Is Whitehaven Coal Being Priced Too Aggressively?

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

Current coal prices underpin the strong run up in Whitehaven Coal shares but brokers are not so sure the heady times will last much longer.

-Strong contract prices being set and rapid cash accumulation support the equity
-Will a loosening of Chinese policy and a supply response mean prices turn lower?
-Bearish longer-term coal price forecasts suggest the stock is being priced too aggressively

 

By Eva Brocklehurst

Will the current buoyancy in coal prices hold out for Whitehaven Coal ((WHC))? Current pricing is helping the company's debt profile to rapidly reduce but many brokers are not so sure the heady times will last. The company produced 5.2m tonnes of saleable coal in the September quarter. Rain impacted open pit operations and delayed around 0.5mt in production, which is expected to be made up in the next three quarters.

While Maules Creek delivered less because of the heavy rain, Narrabri offset this at the group level. Full year guidance is maintained and Maules Creek is still expected to reach a 10.5mtpa run rate by the second half of FY17. Narrabri's expansion project remains on time and on budget. A single long wall change over is expected in the March quarter.

Realised prices in the third quarter were US$70/t for metallurgical (coking) coal and US$64/t for thermal coal. The company expects December quarter prices for coking coal products to be significantly higher quarter on quarter and support for thermal prices to continue over the balance of FY17.

Realised prices were around 5% below Deutsche Bank's forecasts, affected by opportunistic sales of lower quality coal and pricing lags. The company is witnessing solid customer demand and if Chinese supply reforms continue, this supports a view that price momentum can be maintained. If spot pricing persists Deutsche Bank expects the company will be net cash within 12 months.

Morgan Stanley is positive on the outlook, particularly with the strong contract prices being set by the industry at present, and agrees a rapid accumulation of cash should support the equity. The broker wants clarification on how much low-energy coal will be sold in future as, while Maules Creek thermal coal still gets over 8% in premium, the company sold low-energy thermal coal in the quarter which affected price realisation.

The stock has had a strong run-up on the coal price rally and the broker acknowledges lagged price benefits, lower metallurgical volumes and lower thermal coal price realisation may be used by some to call for reduced exposure to the stock. However, Morgan Stanley emphasises Whitehaven's volume growth, product mix and price realisation benefits as the quality Maules Creek volumes ramp up.

The company reports just over 20% of sales in the quarter from Maules Creek were for coking coal and several agreements have been executed, linked to the semi-soft benchmark price. Macquarie believes, given the US$130/t semi-soft pricing announced for the December quarter, the discount to this benchmark price will be critical for Whitehaven as it looks to increase sales to steelmakers. As the impact of some of these contracts is lagged the broker expects the company's realised price will be at a discount to benchmark in the December quarter but potentially at a premium in the subsequent quarter.

While the Chinese policy has lifted coal prices to levels not seen for many years and enables Whitehaven Coal to generate substantial margins, Macquarie remains structurally bearish on coal prices in the long term and believes the share price continues to factor in significantly higher prices than its base case allows.

Credit Suisse is of a similar view, believing coking coal prices have peaked and the high prices will entice re-entry of shuttered capacity and increased washing of coking coals that have recently been sold as unwashed thermal coal. Thermal coal also appears to have peaked and the broker notes China is looking to loosen the restrictions that caught the market unawares and drove up Chinese imports and prices.

The stock is up 300% over the last six months and Credit Suisse finds it hard to envisage much upside from here, downgrading to Underperform from Neutral. The broker expects FY17 earnings will be the peak for Whitehaven in this cycle and FY19 earnings per share will be nearly 60% lower.

The company's de-gearing profile has been transformed and Morgans believes a reinstatement of dividends is looking possible for FY18. The stock does appear to be running ahead of the fundamentals, effectively pricing in 18-24 months of spot prices. While appreciating the amount of leverage to the coal price, Morgans believes this is outlook is too aggressive.

The broker would prefer to buy the stock for its coal price leverage on a pullback in the shares and retains a Hold rating for now. Morgans is yet to find a convincing answer to the question of how long prices will be sustained, other than that the industry expects higher floor prices will persist. The broker envisages some potential for short-term forces, such as the traditional northern summer disruption, to help offset the relaxation of Chinese domestic supply restrictions.

Citi greeted the quarterly with a subdued assessment, maintaining a Sell rating because of its bearish coal price forecasts. The broker acknowledges coal prices are significantly higher than its forecasts and upgrades FY17 EBITDA (earnings before interest, tax, depreciation and amortisation) by 29%. FY18 estimates are reduced by 2% because of the broker's higher Australian dollar forecasts.

Ord Minnett is also cautious regarding the risks to the share price if, or when, the coal price momentum stalls and reverses. The broker continues to believe spot prices are unsustainable on the basis that these will likely induce significant supply responses.

FNArena's database shows one Buy rating (Morgan Stanley), three Hold and four Sell for Whitehaven Coal. The consensus target is $2.46, signalling 16.5% downside to the last share price. This compares with $2.27 ahead of the report. The targets range from $1.50 (Macquarie) to $3.10 (Morgan Stanley).
 

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