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Morningstar | Datang’s 1Q Slightly Missed; Our FVE Remains Intact on Bearish Coal Price Outlook

After excluding one-off items from its first-quarter net profit of CNY 429.8 million, no-moat Datang’s performance was disappointing, with recurring net profit falling 28% year over year to CNY 380 million under PRC GAAP. Despite a 14% fall in the QHD 5,500 kcal benchmark coal price, Datang’s first-quarter performance implies a 3% rise in its unit cost. Besides a drop in operating leverage from the 5% fall in power sales volume that raises per unit cost, we think Datang has been relatively inefficient in its coal purchase strategy. Nonetheless, we expect Datang’s profitability to improve in the coming quarters, amid the continued fall in coal prices. Our long-term bearish coal price outlook is unchanged and we think Datang should be able to benefit from this. We keep our full-year 2019 earnings forecast of CNY 3.7 billion and our fair value estimate of HKD 2.50 for now. We think Datang’s current share price already reflects potential downside risk.

We think the shares are slightly undervalued, trading at 0.6 times price/book, which is lower than our valuation and its 10-year average of 0.8 times price/book. We think the potential improvement in long-term cash flows under rationalized coal prices and a more comprehensive coal-power price linkage mechanism should drive the valuation to our fair value estimate. Our midcycle coal price assumption of CNY 565 per tonne suggests Datang should be able to earn a sound operating margin of 14.5% compared with 10.0% in 2018, with robust annual free cash flow of more than CNY 10 billion.

Datang’s power output volume fell 5% year over year, lagging the 5.5% of nationwide power consumption and 2% of nationwide coal-fired power generation. Although Datang has about 12% power output from clean and renewable energy sources, which enjoyed strong growth in the first quarter, coal-fired output still accounted for about 88% of the total output in the first quarter. Two thirds of these coal-fired power plants are located in the Beijing-Tianjin-Hebei region and East coastal regions, which have suffered from stricter pollution controls that limit the use of coal. In addition, strong water flow since beginning of this year has raised hydro-power outputs. This, along with government’s supporting policy in clean and renewable energy sources, should further dampen Datang’s power utilization hours in 2019. As such, we forecast Datang’s utilization to fall slightly to 4,650 hours in 2019, from 4,728 a year ago.

We estimate Datang’s average tariff should have risen 3%-4% year over year in the first quarter, driving a widening in its gross margin to 16.0% from 15.4% a year ago. We expect Datang’s margin to further expand in the coming quarters, which should benefit from the downward trend in coal prices. We think the lackluster coal demand and growth in supply will keep prices subdued. We think the high inventory level at six major power plants (26 days currently, versus a normalized 18-20 days), and more than 20% drop in import coal prices, further support our bearish outlook in coal prices. We maintain our assumption that coal prices will fall 8%-10% in 2019, averaging at CNY 585-595 per tonne, and we expect Datang’s full-year gross margin to expand by 3%-4%. This will boost full-year 2019 net profit to CNY 3.7 billion (under IFRS), from CNY 1.2 billion in 2018.