Coal Prices The Latest Problem For Wesfarmers

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This story features WESFARMERS LIMITED.
For more info SHARE ANALYSIS: WES
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

The fact Wesfarmers ((WES)) will need several years to turn around the Coles assets is not new news, but for some time the market had factored in stronger coal earnings as an offset for group profits until the supermarket assets began to generate better returns.

According to Merrill Lynch this is now not going to happen as the broker has slashed its coal price forecasts to reflect the impact of the global financial meltdown on economic growth and thus demand for commodities. This flows through into significantly lower earnings estimates for the company, in FY10 in particular.

In terms of its coal price forecasts for the upcoming Japanese financial year beginning next April, on which coal price contracts are based, the broker has lowered its estimates for hard coking coal to US$125 per tonne from US$300 per tonne previously and semi-hard coking coal to US$115 per tonne from US$240 previously.

Similar cuts have been made to both Low Vol PCI and semi-soft coking coal, the broker’s forecasts for the former falling to US$100 per tonne from US$200 previously and for the latter to US$90 per tonne from US$160 previously. Based on its new forecasts the broker’s revenue expectations for the group’s Curragh project have fallen by around $1 billion, meaning the stockbroker expects the project will lose as much as $100 million in FY10.

The Bengalla project will similarly experience a significant fall in earnings and as the broker notes there is little the company can do about it, as even cost cutting initiatives will have minimal impact given coal mines have substantial levels of fixed costs.

The other impact on earnings comes from the group’s Stanwell Royalty obligations, the broker pointing out these are calculated by a formula that includes tonnage at Curragh and the coal price but that is lagged by 12 months. The last element of the formula is the key in the broker’s view, as on its estimates at the same time as coal prices will be falling and so lowering revenues and earnings for the group, its royalty obligation will jump from a forecast of $150 million in FY09 to $450 million the following year.

Factoring all this in sees the broker’s earnings estimates for the company cut by 10% in FY09 and a much more significant 55% in FY10, followed by a 30% cut in its forecasts in FY11. In earnings per share (EPS) terms the broker is now forecasting 226c this year, 91.1c in FY10 and 128c in FY11.

This puts the broker very much at odds with the rest of the market in terms of earnings expectations, particularly with regards to FY10 estimates. The FNArena database shows consensus EPS estimates of 240.1c in FY09 and 190c in FY10. This implies there is scope for significant cuts to consensus estimates if the broker proves to be correct with its outlook for coal prices.

Not surprisingly the broker retains its Underperform rating on the stock, which has been in place for some time given its view the acquisition of Coles was not a good move by the company. Overall the FNArena database shows three Underperform ratings for Wesfarmers, along with three Holds, one Accumulate and three Buy recommendations.

One Buy rating comes courtesy of Macquarie, which also recently cut its coal price forecasts and earnings estimates for the stock. In its view the recent share price decline in the stock -more than 40% in recent months- shows the market has been factoring in lower coal price expectations so confirmation of such an outcome shouldn’t have too much more of an impact on the share price.

The database shows an average price target of $25.73. While Merrill Lynch is the most bearish at $16.50, ABN Amro is easily the most bullish at $37.50. Shares in Wesfarmers today are slightly higher in early trading and as at 10.50am the stock was up 29c at $16.80. This compares to a trading range over the past year of $16.51 to $43.32.

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