Across The Border

Hard times for China’s coal miners means China Shenhua Energy is worth a look, analysts say

Shares of China’s premier coal producer are set for better days ahead

PUBLISHED : Monday, 22 February, 2016, 2:10pm
UPDATED : Thursday, 25 February, 2016, 11:51am

If one is to pick a Chinese coal mining firm to invest in amid the prolonged industry downturn and stock bear market, a fair bet would be industry leader China Shenhua Energy, according to analysts.

The Beijing-based company, the nation’s largest coal miner and one of the largest power producers with major coal logistics and coal-to-liquid fuel and chemicals operations, is among only 10 per cent of the nation’s over 6,000 miners to remain profitable in an industry enduring its fifth year of price decline due to oversupply.

“Shenhua has the industry’s best management team and corporate governance structure, and its coal-power-railway-shipping-chemical integrated business model has shown in its financial reports a clear advantage amid [the commodities] cyclical volatility,” said Zhongtai Securities analyst Liu Zhaoliang in a report.

He expects Shenhua to see further growth in its power operation and benefit from the industry’s ongoing consolidation.

By his estimates, its “reasonable” valuation is 340 billion yuan (HK$405.64 billion), compared to its current market capitalization of 253 billion yuan.

Of China’s 33 listed coal producers, 28 released their result previews last month. As a group, these companies indicated a combined net loss of more than 4 billion yuan for last year, compared to a 37 billion yuan profit in 2014, according to credit ratings agency Fitch.

Of the 28, 20 were loss-making, while the remaining 8 posted profit declines of 57 to 93 per cent.

Ten companies reported net losses of over 10 billion yuan, compared to three in 2014.

“[China Shenhua] topped the 8 companies that managed to make a profit, with a net [profit] that was more than all other [China] listed coal companies combined,” Fitch analysts said in a report.

They added that the company’s vertical-integrated business that stretches from upstream coal mining to midstream coal railway, port handling and shipping to coal-fired power generation and chemicals production underpins its resilience to the decline in coal prices.

But a coal price recovery is “highly unlikely” this year, they added, citing a weaker demand outlook and limited benefits of the Beijing-ordered closure of small and inefficient mines to address oversupply.

“Fitch believes industry consolidation will take longer, and more effort, than the central government had expected,” they said.

Early this month, China’s cabinet the State Council issued a directive ordering the nation’s coal industry to retire 500 million tonnes of annual output capacity and put another 500 million tonnes under restructuring in the next three to five years.

The industry is estimated by China Coal Association to have 5.7 billion tonnes of capacity, of which around 3.8 billion tonnes are utilised, according to a Jefferies Securities report.

The benchmark price of power-station coal with a calorific value of 5.5 million calories per kilogram has fallen around 55 per cent since late 2011.

China Shenhua’s Shanghai-listed shares dropped 47.5 per cent from their highs on June 9 last year, compared to a 44 per cent fall of the Shanghai Composite Index.

The miner’s Hong Kong-listed shares have fallen 43.5 per cent in the same period, compared to a 28.5 per cent decline of the Hang Seng Index.

Jefferies’ analysts, who have a buy recommendation on Shenhua, said they believe coal prices bottomed late last month, and has since risen around 5 per cent since the low point in last year’s fourth-quarter as low prices force mine shutdowns.

“However, with demand plummeting … we believe prices will not materially recover,” they said. “Output, however, should optimise towards efficient but currently restricted producers like Shenhua,” they wrote. “As the lowest-cost producer … we believe Shenhua will benefit from China’s coming production optimisation.”

Fitch’s analysts cautioned that resistance at the local government level will prolong the industry capacity rationalisation that Beijing is pushing.

They cited the recent case of Longmay Mining Holding Group, a large producer based in the northeastern Heilongjiang province.

It was bailed out by the provincial government, which injected huge sums into the company to rescue it, citing a need to maintain social stability.

“This shows that maintaining social stability – by saving the jobs of the more than 200,000 employees – was of higher priority for the shareholder than the central government’s concerns over overcapacity,” they said.

Beijing’s capacity reduction goal would be tough to achieve given more than half of the nation’s coal production is by mines owned by provincial and municipal government-owned companies, they added.

Meanwhile, Moody’s, another credit ratings agency, last week put China Shenhua’s “Aa3” debt issuer rating on review for downgrade, citing the “adverse credit conditions in the mining sector globally” due to falling commodities prices. It expects to downgrade the ratings of most mining firms by at least one notch.