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Yanzhou Coal Summary

Core Content

Yanzhou Coal (1171 HK) is a Chinese coal company with a high beta exposure to coal price volatility. The current share price is HKD5.86, with a target price of HKD6.25, representing a 7% increase. The company's market capitalization is HKD28.8B, and its average daily trading volume is USD8M. The company is categorized under the Materials sector and currently holds a "HOLD" rating.

Main Points

• Valuation and Performance:

  • Yanzhou's valuation is based on a 0.6x PBR multiple for 2014E, leading to a target price of HKD6.25.
  • The company has a lower PBR than Shenhua (1088 HK), which is rated as a "BUY" with a higher growth outlook and more stable earnings.
  • Yanzhou's EV/EBITDA multiple is in the middle of the three coal companies, reflecting its moderate risk profile.

• Market Outlook:

  • Coal prices in China and the region have declined significantly since 2011, with thermal coal prices down 40% and coking coal prices down 63% from their peaks.
  • The outlook for coal price volatility is low, and the market is oversupplied with weak consumption growth.
  • Shenhua is preferred due to its cheaper valuation and more stable growth outlook.

• Financial Leverage and Risk:

  • Yanzhou has high financial and operating leverage, meaning its earnings are highly sensitive to coal price changes.
  • A USD5/t change in coal price impacts earnings by CNY0.30/sh, which is significant given the current low price forecast.
  • The company's net debt to equity ratio is 110% as of 2013, up from 38% in 2010, due to overseas acquisitions.

• Earnings and Profitability:

  • Yanzhou's core net profit was CNY1,442m in 2014E, with core EPS forecast at CNY0.29.
  • The company has partially restored its coal profit margin to USD18/t in 2014E, up from USD15/t in 2013, due to lower costs.
  • Earnings sensitivity to coal price and cost changes is high, with a forecast of moderate improvement in profitability from 2014E to 2016E.

• Share Price Performance:

  • Yanzhou's share price has underperformed compared to Shenhua and China Coal since late 2011, with a 63% decline from 2011 highs.
  • The share price has a strong correlation with coal prices, but this relationship has been disrupted by structural and macroeconomic factors.

• Business Segments and Revenue:

  • Yanzhou's revenue is dominated by coal sales, accounting for 97% of total revenue in 2013.
  • Thermal coal accounts for 79% of the product mix, with semi-coking coal making up 21%.
  • The methanol business is expected to grow to 5% of total revenue by 2016.

• Capital Expenditure and Debt:

  • Yanzhou's 2014E CAPEX is forecast to be 20% below management guidance, and further cuts may be necessary if coal prices do not improve.
  • The company issued a USD300m perpetual bond in May 2014 to meet discretionary spending.
  • Yanzhou has a significant USD denominated debt burden, with liabilities of USD30.84b against USD5.28b in assets, increasing exposure to interest rate and currency risk.

• Investor Sentiment and Strategy:

  • The company is not currently a good buy due to limited upside and the low outlook for coal prices.
  • Yanzhou is seen as a call option on a potential volatile increase in coal prices, but carries more risk than Shenhua.
  • The company's high debt and management changes have negatively impacted its share price.

Key Information

• Share Price: HKD5.86
• Target Price: HKD6.25 (+7%)
• Market Cap (USD): 3.7B
• ADTV (USD): 8M
• PBR (2014E): 0.6x
• ROE (2014E): 3.5%
• EV/EBITDA (2014E): 8.8x
• Net Debt to Equity (2013): 110%
• Core EPS (2014E): CNY0.29
• Net Dividend Yield (2014E): 1.9%
• Free Cash Flow (2014E): Negative, but expected to improve in 2015E and 2016E
• Coal Price Forecast: 5% increase in coal prices from now until year-end, with earnings bottoming in 3Q14
• Earnings Sensitivity: USD5/t change in coal price impacts earnings by CNY0.30/sh
• Outstanding Debt: USD30.84b in USD liabilities, CNY12.9b in total notes
• Perpetual Bond: USD300m issued in May 2014 at 7.2%
• Share Price Correlation: 73% with coal prices, with notable exceptions during the GFC and late 2011

Conclusion

Yanzhou Coal is a high-beta play in the coal sector, with earnings highly sensitive to coal price changes. Despite some recovery in profitability and a target price of HKD6.25, the company's high debt burden and weak fundamentals make it a less attractive investment compared to Shenhua. Investors may consider Yanzhou if coal prices improve significantly, but the current outlook suggests a "HOLD" rating.