coal beginning to turn a corner

http://www.fostock.com.au/announcements/coal-beginning-to-turn-a-corner-buy-whc-guf-bnd



03-Aug-2012
Morning Report

Coal beginning to turn a corner – BUY – WHC, GUF & BND
Today’s Top Picks.

Coal beginning to turn a corner – BUY – WHC, GUF & BND
Over the past 12 months coal stocks have been punished for a variety of reasons, most notably due to declining demand for coal, driven in part by increased interest in natural gas. In addition to this, escalating costs including the introduction of the carbon tax, higher port and rail charges, and lower coal prices have exacerbated conditions for coal stocks.
The majority of coal producers share prices have diminished ~40% over the H1 2012, while existing explorers and developers have plummeted ~60-80% over the same period.
Low demand in the US has seen many coal companies scale back production including Arch Coal closing five of their mines in the Appalachian region and forced Patriot Coal Corp to recently file for Chapter 11 bankruptcy protection.
In spite of all this uncertainty, we believe there are a number of reasons why we think the market has bottomed, and is about to turn a corner. Our reasons include:
Natural gas prices in the US hit fresh 7 month high’s this week touching $3.16/gj and climbing a whopping 65% over the last three months. We believe this will lead to a potential reduction in coal-to-gas switching, improving demand for coal;
Many US based coal companies have scaled back production as a result of dwindling demand which overtime will help reduce stockpiles;
Deals are still being done from an M&A perspective, the most recent being Anglo American’s $555m acquisition for a 58.9% stake in the Revuboe coal deposit in Mozambique’s moatize basin; and
The overall underlying demand from China and India, which is linked to population growth and industrial expansion.
All of these reasons provide clear indication that the uncertainty in coal markets won’t last forever.
Anglo American’s deal last week highlights the majors all have see through investment cycles that they are willing to invest in today when prices are low.
Anglo acquired a 58.9% stake for $555m in cash. The deposit was acquired from the Talbot group to secure a foothold in the region.
The project has a reported resource of 1.4 billion tonnes of hard coking and thermal coal suitable for open cut mining, and could support exports of between 6-9Mtpa. This equates to an EV/Resource multiple of $0.67/t.
Stocks we like and think present the best buying opportunities at these levels include the following;
Whitehaven Coal Ltd (WHC.ASX, $3.55/sh, Mkt Cap $3.6bn, Net Cash $161m) – BUY PT $5.00/sh
There has been a significant amount of press around the last couple of weeks about whether Tinkler’s bid for WHC will succeed or fail.
Regardless of what happens, WHC’s share price has fallen ~40% since the AZT merger was finalised back in May, and we believe buying the stock today will represent good value over the medium term.
Importantly the business is transitioning from being ~70% thermal, 30% metallurgical business producing ~5Mtpa, and will move to 10Mtpa in FY13, assuming the successful implementation of the long wall at Narrabri. The company is targeting long-term production of 25Mt by 2016, and the split will move to ~65% metallurgical 35% thermal over time, which in our view will improve margins and take the reliance away from thermal margins.
We maintain our BUY Recommendation and PT of $5.00/sh
Guildford Coal Ltd (GUF.ASX, $0.355/sh, Mkt Cap $170m, Cash $14m) – BUY PT $1.15/sh
GUF are in the final steps of moving from exploration into production at their South Gobi project in Mongolia. The company’s quarterly, highlights a planned start up schedule for mining targeting an initial run rate of 2Mtpa of production in FY13.
We have modelled conservative margins of ~$25-45/t targeting an initial 2Mtpa and ramping up to 3.6Mt by FY14. Our stand alone valuation on South Gobi is ~$512m or $0.99/sh.
Bandanna Energy Ltd (BND.ASX; $0.36sh; Mkt Cap $190m, Cash $114m) – BUY (PT $1.05/sh)
BND is trading at a very attractive EV of just $76m, with over 1.6bt of coal assets and a 14% equity interest in WICET stage 1 coal terminal (worth $41m). BND has a 4Mt allocation for both port and rail from 2014 and is targeting production from two coal projects, namely Springsure Creek (thermal) and Dingo West (PCI).
If we included the equity value of the WICET investment ($41m), its Net cash would be $155m and EV would equate to $35m.
You are effectively paying $0.07/sh for BND’s coal assets, which is equivalent to $0.02/t on an EV/Resource basis and $0.11/t for marketable Reserves.
We have a BUY recommendation with a PT of $1.05/sh