Commodity investors know that strong demand for iron ore is safeguarded by global infrastructure needs – but what about the world’s dirtiest source of power generation, king coal? Is your money safe in Aussie coal stocks?
Spot prices for thermal coal tumbled over 2012 to a three-year low at $US81 ($A78.51) a tonne at the end of October. The world’s largest importer of Coal, China, has taken its foot off the growth accelerator and prices have retreated. This week, coal prices reached $US84 ($A81.42) a tonne.
It seems hard to recall that not long ago thermal coal was around $140 per tonne. The following chart shows the sliding price of coal:
Metallurgical, or coking, coal used to turn iron ore into steel has not been spared. Here is its price chart:
The declining coal price means that some coal miners have been forced to close operations and shelve expansion plans. Diversified Australian miners BHP and RIO pushed the hold button on expansions at the Peak Downs in Queensland (BHP) and Mount Pleasant in New South Wales (RIO). Pure play coal miner New Hope Corp (NHC) is reportedly delaying expansion plans and planning job cuts. RIO has already slashed jobs across its coal operations.
The Bureau of Resources and Energy Economics (BREE) slashed export revenue forecasts from iron ore and coal by a hefty A$20 billion in September. Resources Minister Martin Ferguson nevetheless highlighted the A$270 billion in resource sector projects still in place – however, truth be told, the bulk of that money is going to Liquefied Natural Gas Projects.
Gloomy conditions sometimes yield solid sharemarket buying opportunities. But are there worthy plays in Australia’s coal mining sector, or is this a sector to avoid?
Considering unprecedented changes in the global energy picture, that question is extremely difficult to answer. First there’s the issue of coal as a commodity and then there’s the issue of Australia as a supplier.
There are factors that have put downward pressure on the price of coal beyond concerns over diminishing demand. The shale gas explosion in the US has devastated its coal industry – leading American coal producers to look for export markets to offload the oversupply. The Chinese government is also expanding coal production in the Xinjiang region. Xinjiang is reportedly on track to double coal production by 2015, from 120 million tonnes to 240 million tonnes. By 2020 the region’s coal production could reach 750 million tonnes, supplanting Mongolia as the top coal-producing region in China.
Already, Xinjiang has operational coal-to-gas production facilities. The Xinjiang region could potentially produce 1 million barrels per day of liquid fuels from coal – if approved by the NDRC (National Development and Reform Commission). The biggest hurdle is availability of water.
There’s the danger that oversupply will continue to keep coal prices low. On the other hand, demand for power generation from emerging economies may see prices recover. A study from global giant Peabody Energy claims global coal demand will increase from the current 7.9 billion tonnes to 8.9 billion tonnes by 2016. About 700 million tonnes of that billion tonne increase will come from China. However, the potential in the Xinjiang region begs the question: how much of that increased demand can be met by China’s own coal production activities?
The World Resources Institute (WRI) forecasts in the table below that around 1,199 new coal-fired plants will come on line across 59 countries. China and India combined account for about 75% of the increased capacity from the new plants. Despite advances in gas liquefication and solar and wind alternatives, coal still has a cost edge:
Despite being a world leader in the supply of quality coal, Australian miners have significant disadvantages. The first is the strength of our dollar. The second is cost constraints. Simply put, labour costs both in the mining of coal and in the construction of the infrastructure needed to support the sector are prohibitively high. Rising mining taxes add another layer to the cost issue. In addition, there is competition for skilled workers between the mines and the Liquefied Natural Gas (LNG) facilities. Furthermore, there’s future financing concerns for infrastructure expansion.
Because of these concerns, the share prices of our major coal miners have suffered. The share prices of big miners BHP and RIO have retreated alongside falling coal and iron ore prices. Here’s a one year share price chart comparing the two against the ASX 200 XJO Index:
Rio Tinto receives only 9% of its revenue from coal with 43% coming from iron ore. BHP receives 32% of its revenue from iron ore and 20% from coal (12% coking coal and 8% thermal coal.) Of the two, RIO is the analyst favorite. All seven of Australia’s major brokerage houses along with Asian regional CIMB Securities have BUY, OVERWEIGHT, or OUTPERFORM recommendations on Rio. CIMB and JP Morgan reduced their forecasts for coal prices and lowered the target price on RIO a bit while maintaining OVERWEIGHT recommendations. BHP has NEUTRAL recommendations from JP Morgan, Credit Suisse, and BA-Merrill Lynch. Here are some valuation and performance metrics comparing the two:
Trailing P/E (Most Recent Quarter)
Forward P/E (2014)
2 Yr Earnings Growth Forecast
RIO boasts the stronger balance sheet, with half the gearing of BHP, less total debt and more cash on hand.
But should the price of coal rebound suddenly pure play coal miners will rebound the fastest. Australia’s two largest pure play coal producers are Whitehaven Coal (WHC) and New Hope Corporation (NHC). A one year price chart for both stocks demonstrates the risk of punting on pure plays. Here is the chart:
Whitehaven Coal has five operating mines in NSW producing both thermal and coking coal. Production for FY 2012 was 5.5 million tonnes but the company forecasts sales to reach 18 million tonnes by 2015.
Major analysts are still uniformly bullish on Whitehaven, although cautioning on the risk of continued weakness in coal prices. This is a little surprising consideringrepeated warnings that without an uptick in the coal price, WHC’s earnings will suffer. An analyst at Citi cut the price target from $5.25 to $4.15 based on that concern yet maintained a BUY rating. Here are some metrics to look at for Whitehaven and rival New Hope:
Forward P/E (2014)
2 Yr Earnings Growth Forecast
Despite the lukewarm opinions of major analysts, New Hope’s fortress like balance sheet and substantially higher dividend yield looks more hopeful on paper. NHC currently produces around 6 million tonnes with plans to more than double production by the end of the decade to 16 million tonnes. Although those plans may be delayed, the company’s stellar balance sheet provides a significant advantage should they go forward. New Hope enjoys its own export terminal in Brisbane and has interests in coal, coal seam gas and liquid gas as well. Given the cautionary environment, some analysts speculate the company could actually issue a special dividend to its shareholders. New Hope is worth researching for the brave.
The recent marriage between Swiss mining giants Xstrata and Glencore serve as evidence of M & A (merger and acquisition) activity in this troubled sector. Australia has several junior miners in the coal sector that could become potential takeover targets. The following table includes three miners with respectable debt to cash positions and low price to book ratios. A P/B under 1.0 means the stock is trading for less than its book value. Here is the table:
Current Share Price
Book Value per Share
Cockatoo Coal (COK) has the weakest balance sheet, but is the only company with currently producing mines. COK increased revenues from U$31.1 million in FY 2011 to U$91.8 million in FY 2012. Stanmore Coal (SMR) has exploration assets and expects to be in production in 2015. Bandana Energy (BND) has 16 exploration permits in Queensland and is looking for Joint Venture (JV) partners to begin production in 2015.
As you might expect, junior miners have been hit hard. Bandana is down 55% year over year; Cockatoo is down 65%; and Stanmore has dropped 70%.
No discussion about the future of king coal would be complete without a word or two about the power of new technologies. Technology throughout history has repeatedly moved the impossible to the possible and ultimately, to reality. In the oil crisis of the late 1970’s the thought of drilling for oil a mile below the ocean’s surface was unthinkable. But it came to pass and the day the world ran out of oil moved further away.
In the minds of some, the notion of “clean-coal” is nothing more than corporate boardroom speak to convince the public that coal has a future, and a greener one. Yet because of the sheer abundance of coal, research into cleaner coal will continue. Never bet against technology.
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