As Mark Twain might have put it, the death of Australian coal has been wildly exaggerated.
Less than a year after Australia’s coal industry was widely viewed as being in serious trouble, a startling reversal of fortune has occurred, with the spot price for coking (steelmaking) coal up threefold since January, to about US$233 a tonne, and prices for thermal (electricity) coal up 80% since January, to US$86 a tonne.
That’s good news for the nation’s finances. According to Deloitte Access Economics, every US$1 rise in the coking coal price delivers a $65 million boost to the Australian budget. Deloitte says coking coal exports in the December quarter should add about $1.7 billion to government revenue, and potentially $7 billion if prices persist for a year.
Australian coal exports – both coking and thermal – were worth almost $38 billion last year, according to Austrade, with 57% of that amount coming from coking coal. In total, coal accounted for almost 12% of Australian exports of goods and services, second only to iron ore in terms of value.
In investment terms, assessing coal companies should be a matter of looking at coal prices, cost of production, margins, profitability, earnings, dividends, reserves and mine life – just as with any other commodity. But the waters have been muddied in recent years by a non-numerical factor, the so-called ethical factor, with regard to coal’s contribution to carbon dioxide emissions, and the alleged effect of these emissions on the climate.
In the developed world, many people hold an ideological distaste for coal on this basis, and a corresponding preference for “renewable” energy, mainly in the form of wind and solar power. The argument has been developed that renewable energy will take over from coal and that the thermal part of the coal industry is doomed.
This argument does not apply to coking coal, which cannot yet be replaced on a meaningful and economic scale in the steel-making process. But coal is very definitely a business that attracts not only opposition, but active campaigns calling for investors to get out of it and banks to cease funding it, actual physical blocking of its operations, and environmentally inspired “green tape” lawsuits brought by activist opponents, designed to frustrate coal mining operations and proposed projects in ongoing “lawfare.” This very definitely has to be factored in by an investor considering coal.
However, coal currently accounts for the lion’s share of Australian electricity production, at 71%, and at the moment, coal fuels 41% of global electricity generation. These percentages will come down as greater investment goes into renewables: in 2030, the International Energy Agency expects coal’s share of global generation to be 31%. The point is that coal will remain the largest single source of electricity generation for quite some time: in the developing world, it will do the heavy lifting in bringing electricity to hundreds of millions of people coming out of poverty.
At the moment, renewable energy capacity – because of its intermittency – needs the constantly available back-up of 24-7 baseload power, and coal is the largest provider of this. Undoubtedly, renewable energy will increase its share of the total generation mix, but it simply is not going to replace coal anytime soon. For investors, it is difficult to sift through the ideologically motivated information, and to approach coal dispassionately.
Even on carbon dioxide emissions, the technology that is being rolled out in the new-generation high-efficiency-low-emissions (HELE) coal-fired power plants – particularly in Japan, the US and Germany – is making huge strides in cutting emissions from coal while increasing its thermal efficiency as a power source, using super-critical and ultra-super-critical (USC) technology.
GE Power has developed advanced ultra-super-critical (AUSC) technology that appears to be able to ensure that clean coal remains pivotal in the global energy mix well into the current century. Australian thermal coal producers are well positioned in this market because of the characteristics of their coal – high-energy, low-ash and low-sulphur content.
Similarly, Australian coking coal is very high in quality compared to other world sources, and very keenly sought by steel mills – that is not likely to change anytime soon.
Coal’s surge in price this year has come mainly off the back of Chinese stimulus: infrastructure spending has been boosted, restrictions on real estate investments relaxed and banks have been encouraged to lend – the resultant real estate and infrastructure booms have fed into greater activity in the steel sector. Virtually no-one predicted the rally in coal prices, and prices will prove difficult to sustain.
So how are the coal companies positioned?
New Hope Corporation (NHC, $1.99)
Market capitalisation: $1.65 billion
Analysts’ consensus price target: $1.675
FY17 estimated dividend: 2.26% fully franked
New Hope produces thermal coal in Queensland and New South Wales. The company operates the New Acland mine in south-east Queensland and recently outlaid $865 million to buy Rio Tinto’s 40% stake in the Bengalla coal mine in the Hunter Valley of NSW. New Hope has been trying for nearly ten years to get approval to expand its Acland coal mine near Oakey in Queensland, in what would be a $900 million project to boost production by 50% to 7.5 million tonnes a year, and extend the mine life to 2029. That process is tied up in a Brisbane court.
In FY16, New Hope produced 6.6 million tonnes of saleable coal, up 15% on 2015. Export sales rose by 18.7%, to 6.7 million tonnes. The company reported revenue of $531.5 million, up 5.1%, and a profit after tax of $5 million, but non-recurring items slashed that to a net loss of $53.7 million. The ordinary dividend was 4 cents a share, down from 6.5 cents a share in FY15 (there was also a special dividend of 3.5 cents a share in FY15).
New Hope coal is right in the sweet spot to supply power plants using the new HELE technology, and that is the main growth area for the company going forward. In the current financial year New Hope expects record Australian production and sales. New Hope says it bought Bengalla at a at low point in thermal coal cycle, it had an immediate positive impact on 2016 earnings, and any subsequent rise in thermal coal prices will further improve its contribution in 2017.
New Hope shares have surged by 78% since March, but that has pushed them well past the Thomson Reuters analysts’ consensus price target.
Whitehaven Coal (WCC, $3.05)
Market capitalisation: $3.13 billion
Analysts’ consensus price target: $2.60
FY17 estimated dividend: no dividend
Whitehaven Coal produces thermal coal and coking coal from its mines in New South Wales, with the former – which it sells to Japanese power customers – accounting for 84% of production. The remainder is its coking coal, which mostly goes to India and Japan.
In FY16 Whitehaven lifted coal sales by 42%, to a record 15.4 million tonnes, and surged back into profitability, making a net profit of $20.5 million, versus a $342.7 million loss in FY15. The company reduced its cash cost of mining by 8%, to $56 a tonne.
The flagship project is the Maules Creek mine, which produces a high-quality low-ash, high-energy thermal coal that sells at a premium to the Newcastle benchmark price, and also a high-quality, low-ash, low sulphur and low-phosphorous semi-soft coking coal (SSCC) that is considered in the market to be a premium blend for coke and steel production. Steel mills are increasingly looking for coke blends with a high proportion of SSCC – Whitehaven has the premier deposit of this type of coal in the world.
Whitehaven is a classic example of what you can find if you can look past the anti-coal rhetoric: it argues quite forcefully for the benefits of high-quality Australian coal in meeting the needs of Asian markets, while working to lower carbon dioxide emissions. Of Whitehaven’s 20.1 million tonne output last year, just 16% was coking coal, but as the coking coal rich Maules Creek is ramped up, this portion should rise to 40% over the next four years. Maules Creek will produce 84% coking coal.
Analysts certainly expect a profit surge at Whitehaven this year, with earnings per share (EPS) rising from 2.1 cents in FY16 to 26 cents in FY17, declining to 19 cents in FY18, according to Thomson Reuters. But a 300% rally over the past six months leaves Whitehaven looking very expensive. However Morgan Stanley retains an “overweight” recommendation with a price target of $3.10, saying the benefits of higher contract prices have not yet actually kicked in.
Stanmore Coal (SMR, 70.5 cents)
Market capitalisation: $157 million
Analysts’ consensus price target: $1.597
The only ‘pure play’ coking coal producer listed on the ASX, last year Stanmore picked up the mothballed Isaac Plains mine from Vale and Sumitomo for $1 (plus some offsetting liabilities and compensation). The mine, near Moranbah in central Queensland, had been placed on care and maintenance in late 2014. It was officially reopened in May, with a production target of 1.1 million tonnes over the next ten years.
Isaac Plains produces premium-quality coking coal that Stanmore sells to Japanese and Korean steel mills on a long-term contract basis. Stanmore has ten years of open cut reserves, with an additional seven years possible from the Isaac Plains East proposed expansion, which was acquired from Peabody Energy in July 2015. Stanmore is hoping for approval at Isaac Plains East by mid-2017.
The December quarterly benchmark price has been set as US$130 a tonne, a rise of US$56 a tonne, or 75%, above the September 2016 quarterly benchmark price of US$74 a tonne. This should apply to coal delivered by Stanmore through to February.
Stanmore is currently a loss-maker, and while the improved coal prices have not flowed through to predictions of moving into the black, according to Thomson Reuters analysts see definite scope for price improvement.
Yancoal Australia (YAL, 39 cents)
Market capitalisation: $388 million
Analysts’ consensus price target: 50 cents
Yancoal produces about 15 million tonnes a year of thermal coal and coking coal from its portfolio of seven open cut and underground coal mines in New South Wales mines and Queensland. The miner is 78% owned by China’s Yanzhou Coal Mining, with Hong Kong-based trading house Noble Group holding 13.2%. The small free float means the shares are thinly traded, and prone to big moves: YAL has almost quadrupled over the year, and are up 77% in October, including a 40% burst on October 18.
Yancoal is also a loss-maker, but The Australian recently reported that it was a potential buyer of Rio Tinto’s Australian thermal coal assets – parent Yanzhou Coal is said to be keen to secure long-term supply into China.
BHP Billiton (BHP, $23.04)
Market capitalisation: $122.6 billion
Analysts’ consensus price target: $21.85
FY17 forecast dividend: 2.4%
The biggest ASX-listed beneficiary of the coal price surge is BHP Billiton, which is the world’s largest coking coal exporter. Last year BHP produced 43 million tonnes of coking coal, mainly from its Queensland joint venture with Mitsubishi, compared with 34 million tonnes of thermal coal. The coal division contributed 15% of BHP’s revenue (totalling $US31 billion) but only 5% of core earnings ($US12.3 billion).
Coking coal’s price strength will be a big factor in this year’s result, with analysts reckoning that every $US10 a tonne price rise increases BHP’s earnings by $US420 million, all other things being equal. Earlier this month, the AFR reported that analysts expected BHP Billiton’s coal division to switch from a loss in FY2016 to contributing 20% of the entire company’s operating earnings this financial year.
Wesfarmers (WES, $44.12)
Market capitalisation: $49.7 billion
Analysts’ consensus price target: $43
FY17 forecast dividend: 4.7% fully franked
No-one is going to buy Wesfarmers for its coal exposure, but neither is it a small player. Wesfarmers’ coal division produces 8.5 million tonnes a year of coking coal for the export markets and 3 million tonnes a year of thermal coal for the domestic market. The major points of interest around Wesfarmers’ coal operations are firstly, what effect the coal price recover can have on the conglomerate’s earnings, and secondly, when Wesfarmers will sell it, in order to focus on its retail operations.
Last year, the coal division lost $310 million, and contributed to an 80% slump in Wesfarmers’ total profit. However, this year, analysts reckon the company’s Curragh and Bengalla mines could earn as much as $296 million, and more than $300 million in FY18. The $500 million turnaround in Wesfarmers’ coal operations may give Wesfarmers the perfect opportunity to exit the coal industry at a good time.
Rio Tinto (RIO, $51.21)
Market capitalisation: $92.2 billion
Analysts’ consensus price target: $56.93
FY17 forecast dividend: 2.8% fully franked
Rio Tinto produces thermal and coking coal at a portfolio of mines in Queensland and New South Wales. The business has been pruned in recent years as Rio sold less profitable and more environmentally sensitive operations, and is now a sideline compared to iron ore, which accounts for more than 80% of Rio’s operations. Rio Tinto’s coal business is reported to be up for sale, and could fetch up to US$2 billion.
Australian Pacific Coal (AQC, 2.7 cents)
Market capitalisation: $117 million
No consensus price target available
AQC picked up Anglo American’s Dartbrook thermal coal mine in the Hunter Valley in December 2015. The company estimates the coal resource at Dartbrook at 1.2 billion tonnes of high-quality, low-ash, thermal coal that is well suited to premium markets such as Japan and Korea. AQC is in the final stages of a business case analysis to assess the potential of re-commencing underground mining operations at the site, and is also seeking approval to move to an open-cut mine.
Former coal baron Nathan Tinkler invested in AQC when coal prices were depressed, in July 2015. Tinkler and entities associated with him hold just over 39% of AQC.
Wollongong Coal (WLC, 1 cent)
Market capitalisation: $94 million
Analysts’ consensus price target: 2 cents
The former Gujarat NRE Coking Coal Limited produces export coking coal from two mines near Wollongong in NSW. Wollongong Coal has expansion plans, and is fighting activists opposed to these.
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