Australia | Apr 18 2016
By Greg Peel
Whitehaven Coal’s share price bottomed out in mid-February at around 37c but a stuttered recovery since then sees a current price of around 75c. The rally is not so surprising given all resource sector stocks have rallied in that time from arguably oversold, panic levels. What is surprising is that while the prices of oil, iron ore, base metals and gold have rallied over the period to justify the resource sector rebound, the price of coal has not.
Does Whitehaven Coal, therefore, offer value to investors?
If there is one thing brokers agree on, it is that Whitehaven is one of the most efficient and quality managers of coal assets in Australia. The company’s March quarter report showed a better than expected 7% increase in production and a further reduction in cost per tonne. FY16 production guidance has been maintained despite a planned shutdown over May and June as the Narrabri mine undergoes a longwall change-up. Analysts assume inventories will be drawn upon to make up the difference.
The jewel in Whitehaven’s crown is the recently commissioned Maules Creek mine, which continues to ramp up at a solid pace. High grades at Maules Creek ensure Whitehaven should receive a premium for both the thermal coal (used for electricity production) and the metallurgical coal (used for steel-making) produced at the mine. Met coal offers the better margins of the two, which is why analysts have lauded an ongoing increase to the percentage of semi-soft and PCI met coal production, now at 16% but expected to reach 20% next quarter.
It took a long time for the Maules Creek mine to gain approval and in so doing it became a bit of game-changer with regard Whitehaven’s future. Due to the quality of the coal and the subsequent premium pricing the company was expected to achieve, it was assumed Whitehaven would have no trouble in rapidly paying down some $1bn of debt required to fund the project on or before the 2020 deadline.
But premiums aside, benchmark coal prices have been falling steadily and have not rebounded alongside the prices of other heavily sold-down commodities. Whitehaven received an average US$51.56/t for its thermal coal in the March quarter, down from US$54.60/t in the December quarter. The average price for met coal received was US$61.77/t, down from US$65.00/t, and below the company’s own guidance range of US$62-65/t.
To compound the issue, the Aussie dollar has jumped sharply over that period.
The good news is that moving into the June quarter, benchmark met coal prices have begun to improve. Thermal prices remain subdued but most analysts believe that they, too, will eventually see improvement. This is why most brokers in the FNArena database are positive on the stock. Price rebounds are critical for Whitehaven given despite solid efforts in reducing costs, at an average US$57/t across the board, cash flow is still treading a fine line. Positive cash flow is critical for debt reduction.
To account for the heavy debt burden, and for the fact Whitehaven’s earnings are highly sensitive to a combination of benchmark coal price, price premiums, product mix and the currency, analysts have applied valuation discounts. Yet five of the eight brokers in the database have set share price targets of $0.90-1.00, suggesting plenty of value still remains in a stock trading at $0.75.
These five brokers all rate Whitehaven a Buy (or equivalent). The fifth is Morgans, who in light of Whitehaven’s March quarter report has decided improving fundamentals make the stock a compelling prospect and has subsequently upgraded to Add (equivalent of Buy).
Morgans does add a caveat to its upgrade to Add nonetheless, suggesting Whitehaven Coal “suits assertive investors”.
While suggesting everything is moving the right way for Whitehaven, except for near-term thermal prices which may yet fall further, Ord Minnett retains a Hold (Higher Risk) rating on the stock due to the debt issue. Credit Suisse is also on Hold but is yet to update post the quarterly report.
The lone Sell rating in the database belonged to Macquarie, until Citi downgraded to Sell on Monday morning.
Macquarie believes Whitehaven’s operational skills “cannot transcend a structural weakness in coal markets”. The broker expects the weak trend in thermal coal prices not to ease but to continue due to weak overall demand. And the broker further notes the premium achieved by Whitehaven for its superior thermal coal in the March quarter fell to 8% from 11% in the December quarter.
Macquarie points out that the value behind the Maules Creek project originally lay in the assumption the mine’s thermal coal would be priced at a premium to the benchmark and that its met coal would be well received, thus enabling the rapid pay-down of Whitehaven’s large debt burden. These two hypotheses are now in question, as far as Macquarie is concerned.
The broker’s Underperform rating reflects a concern over Whitehaven’s ability to tackle its debt issue before 2020. Macquarie has set a share price target of 35c. Citi too remains cautious because of the debt, but its revised price target was set at 66c.
Not that the company lacks other options, other brokers point out. Morgan Stanley (Overweight) acknowledges that Whitehaven’s debt burden is holding back investor sentiment, but suggests that given the debt is being serviced, the company has the option to restructure before it is due. Deutsche Bank (Buy) suggests Whitehaven could sell a partial stake in its Maules Creek or Vickery assets, or in the royalty streams from Maules Creek of Narrabri to repay debt.
Whitehaven Coal is therefore not doomed, and according to five of eight major brokers, the stock offers a compelling investment argument. Critical to that argument is nevertheless the direction from here of coal prices.
Is the world simply moving away from coal?
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