Australia | Jul 17 2017
Despite the complexities in coal pricing most brokers believe Whitehaven Coal is well-placed to leverage the price tension.
-Both challenges and catalysts ahead in FY18
-Whitehaven switching some coking coal to thermal to optimise margins
-Cash to asset ratio could improve in the next 12 months
By Eva Brocklehurst
Whitehaven Coal's ((WHC)) June quarter production update highlighted several important considerations for FY18. Firstly, another change out of the Narrabri longwall is expected in the third and fourth quarters and, Macquarie notes, given the challenges in installing the first 400m longwall, there is a further risk for production numbers.
The company slightly missed its FY17 production target of 21-22mt, delivering 20.8mt. FY17 unit costs were $2/t above FY16. Another challenge is that the company signalled Maules Creek would not have its next production increase until FY19, forecasting 10.5mt run-of-mine for FY18.
Regardless, the primary drivers of Morgan Stanley's positive view remain intact. The cost profile is adjusted and the broker carries some higher costs into the forward years, with the impact being a -5% reduction in forecasts for earnings per share.
Having made the adjustments, Morgan Stanley believes it is important not to lose focus on the volume growth, product mix and the price realisation the company has achieved.
The broker expects $340m to be added to the cash position in FY17, taking net debt down to $290m and gearing to 8%. Morgan Stanley forecasts 22% production growth from FY17-19, which stands out in an industry that is largely ex growth.
Volume will be complemented by the ratio of metallurgical coal rising to 33% from 23%, the broker calculates and, combined with an gradual increase in realised prices for thermal coal, Whitehaven should generate strong free cash flow even as coal prices fall.
Metallurgical Versus Thermal
The metallurgical coal mix improved to 25% in the June quarter, from 22%, despite some tonnage being sold as thermal to optimise margins. The realised thermal coal price improved again, to 4% over the index price.
Macquarie asserts pricing is more complex than it first appears. The result highlighted an important consideration in the semi-soft market: that the company is switching some Maules Creek production to thermal from semi-soft. This signals broader concerns for FY18 and beyond.
The company sold metallurgical coal for around US$106/t, continuing the discount at around -14% for the quarter and close to the FY17 average discount of around -17%.
Commentary regarding switching to thermal coal at Maules Creek, which even with a 9% premium still receives a lower realised price than the company's metallurgical coal price, implies for Macquarie that semi-soft sales may not achieve the pricing and volume expectations in the future.
Sales fell short of Morgans expectations but high inventories suggest the slippage can be recovered. The broker also points to the complications in the realisation of semi-soft prices, which came in around -US$7-8/t below forecasts.
Morgans expects the variance between benchmark and index-linked/spot sales for metallurgical coal should narrow, making price realisation less volatile, and the increasing volume of Maules Creek semi-soft being directed to contract pricing should also help.
All up, brokers conclude that the changing environment for metallurgical coal makes it difficult for producers and investors alike to read the signs.
Following the update, Morgans trims FY18 production assumptions and downgrades FY17-19 forecasts. The impact on valuation is offset by a lift in the long-term assumptions for metallurgical coal to US$110/t.
Morgans also expects a reduction in net debt following the substantial free cash flow being generated over the last 18 months and highlights the fact the company is one of the few listed pure coal players that is able to leverage ongoing price tension.
Size, high cash margins and the potential to pay dividends should drive interest from investors looking for default resources exposure in a market that lacks quality mid cap stocks, Morgans believes. As the stock is trading close to valuation, the broker maintains a Hold rating.
Shaw and Partners had been concerned for some time that the FY17 consensus expectations were too high and further trims its estimates by -2%.
The Vickery project's environmental impact statement should be submitted in the September quarter and this should allow talks on a joint venture to proceed.
Shaw and Partners notes the “healthy” level of inbound interest in the project and would be pleased if the company surprised with a large joint venture divestment payment, such as a 30% sell-down.
The broker, not one of the eight monitored daily on the FNArena database, acknowledges the coal price has caught a tailwind recently but considers the dynamic is more one-off and cyclical rather than medium-term and structural. Shaw retains a Sell rating and $2.40 target.
The Vickery mine will not start up before Maules Creek is running at 13mtpa, in FY20 on Morgan Stanley's estimates, but a joint venture could be established in 2018. Morgan Stanley only attributes $150m in value to Vickery but suspects it could be worth over $1bn once it is operational.
Morgan Stanley assumes the company will not pay a dividend until FY19. The broker acknowledges the stock screens poorly on dividend yield and the total cash to assets ratio in quantitative models but suggests both these could improve in the next 12 months.
There are four Buy, three Hold and one Sell (Macquarie) on FNArena's database. The consensus target is $3.09, suggesting 8.3% upside to the last share price. Targets range from $2.70 (Macquarie) to $3.60 (Morgan Stanley).
See also, Can Whitehaven Sustain Higher Prices? on April 19, 2017.
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