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Morningstar | Shenhua’s Profit Guidance Implies a Flat 4Q Earnings, Despite 9% Fall in Coal Price

China Shenhua’s preliminary full-year 2018 profit guidance of CNY 44.5 billion points to a better-than-expected fourth-quarter performance as an 8.8% drop in the benchmark QHD 5,500 kcal spot coal prices should have led to a drop in earnings. We think fourth-quarter profit could have been supported by stronger-than-expected power output and pickup in second-half coal rail-transport demand. In addition, the monthly coal production volume recovered to 25.5 million tons in the fourth-quarter, from 24.7 million tons a year ago, following the mining approvals obtained at Ha’erwusu and Baorixile open-pit mines in Inner Mongolia, which we think should help to lift unit production margin slightly on better operating leverage. Overall, it appears recurring profit was flat year-over-year in the fourth quarter.

We leave both our earnings forecasts and fair value estimate of HKD 22.00 per share unchanged ahead of the full-year result due out in March. We expect little change to our fair value estimate with our midcycle outlook, which factors in minimal if any five-year growth for Shenhua, unlikely to change given our bearish coal price outlook. We think the shares, currently trading at 1 time price/book, are fairly valued.

Shenhua’s operating performance in the second-half was decent, with all the business segments of coal, power, and coal rail-transportation posting positive growth. Coal production recovered following the mining approvals obtained at the Ha’erwusu and Baorixile open-pit mines in Inner Mongolia, with output volume rising 4.5% sequentially in the second-half, leading to flat full-year volume. Power segment saw a decent 8.5% year-over-year sales volume growth in 2018, which is higher than the 7.3% growth of nationwide coal-fired power outputs. Turnover at coal rail-transport operations also improved to 4.0% year over year for full-year 2018 from 1.6% in first half, catching up to the 4.3% volume growth recorded by its key competitor Daqin Line.

As we expected, the QHD 5,500 kcal benchmark coal price continued its weakening trend, closing at CNY 582 per ton as of Jan 30, 2019, down from fourth-quarter average of CNY 630. In addition, with coal inventory at the six major power plants rising to over 30 days, compared with 10-11 days last year and a normalized 18-20 days, we think stricter safety controls that may limit coal mine output will put limited upside pressure on coal prices. 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 we expect the downward trend in coal price to weigh on coal miners’ profits in the coming quarters. However, we expect positive earnings growth at Shenhua’s power and rail segment to continue to help offset the weakness at Shenhua’s coal segment amid falling coal prices, and we forecast Shenhua’s overall net profit to remain largely flat at CNY 44 billion between 2018 and 2023.