CHGY in 2012
Microwzy, a Chinese PhD engineer, and I have been reviewing China’s 12th Five Year Plan (available in English on the Internet) to see how it might impact the future of CHGY. We focused on the coal industry for the next five years and our conclusion is that significant changes are just over the horizon for CHGY. Inner Mongolia, where CHGY is located, was singled out as a focus for development in the plan, and is already China’s top coal producing region, producing almost 25% of the domestic coal supply. That amounts to about 800 million tons a year with better than 700 billion tons yet in reserve.
A focus of the Five Year Plan is to dramatically increase China’s energy supply with an emphasis on coal production in the short term and green energy alternatives longer term. Inner Mongolia, while the largest coal-producing region, has a large number of small inefficient mines. A government focus for some time has been to consolidate and modernize the mines in the region and has reduced the number of mines from over 1,500 in 2005 to fewer than 500 today. The Five Year Plan calls for a further drastic reduction, consolidation, and modernization, in the mining process. Inner Mongolia will form twenty large-scale coal companies by the end of 2013, each with a production capacity of more than 10 million tons and with projected profits of ten billion Yuan (1.5 billion dollars). Additionally, the government plans to establish one or two giant coal companies, each with more than 100 million tons of production capacity. Smaller coal companies currently operating in the region with less than 1.2 million ton capacity will be eliminated.
Inner Mongolia is strategically located between the northeastern and western provinces in China, and both areas are a focus of the government’s plan for increased industrial and manufacturing capacity over the next five years. To serve these markets a two fold approach is proposed. First a dramatic emphasis on railroad infrastructure that will result in over a 50% increase in the shipments of coal by rail by 2015, and an increase in electrical power generation capabilities within Inner Mongolia. The government projects that it is less expensive to build the coal powered electric generating plants locally in Inner Mongolia and transport the resulting power, than it is to move large quantities of coal long distances.
What does all this mean for CHGY? 2011 production numbers are not yet available, but based upon the recent earnings announcement I would judge them to be at or slightly above the 1.2 million ton cut-off point. Whether CHGY gets swallowed in the planned coal mine consolidation or emerges as a much larger player depends on two main factors in my opinion: past performance and political connections. To my way of thinking CHGY has done everything right. They invested millions of dollars a couple of years ago to fully modernize their mining operations to long wall mining, at the same time putting in place the latest safety equipment and procedures. They have met or exceeded every quota the government granted them for increased production, coal trading and the expansion of rail allotments. They have never experienced a fatal accident and have ramped up production recently to meet the governments’ 1.2 million ton threshold. Most importantly however are WenXiang Ding’s political connections. As the former Chief Accountant and Operations Director of Inner Mongolia Coal of the Peoples Republic of China General Political Department Mr. Ding is exceptionally well connected with the Inner Mongolian officials who will be calling the shots on the consolidation process.
If CHGY is chosen to become a consolidator for several of the smaller mining operations with a total production capacity exceeding 10 million tons they will become a very different company all together. Of course there will be share dilution and additional debt as a result of the merger and acquisition process but the end result will be hugely accretive to CHGY. The mines being consolidated are being combined under government mandate and have little bargaining power to control the outcome. I would expect the merger and acquisition process to accelerate rapidly this year and be pretty much completed by early next year. If the government forecasts are anywhere near accurate let’s assume that CHGY would benefit directly after share dilution and debt burden by just 10% of the government’s forecast for net income of the consolidated mines. That is a staggering 150 million dollars or more than five times last year’s stellar earnings. In the event that CHGY is itself a victim of consolidation, I have to think that they would be treated fairly, once again because of Mr. Ding’s strong political ties to the Inner Mongolian government bureaucrats. All in all 2012 should be a very exciting year to be a stockholder.
As we all know very well one of CHGY’s glaring shortcomings is shareholder communications. Microwzy, who speaks fluent Mandarin, has graciously agreed to call the company from time to time as issues arise that require clarification or further exploration. If you have concerns or questions that you believe the company can legitimately respond to post them here and when we have sufficient inquiries we will make a direct attempt to speak with management.
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