Yahoo Finance: Mining Is a Tough Business in Southeast Asia

August 16, 2016 - By Mark Yu

After putting great pressure on the online gambling industry in the Philippines a few weeks ago, the Rodrigo Duterte administration now aims to straighten up the country's mining industry.

Last Friday, newly appointed Department of Environment and Natural Resources (DENR) Secretary Gina Lopez gave just seven days from Aug. 11 for both Semirara Mining and Sagittarius Mines to answer the show cause order issued by the government agency.

The government agency wants the companies to defend their Environmental Compliance Certificates* for both the Molave Coal Project, which is led by Semirara Mining, and the Tampakan Copper Gold mine project led by Sagittarius Mines, which is largely owned by Glencore.

*Environmental Compliance means conforming to environmental laws, regulations, standards and other requirements such as site permits to operate.

If the two mining companies aren't be able to answer the show cause order, DENR would be unhesitant to withdraw its once issued Environmental Compliance Certificate s for both companies. This would probably result in both companies being unable to further perform mining operations in the respective mines. Semirara Mining's shares dropped about 7.52% at market close Friday (Philippine time).

This was not the first time that the mining industry was hit by the newly elected Philippine administration. Early signs were observable days after Duterte took office on June 30. Nickel prices, in particular, went to an eight-month high early in July as the Duterte administration, accompanied by Lopez, stated that it will close mining companies that had breached regulations and were unable to improve operations.

According to Lopez, less than 33% of all Philippine miners had met international mining standards. Further, the Philippines is far and away the biggest producer of mined nickel according to Bloomberg.

On the other hand, Semirara Mining is the Philippines' biggest coal miner. According to its annual filing, Semirara's coal production output accounted for 7.98 million metric tons or more than 90% of total production in the Philippines. Further, Semirara Mining generates its revenues through the production and sale of subbituminous coal. Subbituminous coal is appropriate for use in a wide range of combustion facilities.

Environmental compliance certificate awarding

Under the previous administration, the DENR had awarded Semirara Mining its ECC for the Molave Coal Project early this year.

Included in the certificate were certain tax incentives for the Molave project and extensions that allowed the mining company to continue its other existing coal mining operations, such were the Panian pit and Narra pit (East Panian). Molave, on the other hand, is located in West Panian.

The Molave Coal Project was expected to provide an additional 3.59 million metric tons to Semirara Mining's annual coal production.

On June 10, just 11 days prior to Lopez becoming the new DENR secretary and 20 days before Duterte took office, DENR issued an amended ECC for the Molave Coal Project.

In the amendment, the DENR allowed Semirara Mining to increase its annual coal production. The Molave Coal Project now is expected to deliver an additional annual output of 7.59 million metric tons of coal.

All this expected coal mining production would be thwarted if Semirara Mining won't be able to address the new administration's demands.

Semirara and the islands

Interestingly, Semirara mines most of its coal on Semirara Island. Semirara Island is one of the three major islands in Antique, Philippines. Further, Semirara Island has an estimated coal reserve of around 170 million metric tons.

Excluding the islands found in the disputed South China Sea, the Philippines has about 7,107 islands.

Going back, Antique is a province in the Philippines that is located in western Visayas. Visayas is one of the three main islands in the Philippines - Luzon, Visayas and Mindanao (see picture above). The Philippines' capital, Manila, is located on Luzon.

Semirara Mining has been awarded the Coal Operating Contract (COC) and has been allowed to operate on Semirara Island since 1977. In 2008, the Department of Energy approved a term extension for the mining company to operate in the area until 2027.

In 2009, Semirara Mining was also provided a COC in two other islands near the Semirara Island, namely Caluya Island and Sibay Island, Antique. In 2013, Semirara was again given two new concessions pertaining to COC in areas found in southwest Luzon and south of Mindanao.

Mining incidents and fatalities

Semirara Mining has been susceptible to suspensions in recent years. In February 2013, a mine pit collapsed and killed five of its miners. The mining operations in the Panian mine, specifically, were shut down for two months. In July 2015, a landslide occurred and buried nine miners. Again, operations were suspended for two months.

Foreign and domestic coal sales

Semirara Mining shipped 37% of its coal production overseas in fiscal year 2015. The company ships its coal to China, India, Hong Kong, Japan, Taiwan and Thailand. Meanwhile, the company supplied 63% of its coal production domestically. According to the company, it was only able to supply at most 18% of the Philippines' total coal demand. The country still relies on coal importation to satisfy most of its coal demand. Coal imports mainly come from Indonesia, China and Australia.

In fiscal year 2015, coal sales dropped a huge 28% to 11.78 billion Philippine pesos* compared to the year prior. Notably, Semirara Mining had a 48% decline in coal export sales but had a 19% increase in domestic sales. Also, the coal business segment has a three-year gross profit margin of 38%.

*1 U.S. dollar equals 46.59 Philippine pesos as of Aug. 15.

Electricity sales

Semirara Mining also runs several wholly owned power subsidiaries. These are SEM-Calaca Power Corporation (SCPC), Southwest Luzon Power Generation Corporation (SLPGC), SEM-Balayan Power Generation Corporation (SBPGC) and St. Raphael Power Generation Corporation (SRPGC). All of these are engaged in the business of power generation.

In fiscal year 2015, the electric or power business grew by 5% to 12.9 billion pesos compared to fiscal year 2014. The business segment also has the better margin compared to coal. The segment has a three-year average margin of 53%.

In the past year, Semirara Mining's electricity business, through its subsidiaries, delivered a total contracted energy of 491.4 megawatts (MW). 85% or 420 of which were contracted to the Manila Electric Company (PHS:MER).

In its annual filing, Manila Electric Company (MERALCO) holds a congressional franchise under the Philippines Republic Act ("RA") No. 9209. The RA No. 9209 granted MERALCO a 25-year franchise valid through June 28, 2028 to construct, operate and maintain the electric distribution system in the cities and municipalities of Bulacan, Cavite, Metro Manila and Rizal and certain cities, municipalities and barangays in the provinces of Batangas, Laguna, Pampanga and Quezon.

Sales and profits

In fiscal year 2015, Semirara Mining had an observable decline (-13.7%) in overall sales. Nonetheless, the company delivered a contradicting gross profit growth of 46%.

Observably, the company made major cuts in its costs in both the coal and power generation business segments to arrive at such good profit growth measures despite the decline in sales. Nonetheless, Semirara Mining delivered a "strong" 23.7% profit growth to 8.49 billion pesos, a profit margin of 34%.

In its unaudited first quarter filing, Semirara Mining delivered an 8.4% decline to 6.6 billion pesos in total sales but a 15.9% growth to 2.9 billion pesos in profits compared year on year. Notably, the miner operated more efficiently compared to last year's quarter. Semirara Mining cut its cost of goods sold by 29% on average on both business segments (coal and power generation). Also, the miner paid 52% less in taxes.

Cash, debt and book value

As of March 31, Semirara Mining had a total cash of 4.6 billion pesos and total debt of 18.3 billion pesos. The company had a debt-to-equity ratio of 0.61 during the period. Semirara Mining had a book value of 29.8 billion pesos.

Cash flow

In 2015, Semirara Mining had a -10.4% growth to 10.7 billion pesos in its cash flow from operations. Notably, the company had 925 million pesos provision in doubtful accounts and a cash flow reduction of 1.5 billion pesos from its inventories. Semirara Mining also allocated 5.04 billion pesos in capital expenditures leaving it with 5.6 billion pesos in free cash flow.

Semirara Mining also paid out 4.275 billion pesos in dividends, or 76% of its free cash flow, to its shareholders. In the past three years (2013-2015), the company maintained a dividend payout of the same amount to its shareholders.

In addition, the miner also took in 9.88 bilion pesos in debt while reducing its debt by 10 billion pesos.

Valuations

Using Bloomberg data, Semirara Mining has a trailing 12-month price-to-earnings (PE) ratio of 12 times and a price-to-sales (PS) ratio of 4.48 times. Accordingly, the company has a price-to-book (PB) value of 3.6 times and a dividend yield of 3.97%.

In comparison, most of Semirara Mining's peers currently trades at a PE of 41.7 times and PS of 3.75 times. Further, the iShares MSCI Philippines ETF (EPHE) has a PE ratio of 22 times and PB ratio of 2.75 times. Also, the company currently trades near its two-year low of 90 pesos per share.

Conclusion

Mining is already a tough business, the business requires heavy capital expenditures to bring forth products and it also has to sell its mined products competitively. Accompanied by record low energy prices (oil, natural gas among others) globally, coal, specifically, experienced decline in value in recent years. Coal miners in the U.S. had been filing bankruptcy, too.

Accordingly, mining companies must also abide by the regulations so as to preserve nature. There is no doubt that the new Philippine administration is just trying to preserve the country's natural resources.

Semirara Mining has been mining in the Semirara Island for decades. One million metric tons of soil and its ingredients, such as coal, had been excavated leaving the land possibly impoverished (see NASA image above).

The DENR claims that Semirara Mining's open pit mine is already below sea level. The DENR fears that the miner would just leave a big hole in the land once it is done excavating all the minerals and resources in the area. Withdrawing Semirara Mining's ECC to expand in the Semirara Island may also produce additional business strains in its mining operations. Nonetheless, DENR admitted that it may be hard to just shut down Semirara's operations secondary to the Philippines' capital heavy reliance in its coal-fired generators (also see MERALCO discussion above).

Semirara Mining has been experiencing difficulty in growing its overall sales in recent years. The company has been coping up by reducing its costs to deliver more profit. This business activity can only go for so long. Nonetheless, Semirara Mining appears to have a healthy balance sheet to overcome this global energy downturn meanwhile.

Prospective investors may be prudent enough to just step aside on an ailing mining business until the company itself demonstrates some form of recovery. The additional government pressure also does not help the struggling business.

Disclosure: I am long Semirara Mining, but may sell my entire investment in the coming weeks.