Material Matters: Updates on Oz Coal And Steel Stocks

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By Chris Shaw

Conditions look favourable for thermal coal prices in the near-term according to Macquarie. The broker suggests rain in both Indonesia and Australia plus labour strikes in Columbia should prove supportive for prices.

Macquarie takes the view current conditions are enough for thermal coal to be one of the best performing commodities near-term, as along with the supply impact mentioned above, the European market continues to support the case for stronger pricing in coming weeks.

The disruptions in the Indonesian and Australian markets are significant, as recent Indonesian port data suggest exports have dropped 7% from their average levels during the first quarter of the year. This implies a fall of around 4.5 million tonnes compared to March quarter levels.

Australian thermal coal exports are similarly falling short as port data for May showed total coal exports were lower than data recorded in April. With heavy rains so far this month this position appears set to worsen, Macquarie noting exports from PWCS (Port Waratah Coal Services) ports are currently down 8.3% in month-on-month terms.

The major area of concern in Macquarie's view is the possibility Chinese domestic prices could drift lower in coming weeks in line with lower freight on domestic shipments and a pickup in stocks. But as the broker notes, falling Chinese domestic prices are not enough on their own to cause weakness in seaborne coal prices.

Bank of America Merrill Lynch agrees current market conditions are positive for global coal markets, as the combination of structural changes in these markets and a cyclical rebound in global growth continues to drive demand for both thermal and metallurgical coal.

In the view of BA Merrill Lynch, this should flow through to positive benefits for the mining services sub-sector, as activity levels have increased strongly over the last couple of years. This has seen companies in the sector rebuild order books and contracts, to the extent aggregate earnings growth of 27% in earnings per share (EPS) terms is expected in FY11.

The RPST may have a short-term negative impact on growth in the sector in BA Merrill Lynch's view, but the stockbroker suggests the existence of strong franchises and overseas growth options means the blanket de-rating of the sector of late is difficult to justify.

Given the potential of the sector, BA Merrill Lynch has initiated coverage on a number of companies including The MAC Services Group ((MSL)), Sedgman Limited ((SDM)), Industrea Limited ((IDL)) and Emeco Holdings Ltd((EHL)). All are given a Buy rating, except Emeco which is rated as Neutral.

BA Merrill Lynch sums up The MAC Services group by classing it as a high quality business with significant leverage to the Bowen Basin coal field in Queensland. On its numbers, capitalised annual EPS growth of 13% through to FY12 is achievable, which suggests an attractive valuation at current levels.

For Sedgman, BA Merrill Lynch sees a similarly high quality business where lead indicators are improving and where operations offer leverage to both domestic and international coal markets. Annual earnings growth is lower than for MAC Services at around 4% through to FY12, but on the broker's numbers the stock is trading on a lower earnings multiple at present.

Industrea is another company with leverage to both Australian and international coal markets and, as BA Merrill Lynch notes, the group is enjoying growth in its order book at present. Annual earnings growth of 13% is expected through FY12, while on the broker's estimates the shares are currently trading on an earnings multiple of less than six times.

Value is an attraction for Emeco Holdings as the stock is estimated to be currently trading on an earnings multiple of just over six times, but BA Merrill Lynch suggests there remain some issues. The company is presently not earning its cost of capital, which has prompted a strategic review. Returns should improve if additional capital can be liberalised and utilisation levels are improved.

BA Merrill Lynch has set price targets of $3.00 for Mac Services, $1.90 for Sedgman, $0.55 for Industrea and $0.59 for Emeco. These compares to respective average price targets according to the FNArena database of $3.01, $1.93, $0.55 and $0.78.

The database shows Sentiment Indicator readings of 0.8 for MAC Services, 1.0 for Sedgman and Industrea and 0.4 for Emeco Holdings.

Turning to steel, JP Morgan has just returned from a two week tour of US steel assets held by BlueScope Steel ((BSL)), OneSteel ((OST)) and Sims Metal Management ((SGM)). The US market is most important from an earnings sense for Sims, followed by BlueScope and then OneSteel.

With respect to Sims, JP Morgan toured the Claremont shredder and export terminal in New Jersey, along with meeting with group MD Dan Dienst. The plant uses the third generation ferrous shredder recovery technology developed by Sims, which targets a lift in recovery levels of 10% or more.

According to JP Morgan, this should give Sims an advantage for two to three years, as beyond this time the stockbroker expects competitors to catch up technology-wise. The management meeting indicated market conditions generally are quiet and soft, so while April and May were good months, the tone of comments suggests a big improvement in the fourth quarter is unlikely.

There was also an update on the e-recycling operations of Sims, JP Morgan noting while the company is the world's largest e-recycler it captures only 1% of the global market. With material procurement quite complex and the market very fragmented in e-recycling, industry consolidation appears a key driver of growth in this business going forward.

Among BlueScope's assets JP Morgan visited the Visalia pre-engineered building facilities in California, which sources flat steel from the company's Steelscape business. Feedstock comes from Port Kembla, as the landed cost of shipping HRC from Australia is equivalent to the cost of purchasing locally.

JP Morgan suggests this synergy benefit has created an outlet for about 250,000 tonnes annually of Port Kembla HRC, which is a positive for the company as this material may have otherwise been shipped to Korea as lower margin slab.

The broker also visited the Kalama, Washington steelscape plant and the NorthStar electric arc furnace joint venture in Ohio, both of which are currently operating at or near full capacity. Expanding volumes for the former appears a difficult ask in the current market, while JP Morgan suggests spreads at NorthStar should continue to improve at steady rates given an ability to operate the plant at higher capacity utilisation rates than US averages.

Among OneSteel's US assets JP Morgan visited the Tampa recycling facility in Florida and the Chesapeake and Maine shredder yards. While throughput at the former is near capacity at present, the broker notes flows are inconsistent.

As with Sims, OneSteel is attempting to improve recovery yields at its shredder operations by introducing new technology, though in JP Morgan's view there is unlikely to be a sustainable margin benefit as competitors will at some point catch-up.

OneSteel also attended a presentation from OneSteel with respect to its LiteSteel beam, used in residential and commercial construction. JP Morgan notes the product offers value relative to steel beams or wood, which is important as the US housing market at present is showing a trend towards lower value homes.

While the product has potential, JP Morgan suggests as it will be a new product in a relatively conservative margin gaining some traction in the industry will continue to be a challenge.

Post the updates, JP Morgan retains its Neutral rating on Sims, its Overweight rating on BlueScope and its Underweight rating on OneSteel. Sentiment indicator readings for the three companies according to the FNArena database currently stand at 0.4 for Sims and OneSteel and 0.8 for BlueScope.

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