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Material Matters: Thermal Coal And Coking Coal

Commodities | Sep 03 2021

This story features WHITEHAVEN COAL LIMITED, and other companies. For more info SHARE ANALYSIS: WHC

A glance through the latest expert views and predictions about commodities: thermal coal and coking coal.

-Despite the market being closed, China was the key customer for Australian lower CV thermal coal
-Credit Suisse predicts a highly cash generative year ahead for some coal stocks
-Market should not fear iron ore-style of correction in coal prices

By Mark Story

Thermal coal: Perfect storm for pricing

Citi attributes a material uplift in China coal prices to mine suspensions in Inner Mongolia, covid-related border closures within Mongolia, plus the ban on Australian imports at a time when China coal consumption is up, having jumped 4% in July.

Given that other Asian customers have a requirement for lower ash/higher calorific value (CV) coals, China was the key customer for Australian lower CV thermal coal (5500kcal). But with this market now closed, Citi notes Australian producers of 5500kcal coal have been buying high-CV coals (NEWC6000 and above) for blending to produce a mid-CV product for sale to Korea/Taiwan (typically 5800kcal).

While Japan has been the traditional market for NEWC6000 coals, Citi believes demand for benchmark coal for blending has created a new demand stream and intensified market tightness for NEWC6000. The broker concludes that as China remains shut, demand for high-CV coal for blending will likely persist.

Based on the prices so far this quarter, Citi has tweaked the bull case for NEWC6000 for the September quarter to $165/t.

Citi’s commodity team has assigned a 20% probability to its bull case for thermal coal. Driven by a major deficit in the seaborne thermal coal market and with risks skewed towards further price spikes in case of another round of heatwaves in East Asia or a cold 2021/22 winter in the Northern Hemisphere, the broker forecasts three-digit NEWC6000 prices for the rest of 2021.

With Citi’s bull case now the base case for second half 2021, the broker has revised up both Whitehaven Coal’s ((WHC)) and New Hope Corp’s ((NHC)) near-term estimates.

The broker has revised up Whitehaven’s FY22 earnings and net profit by 9% and 13% to $1.03bn and $502m, respectively, with FY22 net debt reducing to $192m. As a result, Citi increases its target price to $2.70 and removes its High-Risk designation from its Neutral rating on much stronger balance sheet projections.

Adjusting for July quarter actuals and Citi’s revised second half 2021 price assumptions, the broker revises down New Hope’s FY21 earning per share (EPS) -5%, with FY22 earnings and net profit revised up 21% and 27% respectively. As a result, the broker has lowered New Hope’s target price to $2.20 from $2.10 and retains a Buy rating.

Credit Suisse believes the strong free cash flow (FCF) posted by Whitehaven in FY21 is a solid indication that the coal names (under its coverage) are out of their trough and should embrace a highly cash generative year ahead.

Underpinning Whitehaven’s result, notes Credit Suisse, was the $178m debt repayment post-June 30, which implies to the broker $90m FCF per month.          

Based on spot prices, Credit Suisse suspects Whitehaven could be net cash of $300m by the end of FY22.  Similarly, under the spot pricing scenario, the broker suspects New Hope and Coronado Global Resources ((CRN)) may generate over 50% and 47% FCF yield in FY22 respectively.

The broker reiterates Outperform ratings on Whitehaven (target $2.85), New Hope (target $2.40), and Coronado (target $1.60) in the anticipation that coal may become the FCF captain over the next 12-plus months.

At New Hope’s FY21 result in September, the broker expects the dividend quantum and M&A to be the primary focus.

Meantime, the broker believes the balance sheet deleveraging remains the priority for Coronado and expects the company to exit 2021 with US$20m of net debt. A dividend reinstatement is possible, yet the broker notes management appears to be more interested in growth.

While upside remains in US domestic contract prices, the broker believes there’s a lingering risk that US coal traders may be realising the benefits of elevated prices that China has been paying, in turn hampering Coronado profitability.

Coking coal: No iron-ore style sell-off expected

Morgan Stanley does not expect an iron ore-style sell-off for coking (metallurgical) coal, as China's supply shortfall is likely to provide price support through second half 2021. The broker notes while iron ore now trades -30% below its mid-July peak, hard coking coal (HCC) prices appear impervious to China's slowing steel output and continue their sharp uptick.

To put the rally in context, the broker notes while Australia's free on board (FOB) price stands at a 3-year high of $248/t, the landed China price continues to set new all-time highs, currently at $421/t, up to $112/t (36%) since mid-July.

Given that met coal is less exposed to speculative activity than iron ore, the broker suspects the continued price strength has left investors wondering if iron ore hasn’t been materially oversold. However, Morgan Stanley notes the met coal to iron ore price ratio is mean-reversing, now at 1.6x, which is closer to the 10-year average of 1.8x than the 0.9x it averaged over the last year.

What this highlights, notes the broker, is the return to more normalised relative prices. As a result, the broker believes the iron ore price correction is a fair representation of the current China steel demand situation, and that the met coal strength is being kicked along by China's severe supply shortfall.

Morgan Stanley reminds investors that China’s domestic coal challenges have been heightened by the ongoing import ban of Australian coal, while the currently suspended overland imports from Mongolia have kept China's coking coal imports suppressed in July.

Unsurprisingly, because of this supply tightness, recent surveys suggest that coke inventories at Chinese steel mills are almost at a 4-year low. But despite the marked slowdown in China's steel output, Morgan Stanley notes mills are still looking to restock their coke supplies to return them to a safe level.

However, China's record coke price of $520/t doesn’t appear to be a showstopper for steel mills, with the increased cost of coke since mid-July being less than half the cost savings on iron ore since then.

Against a backdrop of relatively steady domestic steel prices, the broker notes steelmaker's margins have recently expanded.

While resilient ex-China steel production helps push the Australian HCC price up, Morgan Stanley believes the strength in this benchmark is mostly driven by China, even though no Australian coal is shipped to China anymore.

Under the current price differentials, the broker argues that it makes sense for non-Australian producers to redirect as much to China as they possibly can, and for ex-China mills to purchase more Australian cargoes.

Given where China delivered prices are currently at, the broker can still see the Australian benchmark rise further, narrowing the current $173/t arbitrage.

As long as China retains its import ban, Morgan Stanley thinks $140-160/t is the appropriate price range for the Australian HCC price. However, the broker suspects the price might not fall back to such a level until 2022 and sees some potential upside risk to the broker’s $190/t second half 2021 bull case.

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