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Morningstar | Record Whitehaven Profit Reflects Buoyant Coal Price That Is Unlikely to Last

No-moat-rated Whitehaven Coal saw record profit in fiscal 2018, benefiting from the buoyant prevailing coal price. Net profit after tax increased 43% to AUD 526 million, in line with our forecast. The 27% rise in revenue to AUD 2.3 billion was primarily due to price. Whitehaven’s average received price rose 16% to AUD 121 per tonne, while the company’s share of coal sales volumes, net of traded coal, rose 3% to 16.0 million tonnes. Unit cash costs excluding royalties were up 6% to AUD 62 per tonne, reflecting industry cost inflation, longer hauls at Maules Creek as the pit deepens, and weaker-than-expected production from Narrabri, Whitehaven’s lowest-cost mine. Including royalties, cash costs rose 8% to AUD 72 per tonne.

We’ve lowered our near-term earnings forecasts as a result of lower-than-expected production guidance and higher unit costs. We now forecast earnings of AUD 0.61 and AUD 0.38 per share in fiscal 2019 and fiscal 2020, respectively, down from AUD 0.66 and AUD 0.45 previously. We maintain our AUD 3.40 per share fair value estimate, though after factoring in a 50% chance of the Vickery mine’s approval. Based on our new price forecasts, as explained in our last note, we think Vickery’s development is likely to be modestly value-accretive. The 50% probability weighting reflects uncertainty in gaining regulatory approvals. Incorporating Vickery sees increased capital expenditure in fiscal 2020 and 2021 but higher earnings thereafter.

Whitehaven shares remain overvalued. The current spot thermal coal price of about USD 115 per tonne is well above the marginal cost, and thermal coal miners are highly profitable. Consistent with that, Whitehaven earned a return on invested capital, or ROIC, of about 22% in fiscal 2018. We think this is unsustainable in the longer term and forecast the firm to earn an average ROIC of 9.3% for the next five years, close to the company’s cost of capital.

Net operating cash flow of AUD 831 million, up 37%, reflected the improved coal prices and a continued lack of cash tax payments. Whitehaven expects to exhaust its carried-forward tax losses in fiscal 2019 and to start paying cash tax from fiscal 2020. This should allow the franking of dividends from fiscal 2020. Free cash flow fell 26% to AUD 382 million as Whitehaven paid the first AUD 278 million instalment to acquire Winchester South from Rio Tinto. The final instalment of about AUD 90 million is due in fiscal 2019. We currently value the project at cost.

Despite the Winchester South payment, the company’s balance sheet and financial position continues to strengthen. Net debt of AUD 270 million is down from AUD 310 million at end June 2017. The strong cash flow facilitated a doubling of total dividends in fiscal 2018 to AUD 0.40 per share unfranked. The elevated payout ratio of 77%, up from 54% last year, is appropriate, given the boomtime earnings that Whitehaven is enjoying and the relatively low near-term capital expenditure requirements, at least until the company receives approval for Vickery. We support Whitehaven’s shareholder returns through elevated dividends, as opposed to buybacks, given that the high current coal price and company earnings are reflected in an elevated share price.

Fiscal 2019 volume guidance is slightly weaker than we were expecting, primarily due to the requirement for two planned production outages at Narrabri to move the longwall mining equipment. Reduced production guidance from Whitehaven’s lowest-cost mine, along with broader industry cost inflation, means Whitehaven expects a 3.2% increase in unit costs in fiscal 2019 to AUD 64 per tonne. Management says the opportunities for cost reductions are diminishing, given the emergence of broad-based cost pressure in the business. This is consistent with our view that signs of pressure on miner margins continue to emerge.