Stockwatch: An 8% yield to consider

Does coal have a future? Debate over the fossil fuel is exemplified by this £125 million mining royalties group Anglo Pacific Group, largely exposed to coal, whose market pricing is far more cautious than the board of directors.

The non-index stock is currently priced around 73p, yet the board guides towards a minimum 6.0p per share dividend (see table) based on pre-tax profit recovering from three years of losses - to £13.0 million in 2017 according to Peel Hunt, the company's broker.

Meanwhile, finnCap targets £9.8 million, although both brokers concur on a 6.0p dividend in line with the company's published "minimum" guidance. This implies a prospective yield of 8.2%, but notice it isn't covered by forecast earnings and the cash flow/capital expenditure profile also needs to be more payout-friendly.

Like other mining- and commodity-related stocks, Anglo has in recent years seen a bear market, largely on China concerns, although it did bounce off a February 2016 low of 53p to test 75p. Traders clipped this to 63p, but fresh buyers then drove Anglo up to 76p and, at 73p currently, it may be on a positive trend-level.

China is again boosting commodity prices

This technical pattern tracks sentiment towards the Chinese economy as its authorities resort to another round of credit expansion and infrastructure spending. Coking coal - essential to production of stainless steel - has risen by 24% this year.

Quite whether the Chinese communist party knows what it's doing - and whether this will end well - is anyone's guess, but elsewhere the Organisation for Economic Co-operation and Development (OECD) has suggested growth may pick up in Brazil and Russia, which should help the global economy and hence commodities' demand. Keep an eye out for potentially deflationary economic data also, but presently the balance favours upside.

This macro context coincides with Anglo's 2015 results showing royalty income up 149% to £8.7 million, influenced by two Australian royalty interests - strong production from the Narrabri mine and an expected increase in mining within royalty lands at Kestrel.

Overheads were reduced by 34.5%, enabling an adjusted 2014 loss of £2.2 million to rise to £4.0 million underlying earnings in 2015.

In common with other miners having to devalue the carrying value of assets, a £27.2 million charge meant a headline after-tax loss of £22.6 million (after a £47.6 million loss the year before). It would appear Company REFS includes this in its sense of "normalised" profit in the table.

Management expects Narrabri to show further production upside in the coming years, such that (on a discounted cash flow basis) this royalty is already worth more than the US$65 million (£43 million) agreed when buying it in February 2015.

So: there is an upturn in coal prices coinciding with costs cut and Anglo having acquired usefully at what may prove a broadly lower turning point in the cycle.

De-rated dividend yet progressive payout policy

The board has had to cut the dividend in line with financial realities - the 2015 cash flow statement showed £11.9 million paid out in dividends while the balance sheet cites cash reduced from £8.8 million to £5.7 million, versus £7.3 million longer-term debt.

The longer-term objective is to distribute at least 65% of normalised earnings with a medium-term expectation of at least 6.0p per share annually. While a basic scenario of an 8% yield is attractive, mind that it assumes a two-year earnings recovery scenario.

Currencies are also influential on earnings, and hence payouts, for a sterling-based group. In recent years the Australian dollar - in which the bulk of earnings are derived - fell to the lowest level since 2009 amid lower demand by China for iron ore and copper especially.

Some economists reckon on it going lower to about A$0.65 versus the US dollar, recognising how the Reserve Bank of Australia last year described currency weakness as both "likely and necessary".

Yet the central bank has also emphasised "sustainable growth", which implies tackling asset bubbles - i.e. interest rate cuts won't help. From February, the Aussie dollar surged over 10% to A$0.73 versus the US dollar, also because the US Federal Reserve has appeared to back off an expected series of interest rate rises.

This significantly explains sterling weakness in early 2016, but it could move either way according to June's European Union referendum.

Directors have bought substantial stock

After the 2015 results the chief executive bought 40,000 shares at 70p to own 5,546,454 or 3.26%, and a non-executive director 36,181 shares at 69p to own 156,181. A few days later the chairman added 14,000 shares at 71p to own 118,822.

This was modest averaging down after they bought substantially via a near-£40 million placing and open offer at 80p last February to enable the Narrabri royalty acquisition. The chief executive took up 5,362,599 shares, i.e. nearly £4.3 million worth, and three other directors £22,000 to £80,000 worth, representing strong belief in value at current pricing of the mining royalties.

This is partly shown by 11 May news of a financing package that implied a 3.5 times uplift in a Spanish/Portuguese royalty acquired in 2009 versus its balance sheet carrying value.

Individual assets will vary and the 2015 results had £5.3 million impairment charges, down from £31.5 million in 2014, but it's possible this also shows the downturn bottoming out. Obviously, the macro context is key; should China run into economic difficulties, commodity-related stocks will get hit again.

Net assets per share fell from 138p to 95p over 2015, compared with 46.8p on a tangible basis, due to £71.5 million royalty/exploration intangible assets. That may not convince everyone as to "assets-at-a-discount" but, in a scenario of slow global growth, the balance sheet downside risks should be low.

Meanwhile, if China can manage through, it implies a useful time to accumulate stock.

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This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.