Stockwatch: Record profits and 6% yield

What next for coal? Prone to be the most febrile of commodities, investors are faced with the challenge of judging when to back market sentiment or adopt a contrarian view. Only a year ago, prices for both coking and metallurgical coal were savaged amid fears for the Chinese economy and a wave of deflation.

The world's largest coal consumer and producer, China protected its industry by limiting mine operating days, which boost imports. As coal prices rose in response, a mining strike in India then squeezed them even higher and speculators jumped on the bandwagon.

Coking coal soared 440%, from about $70 a tonne in late 2015 to about $310 last November, before a correction to $208 in early 2017 - one of the biggest-ever declines in the spot price. Metallurgical coal soared 150% last year, averaging $143 a tonne.

This context is crucial to big mining stocks: a chief constituent of the FTSE 100 index, these miners usually have coal interests and trends can spill into other commodities. Scrapping President Obama's 2013 Climate Action Plan, the Trump administration has declared a clear focus on oil, gas and coal, and supply of all three is likely to ramp up in the medium-term.

Talk is of using clean coal technology to protect air and water, employing new carbon capture and storage technologies to move towards a diversified energy mix. This aims to boost jobs and free America from dependence on foreign resources.

Meanwhile, China isn't slowing its foreign investment in coal, instead declaring a major mine expansion in Serbia, after financing a coal power plant in Bosnia and two in Pakistan.

A wise time to raise cash

Such a mercurial context makes it logical for London-listed Anglo Pacific Group to strike a £13.7 million placing at 125p a share - after its price has recovered from 53p a year ago to about 131p currently. This has allowed it to weaken its reliance on coal mining with the £26.4 million purchase of a Canadian uranium mining royalty.

This is in context of Anglo's market value of £221 million. A bullish 18 January trading update did cite an objective to invest "some surplus cash in growth royalties... projects able to provide exceptional returns over the next decade" and it looks wise to do so while investor sentiment is strong. Although the market price initially dipped to 122p, the placing was promptly resolved at 125p.

Like-for-like income rocketed by 300% in the fourth quarter

Anglo's non-index shares had slumped from about 300p in 2013 to 53p by early 2016, rebounding sharply thereafter. If forecasts by company broker Peel Hunt are fair, then record pre-tax profit of over £40 million are due. The market prices Anglo on seven times these earnings, with its 6% yield covered 2.3 times - reflecting ongoing caution as to the risks.

I drew attention to the stock last May, when it traded at 73p with a prospective yield of 8%. At the time, rising coal prices coincided with the directors buying at about 70p after the 2015 results. It's worth remembering that Anglo's revenue is nearly 80% oriented to Australian coal, a prime beneficiary of Chinese imports boosting prices.

I re-iterated this last September, when a 110p price tag represented a 5.5% yield. Anglo had benefited from revenues being translated into weaker sterling following the EU referendum, but the dividend looked quite risky. Increasing net debt to £7.5 million, the board borrowed £3.6 million in August, but the gamble paid off and net debt had fallen from £8.2 million in September to £0.9 million at 31 December.

Kestral underpins dividends

A sharp recovery in production at the Queensland Australian Kestrel royalty coincided with higher coal prices in the fourth quarter, which rocketed like-for-like income by nearly 300% to £12 million. This implies overall royalty income of around £21 million, the highest since 2011.

Its size and coal orientation make it a risky play, so watch the macro factors

"Equally encouraging is our outlook for 2017, with 65-90% of Kestrel's saleable tonnes derived from our royalty area, up from 67% in 2016," said the group at the time.

This should mitigate any downside risk to first-quarter coal contract prices of $285 a tonne should market supply tilt the demand/supply equilibrium.

The chief driver remains China: can the authorities continue to navigate high levels of debt successfully? To an extent, their early 2016 production curbs were introduced to improve profits for a heavily-indebted coal industry. After production was then allowed to quadruple, Beijing will let production increase until the end of March.

Meanwhile, US coal exports have risen as producers try to cash in on high prices. It's anyone's guess, frankly, how all this will pan out for spot and contract prices and is one reason why mining equities carry a "speculative" tag.

Right to diversify

Anglo Pacific is therefore right to diversify somewhat. It does, however, remain substantially a play on coal - which is why I spent this piece detailing current key macro factors.

It resorted to an extra £12.7 million credit facility to settle the Canadian uranium deal, in addition to its placing, but Anglo is quite right to develop operations and sustain its payout rate. The impact Chinese and American policies have on coal prices really does matter.

As a relative small cap, Anglo remains a useful means to get exposure to what could be only one year into a general upturn in coal. It's more effective than a big-cap diversified miner.

But as its size and coal orientation make it a risker play; the macro factors need watching. So 'buy' if you reckon a 6% prospective yield is adequate enough compensation for these risks, but be mindful that they could offer better pricing in future. You may need to "sell" if China hits trouble.

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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.