Can Whitehaven Coal Withstand Weak Prices?

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

-Maules Creek ahead of schedule
-Key overhang is debt
-Can WHC withstand weak pricing?
 

By Eva Brocklehurst

Whitehaven Coal ((WHC)) continues to impress brokers with the rate at which its flagship Maules Creek project is coming to fruition. Moreover, the company is exploring ways of bringing Maules Creek production in ahead of schedule – perhaps this year – utilising some of its budgeted $70m contingency funds.

Meanwhile, September quarter production was stronger than expected, largely because the Narrabri longwall is performing well, with software upgrades enabling full automation of the shearer. The company produced 3.3mt of saleable coal in the September quarter, 40% above the prior corresponding quarter. Realised thermal coal prices were US$68/t and metallurgical (coking) coal prices US$89/t, which brokers consider a good outcome in the light of spot pricing. UBS notes some higher priced contract sales to Japan were likely have offset lower sales to South Korea.

CIMB observes the company has subtly upgraded guidance by stating it now expects to produce in excess of 6.5mt run-of-mine coal in FY15. CIMB suspects this is conservative and forecasts 7.4mt of ROM production from Narrabri, even with the upcoming six-week longwall change. The critical rail and earthworks at Maules Creek are now substantially complete and the company is assessing the benefits of accelerating construction of the rail network, which could bring forward production. First coal at Maules Creek is scheduled for March next year, at an operating cost of $62-54/t, but Deutsche Bank also flags the possibility of accelerating delivery of first coal by Christmas.

The key overhang for the company is its debt. The CEO has indicated that striking the right price in the US bond market is challenging while coal prices are depressed, but CIMB expects completion of the Maules Creek project should bolster the company's bargaining position. Deutsche Bank believes the company has the necessary balance sheet flexibility and debt refinancing options. Running spot coal and FX forecasts, and assuming minimum cash of $80-100m, the undrawn debt of $375m will be required by the end of FY16, which leaves plenty of time to complete debt refinancing, in the broker's calculations. 

Morgan Stanley does not envisage the going will be so smooth. Despite operational efforts the company is under pressure on current thermal coal prices. Commissioning and ramp-up of Maules Creek will add value over time, but the broker is focused on the modest margins and negative free cash flow, both of which will suffer if prices stay low. First quarter production may have been sound but output is not the issue. There are options on the upside, if extra capex is directed to the rail build, but the broker notes this is still being reviewed. Morgan Stanley assumes the debt will be addressed. Net debt peaks in FY15 as Maules Creek nears completion, taking gearing to 22%. The broker remains cautious while margins are tight and multiples are stretched.

Despite the deterioration in coal prices the company believes the market is adjusting and moving closer to balance. China's new coal import taxes – 3% on metallurgical and 6% on thermal coal – have a limited direct impact on Whitehaven Coal, just 7% of sales. Nevertheless, the company believes the tariffs could be a catalyst for accelerating further supply closures.

The key is whether the balance sheet can withstand weaker coal prices, in JP Morgan's view. The broker maintains an Overweight rating on the basis of the longer term valuation of the stock. As is the case for other brokers, JP Morgan was assured by management commentary that the thermal coal market is adjusting to a more sustained growth path. In terms of metallurgical coal, the company believes the outlook is more promising. Goldman Sachs observes the company's fortunes are acutely tied to the longer term direction of thermal coal prices and the Australian dollar. While thermal coal markets continue to deteriorate and the Australian currency is supported the company will deliver losses, albeit with a narrowing trend. Still, as Maules Creek moves towards commissioning the stock is expected to re-rate as execution risk narrows. The broker retains a Neutral rating and $1.65 target.

On FNArena's database there are five Buy ratings and three Hold. The consensus target price is $2.16, which suggests 46.4% upside to the last share price.
 

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