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Australia’s iron ore producers are not the only mining operators that have witnessed dramatic share price declines of late. Australia’s coking coal stocks have followed suit, with listed coal companies trading at between 60% and 95% lower. It has been a bloodbath.

The global economy is misfiring on all cylinders, with the US and China leading the pack. The US may be on the brink of a recession and China is slowing. Unless China undertakes an economic stimulus program, there’s talk that Chinese will never need steel again.

Coking coal, or metallurgical coal, is used in the production of steel and therefore China’s growth projections are big factors governing the outlook for coal stocks. Share price declines of between 60% and 95% for coking coal producers, explorers as well as producers of thermal coal warrant the question: Are there cheap buys in this sector?

Despite global jitters, some analysts continue to 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, annualised; and this despite dire predictions and much gnashing of teeth over China’s slowing economy. 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 sharing this point of view. US coal juggernaut Peabody Coal also anticipates rising – not falling – Chinese steel production. A Peabody analytics team highlights the point that steel consumption per capita in China, India and Brazil is currently well below other stgeloped 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 that while coking coal explorers and producers have taken a severe beating, the price of coking coal has held up better than many other metals.

We will look at four Australian coking coal pure plays that are currently engaged in exploration with actual production to follow:

Company

Code

Market Cap

Share Price

52 Week Low

52 Week High

Bathurst Resources

BTU

$296M

$0.42

$0.37

$1.17

Cokal Limited

CKA

$105M

$0.26

$0.20

$0.82

Carabella Resources

CLR

$82M

$0.61

$0.59

$2.35

Jameson Resources

JAL

$51M

$0.33

$0.07

$0.43

 

Why are we wasting time analysing 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. Considering the other three coking coal explorers in the table are down between 60% and 70%, Jameson is swimming against the tide. Why? What’s the story with this stock that’s clearly missing from the other three?

Perhaps some traditional market valuation ratios will help. Let’s take a look:

Company

Code

EPS

P/E

P/EG

P/B

P/S

Materials Sector

XMJ

9.29

0.70

0.98

14.58

Bathurst Resources

BTU

-$0.02.8

1.63

34.84

Cokal Limited

CKA

-$0.01.4

2.38

Carabella Resources

CLR

-$0.064

 

 

1.93

677.78

Jameson Resources

JAL

-$0.06

15.35

 

The table pinpoints a problem with stocks that haven’t generated earnings from operations. The beloved P/E and its cousin the P/EG are not valid (since earnings is the denominator of these ratios). Bathurst Resources (BTU) and Carabella Resources (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 analyse from a fundamental point of view?

With companies like these there’s always a race between cash burn – how much money they’re 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 stgelopment 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 stgelopment 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

Company

Code

2009

2010

2011

Bathurst Resources

BTU

-$1.02M

-$5.11M

-5.97M

Cokal Limited

CKA

-$0.64M

-$0.74M

-$2.02

Carabella Resources

CLR

-$3.18

Jameson Resources

JAL

-$0.44M

-$0.77M

-$0.51M

 

Although the picture is not complete without investing cash flows, you can see Bathurst Resources (BTU) and Cokal (CKA) are headed in the wrong direction and newly listed Carabella Resources (CLR) has insufficient history to judge. Jameson Resources (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.

Net Investing Cash Flows

Company

Code

2009

2010

2011

Bathurst Resources

BTU

-$4.0M

-$6.0M

-$71.0M

Cokal Limited

CKA

-$0M

$0M

-$15M

Carabella Resources

CLR

-$9.0M

Jameson Resources

JAL

-$2.0M

-$2.0M

-$1.0M

 

Financial Ratios and performance numbers like cash flow positions in most cases raise more questions than answers. Sometimes the numbers look so bad most of us would look no further. When the picture is less clear, the numbers give you a path for further research. And depending on share price performance, even a company with horrible numbers may deserve a deeper look.

In most cases, a large increase in investing cash flow activities, as we see in Bathurst Resources (BTU) and Cokal (CKA), are an indication the company is closer to production. Now let’s look at financing cash flows:

Net Financing Cash Flows

Company

Code

2009

2010

2011

Bathurst Resources

BTU

$2.0M

$20.0M

$156M

Cokal Limited

CKA

$0M

$2.0M

$31M

Carabella Resources

CLR

$40.0M

Jameson Resources

JAL

$3.0M

$1.0M

$1.0M

 

With the exception of JAL, as of the end of FY 2011, all companies were raising sufficient capital from financing activities to continue operations comfortably. The significant increase in financing in both Bathurst Resources (BTU) and Cokal (CKA) add evidence to the possibility of ramping up in anticipation of commencing production. That should have been a positive stgelopment for investors, however it’s certainly not reflected in the share price charts of both stocks.

It would appear that Bathurst is commencing operations and anticipates a profit in 2013. Indeed, analysts are bullish on the stock, with five out of six analysts showcasing a BUY rating.

Cokal (CKA) has ambitious plans for its operations in Indonesia and Africa and expects to be in production by mid 2013. They have no debt, financing themselves completely through equity offerings. They have $26M cash on hand, which the company claims is enough for continued exploration of its assets.

Although CLR (Carabella) is the most recent entrant to the ASX, it’s already rated a BUY by RBS Australia who initiated coverage with a BUY rating and a target price of $1.55, which dwarfs the current share price of $0.61. The analyst also raised the possibility of a Joint Venture deal sometime in 2012.

Finally, what about Jameson Resources (JAL), the company that has outpeformed the market? The company’s  cash flow performance has been admirable, with low losses from operations and investments and minimal financing. They have no debt and $7.8M cash on hand as a result of two equity offerings in early 2012.

Propelling the share price, was the acquisition of a Canadian coking coal operation. As you can see from their share price chart, the upward share price momentum commenced around the time of the acquisition announcement – in late October 2011. In May 2012 the company received licenses for their operations in the Crown Mountain area of British Columbia, already the home of 5 of Canada’s coking coal producing mines. Although JAL is already up 400%, if you believe in Buy High and Sell Higher, this one bears watching.

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au.You should seek professional advice before making any investment decisions.