While oil was in the hot seat in March-April, coal is now in focus, reeling from a slump in demand as prices fall to multi-year lows. Benchmark hard coking coal prices have dropped -20% to US$115/t in the June quarter to date, the lowest level since mid 2016.
What is a reasonable short-term floor? Macquarie assesses many seaborne thermal and coking (metallurgical) coal producers remain profitable and it will require more downside to prices before a substantial number become pressured to cut output.
So far, thermal supply disruptions in South Africa and Colombia have been eclipsed by a surge in China’s domestic output, while the pandemic has reduced consumption in all major Asian regions.
The most likely area where coal production will be cut back is Indonesia, in Macquarie’s view. Nevertheless, Mongolia’s exports are ramping up and there are no major disruptions in Queensland.
So there is rising pressure for more reductions among US producers, which are the highest cost swing suppliers on the seaborne market. Macquarie assesses this alone cannot offset a short-term collapse in the price. Morgans is also becoming increasingly nervous about a further correction in thermal coal prices.
The ongoing impact of pandemic-related shutdowns to industry remains the key risk the metallurgical coal markets, and Wilsons notes the forward curve is signalling lower prices for the remainder of 2020 amid further downside risk.
Macquarie agrees, and anticipates the higher downside risk appears to be greater for coking coal as top grade hard coking coal is still 20% above the 90th percentile of the seaborne cost curve. Moreover, coking coal faces a larger problem than thermal coal as demand from the steel industry outside of China may shrink even further.
Australian Producers
Credit Suisse assesses Coronado Global Resources ((CRN)), a pure coking coal producer, is indicative of the current environment enveloping global coal miners. The company, in its latest production report, has withdrawn 2020 guidance and US production has ceased for the time being.
Hence, debt is elevated, rising to US$437m as working capital movements go against the company. The business now faces a 12-month delay to the Curragh expansion in Australia.
This is unfortunate, Wilsons asserts, as Curragh products have superior coking coal qualities and are preferred by customers. Combined with shuttered US production and the weak dynamics of global steel production, the outlook is bearish.
Still, there are further levers to be pulled, Credit Suisse notes, and US operations remain positive in terms of cash flow, given the sale of inventory continues. Plans to re-start Buchanan and Logan are also providing potential for the outlook.
In a normal year, Buchanan and Logan account for around 35% of sales volumes for the company, Bell Potter points out. These operations are expected to be neutral to cash flow while idle, as inventory is drawn to meet sales contracts.
Moreover, as India and Europe emerge from restrictions this will go a long way to supporting a market which only has China driving demand currently. Hence, Credit Suisse warns against crystallising losses at current levels as the assets have a long life and leverage to prices once the market turns.
Bell Potter also points out term contracts to US customers should provide some price protection for Coronado Global, but in the absence of a price recovery there is downside risk to 2020 earnings.
Macquarie recently downgraded New Hope Corp ((NHC)) to Underperform and reiterated an Underperform rating on Whitehaven Coal ((WHC)). The broker has become more negative on coal miners because of the material downside risk to earnings at spot prices. The broker calculates that earnings for the pair swing to a loss under its spot price scenario for FY21.
Whitehaven has asserted it will not seek financial decisions on any of its growth projects at present, which UBS assumes is reflecting the slowing of government approvals, rather than any change of heart by management.
Brokers suspect a large push is required in the fourth quarter for the company to achieve the company’s production guidance. Whitehaven has retained guidance but pointed towards the lower end of the range. Credit Suisse is also cautious as the northern hemisphere exits the heating season, in terms of thermal coal. As with many indicators currently, the downside case is easier to make.
The broker assesses there is value in Whitehaven Coal although multiples are elevated. Morgan Stanley agrees there is material value but awaits operating improvements while Citi considers the stock cheap against mining peers, but on FY22 estimates not on FY21.
