Stockwatch: A near-10% dividend yield

Is it time to follow the directors and buy into this £142 million, mining royalties group? After rebounding from about 80p to 105p during May, the FTSE Small-Cap shares of Anglo Pacific Group are down again to 83p. That's despite three directors buying in at the mid-90p range in May and June, and compares with well over 300p three years ago.

"Promise" to maintain fat dividend

My inverted commas seem appropriate given this extent of payout looks uncovered by operational earnings, and the state of the coal industry - responsible for a majority of Anglo's revenues - is dire. But so far Anglo Pacific is sticking to its guns. Last February it fired off a bold new payout policy targeting 8p per share for the medium term and a minimum 65% of adjusted earnings in the longer term. This was reinforced in the end-March prelims by way of "an expectation that there will be a minimum annual total dividend of 8p per share per annum" within the 65% payout guidance. So if the board's judgment can be trusted, you are looking at a near 10% prospective yield currently; also that if this dividend is paid, Anglo's stock will re-rate over time in order to price such a dividend more competitively (i.e. lower the yield). A price of 83p implies the market doubts this is realistic.

Troubled state of Australian coal

While Anglo's website depicts international diversification, the group's royalty income is heavily dependent on two Australian royalty interests: Kestrel and Narrabri, a major thermal coal project where a private interest was acquired last February for £42.8 million equivalent (aided by a £12.4 million share placing at 80p). The 2014 results showed Kestrel's royalty income down from £9.9 million to £1.7 million (mainly due to last year's production being outside of Anglo's royalty land) and income from EVBC, a Spanish gold/copper/silver project, down from £2.0 million to £1.7 million - hence these two provided the bulk of £3.5 million, total royalty income. The Narrabri acquisition was contra-cyclical, increasing exposure to Australian coal at a time of crises for this industry.

Coal generally is being hit by bad headlines on all fronts such as a slump in demand from China, US power plants switching to natural gas and environmental restrictions as coal becomes seen as a chief culprit of climate change. Persistent reports like these continue to erode stock prices. Whether they are classic "darkest before dawn" news pieces amid a downturn, or reflect deeper changes that diminish coal's attractions, is the ultimate issue for this stock's future.

Dividend depends on disposals

The table shows how, even with an anticipated rebound in profit during 2016, the dividend is not quite covered by normalised earnings and disposals' proceeds are vital for 2015. Within consensus numbers for 2016 there is divergence with finnCap looking for £19.5 million pre-tax profit and EPS of 9.7p, whereas Peel Hunt (Anglo's broker) anticipates £11.4 million and 5.2p respectively. Both brokers target an 8.0p dividend as if they are assuming the directors' guidance, whereas the market is more sceptical in pricing the stock at 83p.

A 14 May update cited Q1 2015 royalty income of £2.3 million, up from £0.5 million in Q4 2014, and £1.7 million generated from disposal of non-core assets. Such figures compare with the 2014 cash flow statement showing £11.5 million spent on dividends relative to an 8.5p per share payout in respect of 2014 and 10.2p for 2013 (figures in the REFS table relate to payments' timing).

According to an agreement with Rio Tinto, providing Anglo with greater visibility over projected tonnage for its royalty land at the Kestrel mine, "the guidance we are now receiving suggests that production and our share of it is increasing above Rio Tinto's previous forecasts, and our expectation of production within our land rising to approximately 90% by 2017 is well on track." At end-March the market value of Anglo's remaining equity portfolio was £6.8 million, there was £6.5 million cash and £15.4m equivalent, undrawn credit facilities. So barring a major crisis the 8.0p per share dividend objective should be feasible even if some market participants don't consider it wise. The downside risk is production increases being just one aspect of the equation, and if they reflect over-capacity in the coal industry at a time of weak demand then prices will continue to suffer. On such logic, production increases collectively become self-defeating.

"Encouraging" updates on Kestrel and Narrabri

So there is a possibly conflicting aspect to 16 July news of improving production rates at Kestrel which according to Anglo's chief executive "will further underpin the dividend", then on 17 July a 57% jump in Q2 2015 production at Narrabri.

Such news affirms Anglo's ability to acquire royalties with strong production upside potential; the fact that its stock languishes on a near 10% yield implies the market questions whether this is astute strategy. If you agree with bears on coal then leave this stock alone, but in the short to medium term the company looks to have overall financial capability to pay an 8p per share dividend.

This makes Anglo shares interesting provided you appreciate the risks; indeed three directors recently judged that risk is on the upside. In May and June (i.e. before the interims' closed period) the chief executive added 70,000 shares to own 5,476,454 in total, a new non-executive director bought 75,000 shares and the chairman 15,400 shares (his wife 6,200 shares also). The price drop to a low 80p area comes amid continued bad news from global coal companies; Anglo has also gone ex-dividend with regard to a 4.0p per share dividend payable on 7 August to shareholders registered as of 26 June.

For more information see anglopacificgroup.com.