Shares in coal mining and trading firm Hargreaves Services (LSE: HSP) fell by 14% when markets opened this morning, after Hargreaves issued a dismal trading update which suggests profits could fall significantly next year.
Trading outlook uncertain
Around 60% of Hargreaves operating profits come from coal trading buying coal from (mainly) foreign producers, and selling it to UK customers such as coal-fired power stations.
This hasnt been a good business to be in during the second half of this year, because falling gas prices have meant that gas-fired power generation has increased, at the expense of coal, which carries higher environmental costs.
Hargreaves expects volumes to recover during the winter, but its clear that if gas prices remain low, volumes may not recover next year.
Mining production halt?
The other problem highlighted in this mornings update was that Hargreaves Scottish coal mines could become loss-making next year, following this years collapse in the price of coal.
Hargreaves is protected from losses this year thanks to fixed-price contracts, but these all expire in the current financial year.
As a result, the firm has effectively said that it will cut or even halt production unless a specific contract is available to prevent the risk of losses, with the goal of maintaining the mines at break-even next year.
Monckton closure = +8m
Hargreaves announced today that it will close its Monckton coke works, having failed to find a buyer. This will result in cash costs of 4.8m and a further 13.6m of non-cash impairments.
However, the gradual sale of Moncktons coke stocks will generate a lot of cash, and Hargreaves expects a cash inflow of 8m from the closure of Monckton during the current financial year.
Hargreaves is in decline
Coal mining and coal-fired power generation will almost certainly continue to decline in the UK.
Rather than trying to fight a losing battle, Hargreaves is simply cutting investment wherever possible and freeing up cash by allowing its business to shrink.
The results are clear: net debt fell from 80m to 69m last year, while the dividend rose by 24%. A further 22% dividend increase is expected for the current year, in addition to a buyback of up to 10% of the companys shares.
Hargreaves shares currently look cheap, with a prospective yield of 5.2%, and a P/E of 5.7.
However, theyre cheap for a reason: its almost impossible for Hargreaves to deliver long-term growth, so the shares are a sell for me.
Hargreaves is becoming a special situation investment, in my view — and requires careful analysis of the UK’s coal industry.
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