel. Therefore, it is perfectly correct to think of the risk at NACCO as being the risk of a long-term decline in the use of coal for power generation in the U.S. This is the same risk other coal mining stocks face.
However, the company’s business model is different from other coal miners. The economics of what it does – in all but one case – are very different from owning a coal mine outright.
So, how – in a case like NACCO – can you come up with a “peer group” to compare the stock to?
That’s the question a podcast listener emailed me recently:
“…a question about finding company peers: I googled this and see that a lot of the other top coal companies in the US industry have gone bankrupt in the last few years - I guess because they are exposed to the coal price, (unlike NACCO which makes a cost-plus profit per ton for unconsolidated mines, as you pointed out) and were over-leveraged. I found these looking further afield:
- Stanmore Coal Ltd (Australia)
- New Hope Corp Ltd (Australia)
- Alliance Resource Partners Ltd (US)
- Whitehaven Coal Ltd (Australia)
Would you consider these companies to be a reasonable basis for comparison? I thought that since the other US ones went bankrupt, e.g. Peabody, etc., I would not be able to calculate long term returns for them, and their post-bankruptcy period was too brief to give meaningful figures, since you mention a minimum three year average for financial figures.”
You're absolutely right that several U.S. coal companies have gone bankrupt recently. This has even happened to a "mine-mouth" coal company like Westmoreland Coal:
You can see how they presented their mine mouth operations as a plus to investors in their most recent investor presentation:
Here is a discussion of Westmoreland's bankruptcy from an environmental group:
You can read Westmoreland's last 10-K.
But, this description shows the similarities with NACCO's business:
"Each of our mining segments focuses on coal markets where we take advantage of customer proximity and strategically located rail transportation. We sell substantially all of the coal that we produce to power generation facilities. The close proximity of our mines and coal reserves to our customers reduces transportation costs and, we believe, provides us with a significant competitive advantage with respect to retention of those customers. Most of our mines are in very close proximity to the customer’s property, with economical delivery methods that include, in several cases, conveyor belt delivery systems linked to the customer’s facilities. We typically enter into long-term, cost-protected supply contracts with our customers that range from one year up to fifteen years. Our current coal sales contracts have a weighted average remaining term of approximately six years."
I underlined the points that are the same as at NACCO. There are differences. NACCO’s customers – not NACCO – put up all the financing for mines (this is why NACCO can’t consolidate the mines for accounting despite having a 100% interest in the earnings of the mines). Another difference would be the length of the contracts. Westmoreland’s longest contract is probably about as long as NACCO’s shortest contract.
As far as the long-term returns in coal, I don't have recent data - but, I have enough very long-term data to know stock returns in coal miners are abysmal. I have seen data for the return in coal stocks generally since about 1900 - and believe they are among the very worst of all industries. I think I may have mentioned in one podcast that over the last century or so, tobacco would have been among the best industry for stock returns and coal would have been among the worst.
I would consider those bankrupt - or recently re-emerged from bankruptcy coal companies to be comparable peers for NACCO. That is, I would definitely use them in a report. Not because it is necessarily accurate to say they are exactly like NACCO - but, because it's my practice to find the 5 closest peers I can find even when there really are no peers. For example, what is Amazon's peer? What is Costco's peer? We know that there is no company with the EXACT same model. But, we can come up with the 5 public companies that are MOST comparable - even when none are comparable. We then take the minimum, maximum, median, mean, etc. figures and compare the 5 stocks AS A GROUP to the one we are analyzing.
So, it's still useful to know whether the market is pricing NACCO above or below - in terms of EV/EBITDA, P/B, etc. - any coal companies that have recently emerged from bankruptcy.
In some cases, where there are no publicly traded companies it may still be possible to find private transactions or outright mergers etc. from previous years. In the case of coal, I think it's very difficult to find peers right now. So, maybe this isn't the best example for how to go about researching a stock normally. But, you're going to find situations like this. There will be times when there just aren't a lot peers. But, I would always say that you should list 5 companies that are the closest you can find.
Maybe you can use met coal companies as well as steam coal (like NACCO), maybe you can use coal companies from other countries (like Australia or the U.K.), maybe you can use a company like Hargreaves Services (in the U.K.) because it is coal related even though it doesn't do the same thing. Maybe you can use customers of coal companies (power companies that burn a lot of coal at the plants they own). Or companies that supply the coal mining industry (mining equipment, etc.). None of these are perfect comparables at all. But, they might show you a pattern. Maybe NACCO is a lot more expensive that most other coal related stocks, maybe it is cheaper, or maybe all coal related stocks are cheap. Sometimes you find a pattern - for example, where car dealers in the U.K. are all stocks that trade a lot cheaper than car dealers in the U.S. Why is this? It's something to think about and discuss in any report on car dealer stocks.
Finding comparables can also help you in one other way. You may uncover a business you like better than NACCO, think is safer than NACCO, or is cheaper than NACCO just because you spent the time to turn over 5 more rocks to see what is under them. A lot of people latch on to the first idea they hear about. You may have heard of NACCO because I bought it. That's fine. But, you don't want to have blinders on and not take the time to look for some idea I haven't discussed. So, I'm always in favor of finding the 5 closest "peers" even when, truthfully, you believe there really are no peers. It's still a useful exercise.
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