Debt And Liquidity The Issues For Yancoal

This story features WHITEHAVEN COAL LIMITED. For more info SHARE ANALYSIS: WHC

 – Yancoal Australia lists
 – Citi and Macquarie initiate coverage with Hold ratings
 – High debt and low liquidity the major issues

By Chris Shaw

Yancoal Australia ((YAL)) commenced trading last week following the merger of Chinese-owned Yancoal and local Gloucester Coal and both Macquarie and Citi have been quick to pick up coverage on the merged entity. Both brokers have initiated with Neutral ratings, Citi setting a price target of $1.50 and Macquarie $1.80. 

Yancoal offers a portfolio of high quality, large tonnage assets with a diverse product mix. Moolarben is an open cut, low cost bulk mining operation, producing high-energy export thermal coal. The Austar mine in contrast is an underground operation with Australia's deepest coal longwall. Macquarie notes the mine is the only one outside of China to successfully operate Longwall Top Coal Caving Technology.

Production by Yancoal should be around 60% thermal coal, with the balance to be either semi-soft, PCI or semi-hard coking coal. As Citi points out, the high percentage of metallurgical coal helps support Yancoal's margins. 

On balance Citi suggests Yancoal's assets are better than industry average. Positives include good volume growth, as Citi expects production should increase from 12.3 million tonnes this year to around 23.4 million tonnes in 2015.

Yancoal will also have good port access thanks to guaranteed access to seven ports in two states. Port allocations could be as much as 20 million tonnes by 2015, which Citi notes wold be only a few million tonnes short of what is planned in terms of production growth. 

Given Yancoal's parent company Yanzhou has considerable mining experience, Citi sees scope for some operational efficiencies in coming years. 

Where Yancoal is only average relative to peers is in its position on the cost curve. Citi estimates unit costs of around $80 per tonne, which it suggests is towards the upper end of the second quartile of costs in the sector.

The other issue for both Citi and Macquarie is Yancoal's debt position. Compared to Whitehaven Coal's ((WHC)) gearing of around 36%, gearing for Yancoal stands at 114% according to Citi. Debt is expected to peak at around $4.5 billion, which equates to around seven times EBITDA (earnings before interest, tax, depreciation and amortisation).

The share register is also a problem for investors, as Macquarie points out Yancoal has a free float of just 8% of its register. This implies some uncertainty with respect to how the company will meet FIRB regulations, though Macquarie sees scope for liquidity to improve if Yanzhou was to sell down its 78% stake to around the 70% level.

This combination of low liquidity and high debt underpins the Hold ratings of both Macquarie and Citi. Near-term Macquarie suggests weak spot prices for thermal coal could also weigh on the share price in coming months.

This weakness is not expected to persist beyond the end of the year, as the northern hemisphere winter should see improved demand and some restocking by industry players. Citi agrees, expecting prices will trend higher through the second half as supply remains relatively tight and demand improves.

In terms of earnings forecasts for Yancoal, Citi has earnings per share (EPS) estimates of 9.1c this year and 18.1c in FY13, while Macquarie's forecasts stand at 16c and 6c respectively. Yancoal is not forecast to pay any dividends to shareholders through at least FY13. 

Shares in Yancoal today are slightly weaker in a down market and as at 12.20pm the stock was off 1c at $1.19. Since listing Yancoal has traded between $1.15 to $1.70, the current share price implying upside of around 39% to the $1.65 consensus price target in the FNArena database.

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