Stoke up on coal

PORTFOLIO POINT: Investors should have coal in their portfolio, given its strong outlook.

“Everything old is new again” is more than a catchy song: it’s a good investment idea, especially when it comes to one of last year’s best investment ideas – coal.

While the temptation at the start of a new year is to look for something fresh, a more successful approach might be to stick with what has already performed well if the fundamentals have not changed.

That is certainly the case with coal in both its forms – thermal for electricity and metallurgical to make steel – where prices have retreated modestly, but are still high enough to ensure fat profits for most miners (even with the new tax on coal and iron ore), and for continued takeover activity.

Forecasts for coal demand in electricity-hungry Asia point to years, if not decades, of opportunity for growth, an outlook boosted by a number of countries closing nuclear power stations in the wake of the Fukushima accident in Japan, or scaling back nuclear development plans.

The problem for Australian investors is that there has been so much recent takeover action that their choice of investment targets has shrunk alarmingly. Merger and acquisition deals in the coal sector in 2011 were worth almost $20 billion and included:

• Peabody Energy buying Macarthur Coal for $3.8 billion.
• Rio Tinto buying Riversdale for $3.4 billion.
• Rio Tinto mopping up Coal & Allied for $1.5 billion.
• GVK of India acquiring control of a Hancock Prospecting coal project for $1.2 billion.
• Lanco Infratech of India buying Griffin Coal for $750 million.
• Whitehaven starting the acquisition process of Aston for $2 billion and Aston acquiring Boardwalk for $520 million.
• Yanzhou of China (which previously bought Felix Resources) proposing to buy Gloucester Coal for $2.1 billion – and possibly list itself later this year.

The rate at which coal companies have been disappearing from the ASX has been so rapid that there is a chance that within the next few months (with Gloucester being acquired and New Hope offering itself for sale) the top 150 companies on the exchange will feature one pure-play coal stock, the merged Whitehaven and Aston, which should in theory be valued at around $5 billion, and rank about the 44th biggest company.

There are other coal entry points among the top ASX stocks, but coal is just one part of a diversified corporate structure in companies such as BHP Billiton, Rio Tinto, Aquila Resources and Wesfarmers.

Beyond the top 150 and the choice expands with a number of promising small players worth following, stocks such as:

• Stanmore (SMR), which is targeting the production of seven million tonnes of coal a year from 2015. Its share price has risen by 2¢ to 78¢ since I last put it on a list of coal contenders (see Coal stock M&A action heats up).
• Coalspur (CPL), which is developing the world-class Vista mine in Canada, and has risen by 7¢ to $1.75
• Cockatoo Coal (COK), which is expanding its Baralaba mine in Queensland to a targeted 750,000 tonnes of metallurgical coal, and despite being a frequently named takeover target has fallen 2¢ to 37¢.
• Carabella (CLR), another frequently mentioned takeover target, which has exploration tenements in Queensland, but which has fallen by 4¢ to $1.23 since last mentioned.
• Bathurst (BTU), ASX-listed but busy developing coal mines in New Zealand. The stock is up 1.5¢ since December 14.
• Metro Coal (MTE), an emerging Queensland producer, which is the latest Australian coal stock to attract a Chinese investor, with DADI Engineering Development lifting its stake in the stock from 15.3% to 19.6% last week.

Other small coal stocks fighting for investor attention include Bandana Energy (BND), Continental Coal (CCC), Coal of Africa (CZA), Tigers Realm (TIG) and New Age (NAE).

Investing in any of those stocks in the hope of a corporate deal is a risky strategy, although there is also no doubt that takeover activity has been the way to maximise the return from an investment in coal.

Another way to take a position in coal is to keep abreast of new floats (and possible new floats) as they make their way through the investment banking phase of their evolution.

Upcoming floats (and possibilities) include:

• Yanzhou, which has promised to offer local investors a slice of its Australian business after it completes the $2.1 billion takeover of Gloucester and marries it with Felix, which it acquired for $3.3 billion in 2009.
• The possible float of QCoal, the private business of Queensland businessman Chris Wallin, and owner of the producing Sonoma mine and soon to be developed Byerwen project. No details have been released and Wallin may prefer to use trade and debt finance.
• The impending float of Cuesta Coal, which owns 33 exploration tenements in Queensland and has just secured a Chinese cornerstone investor ahead of raising $15 million and listing on the ASX.
• Indus Coal, which is seeking to raise $7 million to explore coal assets in Indonesia, but failed to close its prospectus at the end of December.
• The return of Riversdale, this time as Riversdale Resources, but with the same management team that created Riversdale Mining acquired by Rio Tinto last year. The new company will start life with coal exploration tenements in the Mat-Su Valley of Alaska.

Additional coal floats will emerge over the rest of the year if for no other reason than it being a very profitable industry with major customers demanding increased production, and because coal is Australia’s second biggest exporter earner, after iron ore.

The investment gap created by takeovers has opened the way for stockbrokers and banks to assemble new coal floats – and if the brokers of Australia are not thinking about doing that they should be.

Underpinning confidence in coal are multiple optimistic assessments of the supply and demand outlook with the best assessment of the industry in an October 19 report on Eureka Report (see Back to black) which contained a number of graphs produced by world coal authority, Bernard Guarnera, president of the US-based consulting firm Behre Dolbear.

His views have been echoed since then by equally impressive energy sector observers, including:

• The Paris-based International Energy Agency, which has traditionally focussed on oil but on December 13 published its first assessment of the coal industry, concluding that coal demand would continue rising. “For all the talk about removing carbon from the energy system, the IEA projects average coal demand to grow by 600,000 tonnes every day over the next five years,” the IEA said.

• The IEA is forecasting a rise in the average thermal coal price from $US127 a tonne in 2011 to $US138 by 2016.
• The Australian government’s new mining and energy research agency, the Bureau of Resource and Energy Economics (BREE), finding that thermal coal prices in 2012 will be less than 2011, but will still be at historically high levels as demand remains robust.
• BREE also said in its latest report that world thermal coal exports in 2012 would increase by 4% relative to 2011, “underpinned by growth in India, China and Japan”.
• BREE is forecasting a fall in metallurgical coal prices from $US289 a tonne last year, when shipments were curtailed by floods in Queensland, to $US226 this year (which will be $US35 higher than the 2010 price of $US191)..
• ANZ Bank research noting that China appears to have boosted coal imports by as much as 38% (year on year) in December, while cutting exports of its own coal.

• Wood McKenzie, a British energy consultancy, has reported that costs in China’s coal industry are rising sharply, creating opportunities for Australian coal exporters because it will be cheaper to burn imported coal than use domestic material. As an example, Wood McKenzie estimates that labour costs in China’s coal industry rose by 13% last year compared with 8% in Australia.

For investors without direct exposure to coal, the easy option is to maintain a stake in BHP Billiton and Rio Tinto, and if you don’t have either of those, you should.

As for exposure after a busy takeover period, the best entry points are Whitehaven/Aston (for production and itself as a takeover target), Stanmore, Coalspur, Carabella, Cockatoo and Bathurst – with an eye on emerging floats, especially Riversdale Mining.

But, if concerned that you have missed the coal rush then you’re not alone because few brokers or investment banks have coal stocks high on their list of investment recommendations.

The latest recommendations list from leading broking house JBWere covers 210 stocks, with only coal company – Bathurst – rated as a buy. Aston and Whitehaven are on the list, but not rated while their merger is under way.

A similar “coal-free” picture was on display last weekend when the Australian newspaper assembled its “expert stock tipping panel for 2012” with 12 participants from a range of organisations that included Wilson Asset Management, Bell Potter, Bizzell Capital, Fat Prophets, Patersons, and Commonwealth Securities.

With each tipster nominating 10 stocks for the year ahead (120 possible stocks) only two coal stocks were named: Coalspur by Patersons, and Bathurst by Bizzell Capital and Fat Prophets.

The lack of coal tips could be explained by takeovers, but could also be a result of coal being a politically incorrect commodity that has been blamed for playing a leading role in climate change.

Whatever the role of coal in the climate, it is a key and growing part of the Australian economy, with BREE forecasting Australian metallurgical coal exports to rise in total value from $29.8 billion in 2011 to $33.6 billion in 2012, and for thermal coal exports to rise from $14 billion to $18.8 billion.

When combined, the value of Australia’s coal exports will grow at a faster pace this year than iron ore, with coal up by 19.6% and iron ore up by 11.4% from $54.2 billion to $60.4 billion.

The production-growth trend and Asian demand outlook mean that coal will continue to be one of Australia’s most important industries, deserving a place in all balanced investment portfolios.