A Perfect Storm Brewing for Puda Coal

Jan.29.08 | About: Puda Coal, (PUDA)

Puda Coal (PUDC.OB) hasn't been in the best of shape lately. Its Q3 results released in November disappointed with falling year-on-year revenues and operating income, and its shares lost almost 40% of their value in 2007.

Worse, the company, which is in the business of cleaning and processing coking coal for sale to steel makers, is finding itself caught in a tight squeeze between the coal producers and the steel corporations. Steel mills are starting to build internal coking operations, while coal mines are going downstream by setting up their own coal washing plants.

So Puda entered into an agreement last quarter to acquire a coal mine to protect its supply. But this transaction is contingent upon the company getting a mining permit, which, as far as I know, the company has yet to obtain. All this negativity is on top of flat selling prices for its coal output even when raw coal costs are rising (up 6% between 2006 and 2007).

Now, even more bad news. Because this is the Olympic year, the Chinese authorities will now accelerate their plan to cut down on air pollution. News just released Monday shows that many smaller coal-fired power plants will be shut down. Over 500 of these plants were shuttered last year, and this figure is expected to increase by 30% in 2008. It is true that Puda doesn't supply to power plants, but to the extent that coal is not used for these plants, there will be that much more supply in the market. And it is a commodity item.

Further, China is currently experiencing one of the worst power crisis in years because of snow storms in the northern regions. Apparently this season recorded the heaviest snowfall in over 50 years. Surely this must be good for Puda, for coal prices are bound to increase, right? The answer surprises. Because of the bad weather, rail links have been severed between coal suppliers and buyers, just when power usage was peaking. According to the Ministry of Railways, only about 25% of the daily demand for coal has been met. The much needed coal is simply not getting out of the snowbound regions fast enough. And the inclement weather has yet to abate.

How this will impact Puda financially remains to be seen, but it doesn't look good. In a way, this perfect storm only exacerbates the need for management to closely examine the company's long-term strategy, to figure out a way forward for the company. But what a tough task that is. Just look at the coal producers in this country and other industrialized nations and you'll get a crystal ball view of what the future holds.

My Position: None.