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Morningstar | Guidance Confirms Strong Fiscal 2018 Profit for New Hope, but Shares Overvalued

No-moat New Hope’s fiscal 2018 adjusted net profit guidance of AUD 248 million-AUD 253 million is slightly above our prior forecast of AUD 241 million. The marginally stronger guidance reflects a buoyant end to the year. Fourth-quarter fiscal 2018 coal sales of 2.5 million tonnes were up 5.4% on a year ago. Full-year coal sales volumes of 8.9 million tonnes were 3% above our prior forecast. We had already factored in the higher realised coal price in our August update. The higher thermal coal price is the key driver of the near doubling of fiscal 2018 adjusted net profit. Coal sales volumes were up just 3.8% on fiscal 2017.

Despite the increase in expected fiscal 2018 adjusted earnings to AUD 0.30 per share from AUD 0.29, we maintain our AUD 2.70 fair value estimate, and with New Hope trading at AUD 3.75, the shares are overvalued. The share price has risen strongly in the past six months, nearly doubling from around AUD 2.00. This is a function of the buoyant coal price, thanks to strong economic growth and production restrictions in China, along with the agreed acquisition of a further 40% of Bengalla. The near-term earnings outlook is strong, but think the market is overestimating New Hope’s longer-term earnings power in a normalised coal price environment.

Adjusted earnings should rise a further 37% to AUD 0.41 per share in fiscal 2019, primarily due to the addition of a further 40% of the Bengalla mine. The additional ownership underpins a forecast 25% uplift in coal sales volumes to 11.0 million tonnes. Bengalla is a lower-cost mine than Acland. We also expect a further (but moderating) tailwind from the coal price, and forecast a 6% rise to USD 97 per tonne. However, the spot price averaged USD 117 per tonne in August, and if this persists in fiscal 2019, our earnings forecast would rise a further 56% to AUD 0.64 per share, assuming no additional cost inflation. This possible near-term uplift would see our fair value estimate rise 7% to AUD 2.90.

In addition to underlying profit guidance, New Hope expects to incur a AUD 147 million pretax impairment relating to the Colton exploration project. We had nothing specific for Colton in our fair value estimate, so the impairment has no direct impact. Asset impairments are a function of the mining industry being capital-intensive and cyclical. The difficulty in avoiding capital allocation mistakes factors into our thinking around the longer-term competitiveness and returns in mining firms and our view that it’s difficult for mining firms to attain a moat. For mining firms under our coverage, near-term returns on invested capital currently exceed our estimates for the cost of capital in general. However, cyclical prices, the need to invest in new projects to sustain life, high capital intensity, and a propensity for mining firms to invest procyclically mean it’s difficult for excess returns to be sustained.