Questor share tip: Hargreaves' record profits show coal is still king

Hargreaves Services

620p-15

Questor says BUY

Turnover actually fell by 8.6pc to £459.8m but profits still rose 17.4pc to a record £30.7m. That's because the company charges a fixed margin on its coal sales, which means falling coal prices over the period have not impacted profits.

The company also increased its full-year dividend by 14.4pc to 13.6p. The final payment of 9.1p will be made on November 17 and new investors can buy the shares before October 13 to qualify for this payment. The yield is 2.4pc.

But what about future earnings?

Hargreaves' cash position should start to improve now the group's major capital projects are up and running. The company also has projects that could grow organically.

The Tower Colliery in South Wales is likely to open over the next year – and output from this site does not appear to be included in market forecasts.

The company has also moved into Europe, where substantial growth opportunities exist.

In the UK the company has a market share of more than 60pc. Indeed, it supplies coal to all the steam railways in the country and if you buy charcoal for a barbecue the coals are more than likely to have come from one of Hargreaves' mines. But in Europe, the group's market share in just 5pc, so there is ample room to grow.

The group's renewable RocPower project has also developed a small biomass power plant. It plans to develop two more, depending on decisions over government subsides.

The green energy sector has an incentive scheme called the Renewable Obligation Certificate (ROC) and the plant is accredited for this until 2013. Of course, as the Government attempts to introduce cuts there may be some adjustment to this system.

"We will continue to progress planning on the next two sites in the UK but at the same time we will be working with the UK Government... to secure approval of guaranteed renewable accreditation post-2013 to allow us to continue to build further plants through 2011," Hargreaves said.

One positive on this front is that the type of plant developed by Hargreaves burns tallow – a waste product from making paper. The site does not burn agricultural products which could be used as food.

Although Hargreaves said it was "disappointed" by the possible change in future subsidies, the fact that the plant burns a true waste product is in its favour.

The company also has a number of longer-term coal contracts that are at levels below the current spot prices. As these contracts end, they are likely to be renegotiated at a higher level.

Earlier this year, the Hargeaves made a bid for UK Coal, from which it eventually walked away. Questor was very cautious over the potential deal, which ultimately came to nothing. The company is now focusing on the organic growth opportunities detailed above. Management said they do not plan to buy any more deep mines at present.

The shares are up 18pc since their initial recommendation on February 22 last year at 542½p, compared with a market up 42pc.

Trading on a May 2011 price-earnings multiple of just 5.8 times falling to 5.6 in 2012, the shares offer good value.