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Morningstar | Yanzhou Coal's long-term future remains grim.

With acquisitions of Inner Mongolia and Australia assets, Yanzhou Coal is finally ready to ramp up capacity. While capacity growth remains a near-term growth driver for Yanzhou, China's shifting away from coal and energy-intensitive economic growth should mean demand headwinds, painting a grim future. With low expectations, Yanzhou is capable of delivering positive surprises. We expect management to reduce labor intensity and shut down higher-cost mines. While this strategy provides a lift to short-term earnings, it does not alter the high-cost nature of the company's assets.The Shandong, Australia, and Inner Mongolia mines accounted for 34%, 40%, and 18%, respectively, of the firm's coal production in first-half 2018. Though Yanzhou's Shandong mines pale in comparison with those of rivals such as China Shenhua, they continue to deliver plentiful economic profit for the firm, with average costs 10%-15% below the industry's marginal production costs. China's major coal-producing regions (Western China) are far from its high-consumption regions (Eastern China), and high transportation expenses can materially depress profits for coal miners. Located along the northern coast of China adjacent to the Korean peninsula, Shandong Province is one of the three highest-GDP Chinese regions. This has made it easy and profitable for Yanzhou, a provincial government-owned firm, to sell most of its locally produced coal. Our biggest concern lies with the Australia assets. A few lower-cost assets such as Moolarben offer value to shareholders, but with the majority of assets composed of high-cost mines and cash-draining exploration projects, Australia could drag considerably on Yanzhou's profitability in the long term. The debottlenecking of the firm's low-cost and scalable Inner Mongolia mines through a major railway is a silver lining. Profitability and capacity utilization rates at the Inner Mongolia mines will benefit from the improved accessibility and lower transportation costs.