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China Coal Sector
Start of a New Upcycle
What's Changed
Industry View: China Coal In-Line to Attractive
Supply growth is constrained by restructuring
efforts: The Chinese government has, logically, taken
advantage of slowing coal demand to restructure the
domestic sector. In the short term, aggressive mine
closures, especially in Shanxi, will put a cap on
production growth. Meanwhile, consolidation by larger
coal groups will take longer, given the gap in valuation
expectation between buyers and sellers. Overall, we
believe supply growth in the next few years will average
about 6-7%, half that achieved between 2002 and 2007.
Against expected average demand growth of 7-8% over
the medium term, we believe the Supply/Demand of the
domestic coal sector is in balance. As such, coal prices
are well-supported at current levels. We expect gradual
price increases as supply tightens.
Shenhua (1088.HK, upgrade to OW): Shenhua has
clearly demonstrated the quality of its operations in the
current environment. It has taken concrete steps to
achieve its 400mt production target by 2015 thereby
significantly enhancing earnings visibility. We raise our
rating on Shenhua to Overweight with a new target price
of HK$31.00. It is also our top pick in the sector
China Coal (1898.HK, upgrade to OW): We predict
flattish production growth over the next two years.
However, production growth should pick up again in
2011 with the startup of a new mine. Its net cash position
of Rmb26bn also gives it plenty of options, including
paying a special dividend which could boost the yield to
over 10%. We therefore raise our rating to Overweight
with a target price of HK$11.20.
Yanzhou (1171.HK, Maintain UW): Yanzhou stock has
re-rated on the back of smaller-than-expected falls in
domestic spot coal prices. However, we believe that with
spot coal prices unlikely to spike, the stock’s re-rating is
over. At 12.8x 2009-PER Yanzhou is trading at the high
end of its historical range, making valuation unattractive.
Maintain Underweight, target price moves to HK$8.95.
Contents
Domestic coal prices well supported........................................................................................................................... 3
Domestic coal market will remain balance until 2014...........................................................................................................................3
Supply will be constrained in the medium term...................................................................................................................................4
Key conclusion on Supply ....................................................................................................................................................................................... 4
Shanxi is aggressively closing down unsafe mines................................................................................................................................................. 5
But consolidation is not happening as quickly......................................................................................................................................................... 6
Demand is still powering ahead ..........................................................................................................................................................7
Key risks to our Attractive view on the domestic coal sector ................................................................................................................7
Imports puts a cap on domestic coal prices ............................................................................................................................................................ 7
Restart of production from small mines................................................................................................................................................................... 8
Key Sector Charts .......................................................................................................................................................... 9
Regional Coal Valuation Comparison........................................................................................................................ 10
Company Analysis ....................................................................................................................................................... 12
China Shenhua Energy................................................................................................................................................ 13
Investment Case........................................................................................................................................................... 16
Growth is intact despite current environment ....................................................................................................................................16
The 400mt production target ................................................................................................................................................................................. 17
Valuations – high but demanding ......................................................................................................................................................17
China Coal Energy Co., Ltd......................................................................................................................................... 19
Investment Case........................................................................................................................................................... 22
Flat earnings until 2011 because of limited volumes growth ..............................................................................................................22
Stock valuations are attractive but lacks catalyst ...............................................................................................................................23
Better capital management => better shareholders value ..................................................................................................................24
Yanzhou Coal................................................................................................................................................................ 26
Investment Case........................................................................................................................................................... 29
Net cash holdings but limited upside for shareholders.......................................................................................................................................... 30
Valuation is not cheap.......................................................................................................................................................................31
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