Initial Review NHC is a coal mining company firmly stamped with the financially conservative DNA of 61% shareholder, Washington H. Soul Pattinson (SOL). A conservative balance sheet makes NHC master of its own destiny and gives management freedom to be counter cyclical. Production is primarily export thermal, with a smaller component of domestic thermal coal. Most is mined at Acland which has low costs and a long life. Reserves of 235Mt are supportive of growth to at least 10Mt a year in the medium term compared to over 4Mt now. Jeebropilly and Oakleigh near Ipswich provide smaller contributions but cash costs are higher, reflecting limited life and simultaneous land development. Like sister company Brickworks (BKW), NHC turned the encroachment of urban areas on mining into a positive. Land development maximises returns from sunk capital costs, offers diversification and potentially a steady earnings stream to counter cyclical coal earnings. Longer term growth will come from coking coal via New Saraji. Our $6.40 a share valuation is made up primarily of two parts, the thermal coal business – mostly Acland – and New Saraji. Thermal coal accounts for $2.25 or 35% while Saraji is $3.25 or 51%. The remainder is net cash, a 17.7% Arrow Energy (AOE) shareholding, exploration projects and land, net of corporate expenses. Long term assumptions are US$60/t thermal coal, US$100/t coking coal, an A$/US$ exchange rate of 0.80 and a 10% discount rate. Deriving half the valuation from an exploration project is of some concern but New Saraji covers extensions to BHP’s mine which lowers resource and coal quality risks. Our FY08 NPAT forecast of $79.1m assumes NHC meets production guidance of 4.4Mt of coal, average US$65/t export thermal coal and an A$/ US$ exchange rate of 0.90. FY09 profit will be significantly stronger with the record thermal coal contract price of US$125/t from April 2008, more than double 2007’s US$55/t. Our $154.7m forecast assumes 10% production growth, US$103/t export thermal coal and an A$/US$ exchange rate of 0.93. Unlike most coal companies, NHC’s has many contracts with prices settling throughout the year. This smooths prices and means contract changes take a year for the full impact to flow through. The recent US$125/t settlement won’t take full effect until FY10, when we expect earnings to approach 30c a share. Coal prices are forecast to decline to our US$60/t long term assumption by 2014, with NHC to see that price in FY16. Medium term land development earnings and Acland volume growth broadly offset lower margins beyond FY10 if coal prices decline to our long term forecast. Persistent infrastructure tightness will boost the outlook. Energy is vital and somewhat price insensitive. The market expects contract thermal coal to fall next year but it could surprise on the upside. Spot prices out of Newcastle touched US$150/t last week versus the US$125/t April 2008 settlement. The high oil price is driving demand for vastly cheaper coal. Our assumption of stable prices until April 2010 could be conservative and thermal coal may well be higher next year. Domestic coal sells to local power stations. Export coal is railed to Brisbane on by Queensland Rail (QR). Capacity is limited by QR rolling stock, train size and competing Brisbane metro rail services. Despite this, incremental gains continue to be won. Rail capacity is expected to top out at 10-14Mt a year, compared to 5Mt now. Exports are via wholly the owned Queensland Bulk Handling (QBH) port. QBH is under long term lease from the Port of Brisbane. Stage 1 expansion from 5Mt to 7Mt is set to finish October 2010. A likely Stage 2 will lift capacity to 10Mt. QBH serves just two customers, NHC and US major Peabody. NHC should continue to secure capacity for mine expansions. Efficient management and low shiploader utilisation sees QBH demurrage free. Customers love NHC’s reliable supply. Despite being NHC mines thermal coal primarily from Acland, 140km west of Brisbane, a mid-low cost, long life mine. Smaller contributions are from Jeebropilly and Oakleigh near Ipswich where land redevelopment offers a potential new earnings stream after closure. Group production is 5Mt a year, 70% export and 30% domestic. Exports are through a 100% owned facility in Brisbane. Near term growth is from Acland exports. New Saraji in central Queensland’s Bowen Basin will add coking coal in the longer term. Coal seam gas and coal to liquids are early stage but may be important longer term. Management is astute, focused on cashflow, dividends and sensible long term investment. The balance sheet is strong with no debt and over $100m cash. Single commodity, infrastructure and mining risk require consideration. Huntleys’ Your Money Weekly 5 June 08 19 a small port – 5Mt a year versus 55Mt at Dalrymple Bay – QBH is low cost. Central Queensland producers suffer much higher port fees at Dalrymple Bay. The few dollars NHC saves on each tonne of coal helps build a moat. Longer term growth is driven by high grade coking coal from New Saraji. New Saraji covers the underground extensions to BHP’s Saraji mine. Resources of 690Mt are already sufficient to support a world class coking coal mine. Management’s ultimate resource target of 1.5Bt looks achievable. Starting 2011, planned production rises to 10Mt a year by 2017, making NHC a significant export coking coal player. The global seaborne coking coal market is just over 200Mt a year. The timetable to full production at Saraji looks conservative, but is prudent given Queensland infrastructure issues. If the boom roars for the next decade and access to infrastructure remains problematic, coal prices will be higher. Acland, with secure access to QBH, effectively hedges potential delayed Saraji earnings. Higher coal prices increase New Saraji’s attractiveness to established miners, particularly miners with infrastructure access but short mine life. NHC could sell a portion of New Saraji equity to cover NHC’s share of capital costs and reduce financial risk. Neighbour BHP is the logical partner. Instant underground access from BHP’s opencut and use of existing coal processing capacity offers significant capital cost savings. BHP is also the dominant coking coal exporter. The exploration portfolio includes Darling Downs, Bee Creek and New Lenton. Darling Downs covers 4500 square kilometres Around Acland in the Surat Basin. It is prospective for shallow open thermal coal deposits for export, domestic power generation and coal to liquids. Bee Creek in the Northern Bowen Basin is in close proximity to operating mines and has coking coal potential. New Lenton covers depth extensions to Peabody’s Burton mine which produces coking and thermal coal. Resources of 84Mt at Lenton and 9Mt at Bee Creek are limited only by drilling. NHC also has an option on coal seam gas via a 17.7% interest in Arrow Energy. Market value is over $400m. Shell’s agreement to invest up to $776m in Arrow for a 30% stake is another endorsement of coal seam gas by an overseas energy major.
NHC Price at posting:
0.0¢ Sentiment: LT Buy Disclosure: Not Held
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