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Morningstar | Yanzhou’s Decent 2018 Results Largely in Line; Capacity Expansion Remains Key Growth Driver in 2019

Following largely in line results, 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 for no-moat rated Yanzhou Coal, as key production assumptions and our long-term bearish coal price outlook are unchanged. Following a 42% share price rise from the bottom of HKD 5.96 at the beginning of 2019, we think the shares are fairly valued, with an uptick in production growth and coal prices largely reflected.

Along with a slowing economy in China and the U.S.-China trade impasse, coal prices are likely to remain constrained. We maintain our bearish long-term coal price outlook and our midcycle assumption of CNY 565 per ton. A key driver of lower prices is the added supply from Inner Mongolia. In addition, we think the improving coal rail-transport infrastructure, with the new rail corridor Menghua line commencing service in 2020, will also help to reduce bottlenecks and flatten the cost curve. 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.

Yanzhou Coal’s decent full-year 2018 results, with net profit rising 17% to CNY 8.6 billion, was 6% above our expectations. We think this was largely driven by better-than-expected production recovery following the resumption of activity at its Ordos coal mines, which added about 2 million metric tons from a quarter ago, equivalent to 83% sequential growth in the fourth quarter. This, along with strong production growth in Australia, helped to lift full-year production volume to 95 million metric tons in 2018. Given the utilization rate at Inner Mongolia coal mines was just about 60%, we think further production ramp-ups in Inner Mongolia and capacity expansion at Yancoal Australia will continue to be the key growth driver for Yanzhou in 2019.

The strong performance at Yancoal Australia, which benefited from increased capacity coinciding with higher coal prices, continued to be the bright spot for Yanzhou. The acquisition of Coal & Allied in September 2017, and maiden contribution from phase 3 of Moolarben coal mine, drove Yancoal Australia’s commercial coal production up 74% to 33.6 million metric tons in 2018, equal to 35% of the group’s total coal production. In addition, the sound profitability at Coal & Allied lifted Yancoal Australia’s unit profit sharply to CNY 349 per metric ton from CNY 258 per metric ton a year ago. With 90% of coal output being sold on long-term contracts, we expect Coal & Allied’s net profit contribution to stabilize at CNY 2 billion–CNY 2.5 billion on an annualized basis, representing 20%-25% of our forecast earnings for Yanzhou for the next five years. In addition, we expect the production recovery from safety checks, along with capacity expansion at phase 3 of Moolarben coal mine in Australia and Yingpanhao coal mine in Inner Mongolia, to drive Yanzhou’s total output volume to CNY 110 million metric tons in 2019, representing 16% year-over-year growth from our forecast 95 million metric tons in 2018.

The QHD 5,500 kcal benchmark coal price weakened to CNY 618 per metric ton as of March 29, 2019, from its recent peak of CNY 638 in early March. This is in line with our expectations. We think the recent coal price rally was primarily driven by tight supply, due to stricter safety controls during the two sessions of National People’s Congress and Chinese People’s Political Consultative Conference, following a few coal mine disasters in Shanxi, Shaanxi, and Inner Mongolia. We expect coal production to gradually recover from late March and demand to fall amid the end of heating season.