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Morningstar | Daqin’s Decent 2018 Performance In Line; But Expect a Weak 1Q

Narrow-moat Daqin’s fourth-quarter demand was decent, with the daily average coal rail-transport volume on it core Daqin Line of over 1.2 million tonnes. This is largely in line with our expectations and drove its full-year volume up 4.3% to 451 million tonnes. However, the recent coal mine disasters in Shanxi, Shaanxi and Inner Mongolia have triggered stricter safety checks on coal production, and leading to a sharp 10.5% fall of coal volume on Daqin Line in February. We think coal production will gradually recover after the two sessions of National People’s Congress and Chinese People’s Political Consultative Conference, and we expect Daqin’s daily average coal volume to return back to 1.2 million tonnes from the second quarter. We maintain our full-year 2019 coal volume assumption of 425 million tonnes, and our fair value estimate of CNY 9.80 per share. But we estimate Daqin’s first-quarter volume will fall 4%-5%, which will lead to an 8%-10% year-over-year decline in first-quarter earnings. We think the shares, currently trading at 1.2 times price/book, are fairly-valued. But a weak first quarter is likely to pressure the near-term share prices.

We expect Daqin to maintain a stable coal volume of 440 million tonnes over the midcycle. We think China’s stricter air-pollution controls will see rail transport replacing coal trucks and drive robust coal rail-transport volume in coming years, despite rising shares of renewable energy and China’s shift away from energy-intensive growth mode. Although the capacity constraints and the high utilization rate on Daqin Line should mean a relative low growth outlook for Daqin, we think the company’s robust cash flow and lower capital needs will continue to support more generous dividend payouts, and our estimated 2018 dividend of CNY 0.54 per share implies a 6.4% dividend yield, compared with a typical 4%-6% for its infrastructure and utility peers.

Daqin has acquired an additional 20% stake in Tanggang Line at CNY 1.7 billion in Mar 2019. Tanggang Line connects Daqin Line to Caofeidian Port, which is one of the key coal ports that is located in Bohai Rim, with designed capacity of 200 million tonnes. The deal is priced at about 1.1 times price/book, which we think is fairly valued compared with Daqin’s current valuation of 1.2 times price/book. Following the acquisition, Daqin’s holdings in Tanggang Line increased to 62%, which will be consolidated in financial statements and reclassified as subsidiary from associate investment. We’ve adjusted our model accordingly, but little impact to fair value estimate. We expect the deal to create positive synergy to Daqin’s current operation, which will strengthen Daqin’s bargaining power over ports, with increasing flexibility for shipments to Caofeidian Port in the case of capacity constraint and volume control at Qinghuangdao Port, and further enhance its dominant position in coal rail-transport. We estimate the acquisition to increase Daqin’s net profit by 2%, or CNY 300 million in 2019.