Buying coal stocks is a tough ask. Sentiment is abysmal, thermal and coking coal prices have tumbled, and the Chinese Government’s move this month to impose tariffs on Australian coal imports shocked investors.
But every stock has its price. This column last week started identifying resource-related companies that have fallen too far, too fast, amid excess negativity. Mt Gibson Iron was singled out, because a big chunk of its share price is now reflected in its cash backing.
The rail operator, Aurizon Holdings, looks the best way to play the negativity in coal. It is a much better bet than backing coal producers that are being thumped by falling thermal and coking coal prices, or speculative explorers that will struggle to raise funds or proceed with projects.
Aurizon had a remarkable rally and, more recently, a sharp fall. Then called QR National, it raised $4.04 billion in an initial public offering (IPO) at $2.45 a share (for retail investors) in November 2010 as a widely anticipated Queensland Government privatisation.
Aurizon peaked at $5.26 last year, making it one of the best blue-chip floats in years, and reinforced why it pays to invest in privatisations, especially when they are first in the queue and governments need a successful IPO to pave the way for other asset sales.
The market could not get enough of Aurizon. But it slumped to $4.15 this month after China’s news, before bouncing to $4.50.
Over six months, Aurizon has significantly underperformed the Australian sharemarket and its transport peers.
Chart 1: Aurizon Holdings
Coal sentiment plumbed new lows in October after China tariffs action. Some observers said the move may have been gamesmanship as part of China-Australia free-trade agreement China negotiations, and the Chinese government this intimated its tariff on Australian coal imports might be lift. But the tariff risk added more misery to coal miners and transporters.
Another headwind is whether Aurizon will proceed with it proposed Pilbara iron ore project, with a decision not expected for another 12 months. Lower iron ore prices could stymie the project and uncertainty about it could weigh on Aurizon for some time. However, clarity on the project could boost Aurizon, and a decision to not proceed could allow for a significant capital return to shareholders.
Enterprise bargaining negotiations and higher-than-expected capital expenditure requirements are other challenges for Aurizon.
The key question, of course, is whether these risks have been fully factored into Aurizon’s share price. CIMB last week argued that negative coal sentiment and uncertainty over the proposed Pilbara investment are fully reflected in Aurizon after the share price pullback this year.
CIMB expects coal export growth to slow form around 4 per cent in FY15 to 3 per cent annually in the long term. It says Australian coal exports remain strong on a rolling 12-month basis, with Hunter Valley and Queensland coal volume at record highs. “The volume growth has been much higher than we previously expected, given the difficult operating environment faced by coal miners recently.”
CIMB said too much negativity has been factored in to Aurizon. “[It] faces a number of risks that have been impacting the share price. Over the next 12 months the market will get clarity on all or most of these issues. As this occurs, we expect the share price to react positively and we therefore believe there is a good opportunity to build a position at current levels.”
At $4.41 (when the research note was published), Aurizon is trading on a FY15 price-earnings (PE) multiple of 15.4 times on CIMB forecasts – its lowest PE multiple since the IPO and below its average of 17.9 times. “We think the pullback in the PE multiple makes the stock look a lot more reasonable from a valuation perspective,” CIMB said.
It has a $5.12 price target, implying a 21 per cent total shareholder return (including dividends) over 12 months. The forecast yield is 4.4 per cent and there is potential for higher dividends if a capital return is made.
Although Aurizon looks reasonable value, I see no urgent need to buy now. Re-rating catalysts in next few months are hard to find, and the odds favour further commodity price weakness and resource sector negativity. Aurizon will be a lot more interesting closer to, or below, $4.
Even so, Aurizon should have a spot on portfolio watchlists in anticipation of improving value. A lot of negativity that has been factored into its stock should be resolved in the next 12 months, laying the foundation for a decent recovery when sentiment finally improves.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at October 22, 2014.