Fat prophets take profits

We took profits on Fording Canadian Coal (FDG) in FAT86 with a sell half recommendation. We reasoned that the company was looking stretched on a fundamental basis, however the charting outlook remained sound and provided scope for further share price gains.

"And with the absence of significant future coal production, we think the risks of relying on coal price strength just to support margins are compounded significantly. "

The company has since released disappointing results and issued a gloomy outlook which has resulted in a sharp decline in the shares. Needless to say, the charting outlook no longer looks favorable and we recommend selling the remaining exposure.

The Trust's third quarter results revealed a dismal recent performance. Revenues for the period fell 25 percent to C$331 million while net profits fell by nearly the same magnitude, to C$90.5 million.

The primary contributor to this was a lower than expected US dollar coal price but the significant weakening in the US dollar also had a negative impact on earnings. Members may recall that the Trust is exposed to this foreign currency risk as it sells its Canadian coal production into the US market.

Although this was mitigated somewhat from the foreign exchange forward contracts the Trust uses to hedge against adverse movements in the dollar, it was not enough to offset a substantial negative impact on earnings.

Of major concern is the fact that these hedging contracts will expire at the end of March 2008, which means that the Trust will be fully exposed to the weaker US dollar from 1 April onwards. Following this, Trust earnings will become significantly more sensitive to the movements in the US dollar.

Aside from this increased risk, the Trust is now relying on further increases in the US dollar coal price to maintain margins. With the absence of significant future coal production, we believe the Trust faces difficult times ahead, its earnings at the mercy of movements in the coal price.

And while further coal price rises may be possible, we believe any benefits will be erased by the impact of a weakening greenback.

FDG's President Boyd Paine is not painting an optimistic picture in terms of outlook. In issuing a cautionary statement to the market, he indicated that earnings are likely to be sluggish in the near term, saying that "if the Canadian dollar remains at current levels, substantial increases in the 2008 US dollar coal price will be required to avoid significant reductions in margins."

As mentioned, from a charting perspective, there has been a significant deterioration in the outlook over the past week. After reaching a high of $42.58 at the start of the week, the share price broke sharply lower following Tuesday's results announcement. Prices have since traded as low as $33.56, before closing at $35.71 on Thursday.

Given the strong turnaround in momentum, we believe there remains potential for a deeper correction in the coming weeks. As such, we recommend selling the remaining exposure to FDG. FDG will be removed form the Fat Prophets Portfolio.