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Morningstar | Falling Coal Price Will Be a Key Growth Driver for Datang in 2019

Datang International Power Generation's decision to divest itself of its coal-chemical business is an important step toward restoring shareholder value. The divestment of nonperforming and capital-intensive coal-chemical assets allows the firm to improve its financial health and focus on its core competency in power generation. We expect Datang to grow and gain value as a leading independent power producer and believe its favorably located generation assets, with their higher efficiency standards, should drive its plants’ utilization and profitability well above the broader industry average. Datang's gamble in coal-chemical projects has proved to be much more difficult than expected, with challenges from greater uncertainty in production, a higher cost profile, and falling chemical prices. Reliance on debt to fund the ambitious investments also threatened the firm’s financial health and further detracted from returns, with ballooning financial costs. Following the successful divestment, we expect a boost to Datang’s earnings, as the company will avoid losses of CNY 2.0 billion-2.5 billion per year from the coal-chemical projects, and reduced depreciation will also improve profitability. Datang’s generation business is better positioned, with clean capacity accounting for one fifth of total capacity, the highest among its peers. This provides some buffer to the current challenges of declining utilization faced by coal-fired power producers. We expect to see Datang’s utilization rate stabilize in the next two or three years. The increasing awareness in air-pollution control is driving the government to limit approvals for new coal power plants, which should help to improve the supply/demand dynamics.Though the coal price rally and China's flawed coal power pricing mechanism have historically caused coal-fired generators to earn below their cost of capital, the weakening trend in coal prices since mid-June reaffirms our view that coal prices have peaked. We maintain our midcycle coal price forecast of CNY 565 per tonne and expect coal prices to fall another 6%-8% in 2019, which should drive decent earnings recovery for coal-fired power plants.