Are Australian coal mining companies oversold?

There is a world of difference between a commitment to “phase-out” a commodity, and a proposal to “phase-down” a commodity, which is a reason for taking a fresh look at heavily oversold Australian coal mining companies.

While not widely researched because they have become ethically incorrect, some coal stocks are trading at close to half their value as calculated by leading investment banks.

Whitehaven Coal (ASX: WHC), for example, could enjoy a 60% share price increase according to the consensus valuation of six banks, and perhaps as high as an 81% increase if Credit Suisse is right with a price tip of $4.50 versus the stock’s latest sales at $2.49.

Coronado Global Resources (ASX: CRN) and New Hope Corporation (ASX: NHC) could potentially deliver a 55% and 41% capital gain respectively based on consensus forecasts or as much as 76% for Coronado (Credit Suisse) or 91% for New Hope (Macquarie Bank’s forecast).

The wide valuation gaps at the top end of the coal sector almost certainly apply to the even more thinly researched small end of coal where stocks such as Stanmore Resources (ASX: SMR), Allegiance Coal (ASX: AHQ), Bathurst Resources (ASX: BRL), Bowen Coking Coal (BCB), and Montem Resources (ASX: MR1) can be found.

Ethical investors will not go anywhere near coal, the most polluting of fossil fuels, but so long as it remains a major source of energy for most of the world it will be a profitable business.

Phase out vs phase down

While a popular view might be that coal will soon fade from the energy market, that’s unlikely to happen thanks to the last-minute change in wording from “phase out” to “phase down” in the final communique from the recently concluded COP26 climate change conference in Glasgow.

The two most heavily populated countries in the world, China and India, objected to an international agreement which would have required them to stop using coal. They demanded a softer wording which will permit the ongoing use of the fuel, until viable replacements are found.

Europe too is finding it hard to kick the coal habit with demand (and price) expected to rise sharply over the next few months as power shortages trigger rolling blackouts, according to one of the world’s top commodity traders.

Trafigura chief executive officer Jeremy Weir told a conference in London this week that Europe faced a bleak, energy-short winter, caused by tight gas supplies which is likely to see an increase coal consumption.

It’s a similar picture in the United States where coal prices this week hit a 12-year high despite toughening government regulations to limit supply without addressing the flipside of the price equation: demand.

Moody’s Investors Service vice president Ben Nelson told the Financial Times newspaper on Wednesday that “the coal industry cannot respond quickly enough to improved market conditions”, with high prices following a sustained period of under investment which has hampered the ability to quickly lift production.

Utilities forced to revert back to coal

What COP26 delegates overlooked in their widely reported attacks on coal is the ability of a market to adjust to pressures in the same way a balloon responds to being squeezed at one end only to bulge at the other.

In the case of coal, the driving force is a combination of attempts to limit production (especially in China and Europe) without recognising that the alternatives cannot plug the shortfall leading to record prices for natural gas which have, in turn, forced power utilities and factory operators to switch back to coal.

Renewables, which should eventually play a prominent role in the overall energy mix are simply not up to the job, yet.

Forcing banks to stop lending to coal is also proving to be a toothless attack as demonstrated in last week’s ability of tiny Stanmore with a stock market value of $289 million to secure investment fund support to buy two of BHP’s (ASX: BHP) coking coal mines in Queensland for $1.8 billion.

The deal, and others like it, is another reason for anti-coal campaigners to question their tactics because not only has a new financing avenue been opened which bypasses banks, but Stanmore is highly likely to increase coal production to service its debts whereas BHP might have been likely to phase down production.

Despite the poor public reputation of coal caused by its high levels of carbon pollution and the fierce criticism of climate campaigners, the reality is that coal demand continues to rise in much of the world (especially China, India and Africa), more than offsetting modest falls in the western world.

Demand for coal climbs despite clean energy push

Credit Suisse in a research note published earlier this month said, tellingly, that demand for coal is climbing as the energy gap outweighs climate considerations.

The bank said the sharp surge in thermal (electricity producing) coal to a near-record US$250 per tonne (A$343/t) in mid-October was a price premium which reflected a coal shortage in China.

The slide back in the seaborne thermal coal price to around US$170/t (A$234/t) is now at a level where the price should be for the next 12 months, more than double the price of earlier this year and close to 200% higher than the US$58/t (A$80/t) of 2020.

In time, thermal coal will lose market share to renewables such as wind and solar power, but Credit Suisse argues that the lack of investment in new thermal coal mines “should support prices above US$100/t (A$137/t) until at least mid-decade, as transition from carbon fuels will be slow”.

Unloved coal companies have effectively become cash machines, in much the same way tobacco companies prospered enormously after they were banned from advertising with the cash saved on marketing campaigns going straight to the bottom line as cigarette sales boomed in the developing world, if not the west.

In coal, a never-ending round of criticism can be expected over the next few years, though shareholders will be comforted by high share prices and strong dividend payments.