U.S. China Mining Group Analysis

U.S. China Mining Group (SGZH, formerly known as Songzai International Holding Group) is a Chinese coal mining group that operates three thermal coal mines in Heilongjiang province, close to the Russian border.

Production Numbers:

Tong Gong
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March 2008 - Prod: 137,536 - Sales: 137,536
June 2008  - Prod: 168,245 - Sales: 168,245
Sept 2008  - Prod:  66,448 - Sales: 153,517 - Brokerage:  87,069
Dec  2008  - Prod:       0 - Sales: 149,457 - Brokerage: 149,457
March 2009 - Prod:  98,031 - Sales:  98,031
June 2009  - Prod: 184,553 - Sales: 184,553
Sept 2009  - Prod:  67,416 - Sales: 107,645 - Brokerage:  55,000
Dec  2009  - Prod:       0 - Sales:  84,171 - Brokerage:  69,400
March 2010 - Prod:  88,906 - Sales:  88,906 
June 2010  - Prod:  49,310 - Sales:  99,310 - Brokerage:  50,000
Sept 2010  - Prod:  30,810 - Sales: 130,810 - Brokerage: 100,000

Xing An
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March 2008 - Prod: 539,737 - Sales: 472,019
June 2008  - Prod: 120,000 - Sales: 225,590
Sept 2008  - Prod:       0 - Sales: 255,909 - Brokerage: 246,000
Dec  2008  - Prod:  83,543 - Sales: 241,944 - Brokerage: 157,700
March 2009 - Prod: 433,806 - Sales: 271,753
June 2009  - Prod:       0 - Sales: 303,002 - Brokerage: 180,000
Sept 2009  - Prod:       0 - Sales: 102,148 - Brokerage: 100,000
Dec  2009  - Prod: 173,252 - Sales: 172,542
March 2010 - Prod: 148,818 - Sales: 175,216 - Brokerage:  30,296
June 2010  - Prod:       0 - Sales: 116,179 - Brokerage: 159,679
Sept 2010  - Prod:       0 - Sales: 242,984 - Brokerage: 223,185

Avg. Selling Price / Cost per ton

March 2008 - $32.12 - $12.17 (37.9%)
June  2008 - $32.69 - $13.59 (41.6%)
Sept  2008 - $37.61 - $16.75 (44.5%)

March 2009 - $56.14 - $15.37 (27.4%)
June  2009 - $49.59 - $14.96 (30.1%)
Sept  2009 - $44.17 - $21.96 (49.7%)

March 2010 - $47.55 - $29.25 (61.5%)
June  2010 - $46.25 - $28.27 (61.1%)
Sept  2010 - $47.84 - $26.97 (56.4%)

Reasons for higher cost per ton:

- outsourcing the mining work to independent contractors (overall price inflation)
- amortization and depreciation

Brokered coal:

In addition to mining coal, we also broker coal from small independent mines operating in the areas surrounding the mines that we operate. Because operators of these small mines often lack the means to transport coal from the mines, they have no market for their coal other than selling it to us at competitive prices. The brokered coal enables our subsidiaries to fulfill their respective sales obligations. Tong Gong currently brokers approximately 124,400 tons of coal annually at approximately 30% mark up of the costs of the coal that it mines. Xing An, on the other hand, brokers approximately 280,000 tons of coal annually at approximately the same costs as the coal that the company mines.

Sales - Gross Profit - Net Income

March 2008 - 15,162,953 -  9,415,179 (62.1%) -  6,799,176 (44.8%)
June  2008 - 12,873,937 -  7,523,624 (58.4%) -  4,659,861 (36.2%)
Sept  2008 - 14,874,732 -  8,496,047 (57.1%) -  6,122,684 (41.2%)
Dec   2008 - 14,218,476 -  7,349,565 (51.7%) -  5,283,234 (37.2%)
March 2009 - 20,758,454 - 15,076,682 (72.6%) - 11,129,749 (53.6%)
June  2009 - 24,179,166 - 16,532,705 (68.4%) - 12,404,475 (51.3%)
Sept  2009 -  9,267,268 -  4,502,711 (48.6%) -  2,757,819 (29.8%)
Dec   2009 - 10,793,568 -  4,104,337 (38.0%) -    947,871 ( 8.8%)
March 2010 - 12,558,119 -  4,832,496 (38.5%) -  2,125,301 (16.9%)
June  2010 -  9,965,946 -  3,874,659 (38.9%) -  1,832,708 (18.4%)
Sept  2010 - 17,854,483 -  7,787,987 (43.6%) -  3,850,140 (21.6%)
Dec   2010 - 26,121,452 -                    -  6,291,851 (24.1%) GUIDANCE

Reasons for higher operating expenses:

- transportation infrastructure construction fee (since May 2010): RMB 10 per ton of sales
- security special purpose fee (since June 2010): RMB 10 per ton of sales
- coal price adjusting fund (since June 2010): RMB 20 per ton of sales
- total local government fees per tons of sales: RMB 40 ($6.00)
- increased payroll and welfare expenses

Reserves:

Tong Gong: 5.9 million tons
Xing An: 19.6 million tons

Energy Content:

Tong Gong: 10.08 btu/pound (5,600 kcal/kg)
Xing An: 6.6 - 9.0 btu/pound (4,330 kcal/kg)

Average: ~4,650 kcal/kg

Thermal coal prices are usually set for a heating content of 5,500 kcal/kg

Fiscal Year 2010 Guidance:

"Management expects the Company to generate revenue of approximately $66.5 million with net income of approximately $14.1 million for the 2010 Fiscal year ending December 31, 2010."

That translates into a record $26.1 million in sales for Q4/10 and net margins of 24.1%, the highest since Q3/09. The December quarter would be the strongest of the year and the most profitable since Q2/09.

Fiscal Year 2011 Projection:

Production: 900,000 tons (Tong Gong: 200,000 + Xing An: 700,000)
Brokerage: 700,000 tons (First 9 months of 2010: brokered 563,000 tons)
Total sales: 1,600,000 tons

Price projection (2011):
- Shanxi ($78/ton) - 10% (Heilongjiang) - $70/ton
- SGZH's coal (lower energy content): $59/ton
- Using another 10% discount here because the company seems to sell their coal at a discount to market in Heilongjiang.
- Projected price per ton: $53 (up from $48 in Q3/2010)

Total 2011 sales: $92.8 million (up 39.5% from $66.5 million in FY 2010)
Gross margin: 50% (up from 43.6% in Q3/2010) - based on more effective resumed Xing An and management comments
Gross profit: $46.4 million
Operating expenses: $14.9 million or 16% of revenue (up from 13.8% in Q3/2010) on higher wages and welfare expenses, overall price inflation. Included are local and provincial government fees of $9.6 million (based on 1.6 million tons coal sold)
Net income before tax: $31.2 million
Net income: $23.1 million (up 63.8% from $14.1 million in FY 2010)

Total FD shares outstanding: 15.35 million
2011 projected EPS: $1.50

Adjustments:

Adding $0.10 EPS as the company has historically mined more coal than its permits allow. Company says this is tolerated in Heilongjiang province. Demand for steam coal should be strong in 2011 and the company has already announced to pursue "short term production opportunities" next year.

Final 2011 EPS projection: $1.60

Upside:

- higher brokerage sales (likely)
- higher coal prices (unlikely)
- acquisitions ("expanding our efforts to pursue other mining properties")

The company has $40.15 million in cash ($2.61 per share), no receivables problem, insignificant debt, and strong cash flow.

Current valuation ($7.25): P/E 4.5 (ex-cash: 2.9)

SGZH is a current position of the Trading China Model Portfolio