An off the wall idea for the Strawman community, I would welcome comment on is my investment in NHC which I have had for a few years now. They have just provided a Q3 update which has lower production than I assumed (due to weather and Covid) but sales are at higher coal prices – with cash produced for the quarter about where I assumed (case of 2 wrongs make a right…)

Todays Announcement:Quarterly-Activities-Report.PDF

Valuation A$4.41 details: NHC_Analysis.pdf

Valuation Apr22

Base Thesis: NHC is an established coal producer with a significant reserves of quality coal that is low cost to extract (lowest quartile producer). Demand for coal will continue to decline but the supply will fall faster as financing for new coal mines dries up and existing mines deplete, this will place a floor under coal prices and increase margins of established quality producers such as NHC for up to the next decade. NHC has an opportunity to provide shareholders superior cash retunes through dividends despite a steady decline to the business and industry. Leadership and management are very experienced and long term commercially and investor return focused and I trust they will extract maximum shareholder value for the business.

Coal Price: The principal determinant of profitability for NHC is the price of coal, with break even around US$60/t (at current FX rates). In the decade to mid-2021 price was between US$50-120/t but it has spiked as high as US$400/t recently and is currently US$265/t. The current price is unlikely to persist, but we are also unlikely to see sustained periods of a price below US$100/t due to supply limitations and a systematic reliance on coal that will take many years to reduce and is likely to reduce more slowly than supply reduces.

Risks: In addition to the price of coal, the A$ movements change margins with a stronger A$ reducing revenues in A$ but costs fixed in A$. The introduction of a carbon tax or other significant regulatory constrains on production or margins could impact the investment, but they are likely to impact other producers as well and generally such changes favour well established incumbents like NHC. Hence while climate policy impacts are expected, they are considered in the investment thesis and in fact required for it to play out, so it will come down to the balance of favourable Vs unfavourable impacts, but an assumption of a zero-terminal value in 10 years is needed to balance superior margins in the meantime.

Cash Flows: Taking the current elevated coal price into consideration NHC is likely to produce around $A1b in free cash flows in FY22, wiping out it’s debt and produce large dividends to shareholders. Going forward, assuming 10mt average coal production and sales at an average price of US$100/t and FX rate of A0.80 for the next decade, free cash flows will be around $350-380m. 

Valuation: Assuming high payout of free cash and operations terminate in 10 years, a total of $4.19 in fully franked dividends could be paid out over the next 10 years. The present value of this at a 10% discount is A$4.41

Disc: I own NHC