>GUJARAT NRE COKE (MACQUARIE RESERACH)

Coke back in favour

Event
■ Coking coal outlook brightens: Our global team has raised its coking coal price forecast by 17% for FY11, buoyed by China turning a net importer of coking coal and a possible restart of steel capacity globally. For Gujarat NRE Coke (GNC) We have upgraded earnings and increased our target price to Rs87 from earlier Rs58. We maintain an Outperform rating.

Impact
■ Upgrading coking coal forecasts: The recent settlement of coking coal at US$129/t was surprisingly strong, as the expectation was for around US$100–110. More so, the reminder of coking coal quantities left from last year’s contract at US$300 has not be waived off. Given this backdrop, our team has raised its FY11 forecast to US$129 from US$110.

■ China – the big swing factor: Some of the Chinese coking coal mines have faced closure on account of safety concerns post fatal accidents. This, coupled with Chinese steel production back to an all-time high, has turned China into a net importer. In fact, the Chinese government has always discouraged the export of coke, imposing a 40% export tax. Because China used to contribute 14Mnt out of 19Mnt of the global sea-borne trade, any rebound in global steel production would likely bode well for coke prices.

■ GNC – on track to increase production sevenfold in next three years: GNC owns two coking coal mines in Australia, with 580Mnt reserves and a current mine coal production run of 1Mnt. The company is well on course to raise production to 7Mnt by FY13E. We estimate production to be 1.8Mnt in FY10, 2.5Mnt in FY11 and 3.5 in FY12, a bit lower than earlier estimates, as the company slows capex.

■ Capacity increase just in time: GNC has augmented its coke capacity by 25% to 1.25Mnt. We are increasing our coke production estimates by 25% and 4% for FY10 and FY11 to 940kt and 980kt, respectively.

Earnings and target price revision
■ We are increasing our FY10 and FY11 EPS estimates by 50% and 204%, respectively, and are increasing our sum-of-parts target price to Rs87 from Rs58.

Price catalyst

• 12-month price target: Rs87.00 based on a Sum of Parts methodology.
• Catalyst: Increased visibility on its capex and production schedule.

Action and recommendation

■ Maintain Outperform: We believe GNC remains the best stock in which to invest to take advantage of the upturn in the coking coal cycle. GNC has good quality reserves, an excellent location and is well on its way to becoming one of the world’s top-ten producers of prime hard coking coal in next three years. The stock is trading at attractive valuations of around 9x PER and around book value.

To see full report: GUJARAT NRE COKE