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Morningstar | New Hope’s First Half Benefits from Stronger Coal Price, AUD 3.50 per share FVE Maintained

New Hope benefited from a 22% jump in the realised coal price of AUD 140 per tonne. The realised coal price eclipsed the highs of the 2011 China boom, with the weaker AUD/USD exchange rate also providing a boost. Adjusted first-half fiscal 2019 net profit after tax increased 38% to AUD 160 million versus the same period a year ago. Coal sales of 4.4 million tonnes were soft however, and 12% below our forecast. The weaker volumes were primarily because of the higher unit costs at the Acland mine, where stage 2 reserves are nearly depleted. The overall result was strong, but adjusted profit was below our forecast because of lower volumes and higher unit costs. We expect some improvement in the second half as first-half inventory is reduced.

We maintain our AUD 3.50 per share fair value estimate for New Hope, with the higher unit costs at Acland stage 2 having little effect. Now that environmental approval has been confirmed, we expect the firm to start stage 3 mining from 2020, which should lower unit costs at Acland. There is some risk over the timing as the firm still needs the mining lease and associated water licence before Acland stage 3 can proceed. Our valuation includes a 100% possibility that stage 3 will go ahead. The approval from the environmental authority supports this view, which we took after the positive Land Court decision in November 2018.

New Hope needs final approval for Acland stage 3 in 2019 to ensure the continuity of production and employment at the mine. We believe this is likely, but there is a risk of a delay. If we assume a two-year delay, with the start of production from 2023, and an additional AUD 100 million costs, our fair value estimate would fall to AUD 3.00 per share. Our no-moat rating remains, with excess returns on invested capital forecast to erode as coal prices stabilise.

The first half saw New Hope’s ownership of the Bengalla mine increase from 40% to 70%. A further 10% stake will be purchased in this half for AUD 215 million, increasing New Hope’s stake to 80%. Once complete, we expect Bengalla to contribute approximately two thirds of the firm's operating earnings. This purchase will result in the firm having modest net debt of less than AUD 100 million. The balance sheet is in good shape and should remain so, despite likely expenditure needed to develop Acland Stage 3 and the Lenton/Burton mine. We forecast net debt to peak below AUD 500 million and net debt/EBITDA of less than 0.75 to fiscal 2021, declining thereafter.

Net operating cash flow declined 12% in the half versus a year ago, because of the timing of tax payments. The free cash outflow of AUD 300 million reflected the acquisition of a further 30% stake in Bengalla. Free cash flow should return robustly positive in fiscal 2020, once the acquisition costs are behind. Our forecast is free cash flow should average AUD 280 million per annum between fiscal 202 and fiscal 2023. The interim dividend increased 33% to AUD 0.08 per share, fully franked reflecting the rise in underlying earnings. There is potential for a special dividend in 2019. New Hope had AUD 461 million of franking credits at the end of fiscal 2018. However, given the likely upcoming expenditure for acquisitions and mine development, and management’s aversion to debt, a large special dividend is unlikely.