New Hope: price and prejudice

When New Hope bought an 80% stake in the Bengalla coal mine, it instantly accomplished two things: it consolidated fractured ownership; and it opened the once opaque mine - which in the past had always been a small part of larger conglomerates - to greater transparency. For a mine of Bengalla's quality, that is no bad thing.

This is a long-life, low-cost operation with stunning simplicity and excellent economics. Those qualities haven't always been obvious when the mine was a minority holding in a larger group. They might be clearer now. A single owner can exploit efficiencies that multiple owners cannot. 

Finding efficiencies

Contractors and suppliers best suited to the job may not be approved with each equity holder, for example, and decisions get delayed or avoided when they require approval of multiple parties. Shareholders may have different capital constraints and strategies for the mine might differ. 

Producing coal is as much a logistical task as a mining one. Margins can expand by optimising logistics and chasing numerous, small efficiency gains. A single owner is more likely - and better incentivised - to pursue these than a minority owner. 

New Hope has wasted little time in improving operations. It has already announced that the mine will produce at an annual rate of 10m tonnes of coal rather than the long-established 9m.

There are no doubt cost and logistical efficiencies to be made in time as well. This bodes well for future project economics. 

Unpopular

That is just as well because coal remains - to put it politely - unpopular. BHP is the most recent in a long line of producers, including Rio Tinto, Glencore and several Japanese trading houses, to declare an end to coal. BHP went so far as to say it would not reinvest in any thermal coal asset, regardless of returns. 

Miners, bankers and investors are all resigned to avoid coal, seemingly at all costs. QBE has said it will no longer write policies over thermal coal mines. The big four banks have admitted to being reluctant to lend to them. This leaves an opportunity for those happy to exploit it.

Australian coal prices have fallen from highs of over US$120 a tonne a few months ago to about US$80 a tonne now. There has been ample speculation about the cause of those falls; we confess ignorance.

Yet we note that price falls have coincided with delayed passage of Australian coal through Chinese ports. Politics, rather than economics, may be responsible for lower prices. We also know that ideology, rather than profits, is motivating a swift exit from coal production. 

There are currently 83 renewable energy projects worth about $20bn being developed in Australia. You could count the number of coal projects on one hand. With constraints in regulation and finance, capital is hardly flooding the industry. Supply won't be growing in a hurry.

We also find comfort in Bengalla's cost base which, at around $US40 a tonne, is at the bottom end of the cost curve, and that New Hope's second mine, New Acland, adds option value should a pursued expansion be approved (for more details see An opportunity in New Hope). That seems more likely following the re-election of the Coalition government. 

Real threats

With New Hope accelerating production and working on lowering costs, margins and cash flow ought to remain strong - something that's not reflected in the share price. We still think the miner can generate $250m-300m in free cash flow, although it remains dependant on coal prices.

It is clear that coal faces real existential threats: fewer coal generators are being built and pollution from coal will probably be priced at some point.

Yet high-quality coal from Bengalla will still be needed to feed high-tech ultracritical generators in Asia for years to come. This won't be an opportunity for everyone but, for the willing, a potential mispricing persists. BUY.

Disclosure: The author owns shares in New Hope Corporation.

Note: Our Model Growth and Model Income portfolios own shares in New Hope Corporation.