Australia’s iron ore producers are not the only mining operators that have seen dramatic plunges in share price as the world wonders what is going to happen, literally everywhere. Following the disastrous debt ceiling debate and the subsequent credit downgrade in the fall of 2011, the US economy appeared to be a shining star in a dimly lit sky. European concerns keep us all on edge and a China slowdown was somewhat debatable.
Now the global economy is misfiring on all cylinders. The US may be on the brink of falling back into recession with financial experts there claiming the odds of another US Federal Reserve round of quantitative easing are increasing. The China slowdown is real, but the Chinese government’s reaction with another economic stimulus infusion has yet to be seen. Without it, some prognosticators talk as though the Chinese will never again need steel. The European crisis shows no sign of abating with more and more experts talking in terms of decades rather than months or years before the crisis fades from memory.
Coking coal, or metallurgical coal, is used in the production of steel and therefore the share prices of coking coal explorers and producers have fallen from 60% to an astounding 95%. It should be noted these declines include companies engaged in thermal coal production as well, with thermal coal needed for energy production.
On the coking coal front, despite global jitters, various sources still see medium to long term strength in the demand for coking, or metallurgical, coal. International energy, metals, and mining consulting firm Woods Mackenzie anticipates increasing demand from expanding markets like India and Brazil, and pricing pressure from China.
Although China has the capacity to meet most of its coking coal needs internally, Chinese demand affects the price of coking coal elsewhere. Analysts at Macquarie Bank report that at the end of April 2012 crude steel output in China actually hit a new record of 743 million tonnes, annualized; and this despite dire predictions and much gnashing of teeth over China’s untimely demise. This news sent the spot price of coking coal higher and the Macquarie people expect it to go higher still in coming months, albeit at a slower pace.
Macquarie and Woods are not the only ones with this opinion. US coal juggernaut Peabody Coal also expects increasing Chinese steel production. A Peabody analytics team points out steel consumption per capita in China, India and Brazil is currently well below other developed nations, such as Japan. Peabody estimates that approximately 1.2 billion tonnes of coking coal is needed in order for per capita steel consumption in China, India and Brazil to match the levels of Japan, Taiwan and Korea.
The truth is while coking coal explorers and producers have taken a severe beating, the price of coking coal has held up better than other metals. Given the anticipation of robust demand, now may be the time to begin looking at coking coal stocks.
As you may know, BHP is Australia’s largest coal producer, but they are diversified into a multitude of other mining operations. While diversification provides safety, we will look instead at Australian coking coal pure plays, currently engaged in exploration with actual production to follow. In the belief the higher the risk, the higher the reward, here are four beaten down Australian junior coking coal explorers:
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Why are we taking your time to look at these four penny stocks without including at least a few of the big players? Here’s why:
JAL, the runt of this litter, is up 400% Year over Year. You know how badly the iron ore producers have been hurt this year and the other three coking coal junior explorers in the table are down between 60% and 70%. Jameson is definitely swimming against the tide. Why? What is going on with that company that is missing from the other three?
Perhaps some traditional market valuation ratios will help. Let’s take a look:
The table pinpoints a problem with shares of companies that have yet to generate earnings from operations. The beloved P/E and its cousin the P/EG simply aren’t there. BTU and CLR generated some modest sales from some source to show a P/S that is relatively meaningless. Earnings per share reflect financing cash flows that keep the company going until real profits enter the picture. If all these companies are losing money, and negative EPS tells us they are, what is there to analyze from a fundamental point of view?
With companies like these there is always a race between cash burn – how much money are they losing – and the onset of significant revenue generation. While calculating a monthly cash burn rate can be complicated, a simpler way to get the same result is by looking at the company’s operating and investing cash flow over a period of years. Cash flow from financing activities is how these companies live or die. Financing activities are either long term loans or share issuance. Cash flow from operations will always be negative but the worse the number the faster the company is using up its financing cash flow in ongoing operations. The final piece of the puzzle is cash flow from investing activities. For development stage companies this typically represents capital expenditures. For our coking coal explorers this could include geological reports and the rental or purchase of equipment needed for exploration.
When you see negative cash flow from operations and negative cash flow from investing with a combined total greater than cash flow from financing, something has to give. With sound prospects, the company can raise additional cash from financing. Too much reliance on share issuance dilutes current shareholder value and sometimes leads to a drop in share price. Borrowing terms might not be favorable if the company’s negative cash position is worsening over time instead of improving. However, depending on the prospects, even a company burning through cash at an alarming rate is a potential takeover target. Indeed, many investors look at development stage companies with an eye towards merger and acquisition activity.
So let’s take a look at the cash flow situation for each of these companies over the last 3 years. We will begin with cash flow from operations. Here is the table:
Net Operating Cash Flows
Although the picture is not complete without investing cash flows, you can see BTU and CKA are headed in the wrong direction and newly listed CLR has insufficient history to judge. JAL is the only company to improve its cash flow from operations, but only between 2010 and 2011. Now let’s look at Net Investing Cash Flows.