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Although I follow the mining sector in general fairly closely, coal isn’t one of the commodities which has ever interested me much, but despite that, I can see the appeal of Thungela Resources (TGA) at the moment. It is one of the largest thermal coal miners in South Africa and exports its product all over Africa, Asia, the Middle East and India and, whilst coal might not be as exciting as some other commodities, it is very much still in high use and demand in many parts of the world despite what we read in the papers about ‘going green’. Whilst it is of course important to look into the detail of how a company operates and its financial performance, the reality here is that the share price is very much dependent on the price of thermal coal – certainly if you compare the two charts for 2023 so far you can see a close correlation, and the reason why Thungela is trading right at the lower end of its share price range over the past 12 months, at around 585p currently, is as a result of coal prices also being close to the lows that we’ve seen during the same period. So, these shares are very much a pure leveraged play on coal prices – barring anything going badly wrong with its operations or the political situation in South Africa.
It isn’t just coal prices that you need to watch though, as these tend to be determined by gas prices in other parts of the world such as Europe – when gas prices are low there is much lower demand for coal and so that excess supply find its way into other markets such as Africa and Asia, and in turn causes weakness in coal prices there. Recent forecasts seem to suggest that Europe is expecting a mild winter this year and that gas prices aren’t expected to spike higher and, even if they do go up a bit, it won’t be anything like what we saw last year. I would argue that the market seems to be expecting that to be the case means this assumption is already being factored into both the gas and coal markets, and so the current situation with pricing - and therefore the share price of Thungela - reflects that. There is of course always a chance that demand could end up even lower and that coal prices could drop further, but it seems more likely to me, given the current world situation, that we could see something happen that drives gas prices up again, and aside from the weather rarely being as predictable as expected and a chance of a colder winter than is being forecast, the big factor in all of this is still Russia. Whilst Europe is nowhere near as dependable on Russia as last winter, and is also better prepared this time around in terms of gas storage, any cessation of Russian gas supply to Europe would still likely cause a crisis and at best would see gas prices rise well above where they are currently. Given that Russia has just scrapped the grain deal that was in place, I see a risk that it could cut off gas supply, which still makes up around 10% of what Europe uses, with Russian LNG in addition to that as well. Should we see gas prices rising again then thermal coal prices may well follow. Staying with Russia, prior to the conflict with Ukraine beginning, it was responsible for around 18% of exports in the global market, so is also a big factor in terms of the supply of coal, as well as of natural gas, which tends to impact on coal prices.
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On the demand side for coal, the growth of economies such as China and India are big factors in the short to medium term, as China is still the largest importer, with 182MMt during the first five months of 2023, which was up by circa 90% on the previous year, for the same period. Whilst some countries are looking towards renewable projects - such as some in the Middle East - the impact from that on coal demand isn’t going to be immediate, and if anything, with the emerging economies that do still rely largely on coal looking to grow rapidly now that we have come out of Covid, demand for coal should remain buoyant for at least a few years to come. The reason why I’ve focused so much on the macro factors so far, rather than looking in great detail at the Thungela operations, is the fact that the performance of the company is highly dependent on coal prices – obviously other factors such as the cost of producing coal and the amount of output also play a role though. Looking at the trading update for the first half of 2023, production has been in line with expectations at 5.8Mt – versus full year guidance of 10.5Mt to 12.5Mt. As you might expect given the current inflationary situation, cost per tonne has risen to R1,230 versus R1,093 during H1 2022, with the FOB (free onboard) cost of R1,155 being towards the upper end of previous guidance. Export sales have also declined by around 5% compared to the same period in 2022, and that has largely been due to issues with the rail transport system that Thungela uses. The company is still investing heavily in sustaining and developing its projects, and typically that tend to be weighted towards the second half of the year, so we will see higher capital expenditure, but that is as expected – the R2.4 billion investment into extending the life of the Zibulo project has already been approved. At the end of May, the company had a net cash position of R14 billion (£610 million) – with R1 billion of royalties and taxes due and which would have been paid at the end of last month. Earnings per share for H1 are going to be materially lower, when the interims are released, and guidance is for R17 to R19, which could be up to 75% lower than for H1 2022, but that is to be expected given the coal price drop since then, and should already be factored into the current share price.
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One of the attractions with holding shares in this company is that dividends have always been high, with the company having a policy of paying out 30% of free cash flow, and that remains unchanged – although it has recently raised its liquidity buffer on its balance sheet to R8.2 billion, R3.2 billion of that reflects the addition of undrawn credit facilities, and so overall the cash buffer still remains at similar levels to in the past (which was R5-R6 billion). The last dividend payment was for 178p and the shares went ex-dividend on May 8, so you can see just how important the dividend is for investors in this share given the high yield. The next dividend is expected to be declared around August 14, and although it is going to be lower than that which investors have enjoyed over the past year or so, I would still expect it to be significant when compared to the share price. Overall, and although I’m not massively bullish on coal in the longer term, I can see plenty of potential here in the short to medium term, and especially with potential factors which could cause stronger coal prices over the next 12 months, and so on that basis I view this as a Buy at the current share price – though just be aware that the performance is very much linked to coal prices, and so if anything changes and has a major, lasting, negative impact on those, then you may want to reconsider your investment at that point in time. As things stand, I’m not expecting coal prices to worsen, and even if they remain fairly static, Thungela should offer value from a current market cap of circa £800 million.
Filed under: Thungela Resources, NatWest, Revolution Bars, Centamin, BATS, Rio Tinto, Reckitt
2023-07-26 15:18:10