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Material Matters: Thermal Coal, Whitehaven, Iron Ore, Sino Gas & Energy

Commodities | Mar 16 2015

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

-China to build west-east grid
-Seaborne thermal coal threatened
-More positive outlook for Whitehaven
-Difficult for iron ore equities to perform
-Sino Gas too heavily discounted?

 

By Eva Brocklehurst

Thermal Coal

Credit Suisse's China material analysts have concluded that Chinese coal imports will fall drastically, driven by plans to construct UHV electricity transmission lines from coal mine-based power stations in the west to the eastern cities. The broker considers this the largest single threat to coastal coal demand. The urgency in the decision to build the grid comes from the fact that air pollution in China's cities has become an increasing bone of contention and the government's efforts to combat it are serious. Applying the reduction in forecast imports to global thermal coal models produces a dire outlook, in the broker's analysis. 

Following a reduction in Chinese coal imports in 2014, Credit Suisse acknowledges there is no surprise in the claim that China's consumption of seaborne coal may have peaked. The analysts forecast China's thermal coal imports in 2015 will be almost 50mt lower than 2014, and thermal coal's share of power consumption in China will slip to 69% by 2020 from 76% in 2014.

Credit Suisse observes western coal producers seem to be pinning hopes on India taking over demand growth. While India's demand is expected to increase to 214mt in 2018 from 164mt in 2014, the broker also highlights the risks to the seaborne trade in India's huge domestic coal reserves. If mining efficiency and transport links improved sufficiently that country could also end up reducing its imports. India has stated its intention to more than double its thermal coal production by the end of the decade.

Ultimately, Credit Suisse suspects Australia will need to refocus more on traditional markets in Japan and Europe, where coal reserves are limited, but in Europe, it is likely Russia and South Africa would also be lining up in the supply battle.

Meanwhile, the seaborne coal producers are not set up for shrinking, or even flat, demand, in the broker's opinion. Growing surpluses would require years of low prices to progressively close more production each year. Hypothetically for an ex Newcastle producer, take-or-pay contracts on port and rail at around $20/t could potentially allow a thermal coal price floor of $55/t, the level at which the losses from producing, curtailing and paying out the contracts are the same, in Credit Suisse's view.

Whitehaven Coal

Whitehaven Coal ((WHC)) has secured a $1.4bn re-financing facility to push out its debt maturities until 2019. The new facility is likely to have lower interest costs and more favourable covenants. Now the debt refinancing concerns that were overhanging the stock are removed, Deutsche Bank believes it is time the market renewed its focus on the coal. Maules Creek is approaching its targeted run rate and should be operating above 9mtpa by early 2016.

The broker also believes margins during the current half may surprise the market, based on the higher quality coal being sold in February. Tightness in the supply of high quality Newcastle thermal coal has resulted in prices for short-dated contracts increasing to US$65-75/t. The company's earnings margin may have already doubled to $20/t versus the $10/t achieved in the December half, Deutsche Bank suspects.

JP Morgan is a little more cautious, given the company's high leverage continues at a time of weak coal prices and margins. The broker recognises the positives in removing the refinancing concerns and acknowledges the attractive valuation and ramp up at Maules Creek but retains a relatively bearish outlook for coal over the next 18 months.

Morgan Stanley's view is different. Refinancing will be greeted with relief and allow the stock to perform positively, in the broker's view. The broker's Overweight stance is driven by expectations that coal prices will make a modest recovery and Whitehaven's earnings margins will improve to around 21% in FY17 from 10% in FY15. As the company has only sustaining capex requirements from FY16, improving cash flow should allow a reduction in the debt balance, with gearing down to around 12% by FY19.

Iron Ore

UBS has lifted its forecasts for iron ore market surpluses in 2015 and beyond. While Australian iron ore producers have successfully executed cost reductions, UBS questions just how much more can be extracted as prices track lower. UBS considers a declining price environment will make it difficult for the equities to perform. In a relative sense, those best placed will have high quality ore, delivered at low cost to China. The marginal player is moving from within China to the high cost juniors outside of China.

The broker believes, in the medium term, Fortescue Metals ((FMG) may represent the marginal cost producer in the seaborne iron ore market, as BHP Billiton ((BHP)), Rio Tinto ((RIO)) and Brazil's Vale add further low-cost supply. The broker retains a Sell rating for Atlas Iron ((AGO)), given its debt position, and recently downgraded BC Iron ((BCI)) to Sell from Neutral given concerns over mine lift and liquidity. Mt Gibson Iron ((MGX)) and Grange Resources ((GRR)) are spared somewhat because of their zero debt positions and the higher quality iron ore for sale.

Sino Gas & Energy

Canaccord Genuity has incorporated Sino Gas & Energy's ((SEH)) recent reserve update in valuation, highlighting upside risk for the company's project. The broker believes the stock is being too heavily discounted, despite solid progress over the past 6-12 months, and retains a Buy rating with a 48c target. Total project 2P reserves have increased 51% in the recent update with 2P reserves plus 2C resources rising to 4.1tcf. The company has $70m in liquidity to fund its $45m 2015 capex program. Further financing requirements remain manageable, in the broker's view, as is partner MIE Holdings' ability to fund expansion of the project.
 

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