After a tumultuous 1H17 that saw coking coal pricing at a $300/metric ton drop to $150/metric ton just before a cyclone, go back up to near $300/metric ton right after the cyclone, and then reset into the $140s/metric ton, recent stabilization has been welcome. The forward curves, according to Platts, have recently strengthened by over $10/metric ton for the back half of this year, and by several dollars next year. The 2H17 average price now stands near $153/metric ton, down from the 2Q benchmark of $190/metric ton but up from the lows of around $140/metric ton in early June. Similarly, the 2018 curve now sits around $145/metric ton, up approximately $7/metric ton from the early June lows. These numbers compare favorably to MKM Partners' price deck, which stands at $142/metric ton for 2H17 and $140/metric ton for 2018.
Coking coal pricing finding a support level is important, as investors look to understand at what price point the market is in balance. Last year's run-in coking coal from the low $80s/metric ton to over $200/metric ton was driven by a combination of Chinese work rule changes (which have since been relaxed but could return), some Australian mine issues, and a big drop in U.S. coal exports due to weak pricing. By the end of 1Q17, it looked like pricing around $150/metric ton would be set, but the market was disrupted by a third major cyclone in the last 10 years. Spot prices quickly climbed back towards $300/metric ton as Australian rail disruptions caused several force majeure events but quickly retreated. Updated guidance by Teck Resources announced the 2Q benchmark of $190/metric ton but also revealed that the company saw very little spot activity from mid-April to mid-May. Given the disruptions in Australia, this caused investors to question whether the supply response to the late 2016 price run had overshot what would be a healthy supply/demand balance. It is important, in the firm's opinion, for the commodity to find a stable level in order for longer-term coal investors to return to the names after the bankruptcy emergences of most major players over the last year.
MKM Partners believes that recent strength in coking coal prices demonstrates the fundamental return to supply/demand balance achieved (painfully) over the last several quarters. The firm believes prices in the $130-150/metric ton range are very supportive of coking coal producers' equity valuations. MKM Partners' bias in the coal mining equities lies with the coking coal exposed names, while it remains more cautious on thermal coal plays, especially with natural gas in the low $2.80/MMbtu range and stockpiles still stubbornly high relative to current demand levels. MKM Partners recently published a note on sensitivities to coking coal prices Coking Coal Price Sensitivity Analysis, where it shows that ARCH has the highest sensitivity to coking coal prices. And despite the strength in the U.S. dollar relative to coal exporting competitors Australia and Canada, the firm believes the seaborne market has signaled a need for U.S. exports in the 65 million ton/year range to stay at balance, a price it believes needs to be $130/metric ton or more. MKM Partners notes that the turnover of shareholder base for many post-bankruptcy and IPO names will take some time, but it sees current valuations as compelling and risk/reward better than it has been in years. The firm reiterates its Buy ratings on ARCH, TECK, and BTU.
MKM Partners derives its $88 price target using a forward EV/EBITDA multiple of 6.5x on its 2018 estimates, below mid-cycle levels to reflect the elevated prices being realized in the coking coal market, offset somewhat by low in cycle domestic thermal coal prices. The firm derives its $34/share price target using EV/EBITDA. The firm's target multiple of 6.0x on its 2018 estimates is a half turn discount to Arch Coal, the company's closest comp, due to Arch's superior coking coal assets, in its opinion. MKM Partners' $26 price target uses a 6.0x target EV/EBITDA multiple on its 2018 estimates.