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New Hope Looks Good, But Is Free Cash Flow Negative

Summary New Hope is one of Australia’s companies focused on coal. It says it wants to acquire new projects with its A$1B working capital position, but it’s spending cash like there’s no tomorrow. The dividend is 7 times higher than the free cash flow is. If New Hope is serious about its expansion plans, it should reduce its dividend payments right now. Introduction After identifying Whitehaven Coal ( OTCPK:WHITF ) as a great coal company, I continued to look for other companies and was waiting for New Hope’s ( OTCPK:NHPEF ) financial results to see whether or not this is another coal company I should add to my list. Source: company presentation New Hope has a more liquid listing at the Australian Stock Exchange where it’s listed with NHC as its ticker symbol. The current market capitalization is approximately US$1.05B, so this isn’t your average micro-cap company. The company is still flowing cash Everybody knows the entire coal sector is suffering due to low prices, but fortunately the Australian producers have one advantage; the extremely weak Australian Dollar. As the Australian currency has lost in excess of 30% of its value in just one year time, the Australian companies are doing much better than their competition as even though they are still selling the coal in USD, the local expenses are a few dozen percents cheaper than one year ago, protecting the margins. (click to enlarge) Source: financial statements And yes, this seems to be proven in the company’s financial statements as even though the revenue decreased by 11%, the cost of sales fell by 17% and this would have resulted in a pre-tax profit of A$73M ($52M), if New Hope would have been able to avoid an A$97M impairment charge. This pushed the pre-tax profit in the red and even after a small tax benefit the bottom line was still showing a net loss of almost A$22M ($16M). Fortunately an impairment charge never has any influence on a company’s ability to generate cash flows, so I would think the cash flows of New Hope would remain pretty decent but the only way to find out is by checking the cash flow statements. That’s why I waited for New Hope to publish its annual report, as (unlike the quarterly reports), the company has to provide a cash flow overview as well. (click to enlarge) Source: financial statements The operating cash flow was A$88.5M ($63M) (after taxes), and whilst that’s still pretty good, considering the worsening circumstances on the coal market, you shouldn’t forget the total capital expenditures were A$115M ($82M), so New Hope was free cash flow negative. Again, that’s nothing to worry about because a) the negative cash flow is still limited and b) New Hope has a substantial amount of cash on its balance sheet. The negative free cash flow was A$26.5M ($18M), but in the next part of this article I’ll explain why I’m not really worried about this cash shortfall. But is spending more than it receives, and I don’t like that Indeed, that’s New Hope’s strength. It has a working capital position of in excess of A$1B ($700M) and a current ratio of in excess of 11 and that’s extremely high. This strong working capital position will also allow New Hope to indeed pursue the acquisitions it has been eying as this must be the only coal company in the world with such a financial flexibility. (click to enlarge) Source: financial statements The majority of its cash is being held in term deposits, and this resulted in a total interest income of A$38M in FY 2015. This was sufficient to cover the shortfall of the operating cash flow to fund the capital expenditures, but despite the free cash flow increasing to A$11.5M, it’s quite annoying to see the company has spent A$79M on paying dividends. And it won’t stop there. Together with the presentation with the company has announced a final dividend of A$0.025 and a special dividend of A$0.035 to bring the total dividend for the financial year at A$0.10 ($0.07). Using the current amount of 831M outstanding shares, this means New Hope will be paying A$83M in dividends based on its FY 2015 results. And that’s a pity. The adjusted free cash flow was a positive A$11.5M, but paying A$83M in dividends is definitely weakening the company’s financial situation. Of course, it still has in excess of one billion of Australian Dollars in working capital, but I have a firm opinion the company should NOT pay out more cash than it’s taking in from its operations. Investment thesis The shareholders will be happy with a 6% dividend yield, but I believe not a single company should pay out more cash than it’s generating. New Hope has publicly declared it wants to acquire more projects, to paying out almost A$100M ($71M) in dividends probably is one of the most stupid things the company could do. I like coal, and I like New Hope’s strong and solid financial status, but it’s not helping the company at all to spend cash on dividends instead of keeping the cash in its treasury. The working capital decreased from almost A$1.2B to A$1.1B in the past year, and that seems to be a bit contradictory to the company’s public claims it’s looking for acquisition targets. If New Hope is really serious about becoming a major player in the coal space, it should cut the dividend and cash up. Now. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Staying Level-Headed In The Face Of Fed Uncertainty

By John P. Calamos, Sr. As we know, uncertainty about the Fed’s plans for raising short-term rates remains a key driver of market volatility. It’s understandable that investors are afraid to be in the markets and at the same time, afraid to be out. Whenever rates do rise (probably before the end of the year), there’s every reason to expect continued heightened equity market volatility. Even so, I view a more normal interest-rate environment as long-term positive – for the economy and for the equity market. Here are some points to keep in mind. Higher short-term rates should be viewed as an affirmation of U.S. economic health. The Fed has consistently expressed its commitment to a patient, globally-informed, data-driven approach. It will raise rates when it believes the U.S. economy is strong enough to continue growing without artificially low rates. The “path” of short-term rate increases is likely to be slow and shallow. In other words, I don’t believe we’ll see the Fed move to raise rates significantly and many times, provided that the overall economic landscape remains consistent with what we’ve seen over recent years – slow growth, low inflation. A more normal interest rate environment can support continued economic growth, particularly among smaller businesses. When interest rates are higher, lenders can earn more from borrowing activities. This should provide an increased incentive to lend to small businesses, especially against the supportive backdrop of continued economic growth. With increased access to capital, small businesses can grow and hire more people, contributing to better overall economic growth. Higher short-term rates don’t signal that we’ve entered a bear market. Earlier, I noted that markets are likely to remain volatile when rates rise, but that doesn’t mean there won’t be opportunities, especially for long-term investors who take an active approach. Historically, stocks tend to perform well during periods of economic growth (see point #1). Stocks have continued to advance after the onset of an interest rate increase, as Figure 1 shows. Moreover, as our Co-CIO David Kalis explained in his recent video interview , the prospects for U.S. growth stocks look especially attractive. (click to enlarge) Past performance is no guarantee of future results. Source: Cornerstone Macro. “Positioning For A Fed Tightening Cycle,” September 16, 2015. Convertible allocations may be particularly effective in this sort of environment. Because they have fixed income characteristics, convertibles may be able to mitigate the impact of short-term equity downside. And because they have equity characteristics, convertible securities generally demonstrate less vulnerability to interest rate increases than investment grade bonds. That means that when rates do rise, allocations to convertibles may prove more resilient. (Co-CIO Eli Pars outlines more of these potential benefits in this video interview .) It’s been observed time and again that markets hate uncertainty. That’s not likely to change. More importantly, what’s also not likely to change is this: volatility creates opportunity for those who can tune out the short-term noise and take a long-term view. Share this article with a colleague

COPEL Is Much More Stable Than CEMIG, But The Potential Upside Is Also Lower

Summary COPEL’s business is sound, with slow growth, low debt, a good dividend, good fundamentals and a good, stable historical performance. Due to the situation in Brazil, there is still more downside potential for the stock. CEMIG is a much more risky play, but the upside is also much higher. Introduction I recently wrote an article where I analyzed investment opportunities in Brazil that are listed on the NYSE and gave an overview of the economic situation. I found four interesting companies, of which BrasilAgro (NYSE: LND ) and Brasil Foods S.A. (NYSE: BRFS ) are good, but their P/E ratio is too high. This leaves us with two electrical companies, CEMIG (NYSE: CIG ) and Companhia Paranaense de Energia – COPEL (NYSE: ELP ). I have already written about CEMIG here and here , so in this article, I will analyze COPEL. About ELP ELP is the largest company of the State of Paraná (South Brazil), and serves electricity to 4,370,200 units. The company uses 18 hydroelectric plants that give 99.5% of its own electrical production, 1 thermal plant and 1 wind plant, with total installed capacity of 4,754 MW, a transmission system with 2,302 km of lines and 33 substations, a distribution system which consists of 192,116 km of lines and network of up to 230KV, and an optical telecommunication system. The company was founded in 1954, and has been listed on the NYSE since 1997. The State of Paraná is the major shareholder, with 58% of voting shares. There has been a lot of regulatory turbulence in the energy sector lately, especially with CIG losing 45% of its electricity generation capacity due to lost concessions. Energy prices increased and are currently under the red flag 3 regime, meaning that the electrical utilities sector is under pressure. The result of this is that ELP’s revenues increased 32% in Q2 2015, mostly due to price increases. Operating expenses increased even more, around 38% in the same period. The Business One of the main issues in the sector is that all the assets are mostly under concession from the government, but with the latest news on concessions, where the Federal Audit Court authorized the government to renew for another 30 years the concessions for electricity distributors whose contracts expire between 2015 and 2017, the situation is more stable now as compared to that a month ago. This is good news for ELP, as in the Q2 earnings conference call, the company did not know if its distribution concessions would be prolonged. As for electricity production, the situation with ELP is much more stable than it is with CIG, because ELP has only 5% of electricity production in doubt for 2015, whereas CIG had 45% of production in doubt, and eventually lost it. According to ELP’s CEO , the company will bid to renew the concessions and are pretty sure it will happen. The two plants in question are the Parigot de Souza and Mourão plants. ELP is also developing new projects, building 2,000 km of new distribution lines and developing new wind farms, with three new farms expected to start up in upcoming weeks. Fundamental Analysis The current P/E ratio is 7.91, and the price-to-book value is 0.6. In Table 1, you can see the main fundamental indicators for ELP and their stability in the Brazilian currency. Table 1: ELP Fundamentals 2010-2015 (Source: Morningstar ) In the Brazilian currency, ELP is able to transfer the increase in prices to its customers, which shows it to be a great hedge against inflation. The net income is pretty stable for a regulated electrical company, and it can be assumed with a high degree of certainty that ELP will continue to operate less or more positively in the future. The dividend is also stable, and the company has a policy of paying at least 25% of its net profits in dividends. This means that with the trailing earnings, an investor can expect minimally US$0.25 per share at the current exchange rate. This would give a 3% dividend yield at current prices and exchange rates. The gross margin is slowly deteriorating, but we can expect it to improve as soon as the extraordinary circumstances in the Brazilian energy market pass. Technical Analysis The main issue here is not ELP’s business or its fundamentals, but the volatility of the exchange rate between the US dollar and the Brazilian real. In Figure 1, you can see that an end to the depreciation of the real is nowhere to be seen. Figure 1: Brazilian real per US$1 from 2005 to 2015 (Source: XE.com ) I cannot predict what will happen here in the next few years. Currently, the situation in Brazil is far from stable, but in the period from 2009 to 2011, the real appreciated against the US dollar by 60%. We could say that there is blood on the Brazilian financial markets now, and usually, these are the best times to buy. But the main question is: How low can the real go? On the other hand, if we see an improvement in the political and economic situation in Brazil, the exchange rate trend would quickly switch and create a point of stability at a certain level. This trend reversal could give a 25% currency gain and add an extra 25% to the dollar EPS of ELP. This is a scenario that would easily create a 50% return for international investors. But we would need a crystal ball to know when the bottom will be reached in Brazil. Conclusion If ELP were a European or US company, I would probably buy it at these ratios, expecting a healthy 13% yearly return and a 3-4% dividend that would allow me to repurchase shares. With the uncertain situation in Brazil and the real depreciating at a 10% monthly rate (August and September 2015), I want a much wider margin of safety. The margin of safety that I would look for to feel comfortable investing in ELP would be one that gives me a 15% return even if the real depreciates by another 50%. This means that for US$1, we would get R$6. In such a scenario, ELP’s EPS would be US$0.66, and to get a 15% return, the P/E ratio should be 6.66 – meaning that a safe entry-level stock price for ELP is US$4.4. We are still far from that, but everything is possible considering the current situation. ELP is very stable, and Brazil is very unstable for sure in the short term, but potentially stable in the long term. Such a situation makes me believe that there might be a chance of the stock falling a little bit more, and thus, increasing the safety margin for investors. My advice would be put this company on a watch list, estimate your required rate of return for such an investment, adding to that the potential further depreciation of the real, and thus get to a safe entry price for yourself. Comparison with CIG ELP’s price-to-book ratio is 0.6, and CIG’s is currently at the same level. The P/E ratio is 8 with ELP and 3 for CIG, but with the unclear future earnings stream for CIG due to the loss of the concessions on 40% of its energy production, the difference is justified. I do not see potential spectacular earnings growth with ELP, because it is a stable company that aims for sustainable growth, whereas with CIG, everything is possible due to the management’s more risky approach to business. CIG has the potential to bring EPS to $US1.5 per share that would give a P/E ratio of 1.13 at current prices and a dividend yield of around 40%. The risk-reward ratio is 50% downside and 50% upside with ELP, while with CIG, it is 50-100% downside and 600% upside. I will continue to follow the two companies, and if the divergence between the perception the investor community has about Brazil and the businesses’ results continues to grow, thus lowering the potential downside, I will start buying. So, for now, I will put both companies on a watch list and let you know more in the future.