Coal Notes Should Set Off Sparks
04/01/2008 12:00 am EST
Bryan Perry, editor of the 25% Cash Machine, says special notes tied to the stock of a major coal producer should help investors mine double-digit returns.
Arch Coal (NYSE: ACI) mines, processes, and markets bituminous and sub-bituminous coal with low sulfur content in West Virginia, Kentucky, Virginia, Wyoming, Colorado, and Utah. The company sells to electric power plants, steel producers, and industrial facilities.
On February 11th, Arch reported its second-best year on record, posting fourth-quarter 2007 net income of $81.3 million, or 56 cents per fully diluted share, beating Wall Street consensus estimates by nine cents a share, or 19% to the upside.
With severe supply constraints in traditional coal export nations, including flooding in Australia, power outages in South Africa, and coal shortages in China and India, Arch believes that US coal increasingly will be valued for supply diversification.
Arch estimates that US coal exports grew by close to ten million tons in 2007 and conservatively expects another 20-million-ton increase in 2008. The US is the king of global coal exports and pricing has never been better.
Furthermore, Arch believes that 14 gigawatts of new coal-fueled capacity are now under construction in the United States, representing an additional 50 million tons of new annual coal demand as these plants are brought online in the next five years.
[Meanwhile], the 12% Arch Coal SPARQS (Amex: AHB), due September 20th, are just the ticket to riding out the current market volatility.
SPARQS (Stock Participation Accreting Redemption Quarterly-Pay Securities) are structured notes where a sophisticated option strategy of selling out-of-the-money puts and calls are applied to bring in the 12% income stream during the life of the investment.
These SPARQS were issued at $7.615 per share on August 31, 2007, as a one-year note. There are [less than six] months left before this note matures—and that will provide us with a very predictable 12% yield on our money with an almost 100% chance of being called out of the notes before they mature on September 20th.
Why? SPARQS are structured to either pay back your principal plus a premium and interest before they mature (if the underlying stock is trading at a higher price than when the notes were issued) or they will pay you in shares of the underlying stock if, upon maturity, the share price is below the price of the notes when they were issued.
Shares of ACI were trading at $30.46 when this note was issued back in late September 2007, and carry an exchange rate of 0.25 shares (one-fourth of a share).
[They]’re now trading at $43. Multiply $43 by the conversion rate of 0.25 and you come up with $10.75 per SPARQ note. I fully expect the issuer, Morgan Stanley, to redeem this issue before it matures because of the appreciation in shares of ACI common stock.
Assuming Morgan Stanley doesn't call the issue until the final call date in September, we stand to collect [dividends and capital appreciation] of 12.5% over the next six months. Nice!