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CSCI-Power-China Shenhua (1088 HK)：Declining volume weighs on profits - 20180518

Declining volume weighs on profits

• We now foresee a mild 5.8%/2.9% YoY decline in the company’s profitability in FY18E/19E, versus our flat growth forecast previously, on the basis of expectation that the company’s coal production volume would see a decline in 2018 and a cut in our coal price forecast by 3.2% to RMB600/t from RMB620/t in 2019. 
• We have revised down our FY18E/19E EPS forecasts by 8.9%/11.3% to RMB2.26/2.2 from RMB2.48/2.48, respectively, to reflect our revised view on the company’s profitability in both years.
• Reiterate HOLD and DCF-based price target of HK$21.00, on the back of the company’s strong free cash flow as well as our view that coal prices will remain at the 2017 level in the near term.

2018 likely to see slightly lower coal production. Based on the company’s latest guidance and YTD output volume (96.1mnt in 4M18, down by 6.2% YoY), we now expect its coal production volume to decline by 1.7% YoY in FY18E, versus our previous estimate of a 2.9% YoY increase. As its Ha’erwusu mine has contributed 640kt of coal in April, we expect the mine to resume full scale production in 2H18.

Declining coal production to drag on earnings. Based on our calculation, the GPM of the company’s coal production segment, which makes up for c.65% of total sales volume, is currently around 50ppt higher than that of its coal trading segment. Nonetheless, the forecast production volume reduction is likely to drive down the overall coal business’ GPM by 1.6ppt to 25.2% in FY18E from 26.8% in FY17A. In addition, for every 1% change in the production volume, the company’s EPS will change by 0.7% in the same direction for 2018, per our estimate.

We expect coal prices to stay flat in 2018 compared with 2017. We now anticipate the QHD5,500k coal price to see an average price of RMB613/t in 2018, flat from 2017. As such, we foresee the growth in the company’s ASP will also come in relatively flat in 2018. Meanwhile, Chinese government’s policy to restrain coal prices from rising significantly during the peak coal consumption season will remain an overhang for the company’s coal prices going forward, though a slowing coal supply growth amid rising demand should lend support for the coal price to be maintained at the 2017 level in the near term, in our view. Thus, we have tweaked our coal price forecast for 2018 from slight growth to flat growth. In addition, for every 1% change in the coal price, the company’s EPS will change by 1.1% in the same direction for 2018, per our estimate.

Recovering profitability of power business on the back of tariff hike. Based on the company’s 1Q18 results, the company’s on-grid tariff for coal-fired power has increased by 3.7% YoY to RMB310/MWh in 1Q18 from RMb299/MWh in 1Q17, thanks to the local tariff hike which became effective from 2H17. As the Direct Power Supply (DPS) discount is expected to remain at the 2017 level in the near future, we expect the on-grid tariff to hover at the current level of RMB310/MWh for the remainder of 2018.Thus, all in all, the power business’ GPM is estimated to improve by 1.5ppt to 15.5% in 2018, on the back of on-grid tariff hike and flat fuel cost. In addition, for every 1% change in the on-grid tariff, the company’s EPS will change by 1.2% in the same direction for 2018, per our estimate.

Maintain HOLD rating and TP of HKD21.00. After factoring in a reduction in the company’s coal production volume and hike in the on-grid tariff for coal-fired power, we estimate the company’s profitability to drop by 5.8% YoY in 2018. However, as the company’s free cash flow is currently expected to remain stable going forward, we will maintain our TP of HKD21.00, implying 1.0/0.9x PBR FY18E/19E.