$JSW investment thesis

$JSW.WA – MET Coal from Poland

$JSW market cap

“Buy cyclicals when multiples are high” (or if there is no new supply)

In the Basque Tradition, the magical character that brings presents to children every Christmas, is not a fancy magical old man from the North Pole, but just a dirty fat Coal Maker from the mountains (“Olentzero”). In addition to Basque children, many investors have also got used to receiving many gifts from Coal Makers during the last two years. Absolute lack of investment due to Capital Cycle downturn, ESG investment policies and permitting problems have allowed huge margins for both thermal and metallurgical coal producers. However, future demand and supply don’t look that bright to both of them, although alike valuations and many generalists outlook could produce some confusion between these two commodities.

What is met Coal? Is it good for barbecue?

 Coal can be listed as Met (Metallurgical) Coal when it fulfills certain characteristics of volatility and composition. It is special higher quality coal. The rest of the coal compositions will be used for energy purposes and will be known as thermal coal. These special characteristics allow met coal to be used for production of coke for steel production in blast furnaces. Nowadays, all new steel to be produced needs the use of coke during the process of steelmaking from iron ore (Steel can also be produced from scrap without the use of coking coal). There are of course some attempts of steelmaking without coking coal by the use of hydrogen. BHP-Baowu or SSAB are investigating in that direction, but this research is not expected to be finished short term, and there are serious doubts about its economics and potential to be developed in mass scale.

As we all agree steel will always be needed in our society, the idea that also met coal is in a terminal phase of decline does not seem really rational. In the short term, at least, it is not substitutable. Thermal coal, which in addition is also much more abundant, could indeed be substituted, as it can be replaced with any other energy sources. But this substitution rate is probably not at the assigned market rate. As other energy sources are not competitive enough for price sensitive developing economies.

From the demand side, steel may have reached close to a peak consumption in the developed countries. As well as it may still face strong short-term headwinds in China, due to the burst of the real state bubble. Even though government may substitute this demand with massive announced public infrastructure plans. But there are still high growth opportunities coming from India and South East Asia. There is a strong correlation between steel demand and GDP growth of a country. And there is still a huge percentage of global population with nice growth rate numbers. Billions of people aiming to get closer to the quality of life from the west.

Global Steel demand
  • OK well, I think I’ve seen this commodity movie already a thousand times – And suddenly the Supply enters the room, laughs maleficently and disappears in a dense dark smoke.

Coal market has been impacted during the last decade by the accumulation of headwinds. Low prices in the 2016-2020 years, ESG politics divesting investments, as well as permitting difficulties in almost every country for new mines building. The result is a capex starving sector for a long period of time. If any, this could make some sense in thermal coal, as it is also really abundant in almost any part of the world. But as discussed before met coal demand has some stable fundamentals for the foreseeable future.

Furthermore, coking coal supply is constricted to only certain mines from a few main players, with Australia, Russia, USA or Canada as the main seaborne coking coal exporters. This supply-demand imbalance has produced the expected price response even under circumstances like Chinese lockdowns, when other industrial metals have suffered prices near or under the cash cost curve. Only partially sustained by some switch to thermal market. The energy crisis produced a strange situation where thermal coal prices went above coking coal.

Global Coal Capex
Development capex for seaborne coking coal mines

Following the typical behavior of the market, one could expect a strong supply response to the high margins across the industry during the past year. Nevertheless, there is only a minimal investment uptick, at most to substitute depleting mines from some producers. There is only one new greenfield coking coal mine being built (Pembroke, Australia). And it is even wondered if it might be the last one. Most mining majors are moving away from coal to focus in energy transition metals, directly selling assets or just not reinvesting their cash flows. For the few ones that might be interested in investing, permitting problems appear. As an example, Glencore’s Canadian Sukunka coking coal mine permission was denied last December. The case of the new royalties of up to 40% in Queensland (Australia), are also increasing the producing costs of one of the main producing areas in the world. The result is the kind of tight supply commodity investors tend to search for.

Met Coal


  • OK, good, Met looks actually great. But every company in that sector looks attractive. Why then a Wi-Fi password state-owned company?
  • Short answer is cheap. Long answer is dirty cheap. One could say it is even “free”. PER<1 and EV around 0.

At the moment of writing this article market cap of the company stays at 6.63B zloty, end of Q3 net cash (FIZ adjusted) is 6.78B zloty, and Earnings of the last 9 months 6.3B zloty. Those unusual numbers give the Value Investing another dimension. Many investors would suggest it might be a Value Trap. Others would just affirm it must be. The logical explanation to this valuation is that the market assigns the company a future cash burning destiny, or at least unprofitable one. So, let’s take a dive into the fundamentals of the company, and check if its main risks threaten the future profitability of the company. As well as study the perspectives of cash flow returns to shareholders.

$JSW Net debt

JSW actual production is around 11 million tons coking coal and 3 million tons thermal coal per year. Their future plans are to increase the coking coal share over 90% by 2026. Actually, around 60% of the met coal is sold to external customers, while 40% is transformed in coke in their three coking plants. Thus, resulting in sales of around 3 million tons of coke. Their current reserves are estimated in 1.2 billion tons of coal, which implies over 80 years of production. They also have other small segments like by-product hydrocarbon and even cooking salt production, but they are not representative.

The target is to increase coking coal production up to 14.5 million tons per year, and already processed coke to 3.5 million tons per year. Mining cash costs stay currently at 528 zł/ton (110 $/ton) and the plan is to reduce these costs to 485 zł /ton (101 $/ton). With this mining costs they stay more or less in the middle of the cash cost curve of the industry FOB (without transport costs).

Totally, the EU coking coal production is around 14-15 million tons, of which JSW accounts approximately for the 75%. Meanwhile, total EU coking coal consumption arises to around 68-69 million tons. Thus, making EU greatly dependent from the seaborne coal market with imports mainly from Australia, USA, Russia and Canada. In the coking coal market, the low price per ton of this commodity, makes logistic a really important part of the final price for the customer. Thus, proximity to the final destiny provides a huge competitive advantage. This kind of advantages are not easy to find in commodity companies. In this case, most of European blast furnaces operate in a range of 500 km range from the JSW mines and coking plants. Even with their logistical advantage in a market where they still do not have the majority of the market share, their plans are to diversify geographically the coke sales outside of Europe. With a target of 40% of coke sales overseas, rising from the actual 27%. Raw coking coal is expected to be sold just inside Europe but diversifying sales outside of Poland.

On the other hand, probably the weakest point of the company is its shareholder structure, with a control majority of 55% of the company by the Polish state. Just a 6% remains in institutions and the rest 38% in retail investors. It is one of the multiple State-Owned Enterprise (SOE) in Poland, where as a result of their communist past, most of their biggest companies are at least partially state owned. The privatization process of the first years after the wall fall, was later stopped in the current century and the state seems to be really comfortable maintaining the control of the enormous economic power of all these enterprises. This control does not seem to be a high investment risk as Polish government, as well as a big majority of the polish society, is right wing oriented. As opposed to analogue situations in Latin America. But of course, management decisions of the company could follow political interests, rather than best shareholder interests.

Capex investments are mainly sustaining capex, even if they aim to raise coking production still over 35% above actual rate. On the other side, they also plan to cut steam coal production in half in the near future. Capex expenses have moved historically in the gap between 1,5 and 2 billion zloty per year. But with current inflation environment, it is already around 1,65 billion in Q3. So the new gap could be 2-2,5 billion per year. Capex for new mines in the strategic plan is just 400 million for the whole 2022-2030 period, and 250M are already spent by now.

Their cost structure is highly dependent from labor, which sums close to 50% of the cost share. Other costs are 16% materials, 14% external services and just 7% energy. The main risk from this perspective, could be the excessive growth in employee benefits, which were already 22% up in 2022. Nevertheless, they still have clear competitive advantages in this field comparing with their main competitors from Australia, US or Canada. This raise was partially offset by the zloty exchange ratio. As a clear exporter, a weak zloty would benefit the PNL of the company.


Mining and risk are two words that always go together. They are like DiCaprio and 20-year-old. Thus, it is reasonable that mining companies never quote at high, or even medium multiples. In addition to classical mining risks, there are also some additional potential situations, that could explain current share price. These are the main risks, which could, or could not be priced in the share.  

  • Windfall taxes
  • Capital allocation
  • Recession
  • War
  • Mining issues

While EU windfall taxes have already been settled in almost every country, Poland has always shown reticent and even opposed to this kind of taxation. The result is that already well into 2023 they have not been approved or even scheduled. This delay does not mean that they are out of the table, as there is pressure from the EU for this taxation to be effective in every state of the coalition. This pressure is actually the reason for Exxon suing EU, as it is not supposed to be under their competences. In the last months it has been made public that the Government of Poland has already been involved in talks with many state companies (JSW included) about the possibility of introducing this windfall tax. But there is no information about any possible outcome. This talks, make it more probable that taxes will be imposed somehow. On the other hand, from our point of view, there are also reasons why it could not be applied, or in a much smaller size to JSW:

  • Windfall tax is supposed to be applied to energy companies. As more than 80% of the revenue of JSW comes from coking coal and coke, which are industrial and no energy commodities, this taxation must not be applied. At least not to the whole earnings of the company.
  • As already deep in 2023 there is no tax approved, the retroactive taxation of 2022 earnings do not seem to be legal, as it could also trigger a dangerous precedent.

In terms of capital allocation, as a state company, buybacks are out of the table and dividends will be the way to return cash to the shareholders. The possibility of a take-over is also impossible. When the management has been asked about why have they not returned to the dividend policy yet, they have always answered that they wanted to remain cautious about the possibility of a fast pullback in coal prices. They have also mentioned the caution about windfall taxes. It seems clear that they somehow feared huge dividends could even trigger bigger taxes. However, they can’t accumulate cash forever. With the current cash position, it is highly probable that they will restart dividends maybe with a low intensity in the Q4 results, and that they could reach cruise speed after windfall tax situation is solved.

In their current capital allocation plan, they want to have all non-current assets covered by the equity. For this purpose, they have created a 100% owned investment fund (FIZ) to manage all this cash. It looks of course not the best choice in such a high cost of capital industry, but the company seems to have the purpose to be extremely conservative for future pricing environments. As an advantage, it de-risks the investment with negative financial leverage. Looking at the future, it would not make much sense to keep increasing this fund as in Q3 it already covers over three years of capex and equity to non-current assets ratio is close to 1.

During the last decade, without such an advantageous supply environment for pricing and much higher debt ratios, they have only distributed dividends in 3 years (FY2012, FY2013 & FY2019). With payout ratios of 33%, 96% and 32% respectively. There does not seem to be any fixed dividend policy and the company has adapted these distributions to their cash position and outlook for the following years.

In terms of recession fears, it is highly possible that we will not see in the close or medium term the pricing of 2022, but with the supply constraints discussed in the Met Coal sector, it is highly possible that they will stay above the mean pricing during the last decade around 200$/ton. Short term China reopening could also offset some decrease in steel production in the west, as they are in the opposite side of the credit cycle. The beginning of 2023 looks really promising with prices above 300$.

Annual average hard coking coal price

War fear is also a common risk perceived mostly by American investors, as they see Poland in the border of Ukraine. But taking into account that Poland is a NATO member, escalation to Poland would actually mean a full world war, making it quite unlikely. And that remote case would affect not only Poland investments, but a complete worldwide effect. In addition, JSW has all their facilities in the south west of Poland, not close at all with the Ukrainian border.

General mining risks must also be taken into account. But actually, JSW is diversified with five different mining facilities, in quite a safe jurisdiction, as mine friendly as you could find in a western country. It is also a country with no usual major weather issues and good infrastructure. They produce coal with Longwall machines, a method which does not suffer so many issues as other mining methods. It needs to be mentioned, that the accident rate reported looks quite high and is something to be monitored.


“Look at me. I’m the captain now” – Polish Government.

The influence of the Government in the company is not limited to their majority shareholder stake, and the usual capacity of a state to interfere in the resource sector through taxes or permitting. The majority of the board has a state worker profile with most of their career in Poland State-owned mining companies. They even need a special state-company certification to be able to get to managing positions in state-owned companies.  Only the CFO has career experience in private companies like Arcelor Mittal. The state component seems to be deeply implemented in the board configuration. In conference calls, they mention to be also shareholders of the company, but it is unknown to which extension could be their skin in the game, as well as their real independence.

The decisions will be definitely more aligned to the Government than to the shareholders. However, Government and shareholders alignment do not need to be 180 degrees apart from each other. Government of Poland, as opposed to most others in the western world, seems to be clearly aware of the importance of the energy and resource security. This could be the main vector of the future decisions. Poland was actually one of the few governments in the EU opposed to windfall taxes.

Once the strategic supply is secured with a clean balance sheet (as it is already now), there must not be any reason not to give away a nice percentage of the earnings through dividends. The government itself would be also the main receiver of these distributions.

JSW Valuation

In the Valuation process, the following conservative assumptions will be taken into account to simplify the process.

  • Neutral FCF of the thermal coal segment, as well as minority segments. Only valuation of the coking coal and coke business will be analyzed.
  • Three different cases will be studied depending on the met coal commodity price: Bear, Base and Bull. Dependent if the price stays under, at or above the historical average (150$/ton, 200$/ton and 250$/ton).
  • Production bellow last years in bear case, in line with 2022 in base case and up 1000 ton in bull case (Company target is actually increase in +3000 ton)
  • Bear and Base case full 2022 O&G equivalent Windfall tax. Bull case only taxing thermal coal.
  • No earnings from FIZ investments.
  • Target valuation will be assigned at PER x4, which means a 25% yield, considering dividend payout of at least 50% of the earnings 12.5% dividend payout will justify this valuation.
  • Two variants, market does not assign any value to the cash and investments in FIZ, and market does give value to this cash.
$JSW Valuation

Considering a conservative base case scenario with pricing in line with the average of last decade, the company could make half its current market cap every year, while having its full market cap already in cash. Even with not a great capital allocation, but better than this year, that would justify a target price of 117zł which means a 114% upside from current levels.

Catalyst for JSW

  • The main catalyst short term will be the settlement of a dividend policy. With equity to non-current assets ratio already > 1 in Q3, the logical output would be to settle already in Q4 a dividend policy, which would be probably increased after windfall taxes are clarified. With the current cash generation, they would in the worst case, just need one quarter more of earnings to cover the worst windfall tax scenario. March, or in worst case June will be the deadlines for dividends flow start.

Conclusion about JSW

The supply-demand situation in the Met Coal sector looks really promising, unless a really hard global recession hits the economy. However, the valuations all across the sector are pricing a strong drop in the price of the commodity. There are many Coking Coal companies that have been doing a better capital allocation, and are thus priced higher. But the conservative decision of the JSW management provides also downside protection, as the share actually quotes just the cash. The downside is not only constricted by the actual cash position, but also by the geographic competitive advantage, over 80 years of coal reserves, and their position in the cash cost curve.

Even if they don’t have any financial leverage, the company keeps still a substantial upside. Its expected cash flows could easily reach medium double-digit yields. Furthermore, in the short term exist a bunch of possible catalysts, that could rerate the company a little bit closer to its main not vertically integrated competitors. It is also possible that the whole met coal sector receives a deserved rerate. JSW is an attractive risk-reward investment, even if it could still face short term pull backs depending on the outcome of the dividend policy and windfall taxes.

Author: @Elkano_EVFCF

This investment thesis participates in the Moram investment competition. If you want to vote for it, voting will be open for Moram’ subscribers from this Sunday evening (5th March 2023) to next Saturday.

Disclaimer: This thesis is only for educational purposes and does not constitute any investment advice

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