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Brokers Divided Over Whitehaven Coal

Australia | Jan 22 2018

Whitehaven Coal's December quarter sales and production disappointed brokers, despite buoyant prices, amid increased costs at the Narrabri mine that will now continue into perpetuity.

-Management lifts FY19 and FY20 production guidance for Narrabri
-Sales of uncommitted metallurgical coal from Maules Creek remain challenging
-Robust free cash flow suggests more dividends to come

 

By Eva Brocklehurst

Structural issues at the Narrabri mine plagued Whitehaven Coal ((WHC)) during the December quarter and led to a substantial miss on production expectations, overshadowing better outcomes at the company's Maules Creek and Gunnedah mines.

December quarter saleable coal production was well below estimates, attributed to conditions at Narrabri which required additional roof support for the longwall mine, as mining depths move to 250m below the surface. This issue is ongoing and costs will increase by $2/t over the life of the mine, which are now being factored into estimates.

Meanwhile, the company's Maules Creek and Gunnedah mines performed well in the quarter and guidance has been increased for Maules Creek to 11.0 ROM for FY18.

Also, realised coal prices were lower than forecast, attributed to higher low-value sales because there was less volume from Narrabri. Production guidance for Narrabri in FY18 has been lowered to 6-6.5mt from 8-8.4mt and overall guidance lowered to 20.5-21mt from 22-23mt.

On the positive side, Deutsche Bank points out additional drilling on the fault has provided management with the confidence to lift FY19 and FY20 production guidance for Narrabri to 7.7mt and 7mt respectively. While the broker welcomes this longer-term outlook, noting Narrabri is a world-class underground mine, it acknowledges the operations will have more challenges going forward.

Credit Suisse agrees the market has not attributed enough credit to the FY19 and FY20 guidance, or the fact that Maules Creek will produce a little more this year. The broker accepts costs are up and sales of uncommitted metallurgical coal from Maules Creek remain challenging but suggests that the robust free cash flow from Whitehaven's business is compensation.

Moreover, cash generation is not expected to moderate in the near term, although Credit Suisse acknowledges a quick reversal in coal prices remains a key risk. Based on the view that spot prices are still well in excess of forecasts, there are more dividends to come, and Maules Creek is still to ramp up to 13 mtpa, the broker upgrades to Outperform from Neutral.

Citi takes an opposing view and downgrades to Sell from Neutral, although concedes the key risk to its recommendation is resilient thermal coal prices. These remain at US$107/t, well above the broker's forecasts of US$89/t for 2018 and US$75/t for 2019. Realised prices for thermal coal were in line with Citi's forecast but realised semi-soft coking coal prices were below estimates.

Semi-Soft Coking Coal

UBS notes the company has had little demand from steelmakers for uncommitted semi-soft coal, because steel demand is so high that steelmakers are able to pass on the increasing costs of hard coking coal.

Furthermore, this change in product mix has not had a significant impact on margins because the cost of processing semi-soft at Maules Creek is largely offset by the current surge in thermal spot prices, UBS explains. The broker maintains its Buy rating, with a view there is upside potential for the market to price in higher long-term coal prices.

Narrabri Value

Macquarie retains an Underperform rating and believes, because of the long reserve life at Narrabri, increased costs create a substantial downgrade in value, by more than $200m. The broker is also disappointed in the production numbers, given the strength in spot thermal coal pricing.

Morgans, on the other hand, suspects the marginal investor will overlook these issues as coal prices are trading well above expectations. For now, the broker believes the exceptional free cash flow leverage to higher coal prices will offset the operating challenges.

Morgans agrees the stock appears stretched, as it is trading at a 13% premium to the broker's revised valuation, and calculates this implies sustained strength in thermal coal prices upwards of US$95/t, and/or a substantially de-risked valuation of Vickery. Yet, the scarcity of large, liquid ASX-listed pure coal exposures justifies a Hold rating, although Morgans does suggest it may be prudent for investors to trim some profits at this point.

There are three Buy ratings, two Hold and three Sell on FNArena's database. The consensus target is $4.26, signalling -1.7% downside to the last share price. Targets range from $3.75 (Morgan Stanley, yet to comment on the quarterly) to $4.90 (UBS). The dividend yield on FY18 and FY19 forecasts is 5.5% and 11.2% respectively.

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