Anglo Pacific Group (APF)

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Stockwatch: Big upside and 5.5% yield China demand coal steel credit bubble
Coal is burning brightly again, with prices for the coking commodity more than doubling to over $205 a metric ton this year, well above forward contract prices.

China's persistent economic growth and rising steel output has enhanced demand, along with recent domestic supply cuts to reduce stockpiles and combat pollution from low-quality coal. Ironically, Chinese imports soared by 45% in August - the highest in 13 months - to fill the gap with higher-quality coal.

Goldman Sachs reckons higher prices are here to stay: against a third-quarter 2016 contract price of $92.50 it has raised its 2017 estimate by 64% to $135 a ton and for 2018 by 47% to $125.

Obviously, if China increases production, spot prices are exposed to correct"We see upside risks if current policies remain unchanged going into next year and the resulting shortage overwhelms the ability of producers in Australia and the US to respond," the investment bank said recently.

Obviously, if China increases production (as currently requested by its steel producers) then spot prices are exposed to correct, although that's assumed in Goldman's numbers anyway. It all typifies coal as an ultra-cyclical commodity, with miners' operational gearing making their stocks even more susceptible to trends.

Anglo Pacific to shine

Last May I drew attention to coal mining royalties stock Anglo Pacific (APF) at 73p on a prospective 8% yield as rising coal prices coincided with cost cutting and the directors piled into the shares at about 70p following the 2015 results.

Anglo's revenue is nearly 80%-oriented to Australian coal, which is a prime beneficiary of higher Chinese demand boosting prices. Its 26 August interims cited the expectation for the majority of income to be generated in the second half of 2016 after a 6% rise in first-half royalty income, mainly due to higher production from the Kestrel royalty land.

Financial progress has, therefore, yet to see the benefit of higher coal prices, and as consensus forecasts are based on March/September numbers they need upgrading. This lag-effect of higher coal prices working through was highlighted in Anglo's interim forecast that its net asset value will be higher than the 97p balance sheet value.

It's unclear how much Anglo is tied to contract or spot prices, but safest to assume contractThe table shows lower net tangible assets given "royalty and exploration intangible assets" represent 48% of net assets, although you'd need to take a very conservative view not to regard the stock as asset-backed around current market prices. With the earnings outlook suddenly improving and the ambitious dividend policy de-risked as a result, the stock is therefore trending up sharply after four years of downturn.

It's tricky to be specific about share price targeting as the directors don't clarify what extent the group is tied to contract versus spot prices - it's best to assume contract, although based on Goldman's forecasts the consensus earnings projections in the table (30 March and 12 September forecasts) need upgrading. Macquarie, for example, has set a 150p share price target, best regarded as a round number given uncertainties.

At about 110p, currently, the 12-month forward price/earnings (PE) multiple appears to be in the mid-teens or lower, and the dividend yield at least 5.5%; so, unless the Chinese economy suddenly de-rails, miners' operational gearing from soaring coal prices favours upside.

Opportunistic dividend policy

The interim report also cited a likelihood of borrowings reducing despite net debt rising from £3.2 million to £5.0 million during the first half 2016. This was largely due to a 2015 interim dividend being paid last February, which looked risky and unwise in overall context.

The stock's risk/reward profile looks underpinned with a generous yieldYet the board maintained its approach and borrowed a further £3.6 million in August, leaving net debt at £7.5 million - hopefully now reducing, unless coal prices and exchange rates alter adversely.

Post-referendum, the group is benefiting from US dollar revenues being translated into sterling. "The directors believe the group has sufficient cash resources to maintain the dividend at current levels for the foreseeable future," says Anglo.

It's a rather opportunistic policy - Anglo's chief executive has a career background as an activist investor and hedge fund manager - although rebounding coal prices appear to support it. The stock's risk/reward profile, therefore, looks underpinned with a generous yield.

China's red flag

Harvard economics professor and former chief economist at the International Monetary Fund Ken Rogoff just warned that China is slowing much faster than official figures suggest and is "the biggest threat to the global economy". China is going through a big political revolution and a calamitous hard landing can't be ruled out. It's enjoyed credit-fuelled growth and this doesn't go on forever.

His warning follows the Bank of International Settlements asserting China's latest boom is based on an unstable credit bubble with a debt-to-growth ratio of 30.1%, which is very high by international standards. Such warnings are hardly new. Indeed, I've cited them for about two years and yet the communist regime has found ways to muddle through.

A Chinese slump would hit coal-related equities hard, so wariness is vital on Anglo's prospects.Brexit voters may also wonder about Rogoff's judgment, as part of an international elite that has scorned Britain choosing a future independent of the European Union.

Immediately after the referendum, Rogoff made a sneering accusation of "the real lunacy of the United Kingdom's vote", asking: "Did the UK's population really know what they were voting on?"

It was a prime example why the balance of voters blew a raspberry at presidents, bosses and professors like this. He's certainly right to cite risks within China; the question is whether they will manifest trouble or Western sceptics continue to underestimate the regime's ability to adapt.

A Chinese slump would hit coal-related equities hard, so wariness is vital while the Anglo directors and brokers talk up prospects.

It adds up to coal being in vogue as a short to medium-term trend, good for traders to exploit. We shall see whether it ultimately proves a long-term turning point for the commodity, or a debt-ridden Chinese economy topping out.

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Anglo Pacific Group - financial summary Consensus estimates
year ended 31 Dec 2011 2012 2013 2014 2015 2016 2017
Turnover (£ million) 34.7 15.2 14.7 3.5 8.7    
IFRS3 pre-tax profit (£m) 48.5 18.0 -52.9 -42.4 -30.5    
Normalised pre-tax profit (£m) 29.5 21.5 -11.7 -13.5 -24.5 5.8 11.8
Operating margin (%) 24.8 64.3 66.5 -55.4 30.3    
IFRS3 earnings/share (p) 33.5 10.7 -39.0 -42.1 -14.1    
Normalised earnings/share (p) 16.0 13.8 -1.2 -16.5 -10.4 3.0 6.0
Earnings per share growth (%) 15.8 -13.7         100
Price/earnings multiple (x)           36.7 18.3
Cash flow/share (p) 16.7 9.1 3.6 3.2 0.2    
Capex/share (p) 26.4 4.3 -1.9 4.4 24.8    
Dividends per share (p) 9.1 9.8 10.8 10.2 8.5 6.0 6.0
Yield (%)         7.7 5.5 5.5
Covered by earnings (x) 1.9 1.4       0.5 1.0
Net tangible assets per share (p) 217 175 144 98.1 46.8    
Source: Company REFS

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.