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Morningstar | New Hope’s Fiscal 2018 Profit Benefits From High Coal Price; Shares Overvalued

We raise our fair value estimate for no-moat-rated New Hope by 19% to AUD 3.20 per share from AUD 2.70 previously. Despite the increase, the shares remain overvalued with the market factoring in higher coal prices than we think are likely. The current share price around AUD 3.90 is of the buoyant coal price, thanks to strong global economic growth and production restrictions in China, which we think will unwind.

The increase in our fair value estimate reflects three key changes. After further researching the recent Acland appeal, we are now more confident Acland Stage 3 will be approved. Our estimated probability of success is now 75%, up from 50% previously. This adds about AUD 0.20 to our fair value estimate. Second, we see potential for Bengalla to incrementally expand under New Hope’s ownership with minimal capital. We think output can grow by about 10% over the next few years, largely through greater productivity. It also adds about AUD 0.20 per share to our valuation. Third, we explicitly modelled the development of a 1.5 million tonne a year mine at Lenton, later growing to about 1.75 million tonnes a year. While the mine’s operating costs are likely to be in the top half of the cost curve, it is capital-efficient thanks to cheaply buying the next-door Burton mine assets. Lenton adds about AUD 0.10 per share to our fair value estimate.

Overall, we think New Hope is in a stronger position to gain approval of Acland, hence we factor in a 75% chance of success, up from 50%. There are two key drivers. The Land Court hearing this week will be with a different judge, which we think could be positive as the initial Land Court decision was unfavourable to New Hope. In addition, two of the three concerns, which were grounds for the Land Court to recommend New Acland Stage 3 be rejected, will be handled under a different process. Combined, we feel somewhat more confident New Hope will be successful.

The Land Court hearing is underway this week and a decision is expected relatively quickly. The Land Court review will now focus on noise. The initial Land Court decision to recommend Acland Stage 3 not be approved also included water and intergenerational equity--principally longer-term ground water concerns. The approvals around water are now part a separate process. All up, New Hope is hopeful approvals will be forthcoming by next year. However, several avenues for those opposed to the mine remain, including an appeal of New Hope’s judicial review, so we don’t think it’s prudent to assume a 100% chance of success. The experience to date has shown the challenge to the mining lease and associated water licence, despite Acland Stage 2 being an existing mine. Factoring in a 100% chance of Acland Stage 3 approval, would increase our fair value estimate by further AUD 0.15 per share to AUD 3.35.

If approvals for Acland Stage 3 are not forthcoming, we think the most likely scenario is New Hope resubmits its application after addressing the grounds for its rejection. If we assume a two-year delay with first production from 2023, and an additional AUD 100 million in costs, such as to gain approvals and rehire the workforce, our fair value estimate would decline to AUD 3.00 per share. We still think a complete no-go is the very worst-case scenario and one we see as an outlier risk at this stage. If the mine ultimately expands from the current around 5.0 million tonnes a year to 7.5 million tonnes a year, our fair value estimate would rise a further AUD 0.15 per share to AUD 3.50.

At Bengalla, we now believe it’s realistic for the mine to incrementally creep its capacity from about 9.5 million tonnes a year to 10.5 million tonnes a year with little additional capital. We see scope to increase production through a minor change in design and improved equipment productivity. We still assume New Hope acquires an additional 40% of the Bengalla, as announced from Wesfarmers, bringing its total equity to 80%. However, the other joint venture participants, Mitsui and Taipower, who each own 10%, could pre-empt in proportion with their current holdings. If both parties pre-empt, New Hope’s share of Bengalla would be 66.7%. Importantly, we think New Hope is paying a fair price for Bengalla, so we don’t see pre-emption as materially value-destructive. In either scenario, New Hope will be free to manage and operate the mine.

Lastly, we’ve now explicitly modelled the development of a 1.5 million tonne a year mine at Lenton and assumed a 75% chance of success. The lack of detail around the development plan meant we previously captured this in our valuation for undeveloped resources. This stands at AUD 0.25 per tonne of undeveloped coal resources, or AUD 350 million. The mine is expected to produce approximately half metallurgical coal and half thermal coal. The key hurdles remain granting of the water licence at Lenton, but production can start early from the granted Burton mining lease, acquired with the Burton processing plant and other assets. Operating costs are likely to be above the industry average, but low capital costs are key to its viability. New Hope acquired the processing plant and associated infrastructure cheaply from Peabody when it was in administration. Lenton adds AUD 0.10 per share to our fair value estimate.