UK Coal, Freddy's £1 before end 2003 thread

A well thought out though rather negative review of UKC from Muckshifter. Copied from www.iii.co.uk

For the detailed reasoning behind my pessimism about UKC I would suggest that you read my earlier posts on this iii board going back to the start of October and then if you find them interesting read the far more detailed stuff I wrote on TMF over the last two years. On TMF, as I understand it, you can access posts through the posters profile by clicking on their name, although I'm not sure how far back you can go.
In a nutshell I would say the following about UKC:-
1. During the whole 5 year period that I've been studying UKC /RJB and its part in the coal world, UKCs production COST has been lower than the PRICE of coal on the world market probably less than 25% of the time, i.e. UKC have been selling coal at a high price negotiated with highly profitable UK generators (at the time of the contract negotiation) who could have bought more cheaply on the spot market most of the time. If those generators were to enter long term contracts with the overseas coal producers presumably the short periods of high international prices would be negotiated out of the equation.

2. During the whole time that I've been interested in them RJB/UKC have had a constant stream of productivity initiatives. Every year one or two collieries have been singled out as very unproductive and closed. The government provided £75 million in aid for investments to increase productivity. The result has been that production costs have gone from £29/tonne in the 1998 report to £31.35 in the year 2001. A great deal now hangs on project 105. As the latest interim report shows that there has been a cost decrease of 5%, all we need now is a further 13.5% in the next year to achieve the stated aim. This target is an acknowledgement of what I've been saying for some time - that UKC are not able to compete with imported coal most of the time. The only person I've spoken too, involved in 105, remained somewhat sceptical of the company's ability to achieve it.

3. Holders of UKC have always clung to the belief that its cheap foreign labour or subsidies that cause the cheap coal, I've always argued that this is rubbish. The continuing disbelief by Detprog recently provoked an exchange of views on this board which resulted in Detprog effectively proving my case by investigating a single Indonesian opencast mine I identified for him, which produces 16 million tonnes/year of very high quality coal at a potential cost delivered to the UK of about half UKCs stated cost for 2001 - on his figures, which were higher than mine deduced after a site visit in East Kalimantan years ago.

4. Another distinct danger for UKC is dollar weakness. The theory put forward by several UKC holders on TMF is that the dollar price of coal will increase proportionally to make up for a lowering dollar. This theory appears to me to be similarly based on an insular view of the world where the UK is the centre of the universe. The economies which produce huge amounts of coal, with the ability to increase production at will, are mostly geared to the US$ and consequently don't need more dollars/tonne if the dollar falls, as I believe it will, ($2 to the £ coming up IMHO within a year). Looking at the coal price in dollars compared to the $s international value over the last few years I don't think you would find evidence of an inverse correlation.

5. At one AGM recently UKC intimated that closure of collieries, such as the Selby complex, lead to improved cashflow as investment tailed off, my disbelief of this opinion in a post at the time seems to have been proved right by UKCs recent statements.

6. Much has been made of the supposed enormous positive cashflow of the company, which is taken to be the proof that large dividend payments can continue, but when you look carefully at the annual accounts the cashflow is decreasing and a dividend cut is highly likely IMHO. In theory UKC are supplying Drax with about £30 million worth of coal a month, which from the accounts looks like there would be a maximum outstanding debt of £60 million, although I believe 2/3rds of this was originally supposed to be supplied through NP. Either way, failure of Drax or any other big stations would hit cashflow.

7. Major supply orders begin to drop out of the equation from next March, with the biggest two during 2003 & 4 which account for 15 million tonnes/year I think. Are the generators going to be as generous as they were during their last negotiations with UKC five years ago? In present circumstances I think not, and these generators are no longer the old British privatised organisations they mostly were when the last negotiations were concluded, nearly all of them are owned by international companies fully aware of the international coal situation.

So UKC are in a position where opencast, the historically profitable part of the business, looks like its in terminal decline, and the pits have a mountain to climb to achieve cost parity with international producers with the dollar at its present price, or mount Everest if the dollar falls. All against a deadline for negotiation of the next supply contracts with a newly battle hardened set of clients. The way I see it there is at least a 50/50 chance that the whole coal business disappears in the next five years, producing little surplus cash on the way. Don't forget that if this was to happen the vast majority of the Head Office staff of a £600 million a year business would be redundant. Unless of course UKC is a very lucky company in terms of 105, the international coal price, the pollution edicts that the government is committed to, the dollar, etc. I therefore see the value of the coal business as the same length as a piece of string.

Which leaves as the key question IMHO the value of the landbank, the adequacy of the provisions within the accounts, and the company's ability to realise benefit and minimise damage from these matters in an environment where they may not have much support or credibility in the city / banking community. I.E.. The safety factor.

The value of UKCs property is a vital safety net for investors, but who knows what its worth. It is noticeable that the last land revaluation did not include the actual pits and I've seen no explanation of why this is the case. But presumably, for the valuer to come to a conclusion on the value of the pits, the adequacy of all the pit head reclamation provisions had to be validated, and I think this may have been the problem (for the valuer). The vast majority of the landbank consists of very large chunks of land used for opencast. Looking at the AR it seems that most of this land must have been valued off reinstatement plans rather than as a working site, this is fine, but in reality, it does not achieve that value even as agricultural land for several years after the coal site stops coaling and goes cash negative during reinstatement. There have not, to my knowledge, been any successful planning applications for new very large sites since RJB/UKC took over from the coal board, so the completed, or soon to complete major sites, were all the subject of British Coal planning applications. British Coal never pretended or tried to be a property company, they were interested in coal and their planning applications were liberally sprinkled with parks, woodlands, re-foresting, water features etc as a reinstatement benefit sweetener. When the implications of this sort of reinstatement are combined with the long term settlement required on the uncompacted backfill which would normally cover about 80% of the site, and the fact that many large sites are remote, it is difficult to see large potential gains from this element of the company's property. The agricultural land has to be a buyers market at the moment as farmers seem to be struggling to make a living. In terms of the reinstatement provisions for opencast land, these should be adequate in terms of the sites where UKC are doing the work, but I doubt the provisions for the remaining work done by outside contractors. There is one very large site that I know of with entirely inadequate provisions for reinstatement, which means UKC are vulnerable if the contractor becomes insolvent. The remaining claims provisions in the 2001 results also look inadequate.

In terms of the actual pits, both live and disused, the provisions are very hard to judge. They are dependent on many things, such as how many pitheads they can obtain planning permission to opencast as a method of reinstatement, and the progress of clean up legislation. A good example of the importance of this point would be Ferry Moor (Revised) Reclamation Site at Grimethorpe. This site was initially proposed about 4 years ago and had a number of backers such as Yorkshire Forward, the government regeneration agency, as well as UKC, after revision (hence the name) it eventually was passed. But if it had failed there were, from memory, something like 50,000 tonnes of contaminated material on site which I assume would have had eventually to be dealt with by UKC. If this material was taken to a tipping facility this item alone would probably cost a few million as opposed to being disposed of as part of a highly profitable opencast which allows the release of provisions, yields lots of good coal, and provides industrial development areas on fully compacted backfill. So who knows how many swings from a high reclamation cost to a profitable opencast can be made, how much the present provisions are reliant on this type of solution, or even exactly how many pit tops and pit heaps are UKCs responsibility. It appears to me that the pits being developed as rental properties are just the recently constructed ones, which presumably have been operated with a close eye on current thinking and legislation in terms of pollution. The pits I know of that were constructed in the last 20 years are Ashfordby and the Selby complex, but I very much doubt if all the Selby pits could be used in this way. Several other provisions are equally questionable.
So, although I'm definitely an efficient market theory heretic, I feel that the current price is a full one until 105 shows its colours, the first major new supply negotiation comes in at an achievable price, the first major new greenfield opencast site receives planning approval, the dollar rises, UKC begin to obtain planning permission on all little reclamation/opencast sites like Park Brook which allow them to maintain the sites industrial use status after coal removal, the company proves me wrong in terms of its future dividend capabilities, etc etc.
As far as the bottom is concerned, if all the above went against the company and perhaps Drax went bang and others ( I'm not sure of the parent company's profitability, or for that matter if Eddison still own Fiddlers Ferry), the value could become £0.
So the best of luck to all you UKC holders, sorry to be so negative but I hope this has given you food for thought and perhaps a few pointers to watch for.
Regards.
Muckshifter