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Morningstar | Yanzhou’s 1Q Result in Line; Capacity Expansion Remains Key Growth Driver in 2019

No-moat Yanzhou Coal’s first-quarter result, with net profit rising 4% year over year to CNY 2.3 billion under PRC GAAP, was largely in line with our expectations. We maintain both our 2019 net profit forecast of CNY 9.7 billion, as well as our fair value estimate of HKD 8.00 per share, as key production assumptions and our long-term bearish coal price outlook are unchanged. Following a 36% share price rise from the beginning of the 2019, we think the shares are fairly valued, with the uptick in production growth and coal prices largely reflected.

Despite the global weakening trend in coal prices, Yanzhou’s average coal selling price rose 8.4% year over year to CNY 596 per tonne in first-quarter 2019. This reflects the company’s effort in optimizing its product mix, with production shifting to higher profit clean coal, boosting the average unit profit to CNY 260 per tonne, from CNY 247 per tonne a year ago. However, safety checks in Inner Mongolia have led to sharp fall in coal production at its Shiwulasu coal mine, leading to a 5% decline in Yanzhou’s total coal output. We think the impact is temporary. According to management, the production will gradually recover from the second quarter.

Given the utilization rate at Inner Mongolia coal mines was just about 60%, we think further production ramp-ups at Inner Mongolia coal mines, along with capacity expansion at the Moolarben coal mine in Australia, and the Yingpanhao coal mine in Inner Mongolia will continue to be the key growth drivers. We estimate Yanzhou’s full-year production output in 2019 will rise to 108 million tonnes, representing 15% year-over-year growth from 94 million tonnes in 2018.

The daily average QHD 5,500 kcal benchmark coal price fell 14% year over year to CNY 602 per tonne in the first quarter. While the wider-range of mine safety checks and stricter constraints on coal imports have kept the coal price above the “Green Zone” (CNY 500-570/tonne) level, we believe lackluster coal demand and growth in supply will keep prices subdued. We expect the coal price to fall 8-10% in 2019, averaging CNY 585-595 per tonne. So, we expect lower growth of 13% in Yanzhou’s net profit to CNY 9.7 billion in 2019.

In the long term, we think the decline in electricity-intensity of the Chinese economy and the shift toward an anything-but-coal energy policy will continue to dent coal demand and limit any material price increase. As such, our bearish coal price outlook, and our midcycle coal price assumption of CNY 565 per tonne remain unchanged. We forecast Yanzhou’s net profit to grow at a five-year CAGR of 3.6% between 2019-23.