Australia | Feb 20 2018
Strong economic conditions across Asia have supported coal prices and the main issue for brokers is what Whitehaven Coal will decide regarding its enhanced cash flow.
-If spot prices hold up there may be more upgrades to earnings and cash flow to follow
-Concerns regarding future funding commitments, given potential sale process for Queensland coal assets
-Plethora of options exist, including selling stake in Vickery and re-gearing
By Eva Brocklehurst
Buoyant coal prices have enhanced profitability for Whitehaven Coal ((WHC)), countering increased operating costs at its flagship Narrabri mine in the first half and ensuring rapid de-gearing.
The company is nearing a net cash position and the critical issue for brokers is what decisions will be made regarding cash flow, if current coal prices hold up. More detail on the dividend strategy is anticipated at the FY18 result.
Life of mine costs for Narrabri have increased by around $2/t but the near term impact has not been specified. Costs for FY18 are expected be slightly higher than guidance of $59-$60/t although no major changes have been flagged.
Earnings in the half were lower than Macquarie expected because of the higher cost of purchased coal, and slightly higher mining costs. Dividends were in line with the top of the pay-out ratio. As the broker observes, even with a miss on operating costs, coal prices above US$100/t can offset a lot of operating challenges.
Coal prices are elevated and Credit Suisse is aware of the apprehension that prevails regarding investing in a pure-play coal company at this point in the cycle. Still, if spot prices hold up and remain above forecasts, there may be more upgrades to earnings and cash flow.
Citi expects coal prices to decline through 2018 while cost pressures are likely to remain elevated, given restricted production at Narrabri and increased costs at Maules Creek. Hence, the broker opts for a Sell rating.
Morgans suggests strength in thermal coal prices upwards of US$100/t and a substantially de-risked valuation for Vickery are implied in the share price. The scarcity of large, liquid ASX-listed pure coal exposures means the broker maintains a Hold rating at elevated prices.
Queensland Coal Assets
Citi observes, with around $1bn in debt facilities, the company has the balance sheet capacity to grow through M&A, suspecting too that the company is "kicking the tyres" on the Rio Tinto's ((RIO)) coking coal assets in Queensland.
The sell-off in the stock in the wake of the results suggests concerns around future funding commitments, highlighted, as Credit Suisse points out, when a company only pays out $0.13 per share and has a zero net debt balance.
On the broker's calculations, and assuming 30% is the maximum for gearing, equity holders may be asked to front up with around $1.2bn for the Queensland coal assets. Hence, missing out on these assets may be the best thing for shareholders, the broker asserts, as management could be left with no alternative but to give some cash back.
Either way, the Queensland coal sale process implies a risk of dilution in the near term that shareholders need to weigh up against potentially missing out on a capital return.
Credit Suisse acknowledges the options on a strong balance sheet but, failing any significant calls for capital in the next six months, favours the company giving a bump to shareholders in August.
With Maules Creek expected to reach capacity shortly the main growth project now is Vickery, where an environmental impact statement for a 10mtpa mine is to be lodged in March. The company is looking to sell up to 30% during the approval period to help to fund the project.
M&A remains an option but the current focus is on Vickery and UBS suggests, with government policies centred on improving environmental standards amid few signs of new capacity coming on board, high-quality coal should be in demand and this will be a good time for Vickery.
Over the last two years the company has reduced its net debt, taking gearing to only 4%. Morgans estimates the company can fully fund Vickery from operating cash flow and maintain an assumed 35-40% pay-out ratio, while still accumulating cash.
In the absence of external M&A, there is upside to the notional pay-out target, particularly if a partner is introduced at Vickery and the company re-gears to a notional comfort level of 10-15%.
There are three Buy ratings, four Hold and one Sell (Citi) on FNArena's database. The consensus target is $4.51, signalling 2.2% upside to the last share price. Targets range from $4.00 (Morgans) to $5.35 (UBS). The dividend yield on FY18 and FY19 estimates is 6.4% and 5.0% respectively.
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