huntley's article - 18% below buy recommendation He has a buy at...

huntley's article - 18% below buy recommendation He has a buy at $8.20. It is now $6.72

Coal Set for Extended Strength?


The outlook for coking coal has improved and we upgrade our forecast prices from April 2006. We now expect the benchmark price to remain around US$125/t before declining over three years to the long term price of US$60/t from April 2007. We are also looking for flat thermal coal prices of US$52/t, a slight upgrade from US$50/t previously. As a result, we upgrade forecast FY06 and FY07 NPAT by 2.7% to $153.4m and 5.4% to $212.3m respectively. Our valuation rises to $1.8bn or $9.08 per share due to higher prices and the addition of a $150m premium for exploration and corporate upside. The addition of a premium is justified based on the company's track record for acquisitions. Long term assumptions remain a 10% discount rate, US$60/t for coking coal and US$40/t for thermal coal. We upgrade our A$/US$ exchange rate from 0.72 to 0.76.


We visited EXL's head office last week and had an interesting discussion with MD Tony Haggarty and Executive Director of Business Development, Andy Plummer. Our overall impression was positive. The management team has the runs on the board. It has proven its ability to manage acquisitions, development and operations. Management strength and depth is one of the company's key positives. Its ability to string together deals greatly exceeded our initial expectations. While there is nothing specific on the radar, EXL continually evaluates potential deals. We anticipate more to come on the acquisition front. Aggressive growth investors can justify paying a premium to our valuation for future corporate activity. If the company continues to grow as forecast, the big boys will eventually look to take it out. This scenario starts to look likely perhaps in five or so years when the current expansion plans are fully realised. On the value front, there is a good chance volume growth will offset falling prices beyond FY07 to maintain long term earnings around $1.00 per share. On this basis, EXL looks a solid buy, trading on a prospective long term PE of less than 10x yielding +5% fully franked. Attractive multiples should provide medium term share price support. The normal commodity price risk caveats apply, but we believe steel making materials, iron ore and coking coal, could be set for an extended period of high prices.


Market consensus for contract coking coal is for flat to slightly higher prices from April 2006, a steady decline from April 2007. After a period of relative softness in the steel market, prices have again started to improve. Coking coal demand from the emerging economies of China, India and Brazil is robust. With blast furnaces globally operating at full capacity and steel making margins at high levels despite rising raw materials costs, producers are seeking high quality coking coal and iron ore to produce superior steels and improve furnace productivity. Hard coking coal supply is limited by infrastructure and reserve depletion at major mines in Queensland. The Bowen Basin is the most important source of export coking coal in the world. Hard coking prices should outperform lesser quality semi soft and pulverised coal injection (PCI) coals which are seen moving down. Spot thermal prices have softened of late, but this is potentially due to end user destocking. Supply has been much slower to respond than expected with port capacity soaked up by higher priced coking coal, displacing thermal exports. Market consensus is for flat to slightly lower prices. We are relatively confident about thermal coal due to infrastructure supply constraints and strong demand for energy, particularly in China.


On the infrastructure front, Babcock & Brown Infrastructure's (BBI) Dalrymple Bay (DBCT) is expanding capacity from the current declared rate of 56Mtpa to 68Mtpa by early 2008. A decision on who will get the extra capacity is due imminently. There is potential for EXL to increase its production from Millennium to the nameplate capacity of 3Mtpa of coking coal faster than expected, if the company gets a port allocation. Millennium will be EXL's highest margin operation. Bringing forward its ability to deliver 3Mtpa would significantly enhance earnings in FY07 and FY08. The performance of Port Waratah (PWCS) in Newcastle, the world's largest coal export terminal, has improved. Benefits are being reaped from last year's move to manage both rail and port under one roof. DBCT has not yet adopted this integrated approach and may gain some benefit with limited capex by doing so. Output at PWCS regularly exceeds this year's declared capacity of 84Mtpa and an additional 6Mtpa is expected to be shipped in 2006. EXL, along with its Newcastle Coal Infrastructure Group (NCIG) partners, is committed to spending $30m on feasibility and approvals over the next 18 months to advance a second coal loader in Newcastle. The NCIG partners represent the majority of future production expansions and have a vested interest in its development.