3 Ways to Play China Coal

by: Richard Pearson

China is the largest consumer of coal in the world, both in terms of power generation and in terms of supplying coal to the coking industry for making steel. Despite all the progress being made in cleantech areas, such as solar and wind, coal is and will continue to be the predominant source of energy in China for the foreseeable future.

The economic and stock market rebound over the past year has translated directly into massive gains in the coal industry. Combined with the continued growth expected in China over the coming years, coal is clearly an attractive investment opportunity. Currently the three best ways to play coal in China are Yanzhou Coal (NYSE:YZC), Puda Coal (NYSEMKT:PUDA) and the best in my opinion, Sinoclean Energy.

Yanzhou Coal is a giant in the world of coal. The company operates in all aspects of coal mining, sales and rail transportation. At present, the company is traded via ADRs on the NYSE, as well as having listings on the Shanghai and Hong Kong exchanges.

Its current market cap is over $13 billion and it has witnessed a 400% return in the last twelve months, from a low of $5.11 to its current price of over $22.00. YZC boasts gross margins of nearly 50%, has nearly $2 billion of cash on its books, and is consistently highly cash flow positive. In addition, the company has an attractive dividend yield of over 2.6%.

YZC makes for a great play on the long term growth of China. It is a solid large-cap stock with a healthy dividend yield in an industry that isn’t going away. The benefits of owning include a play on energy as well as international diversification for a broader portfolio.

However, I feel that YZC is best viewed as one stock to hold among many, and not one to count on for individual spectacular gains. The stock has already had its run, and future gains are more likely to come in linear fashion alongside economic growth in China. I would expect to see up to 30% upside in YZC from current levels, which is very attractive for a large cap stock, but certainly not something which will dramatically move a portfolio.

For a stock with more upside, I like small cap Puda Coal. PUDA uplisted to the Amex exchange in September 2009 and saw its stock shoot up over 20% on the day. The company is a supplier of high grade metallurgical coking coal, which is used to produce coke for steel manufacturing in China, and has operations across eight coal mines. The company recently raised $13 million in a common stock offering, priced at $4.75 per share, to fund the acquisition of two new coal mines.

Investors clearly like the story because the stock has risen from below $5.00 to over $7.00 at present. Puda trades at only 16 times trailing earnings, which is a clear discount to US comparables such as James River Coal Company (JRCC) (which trades at 22 times earnings) and Pacific Coal Corp (PCX) (which trades at over 30 times earnings), despite having similar margins to both. As a result, over the next year PUDA could potentially see 50-100% upside in its share price.

To find a stock with muti-bagger potential in the coal space, one could look at Sinoclean Energy [currently a penny stock - Ed.]. The company produces “coal water mixture,” a viscous, heavy liquid fuel that is produced by mixing ground coal, water and chemical additives. CWM can be stored, pumped and burned as a substitute for oil and gas in modified furnaces or boilers.

The valuation of Sinoclean is compelling for a company with virtually no long term debt, trading at only 2 times operating cash flow. The company recently provided guidance for 2010 projecting $10 in earnings. This put the company at a valuation of only 4 times projected earnings. Gross margins are nearly 40%, and the company has been growing revenues by double digits. In addition, the company just began production at a new 200,000 ton facility, bringing total capacity to over 850,000 tons.

The stock sold off after last quarter’s results when Sinoclean posted what appeared to be a loss. However, as can be see from the cash flow statement, this “loss” was only due to a non-cash charge related to warrants. In fact, the company generated over $5 million in cash last quarter.

A few noteworthy items give me a déjà-vu feeling with Sinoclean. I see them proceeding on the well trodden Chinese path of reverse splitting the stock and uplisting to the Nasdaq or Amex. First, two weeks ago the company hired an exceptionally qualified English speaking, US educated, GAAP trained CFO named Wendy Fu. Ms. Fu’s background includes being CFO at two other uplisted US listed Chinese companies, as well as having worked at Deloitte & Touche. This type of hire is only necessary in advance of an uplisting.

Second, in 2009 the company retained HC International for their investor relations effort. I took a quick browse at HC International’s website and their client list reads like a who’s who of China uplistings. Various clients include Tianyin Pharmaceutical (NYSEMKT:TPI), Rino International (OTC:RINO), Tongxin International (OTCPK:TXIC) and China Green Agriculture (NYSE:CGA).

Sinoclean has also been very proactive about investor outreach, and is presenting at the Rodman & Renshaw conference next week to institutional investors. This should bring a lot of new attention to the stock. If my uplisting prediction is correct and Sinoclean trades on a senior exchange, the stock should easily be trading on a massively different multiple and potentially provide 300-500% upside to investors who get in before the upward move.

Disclosure: Author long Sinoclean Energy