First Look at Arch Coal (ACI). Stock price -75% over past 52 weeks. Should you buy?

Arch Coal’s stock price has declined over 75% in the past 52 weeks.  Should you buy like this article recommends?  http://seekingalpha.com/article/473521-4-reasons-why-analysts-expect-arch-coal-s-stock-to-double.  The answer is no because the dividend isn’t safe and the balance sheet is weak.  Read on to see how I came to that conclusion.

Arch Coal (ACI)

Price: $9.76

Shares: 213.29 million

Market capitalization: $2.08 billion

What does the company do: Arch Coal is the nation's second-largest coal producer. Based in St. Louis, Arch provides coal for 6% of the United States' electricity generation. The company owns and operates mining facilities in the Appalachian region in West Virginia, Virginia, and Kentucky; the Powder River Basin in Wyoming; and the Western Bituminous Region in Colorado and Utah. In 2011, Arch sold 155 million tons of coal.

Morningstar’s take: Arch Coal is the second-largest coal producer in the United States, with significant assets in the Powder River Basin (PRB), Central Appalachia, and various Western states (Western Bituminous). The PRB is ruled by a stable oligopoly of firms and is Arch's best asset. However, the company's purchase of International Coal Group, which was struck months before the European crisis, may have put that advantage in jeopardy. With the Chinese economy showing signs of slowing, an investment in Arch is now more of a souped-up play on global economic recovery than methodical value creation.

Bonds: $9.0 billion outstanding.  The bonds are a threat to the common dividend.

Times interest earned:  Arch Coal paid $230 million on interest charges in 2011.  They earned $142 million net income in 2011.  This is troubling.  They only earned 0.62 times their interest expenses.  The father of value investing, Benjamin Graham, likes to see a company earn at least four times their fixed charges (interest expenses).  All of these bonds are ahead of the common dividend.

Preferred stock: none.

DIVIDEND RECORD: Arch Coal cut their quarterly dividend by 50% in late 1999 from $0.06 to $0.03.  They have grown it back to $0.11 since late 1999.

Dividend: $0.11 quarterly

Dividend yield: 4.5% ($0.44 annual dividend / $9.76 share price)

Dividend payout: 58.6% ($0.44 / $0.75 2011 EPS) –OR- 56% ($0.44 / $0.79 average adjusted earning power)

EARNING POWER: $0.79 per share @ 213.29 million shares

(earnings adjusted for changes in capitalization – typically share buybacks and/or additional shares created)

	EPS	Net income	Shares	Adjusted EPS
2005	$0.18	$38 M	129 M	$0.18
2006	$1.80	$261 M	145 M	$1.22
2007	$1.21	$175 M	144 M	$0.82
2008	$2.45	$354 M	144 M	$1.66
2009	$0.28	$42 M	151 M	$0.20
2010	$0.97	$159 M	163 M	$0.75
2011	$0.74	$142 M	191 M	$0.67

Seven year average adjusted earnings per share is $0.79

Consider contrarian buying below $6.32 (8 times average adjusted EPS)

Consider value buying below $9.48 (12 times average adjusted EPS)

Arch Coal (ACI) is currently trading at 12.4 times average adjusted EPS.  This is stock is priced for investment.  It isn’t as cheap as the happy faced articles portray.

Consider speculative selling above $15.80 (20 times average adjusted EPS)

BALANCE SHEET – The price to book and tangible book values look great.  But the company has little current assets to pay its current liabilities.  The overall balance sheet is not strong.

Book value per share: $16.78 ($3,578 M equity / 213.29 M shares)

Price to book value ratio: 0.58 (under 1.0 is good)

Tangible book value per share: $13.98

Price to tangible book value: 0.70 (under 1.0 is really good)

Current ratio: 1.16 latest quarter (over 2.0 is good) ($1,183 M current assets / $1,021 M current liabilities)

Quick ratio: 0.14 latest quarter (over 1.0 is good) Horrible!! No cash!  ($138 M cash or equivalents/ $1,021 M current liabilities)

Debt to equity ratio: 1.05 (lower is better)  Too much debt to equity.

Percentage of total assets in plant, property, and equipment: 77.8% (the higher the better).  Current assets = 11.58%, intangibles = 5.84%, and other long term assets = 4.76%

Working capital trend: Their trend is certainly not up, but at least 90% of the last 10 years are positive numbers.

CONCLUSION – Arch Coal is cheaper not than during the Panic of 2008 – 2009.  It has lost over 75% of its share price in the last 52 weeks, but that doesn’t mean you should buy it.  The dividend is 4.5%, but it is not safe due to the bonds.  They have cut the dividend drastically in the past and I see no reason why they wouldn’t do that again in the future.  Coals main competitor, natural gas, is extremely cheap.  That will inhibit earnings growth in the coal industry until the price of natural gas goes much higher.  Arch coal’s share price is currently flirting with value territory of less than 12 times average adjusted earning power.  I think poor commodity fundamentals and a worldwide double dip recession are going to sink this stock further.  The weak balance sheet real is a deal breakers.  They are going to have to sell more shares in a secondary offering or take on more debt to pay for their current liabilities.  I think that Arch Coal should not be bought until they strengthen their balance sheet by paying of debts.

DISCLOSURE – I don’t own Arch Coal (ACI).

Subscribe today for free at www.myhighdividendstocks.com/feed to discover high dividend stocks with earning power and strong balance sheets.

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First look at Enerplus Corporation (ERF). Huge dividend, weak balance sheet.

Seeking Alpha contributor, EFSinvestment, wrote that Enerplus Corporation (ERF) is a buy at today’s price of $17.76.  His article is here: http://seekingalpha.com/article/513701-dividend-stock-ideas-2-buys-3-holds .  He pays no attention to the effects of a worldwide recession on oil and natural gas prices.  That will hurt earning further.  And he pays no attention to the balance sheet.  This is what he wrote:

Enerplus Corporation - Buy

With a dividend yield of 12.1%, Enerplus is one of the top-yielding Canadian commodity stocks. In the last year, the company paid $389 million in dividends. While it might be claimed that the payout ratio is unsustainable, I think the dividend is pretty safe. It is more than fully covered by the company's operating cash flow. Enerplus generated an operating cash flow of $641 million in the last 12 months.

(click to enlarge)

(Source: Finviz.com)

Due to company's exposure to natural gas-related assets, the stock has lost more than 26% in this year alone. However, it looks like a cheap deal after the recent sell-off. Enerplus is trading near its book value. The P/S and P/CF ratios stand at 2.4, and 5.3, respectively. The company has substantial assets in the Marcellus and Bakken shales. Morningstar claims that these assets could prove highly productive in the long term.

My FED+ fair model suggests a fair value range of $20 - $38. Analysts mean target price of $26.79 fits almost perfectly at the middle of my fair value range. The current price of $18 suggests that Enerplus is deeply undervalued. I think the stock is oversold, and ready for a big bounce. That is why I rate it as a buy.

Here is my first look analysis of Enerplus Corporation

Enerplus Corporation (ERF)

Price: $17.76

Shares: 196.30 million

Market capitalization: $3.48 billion

All the financial numbers are in Canadian dollars.  Fortunately the US dollar and Canadian dollar are at near parity.  Here is a Google Finance chart of the last 10 years of USD to CAD exchange rates.

What does the company do – Enerplus, based in Calgary, Alberta, is an independent energy company engaged in the exploration for and production of oil and gas in the Western Canadian Sedimentary Basin and Pennsylvania's Marcellus Shale. At the end of 2010, the company reported proven reserves of 219.4 million barrels of oil equivalent. Daily net production averaged about 83,139 barrels of oil equivalent per day in 2010 at a ratio of 58% gas/42% liquids.

Morningstar’s take - The passing of 2010 marked a series of changes for Enerplus as it converted from an income trust to a corporation. The company sold off conventional and oil sands assets, using the proceeds to build its acreage position in Pennsylvania's Marcellus Shale and the Bakken in North Dakota and Saskatchewan. We think the company will continue to pay an attractive dividend and aggressively pursue production growth in the Marcellus and Bakken.

Bonds: According to Morningstar.com Enerplus Corp has no bond data available.

Times interest earned:  ERF’s 2011 net income was $109 million and the company paid $60 million in interest charges.  This means that the company earned only 1.81 times the interest on its long term debts.  The father of value investing, Benjamin Graham, believed that a company should earn fully four times the interest charges to warrant the purchase of shares of an industrial preferred stock.

Preferred stock: none

Margin of profit: 8.19%  Profit margins were between 18.7% and 37.9% from 2002 through 2008.  Since then they have ranged between 6.9% and 9.4%.

DIVIDEND RECORD: Enerplus Corporation cut its dividend 57% from $0.42 monthly in late 2008 to $0.18 monthly since the beginning of 2009.  There has been no dividend growth since the cut.

Dividend: $0.18 monthly

Dividend yield: 12.16%  ($2.16 annual dividend / $17.76 share price)

Dividend payout: 386% ($2.16 / $0.56 EPS in 2011) –OR- 133% ($2.16 / $1.62 average adjusted earning power).  Either way ERF the dividend is not safe by any measure.  The world is reentering recession.  That will drive the price of oil down and natural gas price will not recover anytime soon.  I expect another significant dividend cut in the next year.

EARNING POWER: $1.62* @ 196.3 million shares

*Canadian dollars (earnings adjusted for changes in capitalization – typically share buybacks and/or additional shares created)

	EPS	Net income	Shares	Adjusted EPS
2005	$3.95	$432 M	109 M	$2.20
2006	$4.47	$545 M	122 M	$2.78
2007	$2.66	$340 M	128 M	$1.73
2008	$5.53	$889 M	161 M	$4.53
2009	$0.53	$89 M	170 M	$0.45
2010	($1.02)	($179 M)	176 M	($0.91)
2011	$0.61	$109 M	180 M	$0.56

Seven year average adjusted earnings per share is $1.62

Consider contrarian buying below $12.96 (8 times average adjusted EPS)

Enerplus Corporation (ERF) is currently trading at 10.96 times average adjusted EPS.  This is stock is value priced.

Consider value buying below $19.44 (12 times average adjusted EPS)

Consider speculative selling above $32.40 (20 times average adjusted EPS)

BALANCE SHEET – ERF’s current ratio and quick ratio reveal how tenuous their balance sheet is.

Book value per share: $16.69 ($3,277 million shareholder equity / 196.3 million shares)

Tangible book value per share: $15.90 (shareholder equity – intangible assets of $155 million / shares)

Price to book value ratio: $1.06 (under 1.0 is good)

Price to tangible book value ratio: 1.11 (under 1.0 is great)

Current ratio: 0.27 latest quarter (over 2.0 is good)

Quick ratio: 0.011 latest quarter (over 1.0 is good)

Debt to equity ratio: 0.26 (lower is better)

Percentage of total assets in plant, property, and equipment: 90.98% (the higher the better)

Working capital trend is down.  That means that ERF must find funding to make up the difference.  This is a bad sign coupled with the extreme dividend payout ratio.

CONCLUSION – The best time to buy Enerplus Corporation in recent years was in 2009 when the stock bottomed around $15 per share.  However there is a worry-some downward spike in the price during the “flash crash” of May 2010.  I don’t like stocks that get pummeled in flash crashes.  ERF is a high dividend stock yielding over 12%, but the dividend is not safe based on the expected earnings in the near future.  The world is slipping back into recession.  Europe is already in recession, China is moving towards recession, and the US data keeps getting worse.  Recessions cause oil prices to drop.  That will reduce ERF’s earnings like in 2009.  Natural gas has dropped, dropped, dropped.  Maybe it stabilizes at around $2 per MCF or $3, but the point is that it will not miraculously go back up to $10 - $14 per MCF with all the supply increases due to the fracking technology.  I expect ERF to cut their dividend significantly again when its obvious to the common man that worldwide recession is back.  The stock price is value now, but it will be even cheaper in the near future.  ERF’s balance sheet has several weaknesses.  Their low current ratio and quick ratio shows that the company has little current assets to pay for current liabilities.  Those liabilities will need to be funded through additional stock offerings or increasing long term debts.  This isn’t a single year issue.  Look at the working capital trend to see a company that is always short of paying its current liabilities from current assets.  I would ignore this company until they cut their dividend and improve their balance sheet.

DISCLOSURE – I don’t own Enerplus Corporation (ERF).

Subscribe today for free at www.myhighdividendstocks.com/feed to discover high dividend stocks with earning power and strong balance sheets.

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TIP OF THE WEEK - What the Heck is Working Capital and Why Should You Care?

What the Heck is Working Capital and Why Should You Care?

Jason Brizic

April 20^st, 2011

You need to know what working capital is because it is one of the indicators of balance sheet strength.

Follow Benjamin Graham’s advice on the importance of working capital.  The following passage comes from the 1937 book The Interpretation of Financial Statements Chapter XII:

            In studying what is called the “current position” of an enterprise, we never consider the current assets by themselves, but only in relation to the current liabilities.  The current position involves two important factors: (a) the excess of current assets over current liabilities – known as the Net Current Assets or the Working Capital, and (b) the ratio of current assets to current liabilities – known as the Current Ratio.

            The Working Capital is found by subtracting the current liabilities from the current assets.  Working Capital is a consideration of major importance in determining financial strength of an industrial enterprise, and it deserves attention also in the analysis of public utility and railroad securities.

            In the working capital is found the measure of the company’s ability to carry on its normal business comfortably and without financial stringency, to expand its operations without the need of new financing, and to meet emergencies and losses without disaster.  The investment in plant account (or fixed assets) is of little aid in meeting these demands.  Shortage of working capital, at its very least, results in slow payment of bills with attendant poor credit rating, in curtailment of operations and rejection of desirable business, and in a general inability to “turn around” and make progress.  Its more serious consequence is insolvency and the bankruptcy court.

            The proper amount of working capital required by a particular enterprise will depend upon both the amount and the character of its business.  The chief point of comparison is the amount of working capital per dollar of sales.  A company doing business for cash and enjoying a rapid turnover of inventory – for example, a chain grocery enterprise – needs a much lower working capital compared with sales than does the manufacturer of heavy machinery sold on long-term payments.

            The working capital is also studied in relation to fixed assets and to capitalization, especially the funded debt and preferred stock.  A good industrial bond or preferred stock is expected, in most cases, to be entirely covered in amount by the net current assets.  The working capital available for each share of common stock is an interesting figure in common stock analysis.  The growth or decline of the working capital position over a period of years is also worthy of the investor’s attention.

            In the field of railroads and public utilities, the working capital item is not scrutinized as carefully as in the case of industrials.  The nature of these service enterprises is such as to require relatively little investment in receivables or inventory (supplies).  It has been customary to provide for expansion by means of new financing rather than out of surplus cash.  A prosperous utility may at times permit its current liabilities to exceed its current assets, replenishing the working capital position a little later as part of its financing program.

            The careful investor, however, will prefer utility and railroad companies that consistently show a comfortable working capital situation.

Let’s take a look at Safe Bulkers (SB) working capital situation from the past few years (Source: Morningstar.com).  Safe Bulkers financial strength has been eroding along with the dry bulk shipping market.

	12/2007	12/2008	12/2009	12/2010	12/2011
Total Current Assets	$98,883,000	$88,086,000	$105,648,000	$104,276,000	$37,959,000
Total Current Liabilities	$43,984,000	$70,863,000	$65,551,000	$52,983,000	$51,673,000
Working Capital	$54,899,000	$17,223,000	$40,097,000	$51,293,000	($13,714,000)
Current Ratio	2.25	1.24	1.61	1.97	0.73
Revenues	$165,848,000	$200,772,000	$164,606,000	$157,020,000	$168,908,000
WC as % of Revenue	33.1%	8.6%	24.4%	32.7%	N/A

For more tips, go here:

http://www.myhighdividendstocks.com/category/tip-of-the-week

The Interpretation of Financial Statements - Ratio Analysis using Safe Bulkes (SB) as an example

I recently finished reading Benjamin Graham’s 1937 classic The Interpretation of Financial Statements.  Graham explains the financial statement concepts in clear English.  At the end of the book he walks the reader through the analysis of a balance sheet and income statement using the ratio method.  His example was Bethlehem Steel Corporation.

I will do the same with Safe Bulkers (SB).

A number of the ratios used in the analysis of an industrial company’s income account and balance sheet are presented herewith by the use of a single example – namely the financial statements of the Safe Bulkers corporation for 2011.  Various items in the Balance Sheet and Income account are numbered.  This will facilitate the explanation as to the method of computing ratios.  For example margin of profit, the first ratio computed in this study, is operating income divided by sales.  On the Income Account operating income is item No. 4 and sales is item No. 1.  The method of computing margin of profit is expressed at (4) ÷

(1) or in actual amounts $108,936,000 ÷

$172,036,000 = 63.3%

SAFE BULKERS

Income Account Year Ended December 31, 2011

(1)	Revenues	$172,036,000
	Commissions	(3,128,000)
(2)	Voyage, vessel operating, general and administrative expenses	(36,542,000)
	Early redelivery income	207,000
(3)	Depreciation	(23,637,000)
(4)	Operating Income	$108,936,000
	Add – interest, dividends, and other misc income	0
(5)	Total Income	$108,936,000
(6)	Deduct-Interest charges	(19,202,000)
(7)	Net Income	$89,734,000
(8)	Deduct-Dividends on Preferred Stock	0
(9)	Net for Common Stock	$89,734,000
	Deduct-Dividends on Common Stock	$42,536,652
(10)	Transferred to Surplus	$47,197,348

BALANCE SHEET

SAFE BULKERS

December 31^st, 2011

ASSETS

	Current Assets:
(11)	Cash, time deposits	$28,121,000
(12)	Other current assets	9,838,000
(13)	Accounts and notes receivable	0
(14)	Inventories	0
(15)	Total Current Assets		$37,959,000
	Advances for vessel acquisition and vessels under construction	$122,307,000
	Restricted cash non-current	5,423,000
	Long-term investment	50,000,000
	Other non-current assets	6,226,000
(16)	Vessels	?
(17)	Less reserve for depreciation and depletion	0
(18)	Vessels, net	$655,356,000
	Total Long Term Assets		$ 839,312,000
	Total Assets		$877,271,000

LIABILITIES

	Current Liabilities:
	Current portion of long-term debt	$18,486,000
	Other current liabilities	$33,187,000
(19)	Total Current Liabilities		$ 51,673,000
(20)	Long-term debts, net of current portion	$465,805,000
(21)	Other non-current liabilities	$27,951,000
	Total Non-current Liabilities		$493,756,000
(22)	Common stock 70,894,420 shares, no par value?	0
(23)	Shareholder equity (Surplus)	$331,842,000
	Total Shareholder Equity		$331,842,000
	Total Liabilities		$877,271,000

Margin of Profit

Operating income divided by Sales.

Formula: (4) ÷

(1)