Glenn Freeman: I'm Glenn Freeman from Morningstar. And in this edition of "Ask the Expert" we're talking about Cole and specifically, Whitehaven, which has hit our Australia and New Zealand Best Ideas List recently.

Matt, thanks for your time today.

Mathew Hodge: No worries.

Freeman: Thermal coal is a dirty word now. Why should investors consider a company like Whitehaven in this context?

Hodge: Yeah. One word really, valuation. The shares have sold off about 60 per cent from the peak. The coal price fallen. They've had some production issues and their unit costs are up. So, really, we see improvement coming from three areas. On the volume side, you know, they've spent a bit of money at Narrabri to improve the longwall and they're going to get some productivity gains from there.

At Maules Creek, they've been disrupted by labor shortages and dust from the drought. I mean, I don't think that the drought issue is going to be permanent one, and they're resolving the labor issues, and longer term, they're spending money on automating their mining fleet as well. So, all that will drive more volumes. As you drive more volumes, you lower your unit costs. And also, the coal price has fallen considerably from where it was, and now it's eating into a decent part of the cost curve. So, $66 we don't really think is sustainable, that prices touch higher than that long term about $73. So, we think the company is going to get more volumes and improve the margin through lower costs and higher prices. So, that's why we think the shares are cheap.

Freeman: And governments around the world are shifting away from coal-fired power.

Hodge: Yeah.

Freeman: So, where is demand going to come from?

Hodge: Well, coal is not going to go away, not for a long time…

Freeman: Contrary to what many people seem to be thinking right now.

Hodge: Yeah, I think, what you're talking about is growth, and we're not expecting growth overall, right? And when we talk about export coal and export coal for Australia, it's really about Asia. So, Asia, particularly Southeast Asia is still growing quite rapidly and that's a source of new demand and India is as well. So, while more mature economies like the AU and the U.S. maybe moving away from coal, that's a smaller source of demand and that's not where demand for Australian coal was coming from anyway.

So, we still think there's a market there for Australian coal. And if you think about Australian coal relative to other sources of coal in the Asian market, say Indian coal servicing their domestic market, or Indonesia into the export market to Japan or China, that is much, much lower quality. So, if there are unforeseen constraints that come on carbon, we think it's those lower-quality coals that are going to suffer disproportionately and perhaps you could even see a case where the higher-quality coals attract a premium.

Freeman: Miners have been behaving a lot like dividend stocks in recent years, but they're not, are they?

Hodge: No, and I think Whitehaven provides a pretty good example of that. I mean, the last three years, it's paid out $1.10 in dividends, which is massive, particularly relative to the current share price of around $2.50. So, they've paid a lot of dividends, but that's been a function of the coal prices really high and favourable.

They weren't spending a lot on capital expenditure at all. The mines were basically steady state and their balance sheet was in good shape. So, returning cash to shareholders was a good thing. 2020 will not look like that.

The coal price has come off, earnings have come off, our dividend forecasts have come off. And going forward, we don't expect coal price to return to where it was.

In addition, they've got two undeveloped projects which they will be investing in over the next five plus years. And that will soak up a good proportion of their cash flow. So, much lower dividends going forward than in the past. And obviously, where the coal price goes will dictate the payout. So, don't expect stable high payouts from these kind of businesses.

Freeman: Just to pick up a point that you raised at the start, is climate change – is all the discussion about climate change going to take a bite out of the profits of coal mining companies?

Hodge: Yeah. So, there's a number of ways it can play out. Part of our valuation $0.70 out of $3.80 comes from undeveloped projects. So, if Australia was to decide that it no longer wanted to build new coal mines, that would be a hit to our valuation.

I don't think it would be the full $0.70 because in that kind of world, I think the supply of coal is going to be more constrained and you're likely to see higher prices as a result of that. It really depends where the constraint comes from.

If there is a wholesale change in Asia, in where the coal is going to, in their demand for that coal, that would be a fundamental shift in the market. But there's going to need to be massive investment in energy to move away from that. And that's going to be a slow-moving phase.

And in the background, you've got growing population and urbanisation and increasing wealth in that area. So, there's still some tailwinds to offset the obvious headwinds as well.