IB Net Payout Yields Model

Puda Coal Cools Off But It'll Heat Up Again

China is the largest user of coal and now they've become a major net importer in the last few years. Although China has embarked on several programs to focus on renewable energy sources such as solar and wind they will rely on coal fired electricity for a long time with some sources estimating that China will nearly double coal use by 2030.

The coal industry in China is very fragmented. Many of the coal mines have been operated by small companies leading to very inefficient mines and a high injury rate with several tragic mine accidents. Hence, the government has embarked on a mine consolidation plan in order to move the majority of the mines into the hands of larger operators that will be more efficient and easier to regulate. The program will reduce the number of mine operators from 1,000 to 100 while also significantly shrinking the total number of mines.

Mine Consolidator
Puda Coal (PUDA) is one of the selected mine consolidators. It's virtually unknown by investors as they recently did an uplisting to the AMEX with little fanfare. Outside of Yanzhou Coal (YZC), the other Chinese public mine operators are relatively small and unknown like PUDA leaving a lot of opportunity for the small investor to capitalize on the lack of institutional investors. To this point, PUDA has been strictly a coking coal washer al beit a very profitable one. They have 3 coal washing facilities with a 3.5M mt annual capacity.

Last year they embarked on the consolidation of 8 coal mines into 5 with the recent purchase of 2 mines in the Shanxi Province. By October, they expect to double the output of the 2 mines to 900,000 mt from the current 450,000 mt. Once completed, they expect to double the output of the original 8 mines from 1,200,000 mt to 2,700,000 mt.

Considering they expect to purchase these mines at roughly 2x EBITDA they will be significantly accretive from day 1. With 40% net income margins, they will also provide significant income to PUDA, but even at these prices the $150M price tag for all 8 mines has been weighing on the stock. PUDA after all didn't even have a $100M market cap when it announced this plan.

Recently PUDA raised over $28M via a $13.6M stock offering and a $14.6M loan from the Chairman. These moves pressured the stock down to sub $5 but they've recently rebounded to over $10. These offerings plus cash on hand and income provides the money needed to close the deals on the first 2 mines and complete the expansion. For the other 6 mines, they are looking for partners to fund the $110M price tag and $56M in capital expenditures.

Another project they are working on is the Jiahne Project. In May of 2009, they bought a 18% ownership in a coking coal mine that has roughly 18M mt of reserves. The company has also applied to be a consolidator of 2 adjacent reserve areas giving them access to prized coking coal that could then be feed into their coal washing operation. For now they will settle for 14% dividends from the income of that mine.

Like most Chinese stocks, PUDA has phenomenal margins. They were already very profitable in the coal washing business, but now they expect to generate over 40% net margins in the mining operation.

On their 3/5 presentation to the Brean Murray Conferense, management guided to earnings of $1.10 to $1.52 for 2010. Although that is a very wide range, the results are very dependent on the finalization of the ownership of the 2 coal mines, the doubling of the mining capacity by Oct, and of course the price of thermal coal in the case of these 2 mines.

By all accounts, Puda Coal is very cheap with lots of potential. The biggest risk is that they don't have a track record as a mine operator. The ability to buy companies at 2x EBITDA doesn't come around very often making that risk worth taking in this case. Even at the low end PUDA trades at only 8x estimated earnings for 2010. Considering that 2011 is likely to easily surpass that high end, PUDA is far cheaper than US coal companies that lack the direct access to China coal demand and the benefits of the attractive consolidation program.


Interesting comments from theSteet.com:
For a stock with more upside, I like small-cap Puda Coal. PUDA uplisted to the Amex exchange in September 2009 and saw its stock shoot up more than 20% on the day. The company is a supplier of high-grade metallurgical coking coal used to produce coke for steel manufacturing in China and a coal mine consolidator of eight coal mines.

The company recently raised $13 million in a common stock offering priced at $4.75 per share to fund the acquisition of two new coal mines. Investors clearly like the story because the stock has risen from below $5.00 to more than $7.00 at present.

Puda trades at only 16 times trailing earnings, which is a clear discount to U.S. comparables such as James River Coal Company (JRCC Quote), which trades at 22 times earnings and Pacific Coal (PCX Quote), which trades at more than 30 times earnings, despite having similar margins to both. As a result, over the next year, PUDA could potentially have 50%-100% upside in its share price.

Disclosure: Long PUDA


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