Stockwatch: An interesting play on global growth

Is this £260 million mining royalties company Anglo Pacific Group, positioning itself for a serious development move while its share price is near a three-year high, and investors are attuned to global growth?

With market volatility said set to rise this year, a relatively small mining-related stock can seem an example of what to avoid. Enough traders will recall being crucified at end-2008 by smaller mining/exploration stocks. Some bounced back with commodity prices, and takeovers delivered great profits from market lows, but experienced traders' sensitivity may recall Roy Scheider in Jaws 2: "I've seen a shark up close and I don't intend to go through all that hell again."

Fast forward to 2018 and a few strategists are declaring: "get out of stocks, into commodities". But private investors are not hedge funds, and where people have attempted exposure to crude oil or hogs bellies via futures contracts, they've usually lost their shirts.

Exchange-traded funds (ETFs) are likewise tied to uncertainties of futures. What these strategists imply is, the global economy probably stands a better chance of remaining intact than do overvalued stocks. It may follow that well-financed mining-related stocks are worth holding through volatility, to gain commodity exposure.

Poised to raise equity for a sizable expansion?

See how strategists' advice for portfolio exposure tallies with company developments at Anglo Pacific Group. Last 13 December it made a curious announcement, appointing a third broker, Canaccord Genuity, to work alongside the already joint corporate brokers, BMO Capital Markets and Peel Hunt.

Whatever will they all do for a £260 million company, if not place stock in due course? Anglo's last capital-raising came a year ago: a £13.7 million placing at 125p to help acquire a portion of toll milling proceeds from Toronto Stock Exchange-listed Denison Mines Inc, for £26.4 million; the balance coming from debt.

On 7 February, Anglo updated in respect of 2017: a 90% increase in annual royalty income near £37.5 million, with higher thermal coal prices (Anglo being largely coal-oriented) boosting royalty revenues by 15% despite lower sales. The annual income hike relates substantially to a major interest in a Queensland operation coming back into production after closure for works, so bear in mind an exceptional factor.

But Anglo's organic context is strong, its cash flow underlined by a 16.7% rise in the annual total dividend and an 8.3% rise in quarterly dividend instalments, thus supporting a prospective yield over 5%.

The update also noted a US$10 million (£7.2 million) expansion in the borrowing facility to $40 million, "which is undrawn and fully available providing significant internal resources to fund future acquisitions." Anglo ended 2017 with £8.1 million cash versus net debt of £1 million; which is vague as to the net position, but the end-June balance sheet had £6.1 million long-term debt, down from £8.9 million

Whatever it is currently, prudence suggests a continued equity/debt mix to fund development; a "black swan" can always appear to disrupt the global economy hence commodity prices, e.g. massive Chinese debts that continue to smoulder.

You could say I am jumping to conclusions while management is just ensuring its decks are clean and ready for action, but all this looks to portend expansion.

Buy ahead of action, or wait for news or a market break?

At its current price of 147p the stock is on a forward price/earnings (PE) sub 9 times, the 5%+ prospective yield covered twice by earnings. You could say its cyclically-adjusted PE is higher, as come the next downturn the multiple will soar as profits fall, even if the stock drops modestly; thus it may already be on a cyclically-adjusted PE of 12-15 times.

The table shows how mining-related stocks can be seriously affected by short to medium-term issues such as volatile commodities or operational issues. (One of Anglo's principal Australian royalties had to suspend production if only for planned renewal.) The cynical view is any mining-related boom sowing its seed of a bust: excess production has to clear just when demand falls, coal markets being especially prone to this.

The resulting slump becomes self-reinforcing as it impacts miners' cash flow, hence exploration/development also ability to service debt. Why the board is wise to be ready to tap equity interest in bullish conditions, so long as any deals are value-accretive.

Wait for the bear scenario if you like, but there's no knowing how many years away. Potentially, interest rates would have to jack up, there be war in Asia-Pacific or a China upset, hurting demand for steel hence coking coal. Mind, the table also shows net tangible assets per share are only about half current market value, i.e. no margin of safety if earnings/ dividends falter. So, there's little defensive aspect: hold this share only if you believe in global growth.

Given the current climate and latest strong update, these new brokers should be able to negotiate a placing price at only modest discount to market price. If an acquisition is then demonstrably value-accretive the stock would likely rise. It has previous form: indeed, rising strongly three years ago after a rights issue to raise £39.5 million at 80p, less than a 4% discount to market price, to buy a royalty interest in the Nabarri thermal coal project in New South Wales, Australia.

I drew attention then, noting the chief executive's having bought 1.2 million shares at a 195p placing when he joined in October 2013, saying Anglo was potentially attractive if management could execute its a development strategy well; and, indeed, they are.

Isn't coal at risk for being the dirtiest source of energy?

At 45%, it is certainly the largest component of global energy emissions, and its main historic application – producing electricity by way of steam – is being surpassed by lower natural gas prices and renewable (hydropower, wind etc). This has led some observers to regard coal-oriented businesses as dinosaurs, hence be wary of acquisition-led companies like this, picking off what's being discarded by others.

Such an argument did the rounds in 2015 when commodity-related stocks were being shorted amid deflation fears, and will probably return. But while coal consumption has declined in Europe and North America, with fracking opening up massive new natural gas reserves, Asia Pacific is expected to continue increasing consumption – from about 77% of global total, up to 87% by 2035.

China and India have vast reserves versus alternatives. China has increased domestic production with the goal of one billion tons annually by 2020, to reduce dependency on imports, although progress on renewables is also rapid.

But coking coal, as is most relevant to Anglo Pacific in its mining royalties mix, should be supported by its manufacturing role for steel and cement. Yes, they too will experience slumps in demand, but their vitality for construction should support long-term demand from developing economies. Anglo Pacific's very name and substantial Australian interests, conveys positioning for this.

Price targeting is hard – and a moving target – given the inherent volatility of commodities and events affecting. But if global demand is sustainable then Anglo's current PE/yield is supportive and the next deal potentially a catalyst for upside. Speculative buy.

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