Add a Lump of Yanzhou Coal to Your Portfolio

Talk about making a bad call. Back in August 2006, I wrote an article telling investors to stay away from Yanzhou Coal Mining (NYSE: YZC  ) . Since that time, as the only U.S.-listed Chinese coal company, it has advanced steadily and is up more than 150% since my shortsighted recommendation. Ouch.

Well, I'm making a U-turn now and urging investors to consider taking a position in this high-margin coal play. Simply put, shares of Yanzhou are likely to put in another strong performance in 2008 because:

  • Coal prices are only going up.
  • The company boasts some of the highest margins in the industry.
  • The shares continue to carry an attractive valuation.

Let's take a fast look at these three factors.

Rising coal prices
A reliable benchmark for gauging the direction of coal prices is the annual contract talks between Australian miners and Japanese utilities. According to a recent JPMorgan (NYSE: JPM  ) report, the contract price of 2008 thermal coal is expected to rise to $90 per ton, up 62% over last year's price of $55.65 per ton, because of supply constraints and surging demand in both China and India.

Yanzhou's sweet margins
Established players Peabody Energy (NYSE: BTU  ) and Arch Coal (NYSE: ACI  ) reported operating margins around 10% for the 2007 fiscal year. Yanzhou hasn't reported its results yet, but its latest available margins double those results. Yanzhou has three distinct advantages:

  • Its mines are close to its customers. The customers pay less for transportation, so they're willing to pay more for the coal.
  • The coal produced at its six main mines in Shandong is high-grade, low-sulfur coal, which fetches a premium in the marketplace.
  • These mines boast significant, easy-to-excavate deposits.

Despite the impressive move over the past year or so, shares of Yanzhou remain attractively valued. At a recent price of $91.47 per share, Yanzhou trades at around 15 times consensus fiscal 2008 estimates of $6.07, a projected 29% increase in earnings this year. Considering that lower-margin players such as Peabody and Arch trade at similar forward estimates, I'd consider Yanzhou to be quite undervalued.

All in all, I'd suggest that investors take a serious look at adding shares of Yanzhou Coal Mining to their investment collection. It could turn into a diamond by next Valentine's Day.

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