As Stephen Simpson recently pointed out in Coal Continues to Creak, the markets aren't exactly stoked about the near-term prospects of companies that harvest the commodity known as "the other black gold." Despite last week's rally in coal stocks because of the Energy Information Agency's prediction of a tightening in the supply/demand equation in 2007, shares of such blue-chip plays as Arch Coal
It's not exactly a welcoming environment for a coal company to report less-than-stellar results in, is it?
Well, Yanzhou Coal Mining
While it's never pleasant for investors to see a resource company report a drop in production volume of its commoditized product (or lower prices for that matter), it's not nearly as bad as watching margins getting dinged and the resultant impact on bottom-line results.
Unfortunately, Yanzhou's investors got to experience the feeling firsthand as the company reported that gross margins fell from 59.9% to 55.3%, primarily because of higher energy costs and a whopping 35% increase in workers' wages. What's scary is that the decline would have been even worse if Yanzhou hadn't reported a 42% reduction in environmental protection and land recovery costs. Perhaps I'm just cynical in my old age, but the timing seems coincidental, doesn't it?
Further insult was added to injury as SG&A expenses climbed by $37 million, an increase of 33%, and contributed to a fall in operating margins to 35% from 44.9% in the prior year's period. As a result, Yanzhou reported net income of $179.7 million, a drop of 24% from the first half of 2005.
Not exactly a pretty picture, is it? And it isn't likely to get better in the near term, as the company is projecting a decline in its higher-margin export sales in the second half and seems to be making overly optimistic assumptions of a rebound in domestic production.
Despite the fact that Yanzhou's stock now trades at a mere eight times fiscal 2006 estimates of $4.34 and carries a 3.8% yield, I would caution investors that there are better ways to play either China's voracious demand for energy -- PetroChina
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