Our view
Previous high valuations and price control fears decoupled Chinese coal stocks
from global coal price hikes. Tight supply will extend the upcycle, leaving scope for
domestic prices to catch up, particularly for contract coal. The earnings outlook and
M&A potential support our valuations, revised to mid-cycle from peak-cycle.
Anchor themes
A moderate slowdown in demand growth is unlikely to alter the tight supply
situation at least until 2009F, given transport bottlenecks, the shutdown of small
mines, and more disciplined production. Industry consolidation will benefit the
industry leaders in both organic growth and acquisitions.
Historically, contract thermal coal was sold to power producers at state-guided
prices that were substantially below market levels. Market deregulation and higher
regulatory costs underpin an uptrend in contract thermal coal prices.
Back on track
Domestic prices have room to rise
We believe coal has stronger fundamentals than oil, and that Asian
prices will stay elevated. The recent surge could limit upside in spot
prices but points to substantial hikes in contract prices. The restrained
increases in domestic prices leave room for catch-up, particularly for
contract coal given the distorted gap with spot prices. This underpins
continued earnings growth post-2008F for the Chinese coal majors. A
seasonal correction in domestic spot prices is likely in 2Q08F, though.
Tight supply reflects structural issues
Beneath China’s coal and power shortages, owing to the severe winter
weather, we see structural problems including an over-reliance on coalfired
power, transport constraints, blanket shutdowns of small mines, a
coal-power pricing dilemma and a lack of strategic coal reserves. Since
these will need time to resolve, we expect continued tight supply.
M&A: much to expect
Small coal mines were a swing factor in the crisis, underscoring an
imperative for industry consolidation. This spells M&A opportunities.
China Shenhua has a strong pipeline of asset injections including coal
mines and coal liquefaction besides overseas acquisitions. We see the
company facing pressure to acquire, amid rich A-share proceeds. China
Coal has two mining areas and some small mines in the pipeline.
Chinese coal majors deserve a premium
The Chinese coal majors are now at significant discounts to global
peers. This is not justified, in our view, given stronger demand growth, a
distorted contract gap and a leading global position. China Coal looks
oversold and value has re-emerged against a strong earnings outlook.
China Shenhua is more defensive and valuations remain high against its
H-share peers and historical average. We believe the FY09F outlook
and M&A potential support such a premium.
Contents
Domestic prices have room to rise 3
Coal’s fundamentals stronger than oil’s 3
Elevated Asian prices to support domestic prices 4
Chinese prices have gone from premium to discount 4
Tight supply to extend the uptrend 5
Revised up our coal price forecasts 5
The distorted contract gap will have to narrow 6
Pricing reform to be the key catalyst 6
China Shenhua leads domestic contract price increase 8
Will China control coal prices? 9
Tight supply reflects structural issues 10
Demand slowdown unlikely to tilt the balance 10
Domestic supply to remain tight 11
China will be a net importer 13
China Coal leads growth profile 14
Natural and human disasters 15
Over-reliance on coal-fired power 15
Transport still bottlenecked 16
Coal-power pricing dilemma 17
Blanket shutdowns adding to the woe 18
The need for strategic coal reserves 19
M&A: much to expect 20
Industry consolidation to accelerate 20
Mining asset injections ready and waiting 21
High oil prices underpin coal liquefaction and chemicals 22
Ambitious overseas drive 23
Cost pressures well covered 25
“One fund, two fees” unlikely to be rolled out 25
“Two fees” not counted under IFRS 25
Higher resource tax coming soon 26
Operating cost pressures covered by price gains 26
Chinese coal majors deserve a premium 28
Earnings revised up 28
Abandon peak cycle valuations 29
Forward-looking view and M&A justify premiums 32
Each has its own merits 33
Potential risks 34
Earnings and fair value sensitivity 35
Latest company views
China Coal Energy 38
China Shenhua Energy 42 |
