Fording Coal...

01/28/2005 12:00 am EST

Focus:

Tobin Smith

Founder and Chief Research Analyst, NBT Equity Group

When isolating major trends, which he calls "ChangeWaves," Tobin Smith looks for catalysts or triggers, which he calls "ChangeQuakes." In his assessment of supply and demand for coal, that trigger has now been seen. Here, he looks at a new favorite for growth and income.

"Our latest income recommendation is Fording Canadian Coal Trust (FDG NYSE). The company is the purest play on the international supply/demand imbalance for metallurgical ('met') coal. The met coal market is being driven by high demand from steel companies because of record global demand for steel that is primarily derived from it. A major example of the supply crunch for steel came from Japanese automaker Nissan in December when they announced that they would be forced to suspend operations at three of their plants due to a shortage of steel.

"Why the shortage? Only a small percentage of coal in the world is of the high purity and composition that steel producers need to make stainless steel. And with very long lead times for finding new supply (four to five years) and stiff ecological barriers to strip mining (the most economical way to mine met coal), we have a secular supply demand imbalance that we love to capitalize on.

"Japan's Nippon Steel just entered into a strategic agreement with Fording Canadian to purchase a 2.5% stake in Fording's Elk Valley Coal Partnership as part of a plan to increase the partnership's metallurgical coal production. Nippon Steel also announced that it has entered into a ten-year supply agreement with Elk View and FDG's Fording Mine to supply it with 29 million tons of coal beginning this year. This is a six million ton increase over the amount that Nippon purchased from the two mines over the past ten years. Nippon did not disclose the price it is paying for its 2005 coal supplies, which will be announced in April. But our estimates put the price around $120 a ton. That's more than double the price that Nippon paid in 2004.

"With all the data points suggesting that 2005 contract prices for met coal will double 2004's price levels, and given the relatively fixed-cost nature of mining met coal, I conclude that FDG could pay us as much as $15-$18 per share in distributions in 2005. Distributions in 2004 were around $4 a share. This equates to a roughly 25% annual yield at the current stock price. And, of course, as a Canadian Royalty Trust traded in the US, we get 85% of the dividend part of that distribution tax-free. Find me a better 'ballast income' investment return, and I'll eat my hat!"

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