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Thermal coal swings and roundabouts

Stock market lore holds that clients always remember their broker’s failures rather than successes.

And so it is, our short term success rate is one out of two in following recent smart money moves. In the longer term,  I believe the Fortescue  share price will rise strongly post Chairman Andrew Forrest’s $100 million share purchase.  The price is currently still struggling sub $5.00.

Had you, dear reader, jumped on board last week’s Kimber Capital Whitehaven Coal buy recommendation in the low $3’s, this week you would be on the receiving end of another billionaire’s largesse in Nathan Tinkler’s $5.20 cash bid. Close to $1.00 paper profit in two days – as Chris Kimber said “It beats working”.

Our Whitehaven recommendation was prompted by a discussion Chris and I had as to how cheap the share prices are of major  Australian  thermal coal producers were.  They looked and still look cheap. Post the Tinkler bid, Whitehaven is trading around $4.  A big discount, even though Tinkler has bank financing in place.  Plenty of price room for arbitraging against the bid’s final outcome.

Perhaps short term, thermal coal producers may be a value trap. Industry thematics indicate that cheap shale gas is replacing thermal coal for American electricity generation .  So domestic US thermal coal producers have been dumping on the European  market, forcing global prices down. High cost producers like Patriot Coal, $US 70 a tonne, have been forced into Chapter 11 bankruptcy protection.  Asian thermal coal demand, however, has remained relatively firm.  A material clearing of supply overhang is probably another six months   away.

The attraction of Australian thermal producers is that coal grades are higher, and production costs are lower and we are closer to the Asian market.  I think we are now seeing a floor in global thermal price. Nathan Tinkler certainly thinks so – $5.2 billion on the table for privatising Whitehaven is not just altruism at work!

New Hope Corporation (or No Hope Corp , as  tagged by in its earlier days by less enthusiastic broker supporters)  was our second  thermal coal choice to Whitehaven.  The current price of just under $4.00, is about 40% discount, excluding cash,  to Net Present Value of around $5.30.  The company currently has $1.82 a share in cash backing (annual interest income about $90mln) and a history of paying large special one off dividends – which its major shareholder,  Washington Soul Patts, loves.  Perpetual  Trustees, another value fund manager, has bought a further 10 million NHC shares recently to take its stake to 8.1%

It’s a fair punt that NHC can pay a small special dividend of between 6-10 cents when it announces its September results. But no cigar on that! Ordinary full year div payout is expected to be around 13 cents.

So NHC’s share price has plenty of scope to play catch up to its NPV.  A good chunk, about 60% of NHC’s 2013 thermal coal earnings have been set around $US115 a tonne.  Forward sales will be determined by demand from Japan and Asia, and any uptick will be supported by higher shale gas prices, which in the US are showing signs of stabilising.

What has been concerning the market has been the Queensland Government’s  approach to expansion of thermal coal mining on the Darling Downs, where NHC’s Acland open cut mine is located .  A case of farmer versus miners.  It appears the new QLD government is prepared to move on a compromise for New Acland production increases, beyond a conservative  target of  6.8 million tonnes a year.

NHC has further  upside through its greenfield developments at Colton and Wilton. However there are expectations of delays and higher capital costs. For Lenton, the expectation is a 2017 ramp up, with capex of close to $1.2 billion for both.

Also of interest is to compare forecast P/E’s of NHC against that of Whitehaven. NHC is trading around 15-16 times, while Whitehaven’s P/E  is a about 2.5 times that again at the cash bid price. Nathan Tinkler is paying for the growth profile.

Our bet is NHC is also assessing  M&A opportunities. Both from  an acquisition  and acquired viewpoint.

Soul Patts is a canny investor.  And if the right bid for NHC was tabled at north of $5 a share, we reckon they would do the Harold Holt !





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