Washington H Soul Pattinson

As hinted by the title, yesterday’s review—Coal: A dark future ahead?—highlights our increasing concern about a potential oversupply in the global coal sector. In that review, we downgraded our recommendation on New Hope Corporation from Hold to Avoid (we’ve never had a positive recommendation on the stock).

Given New Hope’s significance to investment company Washington H. Soul Pattinson’s valuation—outlined in Soul Patts: chemists, coal or cash? of 29 Sep 11 (Long Term Buy – $12.50)—there’s a logical follow up question; is Soul Pattinson also due a downgrade? Even after the recent New Hope share price fall, about half of the asset value of Soul Pattinson is attributable to its 60% stake in the coal miner. We’ll update our sum-of-the-parts valuation in a detailed review after the company’s full year results are released in September. But the fall in New Hope’s stock from $5.21 at the time of our last full valuation to below $4.00 today, partially offset by increases in the value of other investments, takes our ‘Market valuation’ for Soul Pattinson from around $18.30 on 29 Sep 11 to roughly $16.00 today.

There’s certainly no cause for panic. At today’s lower price, almost half of New Hope’s $3.3bn market capitalisation is backstopped by its $1.5bn net cash pile. The management of New Hope has well-deserved counter cyclical credentials and the cash pile is unlikely to be whittled down substantially unless real bargains emerge. The valuation of Soul Pattinson has become less reliant on coal compared with a year ago.

Highlighting the benefit of a cheap purchase price, Soul Pattinson’s share price is actually up 7% since Soul Patts: chemists, coal or cash?, despite the substantial fall in the market price of its key investment. But the margin of safety has been eroded as a result, reflected in the changes to the recommendation guide attached. We’re downgrading to HOLD now and will provide a more detailed sum-of-the-parts review when the full-year results have been released.

We’ll update the situation on sister company Brickworks tomorrow. The effect on Brickworks is less pronounced.

Note: The model Income portfolio owns shares in Soul Pattinson.