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Bargains in the unloved coal sector

Lewis Jackson  |  27 Jul 2021Text size  Decrease  Increase  |  
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A handful of coal miners are among the only bargains left in the mining sector, says Morningstar direct of equity research Mathew Hodge.

Australian thermal coal majors New Hope (ASX: NHC) and Whitehaven Coal (ASX: WHC), along with coal exposed South32 (ASX: S32) are trading at double-digit discounts to fair value.Mining names under Morningstar coverage are trading at an average 9 per cent premium to fair value.

Coal miners are benefiting from rising prices as increasing demand hits limited supply, says Hodge. Thermal coal, which is used in power generation, is up nearly 90 per cent since January. Metallurgical coal, used in steelmaking, has nearly doubled since April 2021. Demand has increased with the economic recovery while major producers have delayed expanding production, pushing up prices.

Demand for Australia’s high-quality thermal coal should do “better than the overall market”, said Hodge in a recent note.

Asia’s young fleet of coal plants burn the higher-quality coal that Australian producers specialise in.

Hodge raised the fair value estimates (FVE) for Whitehaven and New Hope by just over 20 per cent as part of the review. South32 was raised by 11 per cent. Estimates were higher on upgraded forecasts for coal prices between now and the end of 2024.

Four miners were trading around fair value, alumina producer Alumina Limited (ASX: AWC), gold-miner Newcrest (ASX: NCM) and diversified miners Teck Resources (TECK) and Glencore (GLEN).

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Rising prices come as Australian coal miners are increasingly locked out of insurance and financing markets. In an April parliamentary submission, Whitehaven Coal said the unwillingness of the big four banks to associate with coal projects was raising financing costs.

“The common question asked by international banks when these issues arise is: If you cannot raise funding and support from your own banks in your own country, then why should we take the risk in backing you?” said Whitehaven.

Hodge said climate policies are a substantial risk to the thermal coal industry but expects Asian demand to remain resilient even as coal is phased out in Europe and the US.

He cites data from the International Energy Agency expecting coal’s share of global energy to be 21 per cent by 2040, down from 27 per cent in 2018.

It follows news last week that BHP (ASX: BHP) is considering exiting its oil and gas business. The firm sold its US shale oil assets in 2018 and plans to sell its small thermal coal assets.

Major names are expensive

A commodity boom from copper to iron ore has boosted miners such as Rio and BHP but Hodge expects this sugar hit to fade as new supply comes online and stimulus-fuelled economic growth slows.

He expects elevated prices for iron ore to persist through 2024 but forecasts prices normalising from 2025 as new supply in Africa and Latin America comes online and Chinese demand slows after the covid -rebound.

“We see industry returns as unsustainably high at the moment and prices as almost certain to fall,” he says.

Iron ore prices are up 41 per cent in 2021, comfortably trading above the $US200 mark.
Hodge increased FVEs for iron-ore exposed miner BHP by 11 per cent, Fortescue (ASX: FMG) by 9 per cent and Rio Tinto (ASX: RIO) by 6 per cent.

All three trade at double digit premiums to fair value. BHP is the cheapest at a 20 per cent premium to fair value.

Rio Tinto will report earnings Wednesday with analysts expecting a big jump in profits and dividends.

Lower-quality iron ore producers, such as Fortescue or Mineral Resources (ASX: MIN) are most at risk should prices fall, says Hodge. Lower quality iron ore is more expensive for steelmakers to use and emits more carbon and these grades trade at a discount to higher-quality iron ore.

Copper prices hit a record in May, lifted with the economic rebound and investor enthusiasm over the metal’s use in the electric vehicle sector.

Hodge raised the fair value for Australian copper miner Oz Minerals (ASX: OZL) by 8 per cent. The miner trades at a premium of 25 per cent to fair value.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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