EUR 850.00 For Business Accounts Only

Morningstar | Impairment Drove China Coal’s 4Q Net Loss; Coal Production Expansion in 2019-21 a Key Highlight. See Updated Analyst Note from 18 Mar 2019

China Coal’s full-year 2018 net profit of CNY 4.5 billion includes a loss-making fourth quarter, driven largely by a CNY 1.1 billion non-cash impairment. Core operating performance was decent, with coal production volume rising 21% year over year in the fourth quarter, following the commercial start of production of two coal mines in Inner Mongolia in November. With visible new coal projects in the pipeline, we think strong coal production growth of 30% will be a key highlight for China Coal in the coming three years. This, along with improving coal-chemical profitability, will help to offset the negative impacts from weakening coal prices. We raise our earnings forecasts by 6%-7% in 2019-21, to CNY 4.4 billion, CNY 4.8 billion, and CNY 5.2 billion, respectively, to reflect a stronger-than-expected coal production growth in the coming three years. However, our bearish coal price outlook is unchanged, which should see China Coal’s gross margin narrow to 16.0% in 2021 from 17.5% in 2018. Accordingly, we raise our fair value estimate to HKD 4.18 per share from HKD 4.10, after accounting for a weaker yuan against the Hong Kong dollar.

We think the shares are slightly undervalued, trading at only 0.4 times price/book, compared with its 10-year average of 0.9 times and our valuation of 0.5 times. Our midcycle coal price forecast of CNY 565 per ton, along with improving chemical segment profitability, suggests the company will be able to deliver healthy midcycle annual free cash flow of over CNY 10 billion. In addition, China Coal raised its dividend payout ratio slightly to 23% in 2018, with a proposed dividend CNY 0.078 per share. With a visible growth outlook, we think the company will further raise the payout ratio to 30% in the next five years.

China’s supply-side reform has seen China Coal’s coal output fall to 77 million tonnes in 2018 from 98 million tonnes in 2015. With two coal mines, Nalinhe #2 and Muduchaideng coal mines in Inner Mongolia, commencing production in November, China Coal saw its coal output jump 21% year over year, and 12% from a quarter ago. In addition to production ramp-up at the two mines, China Coal also has capacities from Xiaohuigou coal mine, Dahaize coal mine, and Libi coal mine to put into production in the coming two years. These will significantly boost China Coal’s production volume in 2019-21, and we estimate the company’s production will grow more than 30% in the next three years, to over 100 million tonnes in 2021. This will help to offset some negative impacts from weakening coal prices, and we forecast China Coal’s net profit to grow at a CAGR of 6.2% over the next five years.

The QHD 5,500 kcal benchmark coal price weakened to CNY 623 per tonne as of March 15, 2019, from its recent peak of CNY 638 on March 8. 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. 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. We think growth in supply from Inner Mongolia will keep prices subdued. And 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.

Driven by strong olefin production volume growth at Mengda project, coinciding with higher olefin prices, China Coal’s chemical segment saw an impressive 98% year-over-year operating profit growth in 2018. However, unit production cost at its olefin projects rose to CNY 6,808 per tonne from CNY 6,313 per tonne a year ago, representing an 8% rise in unit production cost. We think this reflects the challenges in gaining scale benefits and we remain cautious on the company’s coal-chemical business. We think volatile production volumes and costs, as well as the cyclical chemical prices, adds risk to China Coal’s earnings. The good news is that cash flows are healthier, as while the company still has a few chemical projects in the pipeline, its capital expenditure for this segment has fallen sharply to CNY 847 million in 2018 from a significant CNY 18 billion in 2013. We think this will help improve the company’s financial position and put it on firmer footing to face the next round of macro risks.