China Coal
Too Early To Turn Positive
With coal demand sluggish and inventory levels
near crisis levels, we believe the performance of the
Chinese coal sector will be under pressure. In 2H12
we expect coal prices to fall at least 23% YoY,
before picking up by just 3% in 2013. Shenhua is our
preferred pick and we are sellers of Yanzhou.
We expect 23% YoY drop in 2H12 average spot
price: Since our industry downgrade earlier this year,
the outlook of the Chinese coal sector has deteriorated
further, with power generation slowing to sub 5% growth.
More worrying is the uptick in inventory levels, which
have reached over 25 days. Heading into 2H12, we
believe the average spot coal price in China will be 23%
lower YoY at Rmb650/ton, implying a 14% fall in the
2012 average spot price. With ample capacity in the
system, upside to 2013 average coal price will also be
limited. For now, we are building in just 3% increase.
Pricing gap vs. region implies downside risk to
domestic prices: Our channel checks suggest that
most Indonesian coal producers are still sticking to their
2012 production targets. Their near-term focus is to
actively manage down strip ratios as a way to control
costs. With no meaningful pullback in exports, we
believe the seaborne coal market will remain
oversupplied, putting more pressure on pricing than the
market expects. On a relative basis, China’s coal market
is more balanced. However, the huge pricing gap
between China and the seaborne market presents a real
downside risk to domestic spot prices.
Macro overhang outweighs undemanding
valuations: We have cut our forecasts for the Chinese
coal stocks over the next three years to reflect lower
ASP and volume assumptions. That said, the major
pull-back in stock prices has made valuations less
demanding. At current levels, stocks are implying a
long-term coal price of US$70-80/ton. However, we
expect the sector to trade sideways until demand picks
up and outlook improves. On a fundamental basis,
Shenhua is our top pick given its strong operational
capabilities and earnings resilience.