Whitehaven Coal Is Dirt Cheap (OTCMKTS:WHITF)

Over the last two months, most coal stocks have struggled. However, there is one company, Whitehaven Coal (OTCPK:WHITF) from Australia that has taken a beating. I think the shares are cheap and most of the weakness is due to their recent asset acquisition.

In October 2023, WHITF acquired BHP’s Daunia and Blackwater coal assets (BMA Assets). Initially, the market cheered the announcement and the share price rose from $6.68 to $8.00. However, over the next several months, the shares of Whitehaven have struggled and now investors can buy the shares for the same price as when the deal was announced.

I think the share price plunge is temporary. There is a class of investors who do not want coal companies to increase capacity and shun growth-oriented coal companies. Many coal investors are simply focused on share buybacks and special dividends. However, in due time, I think coal investors will fully understand the BMA transaction and shares should move markedly higher.

Blackwater Acquisition

Whitehaven’s acquisition of the BMA Assets is expected to be completed on April 2, 2024. The deal terms are as follows – WHITF pays US $2.1 bn upfront and US$1.1 bn in deferred consideration payable over the next 3 years. It is important to note that there is a contingent consideration of US$900m that is related to realized prices. Annual contingent payments are capped at US$350m. The upfront payment is to be funded with cash on the balance sheet and a $1.1 bn term facility. This $1.1 bn loan has attracted 17 private lenders and one bank.

Furthermore, Whitehaven has indicated that they would like to sell 20% of the Blackwater mine. It has been reported that India’s JSW Steel and Japanese trading houses are looking to acquire the 20% stake for $500 mm up to $1 bn. Once they sell a 20% stake to the joint venture partners, the total transaction will be significantly de-risked as the company will not have to issue any shares and the company will be debt free. Since the company had over $2.775 bn of cash on the balance as of June 2023, WHITF was in the rare situation to finance a huge acquisition internally.

Mix Of Thermal And Met Coal

The main reason why I am bullish on the BMA assets is that I prefer the “new” company with a mix of met coal and thermal assets. Prior to this transaction, WHITF was primarily a thermal coal producer. Almost 90% of production was related to thermal coal.

As I’ve mentioned previously, I am not particularly bullish on thermal coal. Unseasonably warm temperatures over the last two years and low natural gas prices have been a nightmare for thermal coal producers.

However, once the deal is completed, the sales mix will be equally divided between met coal and thermal coal. These are two different end markets and a different sales mix means that the company will not be entirely exposed to one commodity price. This diversification makes the company less risky.

The second reason for my bullishness is that the BMA assets acquisition will double sales volume. Currently, WHITF is producing almost 20 mn Mts. However, upon completion of the BMA assets acquisition, production is expected to exceed 40 mn Mts per year. It should be noted that the FY22 BHP annual report listed the Blackwater reserve life at 24 years and Daunia at 17 years.

Balance Sheet Post Acquisition

Prior to the BMA Asset acquisition, WHITF was swimming in cash. The company had $2.775 bn (AU) in cash versus an enterprise value of $4 bn (AU).

To fund the BMA asset acquisition, WHITF is using $2.1 bn of cash and a debt facility of US$1.1bn. Assuming that the company sells 20% of the project, no debt will need to be added to the balance sheet. Total debt to equity is currently only 2.76%.

Valuation

Prior to the acquisition, WHITF shares were cheap. The company is trading with a PE of 4.68X. I generally find that 6X is the average in the coal industry.

Post acquisition, the PE ratio should be even lower at less than 4X.

Structural Supply Gaps

I’ve modelled coking coal at $200/Mt and thermal coal at $140/MT.

As with any commodity price, the key risk is that there is weakness in either the thermal or met coal market.

However, with little new supply coming online and relatively resilient demand, I think both thermal and met coal prices should be stable over the next few years.

Conclusion

I think that the recent short-term price fluctuations are temporary. With an acquisition of this size, there is a lot of arbitraging and I wouldn’t be surprised if the shareholder base has turned over to more growth-oriented commodity investors. A lot of coal investors have been shell-shocked due to the last coal cycle and they only want to invest in companies with large buybacks. Growth is viewed as too risky and I think some investors have pulled the plug on WHITF.

However, I think within the next year, the market will recognize that the BMA asset acquisition is accretive with no share dilution.

The company will be further de-risked as the production mix will shift to an even mix of thermal coal and met coal. These are two distinct markets and it is preferable to have a sales mix for different end users.

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