MACQUARIE RESEARCH Regional coal - Smoking hot thermal, head to Asean

Bullish on coal with a differentiated view on thermal

Macquarie's global commodity team has upgraded all global coal grades throughout the curve with the highlight being upgrading thermal by 38% and 20% to US$145 (JY11) and US$120 (JY12) per tonne, which is roughly US$20 per tonne ahead of consensus in both years, and raising hard coking coal prices by 4–11% throughout the curve to US$251 in 2011 and US$223 in 2012.

Our differentiated call is on the thermal side. Consensus believes that prices have peaked as the floods in Australia are starting to subside. However, our traders see the potential for a further rally, and we expect the
Japanese settlement to be at US$145. This is on the back of further potential supply disruptions (as we have only just entered the “traditional” Australian wet season), coal producers prioritising coking coal over thermal in the supply chain, and upselling thermal in to PCI and Semi soft markets, making thermal supply tighter. Beyond the current supply disruption we see the supply-demand balance for thermal remaining tight medium term due to robust demand from India, Indonesia and China.

Harum, SAR & Adaro are our top picks in the thermal space with Gujarat NRE and Mitsubishi our key plays on the coking coal thematic.

Asean is the place to be – Top picks: Harum, SAR & Adaro

We prefer the Asean plays vs the Chinese (due to pricing leverage) and the Australians (given valuation and production difficulties). Our top picks in the sector are Harum, SAR and Adaro. Our higher global coal price assumptions lead us to raise our Asean earnings forecasts by 16–30% in 2011 and 2012, leading to us to be ~35% ahead of consensus expectations in 2011 and 2012. The sector is trading on 10.6x (2011E) and 9x (2012E) PER, which is at a ~30% discount to the historical sector trading multiple. Further the sector has an attractive FCFE yield of 8% and 11% in 2011 and 2012, respectively.

China – limited pricing leverage but China Coal is preferred

Despite the major upgrades we have done to seaborne thermal coal prices in 2011–12, we expect Chinese domestic thermal coal prices to be fairly stable in 2011. We are expecting both spot thermal coal & coking coal price to increase by 5% YoY on average. Stocks are likely to be driven by seasonal coal price fluctuations, policy risks and asset injection events in 2011.

We continue to like China Coal for superior long-term growth prospects, given our view that major coal miners could face a gradual margin squeeze over a 3–5 year period. In the near term, we expect the Chinese coal stocks to continue to underperform the Indonesia coal names given the lack of pricing exposure.

Limited Australian value, outside of Aston Resources

In our view, there is limited value across the Australian coal sector given recent outperformance. Our key pick in the coal sector is Aston Resources with a TSR of 15%. Aston is exposed to both metallurgical and thermal coal as production starts in FY13. While the ramp-up is heavily dependent on the procurement of further port allocation, we remain confident our conservative volume forecasts will be achieved.