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Strong coal, iron prices provide short-term boost for miners

Glenn Freeman  |  21 Feb 2019Text size  Decrease  Increase  |  
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Higher commodity prices delivered welcome profit boosts to iron ore producer Fortescue (ASX: FMG) and coal miners South32 (ASX: S32) and Whitehaven (ASX: WHC) as they delivered half-yearly results this week, dampened slightly by rising costs.

Iron ore producer Fortescue's net profit after tax fell 5 per cent to US$ 644 million for the half, from US$ 681 million a year earlier.

However, adjusted profit was up 66 per cent on the second-half of fiscal 2018, as it realised better prices on iron ore and expanded by 24 per cent its earnings before interest, tax, depreciation and amortisation margins.

"Reduced discounts for lower grade ore reflect a renewed focus on raw material input costs for steel makers," says Morningstar senior equity analyst Mat Hodge.

Lower margins have seen miners focus on reducing their production costs instead of trying to boost output of higher-grade raw materials.

Hodge expects further "incremental cost efficiencies" through increased automation and other innovations through to 2022.

"As a result of the cost and price discount changes, we raised our earnings forecasts by 15 per cent to US 58 cents a share in fiscal 2019, and by 18 per cent to US$ 52 cents a share in fiscal 2020," he says.

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He made a slight increase to his fair value estimate, to $4.50 from $4.20, in response to a stronger outlook for near- and medium-term earnings.

Lower steel maker margins have again seen those firms focus on minimising unit costs through lower cost inputs, rather than maximising steel volumes with higher grade raw materials.


Lower margins have seen miners focusing on reducing their production costs 

Fair values on hold

Coal producers South32 and Whitehaven each posted similar gains in net profit for first-half fiscal 2019, up 18 per cent and 19 per cent, though rising production costs and demand for higher-grade coal are cause for concern.

South32's profit jump was due to surging metallurgical coal output and sustained strength in coal prices.

Underlying profit came in at $642 million for the six months ended December 31, compared with $544 million a year earlier.

Morningstar senior equity analyst Mat Hodge maintained his $2.80 fair value estimate, saying lower unit costs related largely to a higher US-dollar were insufficient to prompt an increase.

"South32 remains overvalued. Commodity prices remain the key driver of shareholder returns. Many of the company’s key commodities trade well above our estimated long-term marginal cost, namely manganese, alumina, and metallurgical coal, suggesting earnings are above sustainable levels," he says.

Fortunes of the miner improved after production at its Illawarra Metallurgical Coal project which accounts for most, if not all, of South32's coking coal output, ramped up during the second quarter.

South32 declared an interim dividend of 5.1 cents per share, up from 3.6 cents per share a year ago, and a special dividend of 1.7 cents per share.

Higher processing costs take toll

Similarly, Whitehaven Coals' first half profit jumped 19 per cent on strong prices of its higher-grade thermal coal - but rising costs have rattled investors.

Revenue increased 11 per cent, despite the volume of coal sales declining by the same amount.

Net profit for the six months ended December 31 came in at $305.8 million, up from with $256.2 million last year.

Coal production costs have spiked on higher diesel prices, increased washing of coal to sell more higher quality product, and lower output from the company's lower cost mines.

Morningstar's Hodge left his fair value estimate of $3.80 unchanged. He says the focus on higher quality coal allowed Whitehaven to realise higher prices, but this also comes with increased processing costs.

The miner opened at a share price of $4.58 today. Whitehaven shares fell as much as 9.2 per cent to a one-month low of around $4.30 when the result was declared on Monday.

"Operating cost inflation was high and guidance weak, but we maintain our $3.80 per share fair value estimate.

"Unit costs rose 21 per cent to $69 per tonne versus a year ago, reflecting higher oil prices and transport costs and weaker volumes," Hodge says.

Whitehaven has increased full-year unit cost guidance to $67 a tonne excluding royalties, from $64 previously. This compares with $62 per tonne in fiscal 2018.

Around half of these increased costs are structural, including lower Asian demand, and the remainder linked to higher oil prices and weaker production volumes.

China cut coal imports last December, following signals from Beijing that it would stop clearing shipments until 2019.

The company declared an interim dividend of 15 cents a share, above last year's 13 cents a share, and said it would pay a special dividend of 5 cents a share.

is senior editor for Morningstar Australia

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