Can Whitehaven Defy The Odds On Thermal Coal?

This story features WHITEHAVEN COAL LIMITED, and other companies. For more info SHARE ANALYSIS: WHC

-Are buoyant prices now factored in?
-Can thermal coal prices be sustained?
-Potential to pay down debt faster
 

By Eva Brocklehurst

The share price of Whitehaven Coal ((WHC)) has rallied substantially recently. Brokers are lauding the efficiency of the northern NSW producer, which took advantage as the price of thermal coal shot higher over the June quarter. Nonetheless, differences are emerging over whether the rally is sustainable.

Morgans observes the company continues to build up confidence, with its operations and marketing performance better than expected. Debt is also being unwound faster than expected, assisted by the rally in thermal pricing. The broker believes the worst of the current cycle has probably passed. Therefore, the stock's leverage to the upside remains high.

Whitehaven Coal produced 19.7mt tonnes in FY16, within guidance and a 35% increase on FY15. Yet, Morgans believes the stock has now over-shot the short-term fundamentals and the potential for a correction when the current coal price rally abates is high. Hence, a downgrade to Hold from Add.

Based on industry feedback, the broker interprets the spike in thermal coal prices as part seasonal, ie temporary, and part structural, ie cuts to Chinese supply, with the main factor believed to be financial, in terms of short covering. Whitehaven had earlier reached into the high single digits of percentage shares shorted.

Chinese activity is of most interest to Morgans as reductions to supply have been flagged and not delivered in the past, although this potentially removes a tranche of irrational supply competition for seaborne exports that can compete in China over the longer term.

Morgans suspects this should, in turn, support higher floor pricing in the near term. Nevertheless, the 2016 supply disruptions and higher-than-usual trading activity are underscoring prices at present and a cooling off is expected.

Importantly for Deutsche Bank, both Maules Creek and Narrabri operations beat expectations and upside risk to FY17 group production guidance is subsequently anticipated. The broker increases FY17 saleable coal production forecasts to 22.3mt from 21mt and lowers unit cost estimates to $55/t but on its price deck, the stock appears fully valued.

Despite the strong rally, Macquarie is unconvinced, acknowledging the strength in the June quarter but not expecting the current coal price to hold up. The broker's target of 60c is well short of the current share price.

The thermal price averaged US$54/t in FY16, in line with Macquarie's estimates, but the pricing of metallurgical (coking) coal was much weaker than expected in the June quarter. This was US$63.2/t, versus guidance of US$64-71/t and US$70/t for spot pricing. The company's FY16 average for coking coal was US$65/t.

Macquarie is pessimistic regarding the outlook for thermal coal. China's 276-day policy for coal mines has lifted domestic prices and, correspondingly, export volumes and prices. Furthermore, the forward curve is now US$62.50/t FOB Newcastle, almost US$20/t higher than three months ago.

This is considered unsustainable, as the broker maintains it would be enough to ensure that almost every thermal coal producer, globally, could be cash positive again. Such conditions are not expected in the medium term, although, Macquarie accepts, if Whitehaven Coal can lock in prices around such levels it could de-gear at a much faster rate that previously estimated.

Ord Minnett takes the middle ground with its Hold rating. The production numbers were 15% ahead of forecasts and the company is now considered well placed to reduce debt but the rally has put the stock above the broker's target and, as spot thermal prices remain buoyant, this could signal potential upside risk.

While raising its target to $1.50 from 66c to accommodate the current rally, and expecting prices for both metallurgical and thermal coal will remain around present levels for some time, Citi remains unmoved from its Sell rating.

Buyers of the stock have a champion in Morgan Stanley. Despite the strong run-up in the stock the broker believes there is more to come, with costs at the low end of the target range, an increasing ratio favouring metallurgical coal and premium price realisation.

Morgan Stanley expects, annualising net cash flow and spot prices, that this should alleviate investor concerns about the circa $1bn in debt that is due in FY19. The broker compares the stock with Fortescue Metals ((FMG)), for which even a couple of quarters of elevated commodity prices enabled a rapid shift in the company's financial position. The broker asserts Whitehaven Coal is not capturing the current coal price and raises its target 40% to $2.25.

Credit Suisse observes Maules Creek continues to receive strong premiums for its thermal coal product, with the ratio of thermal versus metallurgical at 84:16. The company has stated the mix towards metallurgical coal sales will increase as additional semi-soft tonnage is sold from Maules Creek. Maules Creek will ramp up to 10.5mtpa in the second half of FY17 from the 9.9mtpa run rate in the June quarter.

The broker revises up FY16 earnings by 10% but given the Newcastle benchmark thermal price is now near a US$8/t premium to China's import parity price, does not believe spot pricing will hold beyond the Chinese summer. Credit Suisse retains a Neutral rating ahead of the FY16 results and updated FY17 guidance.

FNArena's database has two Buy ratings – Morgan Stanley, and UBS, which is yet to update on the quarterly production. There are four Hold ratings and two Sell. The consensus target is $1.38, suggesting 20.7% in downside to the last share price. This compares with 97c ahead of the report. Targets range from 60c (Macquarie) to $2.25 (Morgan Stanley).

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