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Morningstar | Raising Our New Hope FVE to AUD 2.70 With Higher Coal Prices

Thermal coal prices have rallied since the beginning of 2016, with the current monthly FOB Australia price more than doubled from the depressed level of USD 50 in January 2016. This was boosted by China’s supply-side reform, which limited coal supply by a 276-day production policy versus 330 days previously, as well as closures of small and inefficient coal mines. However, near-term demand has been stronger than we expected due to the recovery of industrial activity and extreme weather conditions. The latter boosted electricity demand for heating and cooling and limited hydropower output due to low waterflow. Coal-fired power generation in China grew 8% in first-half 2018. In the longer term, though, we expect China’s demand for coal slowly decline as energy production transitions away from coal.

In nominal terms, we’ve increased our forecast Newcastle export thermal coal price for calendar 2018 by 6% to USD 105 per tonne, in 2019 by 13% to USD 90 per tonne, in 2020 by 14% to USD 80 per tonne, and midcycle by 19% to USD 73 per tonne from 2021. This sees our fair value estimate for no-moat New Hope increase by 13% to AUD 2.70 per share from AUD 2.40. The benefit of higher coal prices is partly offset by an assumption of commensurately higher cost in future.

With our new coal price forecasts, we think New Hope has agreed to pay a fair price for a further 40% of Bengalla and on balance see the acquisition as value-neutral. The market reacted surprisingly favourably, but we think expectations for future coal prices are optimistic. We have incorporated the purchase of a further 40% interest in Bengalla from Wesfarmers for AUD 860 million into our forecasts. It should bring New Hope’s interest to 80%, but final ownership depends on the joint-venture participants. Taipower and Mitsui can proportionally increase their 10% shares in Bengalla on the same terms. We think it’s most likely that New Hope will get 80% and have assumed the deal completes in November 2019.

Our new midcycle price is based on the marginal cost of coal produced in Shanxi and delivered to the Qinhuangdao port in North China. The port is the barometer of China’s coal demand and is where thermal prices are set. Key assumptions underpinning our estimate include a higher coal rail-transport rate of CNY 87 per tonne from CNY 62 previously, set by the National Development and Reform Commission, and a rise of cash mining cost for 5500 kcal coal to CNY 163 per tonne from CNY 115 previously, driven by higher labour and equipment expenses, as well as safety- and environmental-protection-related costs. These bring our marginal cost forecast for coal delivered to the Qinhuangdao port to CNY 379 per tonne from CNY 307 previously, which along with the recent Chinese yuan depreciation, will translate to USD 57 per tonne. In addition, rising shipping rates drove up our midcycle forecast for Newcastle 6000 kcal coal by 19% to USD 73 per tonne from 2021.

While we’re raising both our near-term and midcycle thermal coal price forecasts, we still see risks to the downside from current elevated spot levels of nearly USD 116 per tonne. At this level, thermal coal miners are highly profitable, and the price is trading well above the marginal cost, which we estimate at USD 68 per tonne in today’s dollars. Key drivers of lower prices are capacity expansions in China, with repeal of the 276-day production constraints, growth in supply from Inner Mongolia, and loosening coal import restrictions. In addition, we think the improving coal rail-transport infrastructure, with the new rail corridor Menghua line commencing service in 2020, will also help to boost supply and flatten the cost curve. In the long term, we think the decline in electricity intensity of the Chinese economy and the shift toward an anything-but-coal energy policy will continue to dent coal demand and limit any material price increase.

Predominantly due to the higher coal prices and, to a lesser extent, the additional interest in Bengalla, we raise our fiscal 2019 earnings forecast by 41% to AUD 0.41 per share and fiscal 2020 nearly doubles to AUD 0.17. Our midcycle forecast is AUD 0.15, up from AUD 0.09 previously. The purchase of Bengalla will likely be funded from existing cash, cash flow and modest debt. We don’t see any need to issue new equity for the purchase.

New Hope had more than AUD 350 million net cash at end January 2018. At the end of fiscal 2019, following the payment to Wesfarmers, we expect New Hope to have net debt of about AUD 310 million. This is relatively modest and manageable. Assuming a 60% payout ratio for dividends from fiscal 2020 and factoring in the capital expenditure for a 50% chance the Acland expansion is approved, we expect net debt/EBITDA to remain well below 1.0 for our five-year forecast period and average about 0.5 for the four years ended fiscal 2022. If we factor in a 100% chance the Acland expansion is approved, net debt/EBITDA is still less than 1.0 in fiscal 2022, once the mine ramps up to full production.

In our base-case fair value estimate, we still rate approval of Acland Stage 3 a 50% chance. Given our higher coal price forecasts, we now think a go-ahead would add about AUD 0.35 per share to our fair value estimate, whereas a rejection would reduce our fair value estimate by the same amount. Uncertainty around Acland’s approval is part of the reason New Hope’s fair value uncertainty rating is very high.