Fat Prophets take profits

We initially recommended Fording Canadian Coal (NYSE:FDG, TSX:FDG.UN) last December around $23.80, and subsequently in May this year around $25.50. We believed the stock had been oversold throughout 2006, and at the time of our buy recommendations, thought the turnaround had begun.

"While potential remains for further gains toward the September 2005 all-time high of $45.147 in the months ahead, we believe it is prudent to lock in a portion of the profits already achieved. "

As a reminder to Members, FDG owns a 60 percent interest in the Elk Valley Coal Partnership, which produces and sells hard coking coal for the manufacture of steel. Teck Cominco owns the remaining 40 percent. Elk Valley Coal owns interests in six operating coal mines, five of which are located in the Elk Valley region of Southeast British Columbia.

The bearish sentiment towards FDG in 2006 came from two areas. Firstly, the Canadian Government signaled its intention to change the income trust status of many existing Canadian Trusts. FDG operates under Trust status, which basically means it does not pay tax. However, in 2011, FDG will operate as a company and be taxed accordingly.

The other reason for FDG's decline was concern over coal prices. The market appeared to be betting that coal prices would revert to their long term averages, well below the price that FDG was receiving for their coal at the time.

This combined to see FDG's price fall considerably, and we sensed a contrarian opportunity.

This certainly turned out to be the case, as FDG has performed very well throughout 2007. Earlier this week, the trust reached a 19-month high of $40.99. This represents a gain of 72 percent in the 10-months since our initial buy recommendation, including a gain of almost 50 percent in the last two months alone.

While upward momentum remains firm with few significant signs of rally fatigue, any security would struggle to sustain such rapid gains. Accordingly, we cannot rule out the potential for a modest corrective dip in the weeks ahead. As marked on the daily chart, the July high provides support in the region of $35.39.

While potential remains for further gains toward the September 2005 all-time high of $45.147 in the months ahead, we believe it is prudent to lock in a portion of the profits already achieved.

Fundamentally, the company appears stretched. Investors seem to be anticipating higher coal prices over the next few years and while this is possible, US dollar weakness will likely offset much of these gains for the Canadian Trust.

According to Bloomberg consensus estimates, for the 12 months to December 2007, FDG trades on a price-to-earnings ratio of nearly 18 times. Higher expected coal revenues next year see this ratio drop to around 13.5 times for 2008. While this appears reasonable, FDG's revenues and earnings remain highly susceptible to coal prices given the absence of increased future production.

We therefore believe a prudent course of action would be to take some profits and recommend Members sell half of their exposure in FDG.

As highlighted in our technical analysis, given the strength of the underlying trend there is scope for further gains, following an anticipated correction. A 'strategic' value argument may drive these gains. Teck Cominco, who own a 40 percent stake in the Elk Valley Partnership, recently increased its stake in FDG by acquiring an additional 11.25 percent.

This takes Teck Cominco's stake to 19.95 percent and may well be a prelude to a full buy out. Predictably, Teck denies this. In an accompanying press release, the company stated, "Teck Cominco has acquired the units for investment purposes and has no plans to acquire any additional units of Fording". It would hardly be wise to tell the market you plan on buying more.

So this interest from Teck could see FDG's stock price remain buoyant, despite the fact the valuation appears stretched. As such, we will retain some exposure.