Australia | Aug 21 2017
Cash flow was strong and net debt has fallen as FY17 transformed Whitehaven Coal. Yet, concerns have now been raised regarding the production profile at the Narrabri mine.
-Sustaining capex to double and costs to rise
-Lower production at Narrabri moves total production to a plateau
-Potential to accelerate returns to shareholders?
By Eva Brocklehurst
FY17 transformed Whitehaven Coal ((WHC)) and the company is now able to pay out a high dividend and invest in growth. Cash flow was strong and net debt has fallen. The company surprised brokers by declaring a $0.20 dividend, including a $0.14 special dividend.
Still, the positive news was overshadowed by weaker operating guidance. Production at Narrabri will decline -20% by FY20 and unit costs and capital expenditure are increasing.
Sustaining capital expenditure will double, mainly stemming from truck engine re-building at Maules Creek and Tarrawonga. Costs will rise as a result of increased strip ratios, longer haul distances and increased washing at Maules Creek, although this does come with some revenue offset, UBS observes, from a lift in metallurgical (coking) coal production.
The broker does not yet believe the market is prepared to pay for the possibility of higher longer-term pricing driven by Chinese coal policy and thus maintains a Neutral rating. Nevertheless, upside is heightened if, and when, the market does incorporate this possibility.
Credit Suisse observes China is currently the only driver of demand, as India stepped out of the market when the hard coking coal price rose in July, while Europe is on holidays and there has been no interest from Japan or South Korea. The broker notes some traders believe India may be running low on supplies and if it re-enters the market soon, this may tip coking coal prices over US$200/t.
Thermal coal pricing is also likely to continue to drive material cash flow. With just 9% gearing, this underpins confidence in its balance sheet and prospective returns, in the broker's view.
Citi upgrades FY18 and FY19 estimates in marking to market the coal price, although downgrades FY20 because of lower production from Narrabri. The lower production at Narrabri will effectively move the company's production profile to a plateau, and growth beyond FY21 is dependent on Vickery prevailing through regulatory approval processes to expand capacity up to 10mtpa.
The Narrabri mine has been affected by two geological features, an intrusion and fault, and both will affect production. As a result, run-of-mine production will fall to 7.4mt in FY19 and to 6.7mt in FY20. The company will not know if the fault continues to the west until a tailgate in panel 9 is developed in the second half of 2018. Citi currently assumes a life at Narrabri until FY32, but additional marketable reserves could extend this significantly.
There is further upside from applications to the north-west, and valuation upside if approval to mine the north-west extension is granted. UBS observes the Narrabri downgrade overshadowed the results, but does appear to be a two-year issue and subject to further drilling and analysis.
Credit Suisse agrees time and further development drilling should reveal more, but remains concerned as geotechnical issues in a longwall mine are most unwelcome. With ongoing uncertainty over Narrabri and a share price rise of more than 10% since the June quarter, the broker expects a mixed reaction to the results. Cash generation and returns may be enough to keep existing shareholders happy but the operating risks for those contemplating entering the stock may prove a barrier.
Beyond Narrabri, pricing and growth from the Vickery project are difficult to ascertain, Credit Suisse asserts, particularly from a timing perspective. First shipments are guided for the first half of 2020 ahead of full construction by the first half of 2021. Therefore, the risk for approvals, joint venture formation and investment decisions is unlikely to surprise on the upside, in the broker's view.
The challenges at Narrabri mean Ord Minnett downgrades FY19 and FY20 estimates, which raises the risk profile around production estimates for the operation for the medium term. Combined with the recent run-up in the share price, this leads the broker to downgrade to Accumulate from Buy.
The company intends to pay out 20-50% of earnings with the aim of maintaining gearing at 10-15% through the cycle. Deutsche Bank assumes a 50% pay-out and calculates a net cash position in FY19. The broker believes there is potential for additional returns in the future, even with the development of Vickery and expansion of Maules Creek to 15mtpa.
UBS agrees additional returns are possible, while Citi suggests that, with no significant capital expenditure for Vickery until 2019, there is potential to accelerate returns in FY18. The broker believes there is potential to consider other forms of capital management such as buy-backs, estimating that, after a 35% dividend pay-out, there would be potential to buy back $320m in FY18 and $160m in FY19.
Credit Suisse questions whether distributing unfranked dividends is the most effective way to return money to shareholders, although this appears to be the preferred method until franking credits are available in FY20. Adding the concerns about Narrabri and the risk in quantifying a value for Vickery, the broker agrees there is an argument the stock looks fully priced.
Nevertheless, with coal prices at current levels it is hard to envisage cash generation unwinding in the near-term. While the stock may weaken in the wake of the result, Credit Suisse suggests it could also bring a buying opportunity for some.
The stock appears stretched to Morgans and pricing is expected to ease on the back of the short-term reversion of over-heated thermal coal markets. The broker believes the current share price is implying even higher short-term coal prices and/or a substantially de-risked valuation of Vickery. Both scenarios appear too much to incorporate for the broker, given the inherent risks.
Spot Newcastle thermal coal prices have moved back towards US$100/t in recent weeks and while there is genuine supply tightness, the broker believes the market lacks fundamental support at these prices.
FNArena's database shows four Buy ratings, three Hold and one Sell (Macquarie, yet to update on the results). The consensus target is $3.23, suggesting 2.4% upside to the last share price. Targets range from $2.60 (Deutsche Bank) to $3.85 (Citi).
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