Value Investors Tribe

Analysis Date: October, 2023

For the analysis of any business, I use the framework described by Warren Buffett in 2007 letter to shareholders. Warren Buffett looks for four parameters particularly: a) Understandable business economics b) Long-term growth prospects c) Able and trustworthy management d) A sensible price tag.

Business Economics and its Moat

Consol Energy is one of the largest underground coal mining company in US and was established in 1864. Consol energy mines basically four types of coals: Bituminous coal, Subbituminous coal, Metallurgical coal and Thermal coal. All these types of coals are used in various industries; primarily in steel production, power generation, cement manufacturing and few others. Steel, power and cement production is heavily dependent on coals and there are very few substitutes to using coal. Of all the available substitutes, coal is the cheapest power source used in these three industries. In most markets, steel, power and cement are commodity products and hence are heavily dependent on price. As a result, any manufacturer is unlikely to use a power source which is significantly expensive than coal which in turn increases price of final product in commodity market. This is big gamble which most of the companies avoid playing. As a result, even though environmentally degrading, coal will be in industrial use for at least couple of decades from now. This provides moat to the coal industry as a whole. Consol energy has the legacy of over 160 years in coal mining which provides them managerial edge since the company has witnessed various cycles and hence Consol Energy has been able to maintain its position amongst low-cost producers in the industry. Additionally, Consol has logistical advantage with Consol marine terminal in Baltimore which has throughput capacity of 20 million tons and storage yard capacity of 1.1 million tons. This helps them reduce transportation cost further and enjoy cost savings of roughly $5 to $8 per ton of coal delivered to Europe and India. Being a low-cost producer with logistical synergies provides Consol Energy a huge competitive advantage in a commodity market.

Growth Prospects

Consol Energy mainly operates in Appalachian Basin. As of December 2022, Consol Energy has a total of 742 million tons of coal reserves and 1322 million tons of coal resources which is mineable. To put this in context, in the year 2022 Consol Energy shipped about 24 million tons of coal. Considering similar run-rate, Consol Energy has sufficient coal to mine and ship for at least two decades. Given the surety of demand from steel, power and cement industries, Consol is poised to meet this demand by supplying coal in all the markets globally. This ensure high growth prospects over long-run and Consol Energy being a low-cost producer is amongst the top supplier for most of the buyers. Additionally, Consol energy has also started exploring natural gas mining and shipping which provides additional source of business.

Management Trustworthiness

Consol Energy was formed after Consol was separated into two separate entities in 2017. Most of the management has been with Consol energy since its demerger in 2017 which creates stability. Coal industry is highly regulated mainly due to environmental concerns. Management of Consol Energy has been candid with shareholders and makes a good attempt to explain intricacies of coal industry and the company to its shareholders. Management has been effective in capital allocation and has taken effective steps to grow the business.  

Valuation

Coal is a commodity and hence by nature is a cyclical industry. Cyclicality causes free cash flow estimates highly imprecise. There can be multiple ways to compute intrinsic value of the company and in this case, DCF can be highly misleading since cash flows are not predictable. The caveat over here is that even though the cash flows are not predictable every year, historical figures can provide good estimates of total product that’ll be sold in the future. To put this in context, table below summarizes total volumes of coals produced and average cash margin per ton.

Year	Volume (million tons)	Cash Margin per ton ($)
2018	27.6	19.99
2019	27.3	16.20
2020	18.8	12.19
2021	24.0	17.50
2022	24.1	35.33
Average	24.4	20.2

Over the next ten years, assuming that Consol energy will ship on an average 25 million tons of coal per year leading to about 250 million tons (25*10). Assuming cash margin of $30 per ton over the next ten years, the business will produce cash of $7.5 billion. Conservatively assuming 50% of the cash margin to be used in capital expenditure, acquisitions and other operating expenses, the business will produce free cash of $3.75 billion.

Usually a business trades at a multiple of free cash flow expected out of business however for conservative estimates, assuming no multiple, the business is worth $3.75 billion.  As of the annual report for 2022, the company has 34.7 million shares outstanding which leads to intrinsic value of $108 per share.

What does this mean? Based on the rough estimates of cash business is expected to generate, intrinsic value of Consol Energy is $108 per share. Additionally, Consol Energy has repurchased shares in December 2023 at an average price of $104.72 per share.

Disclaimer: This fundamental analysis of Consol Energy is primarily for educational purposes so as to help value investors learn core concepts. This is not a buy or sell recommendation of any form whatsoever. Reader discretion is advised.