Australia | Feb 19 2019
Higher expenditure and lower production cast a shadow over Whitehaven Coal's first half result. Yet, brokers observe the market is likely to set this aside amid the potential for capital returns.
-Rise in coal volumes and firm prices likely to offset increased costs
-Narrabri needs to demonstrate it can overcome the challenges
-Plans to sell more coking coal from Maules Creek
By Eva Brocklehurst
Whitehaven Coal ((WHC)) surprised brokers, as cash was run down over the first half to a larger-than-expected extent. Higher expenditure on exploration had not been flagged in the lead-up to the interim results. A combination of more money being spent on exploration, plant and higher receivables meant a much lower level of free cash flow. Cash flow was around -$100m below UBS estimates.
A downgrade to production is coupled with an increase in cost guidance and, ultimately, increased capital expenditure. Deutsche Bank notes each factor is small in isolation but has cumulatively dented short-term confidence, given a significant shareholder return was also absent. The company paid an interim dividend of $0.15 a share and a special dividend of $0.05 a share.
Market interest in capital management should now rebuild, Morgans believes, as the board has form in skewing the dividend to the second half as it seeks greater certainty around capital movements.
Citi forecasts an ordinary dividend at a 50% pay-out plus a special dividend of $0.10 per half in the second half and through FY20. Thereafter, capital expenditure for Vickery is expected to ramp up and, hence, special dividends will be deferred. On this basis, the broker estimates Whitehaven Coal will offer an aggregate dividend of $0.46 a share in FY20.
Costs have risen by around $13/t since the first half of FY18, the vast majority being structural, although Macquarie suspects some relief is likely as volumes rise again in the second half.
The company has again downgraded expectations for Narrabri. The downgraded guidance and $35m in capital expenditure to upgrade the chocks makes Morgans question the long-term production and cost profile of the mine. Several other brokers agree there needs to be a couple of trouble-free quarters of output at Narrabri to allay concerns. Narrabri comprises 21% of Morgans' valuation by operating assets.
Macquarie suggests, as the final stage of the longwall 108 is being left out to avoid the volcanic intrusion, there will, ultimately, be a benefit to earnings. Still, this is the third year in a row the company has cut production estimates for Narrabri, although an expected lift in FY20 could be an offset.
However, Deutsche Bank observes the option to buy an additional 7.5%, dependent on the Narrabri South exploration process, looks less likely to proceed in 2019.
The slump in the share price the wake of the results reflects continued issues at Narrabri, Credit Suisse asserts, and the next 18 months will be critical in order to demonstrate that Narrabri can navigate the challenges. Still, the company has delivered $800m in returns to shareholders over the past 18 months and, with no material expenditure required until Vickery commences, this is likely to feature.
A formal process to sell down a stake to offtake customers at Vickery is to be launched in the next 12 months as the company envisages owning just 80% of the project. Deutsche Bank assesses the market is attributing nothing to Vickery or the Winchester South expansion. The plans for the Vickery have been pushed out to FY21 and the company has highlighted a likely legal challenge to the mine.
A statement of intent is expected in the near term for Winchester South and an initial reserve statement is expected in August. Deutsche Bank includes Winchester South in its valuation, at a 50% risk weight or $0.20 a share. In regard to Winchester South, Bell Potter expects the company will increase its value leverage to metallurgical coals, a positive factor.
The company is developing a new product strategy for Maules Creek, a return to the previous owner's 50% semi-soft metallurgical (coking) coal target, which will result in lower volumes and yields, and higher costs. The offset is the higher margins that should be forthcoming. The run rate of 13mtpa is still on track for the end of FY19 and Credit Suisse assumes an 88% yield.
Deutsche Bank notes the rise in unit costs at Maules Creek is based on the strategy to sell more coking coal, which requires washing. There is also a temporary increase in costs because of greater haul distances at Maules Creek, which will cease when in-pit dumping commences.
Management expects coal demand will remain strong and, even with the downgrades from the loss of tonnage and higher costs, higher prices will offset most of the losses.
Morgans suspects the best margins are behind the business, as costs are creeping higher and Whitehaven Coal's operating reputation has taken a knock. Still, the stock appears cheap and, with a capital management story still intact, the broker maintains an Add rating.
Bell Potter believes the market has over-reacted, noting the strong balance sheet and a production growth profile which should support shareholder returns. The broker, not one of the eight monitored daily on the FNArena database, has a Buy rating and $6.20 target, believing its recommendation is also supported by the strong outlook for seaborne coal prices.
CLSA, also not one of the eight, is a little more concerned about the outlook. The broker notes price realisations were mixed in the half-year, with thermal coal surprisingly weak because of low caloric value sales.
In any other market the broker envisages the stock would have been sold off more, but with thermal coal pricing above US$110/t the market is shrugging off the latest figures because of the attractive free cash flow yield and capital return upside. CLSA has an Outperform rating and $5.80 target.
The database shows seven Buy ratings and one Hold (Macquarie) for Whitehaven Coal. The consensus target is $5.21, suggesting 16.6% upside to the last share price. The dividend yield on FY19 and FY20 forecasts is 9.3% and 6.9% respectively.
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