Friday, February 17, 2017
Lesson in China's Coal Clampdown
As part of United Nation’s imposed sanctions on North Korea for its tests of nuclear missiles, China has suspended coal imports from its southern neighbor. China imports about $1 billion in coal from North Korea each year - mere dust in the coal bucket for China but a sizable chunk for North Korea. According to Trading Economics, the gross domestic product of North Korea was near $16.2 billion in 2015 after hitting a historic high of $17.4 billion in 2014. Thus China’s coal order represents about 6.2% of North Korea’s entire economy and about 30% of its total exports.
No matter whether or not there are any doubts in North Korea about the ill advised missile tests, in China the event may have just been the best chance for China to break off from its irascible trade partner in Pyongyang. China has been attempting a restructure and upgrade of its own domestic coal production, closing mines and consolidating small, inefficient and unsafe mines into larger mining companies.
Among China’s top mining companies are two which have common shares listed on U.S. stock exchanges. They provide an interesting contrast to renewable energy companies, which struggle to maintain valuation and win new capital.
Aluminum Corporation of China Limited (ACH: NYSE), or Chalco for short, reported $17.3 billion in total sales over the year ending September 2016, providing $184.5 million in net income or $0.10 per share. A narrow net profit margin may put of some investors. However, the real worry should be the declining top line. Year after year Chalco has turned out lower revenue as commodity prices have faltered. Chalco is China’s largest bauxite producer, a vital material for aluminum, and a fabricator of finished aluminum products. As a consequence the company has reported net losses in two of the last four years.
On the plus side for Chalco, operating cash flows have remained positive in thick and thin. The company’s inherent strength may be part of what has kept interest in the stock. While off dramatically from its historic high valuation in 2007, the stock has held up well in the face of competitive challenges in China’s coal market as well as on the global arena. Indeed, even as China’s interest in coal has cooled, Chalco shares have rebounded.
Shares of Yangzhou Coal Mining Co., Ltd. (YZC: NYSE) have been even more robust, rising 96.9% over the past year. Yangzhou is majority owned by Yankuang Group, an operator or coal mines and rail transportation networks. In the nine months ending September 2016, Yangzhou delivered RMB 64.8 billion (US$9.4 billion) in operating income, a significant increase from the same period in the previous year. The increase was due in part to an increase in the selling prices Yangzhou received for its coal and despite a decrease in sales volume. Following the recent price rise, Yangzhou shares are trading at lofty multiples of earnings: 37.1 times trailing earnings and a whopping 90.8 times the consensus estimated earnings in 2017.
Contrast the performance of these two companies with the alternative energy industry in the U.S. It is a loose and wide ranging conglomeration of wind, solar, hydro, tidal and geothermal technologies and assets. There are at least a dozen Exchange Traded Funds listed on U.S. exchanges that are devoted to alternative energy interests. In terms of recent performance top of the list has to be Guggenheim Solar ETF (TAN: NYSE), which has returned 13% since the beginning of 2017, after losing 46.2% of its value during the year 2016. A more mixed is found in the iShares Global Clean Energy ETF (ISLN: NASDAQ) that has climbed 11.2% since New Year 2017. This does not make up for the loss of 16.4% of its value in 2016. The story is largely the same for the other ten alternative energy ETFs listed on U.S. stock exchanges.
The directional trends of these securities - coal gaining in value while clearer more ecologically friendly assets lose value - took place as a drum beat of environmental alarms sounded across the globe. The September 2016 open letter signed by 375 members of the National Academy of Sciences warned of “real, serious, immediate climate threat.” The news from scientists monitoring the Arctic Ocean has been particularly disquieting as the solar cap suffers irreversible damage that will impact ocean water levels and temperatures throughout the planet.
Yet the investment community seems incapable of incorporating the risks and costs of environmental damage into their analysis of energy sources that are clearly linked to global warming. The alternative view is that investors have acknowledged the costs, but anticipate that there will be little or no economic or financial retribution for environmental damage given the current political climate in leading countries around the world. Thus, cash flows from offending energy sources such as coal need not be discounted by penalties or future contingent liabilities.
For U.S. investors the trade must be long coal and maybe long boat builders as a hedge. Except in China, where the environmental consequences of burning coal has been acknowledged, political leaders jump at chances to reduce coal usage, even if it is just a token reduction of imports from North Korea.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.