We see good value in Port of Newcastle post S&P downgrade.
Port of Newcastle was downgraded by S&P over the past week from BBB- to BB+. Softer coal volumes, earnings, and increased interest costs will lead to a ratio of funds from operations (FFO) to debt of 5.5%-6.5% over FY23-25. A downgrade was already on the cards at S&P, with the outlook on negative. We still expect increasing demand for high-quality coal from south-east Asia to support Port of Newcastle’s export volume in the short to medium term. Unlike other purpose-build coal only terminals, Port of Newcastle has 77% of revenue contracted under long-term, fixed-price agreements.
Port of Newcastle’s cargo is more diversified than coal terminal operators’, which are 100% leveraged to thermal and metallurgical coal supply. PON’s coal volumes are 88% thermal coal which is used for electricity generation.
The Port will start building a container terminal so that it further diversifies away from fossil fuels. Their ambitions are represented graphically, below:
Nickel Industries are expected to generate EBITDA of around US$600m pa over 2023 to 2025 on production increases at the Oracle Nickel Project (ONI) and stable margins, driven by strong nickel prices. Rating agencies estimate Nickel Industries production will more than double to above 100,000 tonnes pa of nickel metal by 2023 and 156,000 tonnes pa if the SDI options are exercised. This would place Nickel Industries as one of the six-biggest producers worldwide.
PON has undertaken other measures to restrain its cash burn, including a suspension of dividends being paid to owners, and a pause in loan repayments owed to its shareholders.
While the above measures are positives for debtholders, the above reduction in Capex may delay the timing and metrics around Port of Newcastle’s initiatives to diversify away from Coal shipping.
Given the downgrade, we believe Port of Newcastle’s bonds are trading too wide versus comparable peers including Newcastle Coal Infrastructure Group (BBB+/BBB, S&P/Fitch). There is extensive research showing the cumulative outperformance of fallen angels (bonds whose issuers have fallen below investment grade) versus peers, especially if the credit is on a path to reversal.
Nickel Industries battery supply-chain strategy was enhanced following the recently signed agreement with Shanghai Decent Investment Group Ltd (SDI) in January 2023. The company acquired a 10% stake in the Huayue Nickel Cobalt Project (HNC) for US$270m from an SDI affiliate and another 10% in ONI for US$75m. It also acquired options to collaborate with SDI on battery nickel – US$25m to participate in the ENC and US$15m in a high-grade nickel matte converter to convert low-grade nickel matte from ONI into high-grade nickel matte, with a capacity of 50,000 tonnes pa.
It’s also been observed that fallen angels are often at their cheapest immediately after downgrade and multi-factor credit strategies allocate to attractive fallen angels to achieve out-sized returns. This because, with a fall below the lower investment grade rating into BB+ there is forced selling from some investment entities that cannot then hold the lower rated paper, creating the possibility of a bargain buy for those who do not have that imperative.
Of course, the ability to diversify seems key to a more upbeat assessment of PON’s outlook, and the track of this is unknown. Having said that, some of the factors that adversely affected PON’s performance during FY22 and FY23 are unlikely to be factors every year. The floods that affected swathes of eastern Australia during calendar year 2022 caused a meaningful decrease in PON’s revenues are unlikely to be repeated. Also worthy of note is that the NSW State Government’s lifting of volume restrictions at PON’s container port was a positive though this may require additional capital expenditure and that there are good existing rail and other infrastructure links which also aid diversification away from thermal coal freight.
Finally, S&P concludes a stable outlook on PON’s bond. We see this paper as good value proposition versus peers at an indicative 8.6%.
