20130910-美银美林-Reconsider_risks_after_rally_14页_378kb

Summary of "Reconsider risks after rally" Report

Core Content

This report from Bank of America Merrill Lynch analyzes the recent performance and underlying risks of the China coal industry following a sector rally driven by strong August industrial production data. It highlights that while share prices have rebounded, coal prices have continued to decline, and the fundamentals of the industry remain weak, suggesting that the market may have overreacted to short-term data.

Main Points

1. Share Price Rally and Industry Performance

• YZC (Yanzhou Coal) surged by 10% on the day of the report, leading the sector rally.
• August industrial production data showed strong growth:
  • Power generation: +13.4% YoY (July: +8.1%)
  • Crude steel production: +12.8% YoY (July: +6.2%)
  • Cement production: +8.2% YoY (July: +9.1%)
  • FAI (Finished Steel Output): +20.3% (July: +20.1%)
• Coal consumption rebounded strongly, and major IPPs (Independent Power Producers) coal inventory fell to 63.1 million (15-day) by the end of August, down 25% YoY.

2. Declining Coal Prices

• QHD5,500 coal price dropped to Rmb530/t, a 16% YoY decline (1H13 average: Rmb610/t).
• Reasons for price weakness:
  • Competitive seaborne coal prices.
  • Abundant coal supply.
  • IPP destocking (reducing inventory).

3. Risks to Industry Fundamentals

• Import risk:
  • Indonesian Rupiah (IDR) and Australian Dollar (AUD) are depreciating against the Chinese Yuan (CNY), increasing the competitiveness of seaborne coal.
• Overcapacity issue:
  • Demand is slowing, while new coal capacity is increasing, which could worsen overcapacity.
  • Coal mining utilization is declining, indicating a weak production-to-demand ratio.

4. Share Price vs. Coal Price

• China coal stocks have rebounded by 40%–55% from July lows.
• Despite this, coal prices have fallen by 24% since July and have not yet bottomed out.
• The report suggests that the coal price recovery will be later and weaker than the market expects, making the share price rebound unjustified.

5. Reiterated U/P Ratings

• Shenhua and YZC have been re-rated as U/P (Underperform).
• Shenhua:
  • Strong earnings unlikely to repeat due to weak coal prices.
  • Potential power tariff cuts could affect the power segment.
  • Valuation premium is not justified due to falling ROE.
• YZC:
  • Valuation is the most expensive among coal peers.
  • Earnings downside is expected due to weak coal prices.

Key Information

Valuation Table (Peer Comps)

Price Objective Basis

• Shenhua:
  • Price objective: HK$17.60
  • Based on 0.80x P/NPV, implying 7.1x P/E 2013E and 3.7x EV/EBITDA.
• YZC:
  • Price objective: HK$4.6
  • Based on 0.6x P/NPV, implying 52x P/E 2013E and 7.7x EV/EBITDA.

Risks to Price Objectives

• Shenhua:
  • Unexpected increases in mining costs could affect profit margins.
  • Demand recovery in 2H13 may lead to higher coal prices, increasing net profit.
• YZC:
  • A significant increase in coal prices due to better-than-expected demand recovery.
  • Improved coal quality in Australia may reduce mining costs.
  • Foreign exchange losses and impairment losses could impose downside risks.

Investment Rating Distribution

• Non-Ferrous Metals/Mining & Minerals Group (as of 05 Aug 2013):
  • Buy: 80 (47.34%)
  • Neutral: 45 (26.63%)
  • Sell: 44 (26.04%)
• Global Group (as of 05 Aug 2013):
  • Buy: 1660 (48.55%)
  • Neutral: 868 (25.39%)
  • Sell: 891 (26.06%)

Conclusion

The report emphasizes that while the coal sector experienced a rally due to strong August production data, the fundamentals remain weak, and coal prices continue to fall. The market may have overestimated the recovery potential, and the valuation of coal stocks may not be justified. The U/P ratings on Shenhua and YZC are reiterated due to the weak coal prices and potential earnings downside. The price objectives are based on discounted cash flow models, but market risks such as rising imports and overcapacity could affect investment returns.