Coal | C H I N A                B AS I C M AT E R I AL S / M E T AL S & M I N I N G                                       ...
Coal | C H I N A  B AS I C M AT E R I AL S / M E T AL S & M I N I N G                                                     ...
Coal | China                                                   Ivan Lee, CFA / Matty ZhaoContentsAlways room for dessert  ...
Coal | China                                              Ivan Lee, CFA / Matty ZhaoAppendix I: Policy development on coal...
Coal | China                                                                            Ivan Lee, CFA / Matty ZhaoExecutiv...
Coal | China                                                  Ivan Lee, CFA / Matty ZhaoExhibit 2. China: coal industry su...
Coal | China                                             Ivan Lee, CFA / Matty Zhaoadjustments), which may suppress Yanzho...
Coal | China                                                    Ivan Lee, CFA / Matty ZhaoP/E, P/B comparisonP/E compariso...
Coal | China                                                  Ivan Lee, CFA / Matty ZhaoP/B comparisonExhibit 7. Shenhua f...
Coal | China                                              Ivan Lee, CFA / Matty ZhaoOperation metricsOperation metrics com...
Coal | China                                       Ivan Lee, CFA / Matty ZhaoExhibit 11. Operation metrics comparison (2/3...
Coal | China                          Ivan Lee, CFA / Matty ZhaoExhibit 12. Operation metrics (3/3)                       ...
Coal | China                                                                 Ivan Lee, CFA / Matty ZhaoValuationValuation ...
Coal | China                                                                      Ivan Lee, CFA / Matty ZhaoExhibit 14. Va...
Coal | China                                                                               Ivan Lee, CFA / Matty ZhaoExhib...
Coal | China                                                              Ivan Lee, CFA / Matty ZhaoCoal pricingCoal price...
Coal | China                                             Ivan Lee, CFA / Matty ZhaoPrice cap only applies to key contracts...
Coal | China                                             Ivan Lee, CFA / Matty Zhao…but to rise 7% in 2Q-4Q11However, in l...
Coal | China                                                                                 Ivan Lee, CFA / Matty ZhaoCon...
Coal | China                                                     Ivan Lee, CFA / Matty ZhaoExhibit 22. National coal inven...
Coal | China                                                          Ivan Lee, CFA / Matty ZhaoDemandSolid coal demand gr...
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47375199 nomura-coal-china-18-jan-2011

  1. 1. Coal | C H I N A B AS I C M AT E R I AL S / M E T AL S & M I N I N G NOMURA INTERNATIONAL (HK) LIMITED Ivan Lee, CFA +852 2252 6213 ivan.lee@nomura.com Matty Zhao +852 2252 1397 matty.zhao@nomura.com BULLISHR E P O R TA N C H O R Always room for dessert Stocks for action We think the China coal sector remains a sweet investment even after a satisfying We prefer coal players with strong course of price performance since the lows of 4Q10. We are bullish despite near-term reserves, sustainable output growth and government intervention (cap on “key” contract prices) and escalating input costs, higher exposure to spot rather than given (a) solid demand growth (6.5% in 2011F) backed by strong GDP growth and the contract prices. We highlight Shenhua’s price competiveness of coal; (b) tight supply (4.2% in 2011F) given accelerating integrated model and third-party trades, industry consolidation, safety concerns, depleting coal resources in the east and and Yanzhou’s highest leverage to the transportation bottlenecks; and (c) strong pricing power, the seller’s market and low spot market and international gearing, allowing coal firms to pass on additional costs like resources tax to buyers transformation. and to sail safely against the macro headwinds. We expect spot prices to rise by 8% in 2011F and 5% in 2012F with seasonal adjustments, and contract prices to gain 3% Price Stock Ticker Rating Price target and 7%, respectively. We think the market is concerned about the price cap, and Shenhua 1088 HK BUY 34.40 41.0 missing the point that it applies only to “key” contracts (40% of total contract sales), China Coal 1898 HK NEUTRAL* 12.90 13.90 and we see ASP upside from potential upward revision of non-key contract prices Yanzhou Coal 1171 HK BUY* 24.45 30.4 * Initiating coverage,  Cutting PT when inflation cools. To mitigate the impact, coal players can also cut their contract Note: local currency, share prices as of 12 January 2011 sales portion, reduce fulfilment rates or provide lower-quality coal. Overall, we see closing double-digit EPS growth for the top players; BUY calls on China Shenhua (integrated business model and third-party trades) and Yanzhou Coal (spot market and global Analysts exposure). China Coal, NEUTRAL, is the biggest victim of the price cap. Ivan Lee, CFA +852 2252 6213  Tight supply/demand outlook with strong pricing power ivan.lee@nomura.com  Coal price to remain strong in 2011-12F Matty Zhao  Government intervention not a serious headwind +852 2252 1397 matty.zhao@nomura.com  Top pick Shenhua; initiate on China Coal (Neutral) and Yanzhou (Buy) Nomura Anchor Reports examine the key themes and value drivers that underpin our sector views and stock recommendations for the next 6 to 12 months. Any authors named on this report are research analysts unless otherwise indicated. See the important disclosures and analyst certifications on pages 113 to 116. Nomura 18 January 2011
  2. 2. Coal | C H I N A B AS I C M AT E R I AL S / M E T AL S & M I N I N G NOMURA INTERNATIONAL (HK) LIMITED Ivan Lee, CFA +852 2252 6213 ivan.lee@nomura.com Matty Zhao +852 2252 1397 matty.zhao@nomura.com BULLISH Action Stocks for action We are Bullish on China coal despite the strong performance, due to tight supply We prefer coal players with strong (+4.2% pa) and resilient demand (+6.5% pa) in 2011F. We see the spot (contract) reserves, sustainable output growth price rising 8% (3%) in 2011 and 5% (7%) in 2012 with seasonal adjustment. and higher spot portion. We highlight Despite a contract price cap, ASP upside should come from non-key contract price Shenhua’s integrated model and revision. Shenhua: BUY. Initiate on China Coal (NEUTRAL) and Yanzhou (BUY). third-party trades, and Yanzhou’s Strong pricing power and low gearing allow them to sail against macro headwinds. highest leverage to the spot market and international transformation. Catalysts GDP; seasonal price movement; seaborne price; asset injection; consolidation. Price Stock Ticker Rating Price target Anchor themes Shenhua 1088 HK BUY 34.40 41.0 China Coal 1898 HK NEUTRAL* 12.90 13.90 Despite government intervention, we are Bullish, driven by solid demand backed by Yanzhou Coal 1171 HK BUY* 24.45 30.4 GDP growth and coal’s price competiveness; tight supply given safety concerns, * Initiating coverage,  Cutting PT Note: local currency, share prices as of 12 January 2011 industry consolidation, depleting resources in east and transportation bottlenecks. closing Always room for dessert Analysts Ivan Lee, CFA Tight supply/demand outlook with strong pricing power +852 2252 6213 China is heavily reliant on coal and will likely continue to be so until it finds an ivan.lee@nomura.com inexpensive substitute. We are positive on the coal sector despite near-term government intervention (key contract price cap) and escalating input costs, given: Matty Zhao 1) solid demand growth backed by strong GDP growth and coal’s price +852 2252 1397 matty.zhao@nomura.com competiveness; 2) ongoing tight supply given increasing safety concerns, accelerating industry consolidation, transport bottlenecks and depleting coal resources in the east; 3) the strong pricing power, the sellers’ market and the low gearing, allowing coal firms to pass on additional costs (like a resources tax) to buyers and sail safely against macro headwinds. Industry consolidation with more disciplined supply favours big players with government support for resources, allowing them to grow faster than the industry. Coal price to remain strong in 2011-12F Despite the spot coal price already rising 25% y-y in 2010, given the tight supply and rising commodity prices, we expect the spot price to rise 8% and 5% and the contract price to rise 3% and 7% in 2011-12F. Yet the spot price, at RMB775, is likely to be RMB735-RMB865 over the rest of the year with seasonal adjustment. Government intervention not a serious headwind Price cap only applies to key contracts, accounting for 40% of total contract volume sales. To mitigate the impact, coal players can cut contract sales portion, cut fulfilment rate or provide lower quality coal. ASP upside may arise from a potential 7% non-key contract price revision later this year when potentially inflation cools. Top pick Shenhua; China Coal (NEUTRAL ) and Yanzhou (BUY) Shenhua’s unique integrated business model, with captive logistics network and sufficient reserves, helps it facilitate third-party trade and sustain double-digit growth and above-average ROE. Yanzhou’s expansion into Australia and high exposure to the local spot market lets it benefit from strong regional prices and be immune to the 2011 local contract price cap. While we like China Coal’s long-term outlook, due to its recent resources gained through industry consolidation and acquisitions, near-term performance could be hit by the 2011 contract price cap. Nomura 1 18 January 2011
  3. 3. Coal | China Ivan Lee, CFA / Matty ZhaoContentsAlways room for dessert 4 Robust coal price in 2011-12F due to tight supply/demand 4 Potential winners are 5 Sensitivity Analysis 6 Investment risk 6P/E comparison 7P/B comparison 8Operation metrics comparison 9Valuation comparison 12Coal price to remain strong in 2011-12F 15 2011 contract price cap 15 No price control on non-key contracts 16 2012F contract price to increase by 7% y-y 17 Strong spot price with seasonality fluctuation 17Solid coal demand growth 20 …driven by power, steel and cement 20 th 12 FYP: coal drops to 63% of total energy consumption 23 … but absolute coal demand will continue to outpace supply 24 … and it is difficult to replace coal in the near term 24Tight supply remains 26 Expect coal supply to see 4.2% CAGR for 2010-15F 26 Government restriction on capacity expansion 26 Geographically imbalanced supply 27 Small mines consolidations cause short term tightness 28Transportation bottlenecks to persist until 2014F 30 Limited capacity expansion from the two backbone lines 31 Trucks too expensive and less efficient 31 Regional lines link Inner Mongolia but cannot solve the problem 32 New railways to ease the bottleneck in 2014F/ 2015F 32Increasing imports to fill the supply gap 34 China becomes a net coal importer in 2009 34 Supply gap to be filled by imports in 10F-12F 34 Indonesia and Australia as main suppliers 35Rising costs ahead 36 Fees and levies edging up production cost 36 Transportation costs is a big part 37Nomura 2 18 January 2011
  4. 4. Coal | China Ivan Lee, CFA / Matty ZhaoAppendix I: Policy development on coal 38 Development on the price intervention policy 38 Coal and energy consumption reduction initiatives 38 Development on resources tax and other surcharges 39 Small mine consolidation 39Appendix II: Industry knowhow 40Sector valuation 42Valuation methodology and key risks 45Latest company views China Shenhua Energy 48 China Coal Energy 67 Yanzhou Coal 88Also see our Anchor Report: Indonesia And our global mining team’s report:Coal mining: Perfectly placed Chinese supply shortage and Indian(18 January, 2011) electricity take-off set stage for strong coal decade (9 January, 2011)Nomura 3 18 January 2011
  5. 5. Coal | China Ivan Lee, CFA / Matty ZhaoExecutive summaryAlways room for dessertChina is reliant on coal as its major primary energy source, with around 70% of its China is reliant on coal as itsprimary energy needs met by coal in the past 10 years — higher than the world major primary energy source, withaverage of 29% in 2009 (source: CEIC). On the back of the strong GDP growth, around 70% of its primary energy needs met by coal in the past 10China’s abundant coal resources and coal’s price competiveness, we believe China’s yearscoal-powered industry expansion model will continue in the next decade until it findsan inexpensive substitute. Although NDRC (National Development and ReformCommission) plans to reduce coal’s contribution to the country’s primary energy mix to63% by 2015, coal will likely remain the key energy source for many years.Despite robust share price performances for stocks in the coal sector, we stay positiveand expect domestic thermal coal prices to stay strong in FY11F-FY12F. This isdespite the announced near-term government intervention (key contract price cap) andescalating input costs given: Solid demand growth backed by strong GDP growth and price competiveness of coal; Ongoing tight supply given increasing safety concerns, accelerating industry consolidation, transport bottlenecks and depleting coal resources in the east; The strong pricing power of coal companies in the sellers’ market. Coal firms can pass on additional costs (like a resources tax) to its users, in our view; and Despite rising inflation and interest rates in China, we believe the strong pricing power and the low gearing should allow coal companies to sail safely against the macro headwinds.Robust coal price in 2011-12F due to tight supply/demand 2011F: We expect key contract price to be frozen; non-key contract to rise 7% from 2Q11F; blended contract price to rise 3% y-y; spot price to rise 8% y-y; key contract-to-spot price discount of 29% 2012F: We expect key contract and non-key contract prices to rise 7%; spot price to rise 5%; key contract-to-spot price discount of 28%Although we expect the average spot coal price to rise 8% y-y to RMB804/ tonne for2011, given the current coal price at RMB775/tonne (10 January 2011), we expect theprice to move between RMB735-RMB865/tonne for the rest of the year, with seasonalweakness (strength) in February to May (June to August) and September to October(November to January).Exhibit 1. Projected price trend in 2011-12F FY12F avg. spot RMB844/t (+5% y-y) FY11F avg. spot RMB804/t (+8% y-y) spot price non-key contract 7% rise in 2012F key contract 7% rise from Q211 RMB610/t (+7% y-y) RMB570/t (unchanged) May-11 May-12 Mar-11 Nov-11 Mar-12 Nov-12 Jan-11 Jul-11 Sep-11 Jan-12 Jul-12 Sep-12 Spot Key contract Non-key contractSource: Nomura est.Nomura 4 18 January 2011
  6. 6. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 2. China: coal industry supply / demand forecast(mnt) 2005 2006 2007 2008 2009 2010F 2011F 2012FCoal production (a) 2,350 2,529 2,692 2,802 3,050 3,261 3,397 3,539% chg 7.6 6.4 4.1 8.9 6.9 4.2 4.2Net increase 179 163 110 248 211 136 142Coal consumption (b) 2,319 2,551 2,727 2,811 3,020 3,299 3,515 3,707% chg 10.0 6.9 3.1 7.4 9.2 6.5 5.5Net increase 232 177 84 209 279 216 193Change in inventory and others* (c) (15) (47) (38) (14) 133 105 55 49As % of total production (0.6) (1.9) (1.4) (0.5) 4.4 3.2 1.6 1.4As % of total consumption (0.6) (1.9) (1.4) (0.5) 4.4 3.2 1.6 1.3Net exports/(imports) (d) 46 25 2 5 (103) (142) (172) (217)% chg (44.8) (91.4) 134.6 n/a 38.2 20.9 26.2As % of total production 1.9 1.0 0.1 0.2 (3.4) (4.4) (5.1) (6.1)As % of total consumption 2.0 1.0 0.1 0.2 (3.4) (4.3) (4.9) (5.9) Export 72 63 53 45 23 20 20 20 % chg (11.8) (15.9) (14.6) (49.7) (12.4) - - Import (26) (38) (51) (40) (126) (162) (192) (237) % chg 45.6 33.9 (20.9) 211.9 29.0 18.4 23.5Source: CEIC / NBS, Nomura est.Potential winners areWe reiterate our BUY call on Shenhua and initiate coverage on China Coal with aNEUTRAL call and Yanzhou Coal with a BUY.Shenhua (1088 HK, BUY): unique integrated coal giant; third partytrade to sustain double digit growth and above-average ROEShenhua’s distinctive integrated business model, with a captive logistics network andsufficient reserves, helps facilitate third-party trade and sustain double-digit growth andabove-average ROE despite slowing self-production in our view. We think the potentialnon-key contract price revision and whole group listing are near-term catalysts. Thestock is at 12x FY11F P/E, in line with the industry average 12.2x FY11F P/E; ROE ishigher than sector average.China Coal (1898 HK, NEUTRAL): attractive long-term picture butlacks short-term catalystWhile we like China Coal’s long-term output growth story, backed by resources gainedthrough recent acquisitions and industry consolidation, we are concerned about itsnear-term performance as it is the biggest victim of the 2011 contract price cap andgiven a lack of near-term catalysts, in our view. At 11.8x FY11F P/E, in line with theindustry average, we believe it is fairly valued. Initiate with NEUTRAL and PT ofHK$13.90.Yanzhou Coal (1171 HK, BUY): best-positioned to benefit from pricingtrends, transforming into an international play; well-deserved re-ratingWe like Yanzhou Coal as a pure play on our Bullish view on coal prices given itsexpansion into Australia and high exposure to the local spot/seaborne market. TheFelix acquisition and the announced planned stake increase in Ashton mine underpinproduction and our 23% EPS growth projection for 2011F. Its 10.9x FY11F P/E looksundemanding compared with Asian players at 15.6x FY11F P/E. Although seasonalcoal price weakness may prompt some volatility, we call a BUY.Although we like Yanzhou’s expansion into Australia and its high leverage to the spotmarket, Shenhua is our top pick in the sector, as we are concerned about potentialweakness in spot prices in the coming months (from February-May due to seasonalNomura 5 18 January 2011
  7. 7. Coal | China Ivan Lee, CFA / Matty Zhaoadjustments), which may suppress Yanzhou’s share price performance in the nearterm.Sensitivity AnalysisWe have conducted an earnings sensitivity analysis on spot price, contract price, unitproduction cost and sales volume. It shows that Yanzhou Coal has the highest positiveleverage to spot coal prices upside, while China Coal is the most vulnerable to theincrease in unit production cost.Exhibit 3. Sensitivity analysis to 2011F net profit(%) Shenhua China Coal Yanzhou*% chg in net profit on 1% chg in spot price 1.03 1.10 3.1% chg in net profit on 1% chg in contract price 0.97 1.60 1% chg in net profit on 1% chg in unit cost (1.02) (2.03) (0.76)% chg in net profit on 1% chg in sale vol 0.90 0.80 1.05* Yanzhou - ASP for self-produced coalSource: Nomura ResearchInvestment riskUpside risks: Higher than expected coal price and volume sales: Coal prices are the most sensitive factor to earnings. Our sensitive analysis shows that for every 1% rise in coal price, coal companies’ average earnings are expected to increase by 1.5%. Higher coal import boosted by a strengthening Renminbi. Our economics team expects the Renminbi to appreciate 6% and 5% against the dollar in 2011F and 2012F, respectively. If the appreciation is faster than our expectation, we believe coastal import volumes will rise, putting upward pressure on domestic coal prices.Downside risks: Weaker-than-expected recovery in China’s economy. If China’s economy recovers more slowly than we expect, we believe coal demand from the four key sectors will deteriorate and exert pressure on coal prices. Higher unit production cost: Higher cost hikes could be mainly from policy- related cost increases. For FY11F, the Chinese government is highly likely to implement a new resources tax based on coal prices, rather than on current production volume, which could raise costs for all Chinese coal producers. We have already factored in 5% of the ex-mine coal price resources tax in 2011F. Our sensitivity analysis shows that every 1% change in unit production coal, coal companies’ earnings are affected by an average of 1.27%. High CPI inflation: High CPI inflation not only increases input costs but also puts pressure on a likely coal price cap. The strong pricing power and the sellers’ market have allowed coal firms to pass on additional costs to buyers. The coal price cap is unlikely to be long-lived and effective, in our view. Higher interest rate: The expected 3 interest rate hikes (25bps each) in 2011F is not an issue for Shenhua and China Coal as they are under-geared with net cash, and at 21.9% gearings (net debt to equity) respectively, with strong positive free cash flow. However, this may be a bigger concern to Yanzhou given its 51% gearing level as of 2011F.Nomura 6 18 January 2011
  8. 8. Coal | China Ivan Lee, CFA / Matty ZhaoP/E, P/B comparisonP/E comparisonExhibit 4. Shenhua forward P/E Price (HK$) 100.0 90.0 Avg: 16.5x 30x 80.0 70.0 25x 60.0 20x 50.0 40.0 15x 30.0 10x 20.0 5x 10.0 0.0 Jan-07 Feb-08 Mar-09 Apr-10Source: Bloomberg, Nomura estimatesExhibit 5. China Coal forward P/E Price (HK$) 35.0 Avg: 16.4x 30x 30.0 25x 25.0 20x 20.0 15.0 15x 10.0 10x 5.0 5x 0.0 Jan-07 Feb-08 Mar-09 Apr-10Source: Bloomberg, Nomura estimatesExhibit 6. Yanzhou Coal forward P/E Price (HK$) 50.0 20x 45.0 40.0 Avg: 8.8x 35.0 15x 30.0 25.0 10x 20.0 15.0 5x 10.0 5.0 0.0 Jan-07 Feb-08 Mar-09 Apr-10Source: Bloomberg, Nomura estimatesNomura 7 18 January 2011
  9. 9. Coal | China Ivan Lee, CFA / Matty ZhaoP/B comparisonExhibit 7. Shenhua forward P/B Price (HK$) 80.0 70.0 5x Avg: 3.0x 60.0 4x 50.0 3x 40.0 30.0 2x 20.0 10.0 0.0 Jan-07 Feb-08 Mar-09 Apr-10Source: Bloomberg, Nomura estimatesExhibit 8. China Coal forward P/B Price (HK$) 45.0 40.0 Avg: 2.3x 5x 35.0 30.0 4x 25.0 3x 20.0 15.0 2x 10.0 1x 5.0 0.0 Jan-07 Feb-08 Mar-09 Apr-10Source: Bloomberg, Nomura estimatesExhibit 9. Yanzhou Coal forward P/B Price (HK$) 35.0 3x 30.0 Avg: 1.8x 25.0 20.0 2x 15.0 10.0 1x 5.0 0.0 Jan-07 Feb-08 Mar-09 Apr-10Source: Bloomberg, Nomura estimatesNomura 8 18 January 2011
  10. 10. Coal | China Ivan Lee, CFA / Matty ZhaoOperation metricsOperation metrics comparisonExhibit 10. Operation metrics comparison (1/3) 2009A 2010F 2011F 2012FProductionCommercial coal production volume -self (mnt)China Shenhua 210 226 257 285China Coal 79 94 101 111China Coal (Raw coal) 101 120 130 142Yanzhou Coal 36 45 48 50(y-y%)China Shenhua 7 14 11China Coal 19 8 9China Coal (Raw coal) 19 8 9Yanzhou Coal 26 6 4Sales volume (mnt)China Shenhua 254 294 327 360China Coal 97 117 124 134Yanzhou Coal 38 51 54 56Contract sales volume contribution to domestic sales(%)China Shenhua 71 58 55 55China Coal 73 71 65 62Yanzhou Coal 23 28 25 25Coking coal sales volume contribution (%)China Shenhua 0 0 0 0China Coal 2 2 3 5Yanzhou Coal 28 32 32 33PricingASP of self-produced coal (RMB/t)China Shenhua 388 431 457 479China Coal 416 472 505 547Yanzhou Coal 506 648 748 800(y-y%)China Shenhua 11 6 5China Coal 13 7 8Yanzhou Coal 28 16 7CostUnit production cost - self produced (RMB/t)China Shenhua 101 109 119 128China Coal 199 213 230 246Yanzhou Coal 245 286 299 315(y-y%)China Shenhua 8 9 8China Coal 7 8 7Yanzhou Coal 17 5 6Source: Company, Nomura estimatesNomura 9 18 January 2011
  11. 11. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 11. Operation metrics comparison (2/3) 2009A 2010F 2011F 2012FCost (Cont)Unit transportation cost - self produced (RMB/t)China Shenhua 106 109 113 116China Coal 84 90 94 97Yanzhou Coal 11 11 12 12Total unit cost - self produced (RMB/t)China Shenhua 207 219 231 244China Coal 283 303 324 343Yanzhou Coal 256 297 311 328(y-y%)China Shenhua 5 6 6China Coal 7 7 6Yanzhou Coal 16 5 5Effective tax rate (%)China Shenhua 21 21 21 21China Coal 23 23 23 23Yanzhou Coal 27 27 27 27Effective interest rate (%)China Shenhua 6 6 6 6China Coal 4 6 6 6Yanzhou Coal 0.4 4 5 6ProfitabilityRevenue (RMB mn)China Shenhua 121,312 155,638 187,715 213,719China Coal 53,187 71,280 81,909 95,170Yanzhou Coal 20,253 35,095 42,566 46,959(y-y %)China Shenhua 28 21 14China Coal 34 15 16Yanzhou Coal 73 21 10Reported EPS (RMB)China Shenhua 1.59 1.91 2.29 2.67China Coal 0.59 0.79 0.87 1.10Yanzhou Coal 0.84 1.52 1.87 2.05(y-y %)China Shenhua 20 20 17China Coal 34 10 26Yanzhou Coal 81 23 10Source: Company, Nomura estimatesNomura 10 18 January 2011
  12. 12. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 12. Operation metrics (3/3) 2009A 2010F 2011F 2012FProfitability (Cont)Overall EBITDA margin (%)China Shenhua 48 45 44 45China Coal 25 26 26 28Yanzhou Coal 35 38 40 40Overall EBIT margin (%)China Shenhua 39 37 36 37China Coal 21 22 21 23Yanzhou Coal 26 31 33 33NPM (%)China Shenhua 26 24 24 25China Coal 15 15 14 15Yanzhou Coal 20 21 22 22Key RatiosROE (%)China Shenhua 20 21 22 22China Coal 13 15 15 17Yanzhou Coal 15 23 24 23ROCE (%)China Shenhua 15 16 17 18China Coal 11 11 11 12Yanzhou Coal 10 14 15 16Net gearing (%)China Shenhua 6 1 net cash net cashChina Coal net cash 14 22 24Yanzhou Coal 48 54 51 33EBITDA interest coverage (%)China Shenhua 29 20 23 32China Coal 30 17 17 19Yanzhou Coal 158 12 10 9Current ratioChina Shenhua 1.7 1.7 1.6 1.7China Coal 3.3 2.6 2.1 1.9Yanzhou Coal 1.9 2.1 2.2 2.3Source: Company, Nomura estimatesNomura 11 18 January 2011
  13. 13. Coal | China Ivan Lee, CFA / Matty ZhaoValuationValuation comparisonExhibit 13. Valuation comparison (1/3) Price Market Free Net profit Net earnings target Price cap float Reptg Fiscal (Local $ m) growth (%)Company Ticker Rating L. Curr. L. Curr. (US$mn) (%) curr. Y/E 10F 11F 12F 10F 11F 12FCoalAsiaHong Kong - Thermal CoalShenhua Energy-H 1088 HK BUY 41.00 34.40 87,946 27 CNY Dec 37,999 45,585 53,174 20 20 17China Coal-H 1898 HK NEUTRAL 13.90 12.90 21,984 44 CNY Dec 10,516 11,595 14,627 34 10 26Yanzhou Coal-H 1171 HK BUY 30.40 25.45 16,089 40 CNY Dec 7,459 9,190 10,105 81 23 10Average 45 18 18Hong Kong - Coking CoalFushan 639 HK Not rated n.a. 6.11 4,229 69 HKD Dec 1,897 2,218 2,443 68 17 10Hidili 1393 HK Not rated n.a. 7.47 1,979 46 CNY Dec 719 1,064 1,323 78 48 24Average 73 32 17Hong Kong Average 56 24 17ChinaDatong Coal 601001 CH Not rated n.a. 20.59 5,212 38 CNY Dec 1,157 1,409 1,562 (22) 22 11Pingdingshan Tianan Coal Mining Co 601666 CH Not rated n.a. 21.31 5,853 38 CNY Dec 2,467 2,762 3,057 75 12 11Shanxi Guoyang 600348 CH Not rated n.a. 28.10 10,220 42 CNY Dec 2,607 2,947 3,347 40 13 14Shanghai Energy 600642 CH Not rated n.a. 7.70 3,671 49 CNY Dec 1,528 1,658 1,798 (5) 8 8Hengyuan Coal 600971 CH Not rated n.a. 50.01 3,316 27 CNY Dec 1,078 1,223 1,270 107 13 4Luan Environmental Energy 601699 CH Not rated n.a. 58.55 10,187 31 CNY Dec 3,011 3,484 4,184 43 16 20SDIC Xinji 601918 CH Not rated n.a. 14.08 3,940 20 CNY Dec 1,320 1,745 2,299 58 32 32China Average 42 17 14S.E. AsiaBanpu BANPU TB Not rated n.a. 846.00 7,565 63 THB Dec 18,395 19,781 22,077 29 8 12Bumi BUMI IJ BUY 4,300 3,075.00 7,098 91 USD Dec 147 246 984 (23) 67 300ITMG ITMG IJ BUY 73,000 54,600.00 6,855 35 USD Dec 305 517 934 (9) 70 81Bukit Asam PTBA IJ BUY 30,000 23,100.00 5,873 35 IDR Dec 1,851,924 3,000,869 5,247,881 (32) 62 75Indika Energy INDY IJ Not rated n.a. 4,975.00 2,858 37 IDR Dec 1,161,037 1,981,082 2,316,451 60 71 17Adaro ADRO IJ BUY 3,700 2,625.00 9,264 40 IDR Dec 2,879,949 6,033,456 11,255,203 (34) 109 87S.E. Asia Average (2) 64 95Asia Average 32 35 42AustraliaWhitehaven Coal WHC AU Not rated n.a. 6.80 3,394 33 AUD Jun 58 91 196 (76) 57 115New Hope Corp NHC AU Not rated n.a. 4.90 4,113 88 AUD Jul 189 190 233 (90) 1 22Gloucester Coal GCL AU Not rated n.a. 12.87 1,827 35 AUD Jun 44 67 109 (46) 53 62Stanmore Coal SMR AU Not rated n.a. 1.35 169 66 AUD Jun n.a. n.a. n.a. n.a. n.a. n.a.Macarthur Coal MCC AU Not rated n.a. 13.55 4,102 51 AUD Jun 123 231 306 (27) 88 32Australia Average (60) 50 58North AmericaArch Coal ACI US Not rated n.a. 35.53 5,773 100 USD Dec 178 453 627 323 154 38Consol Energy Inc. CNX US Not rated n.a. 53.04 11,979 100 USD Dec 458 716 1,056 (15) 56 47Peabody Energy Corp. BTU US Not rated n.a. 63.34 17,079 100 USD Dec 810 1,281 1,549 81 58 21N. America Average 129 90 36Note: pricing as of 12 Jan 2011 closing / Indonesia Coal report published on the same day uses 11 Jan, 2011 closing price for pricing.Source: Company, Bloomberg, Nomura estimatesNomura 12 18 January 2011
  14. 14. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 14. Valuation comparison (2/3) EPS (Local $) EPS growth (%) P/E (x) PEG P/B (x) Yield (%)Company 10F 11F 12F 10F 11F 12F 10F 11F 12F 10-12F 10F 11F 12F 10F 11F 12FCoalAsiaHong Kong - Thermal CoalShenhua Energy-H 1.91 2.29 2.67 20 20 17 15.3 12.0 9.8 1.0 3.0 2.4 2.0 2.2 2.8 3.4China Coal-H 0.79 0.87 1.10 34 10 26 13.8 11.8 8.9 1.0 2.0 1.7 1.4 1.9 2.2 2.9Yanzhou Coal-H 1.52 1.87 2.05 81 23 10 14.3 10.9 9.4 1.0 3.1 2.5 2.0 2.1 2.7 3.2Average 45 18 18 14.5 11.6 9.3 1.0 2.7 2.2 1.8 2.0 2.6 3.2Hong Kong - Coking CoalFushan 0.35 0.40 0.45 49 15 12 17.4 15.2 13.6 1.8 1.9 1.7 1.6 2.6 3.2 3.6Hidili 0.35 0.54 0.67 76 56 24 17.3 11.1 9.0 0.5 2.0 1.7 1.5 1.3 2.0 2.7Average 63 35 18 17.4 13.2 11.3 1.0 2.4 2.0 1.7 2.0 2.6 3.2Hong Kong Average 52 25 18 15.6 12.2 10.1 1.1 2.4 2.0 1.7 2.0 2.6 3.2ChinaDatong Coal 0.86 0.99 1.18 (4) 15 20 24.1 20.9 17.4 1.8 4.0 3.7 3.5 2.0 2.4 2.7Pingdingshan Tianan Coal Mining Co 1.31 1.51 1.69 69 16 12 16.3 14.1 12.6 1.6 3.5 2.9 2.6 2.9 3.1 3.1Shanxi Guoyang 1.15 1.34 1.46 49 17 9 24.5 21.0 19.3 2.5 8.3 6.6 4.9 1.9 2.2 2.4Shanghai Energy 0.52 0.56 0.60 (7) 8 7 15.0 13.8 12.9 2.7 1.3 1.2 1.2 2.0 2.5 2.7Hengyuan Coal 2.50 2.76 2.88 77 11 4 20.0 18.1 17.3 3.7 4.4 3.7 2.9 n.a. n.a. n.a.Luan Environmental Energy 2.62 3.09 3.58 43 18 16 22.3 19.0 16.4 1.7 6.2 5.1 3.8 2.0 3.1 3.5SDIC Xinji 0.75 0.96 1.20 67 28 25 18.7 14.7 11.8 0.9 3.8 3.1 2.5 n.a. 2.1 2.9China Average 42 16 13 20.1 17.4 15.4 2.1 4.5 3.8 3.0 2.2 2.6 2.9S.E. AsiaBanpu 68.95 72.87 80.94 32 6 11 12.3 11.6 10.5 2.1 3.4 2.9 2.4 2.2 2.6 3.0Bumi 0.01 0.01 0.05 (23) 67 300 48.3 28.9 7.2 0.3 3.7 3.3 2.3 0.8 0.4 0.7ITMG 0.27 0.46 0.83 (9) 70 81 22.5 13.3 7.3 0.3 7.4 5.4 3.6 2.4 2.7 4.5Bukit Asam 803.74 1,302.39 2,277.60 (32) 62 75 28.7 17.7 10.1 0.4 8.6 6.4 4.4 2.6 1.7 2.8Indika Energy 228.25 385.51 447.35 64 69 16 21.8 12.9 11.1 0.5 4.2 3.4 2.8 1.3 2.1 3.1Adaro 95.43 188.63 351.88 (30) 98 87 27.5 13.9 7.5 0.3 4.2 3.3 2.4 0.9 0.6 0.7S.E. Asia Average 0 62 95 26.9 16.4 9.0 0.7 5.3 4.1 3.0 1.7 1.7 2.5Asia Average 31 34 42 21.1 15.6 11.8 1.3 4.2 3.4 2.7 1.9 2.3 2.8AustraliaWhitehaven Coal 0.11 0.19 0.40 (82) 70 115 62.4 36.8 17.1 0.7 3.1 3.1 2.8 0.8 1.3 2.6New Hope Corp 0.23 0.23 0.28 (90) (2) 26 21.3 21.7 17.3 3.0 1.7 1.7 1.6 2.7 3.6 3.3Gloucester Coal 0.51 0.47 0.72 (44) (7) 52 25.3 27.2 17.9 2.2 5.6 2.7 2.4 0.4 0.5 0.9Stanmore Coal n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a n.a. n.a. n.a. n.a. n.a. n.a.Macarthur Coal 0.49 0.77 1.03 (39) 59 33 27.9 17.5 13.2 0.6 3.0 2.3 2.1 1.5 2.6 3.4Australia Average (64) 30 56 34.2 25.8 16.4 1.6 3.4 2.5 2.2 1.4 2.0 2.5North AmericaArch Coal 1.17 2.85 3.78 317 144 33 30.4 12.5 9.4 0.3 2.6 2.2 1.8 1.1 1.1 1.1Consol Energy Inc. 2.25 3.04 4.46 (25) 35 47 23.6 17.4 11.9 0.7 3.7 3.1 2.5 0.8 0.8 0.8Peabody Energy Corp. 3.03 4.80 5.80 81 58 21 20.9 13.2 10.9 0.5 3.7 3.0 2.3 0.5 0.5 0.6N. America Average 124 79 33 25.0 14.4 10.7 0.5 3.3 2.8 2.2 0.8 0.8 0.8Note: pricing as of 12 Jan 2011 closing / Indonesia Coal report published on the same day uses 11 Jan, 2011 closing price for pricing.Source: Company, Bloomberg, Nomura estimatesNomura 13 18 January 2011
  15. 15. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 15. Valuation comparison (3/3) Net debt/equity (%) RoE (%) RoA (%) EV/EBITDA (x)Company 10F 11F 12F 10F 11F 12F 10F 11F 12F 10F 11F 12FCoalAsiaHong Kong - Thermal CoalShenhua Energy-H 1 net cash net cash 20.7 21.6 21.8 14.5 15.1 15.4 8.3 6.6 5.3China Coal-H 14 22 24 15.4 15.2 17.0 10.1 9.2 10.0 8.3 7.2 5.7Yanzhou Coal-H 54 51 33 23.5 24.4 22.8 12.3 12.6 12.7 9.2 7.1 5.9Average 23 36 29 19.9 20.4 20.5 12.3 12.3 12.7 8.6 7.0 5.6Hong Kong - Coking CoalFushan net cash net cash net cash 11.6 12.4 12.7 8.2 8.7 9.0 8.7 7.2 6.6Hidili 41 41 35 11.5 14.5 16.6 6.0 7.4 9.1 12.5 9.2 7.2Average 26 37 30 17.1 18.1 18.6 10.6 10.9 11.5 9.3 7.4 6.0Hong Kong Average 27 38 31 16.5 17.6 18.2 10.2 10.6 11.3 9.4 7.5 6.1ChinaDatong Coal n.a. n.a. n.a. 13.2 15.1 15.7 12.2 12.3 12.6 n.a. n.a. n.a.Pingdingshan Tianan Coal Mining Co n.a. n.a. n.a. 25.6 24.6 22.6 14.8 15.2 14.1 n.a. n.a. n.a.Shanxi Guoyang n.a. n.a. n.a. 33.8 29.8 26.6 14.6 13.8 13.6 n.a. n.a. n.a.Shanghai Energy n.a. n.a. n.a. 9.3 8.7 9.3 6.8 6.1 6.4 n.a. n.a. n.a.Hengyuan Coal n.a. n.a. n.a. 19.7 18.9 17.0 n.a. n.a. n.a. n.a. n.a. n.a.Luan Environmental Energy n.a. n.a. n.a. 31.1 29.8 27.5 13.7 15.1 15.3 n.a. n.a. n.a.SDIC Xinji n.a. n.a. n.a. 18.9 20.4 21.5 n.a. n.a. n.a. n.a. n.a. n.a.China Average n.a. n.a. n.a. 21.6 21.1 20.0 12.4 12.5 12.4 n.a. n.a. n.a.S.E. AsiaBanpu 58 39 13 34.6 27.0 25.4 16.0 12.8 12.5 13.6 8.1 6.8Bumi 195 166 80 8.7 12.1 37.8 1.9 2.9 11.4 9.1 6.4 3.0ITMG net cash net cash net cash 35.5 47.1 59.2 37.2 57.7 97.6 13.5 8.1 4.2Bukit Asam net cash net cash net cash 31.1 41.5 51.8 54.5 74.8 97.7 21.0 12.1 6.5Indika Energy 9 net cash net cash 20.2 27.1 26.9 9.8 14.1 16.3 63.9 48.4 41.2Adaro 21 6 net cash 15.5 26.8 37.2 8.9 17.0 28.9 10.6 6.4 3.4S.E. Asia Average 71 71 47 24.3 30.3 39.7 21.4 29.9 44.1 22.0 14.9 10.8Asia Average 49 54 37 21.1 23.2 26.1 15.1 18.4 23.9 16.2 11.5 8.7AustraliaWhitehaven Coal net cash net cash net cash 5.9 8.7 17.5 7.1 9.7 18.8 30.8 19.4 10.1New Hope Corp net cash net cash net cash 7.1 8.5 9.5 9.2 9.7 12.7 12.8 9.3 9.5Gloucester Coal net cash net cash net cash 25.6 16.4 18.4 23.0 18.9 22.6 25.0 16.5 10.7Stanmore Coal n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Macarthur Coal net cash net cash net cash 11.5 15.0 17.3 11.2 14.5 17.6 17.6 11.2 8.3Australia Average n.a. n.a. n.a. 12.5 12.1 15.6 12.6 13.2 17.9 21.6 14.1 9.6North AmericaArch Coal 71 42 22 8.8 19.0 22.5 5.9 9.8 12.8 9.9 6.6 5.5Consol Energy Inc. 106 85 56 15.6 18.3 23.0 8.2 9.2 12.9 11.1 8.4 6.4Peabody Energy Corp. 27 11 net cash 19.3 24.6 23.6 9.5 13.0 13.8 9.8 7.3 6.3N. America Average 68 46 39 14.6 20.6 23.0 7.9 10.7 13.2 10.3 7.4 6.0Note: pricing as of 12 Jan 2011 closing / Indonesia Coal report published on the same day uses 11 Jan, 2011 closing price for pricingSource: Company, Bloomberg, Nomura estimatesExhibit 16. Diversified mining with sizable coal assets Mkt Cap Current Target Potential Base Growth Total Price/ P/E EV/EBITDA FCF YieldCompany Ticker Rating Price Price Upside NPV Options NPV Total NPV 10E 11E 12E 10E 11E 12E 11EXstrata XTA LN $70,814 Buy £15.35 £22.00 43% £17.1 £4.8 £21.9 0.70 14.2 7.1 5.8 8.5 4.3 3.3 15.5%Rio Tinto Rio LN $140,265 Buy £45.43 £61.00 34% £48.0 £13.1 £61.1 0.74 10.3 7.0 6.4 6.2 4.2 3.4 13.6%BHP Billiton BLT LN $224,780 Reduce £25.50 £24.00 -6% £18.8 £5.5 £24.4 1.05 12.2 7.9 6.7 6.9 4.2 3.2 14.0%Anglo American AAL LN $66,045 Buy £33.97 £44.00 30% £34.3 £9.3 £43.6 0.78 13.3 6.2 5.4 8.7 4.2 3.4 15.1%Average Diversified Mining Sector 12.5 7.0 6.1 7.6 4.2 3.3 14.5%Global Average* 22.1 15.7 11.5Note: As of closing price on 12 Jan, 2011 (Pricing day), Global average computed using companies shown in Ex. 15 and 16. Indonesia Coal report published on thesame day uses 11 Jan, 2011 closing price for pricing.Source: Bloomberg, Datastream, Nomura estimatesNomura 14 18 January 2011
  16. 16. Coal | China Ivan Lee, CFA / Matty ZhaoCoal pricingCoal price to remain strong in 2011-12FDespite investor concern that NDRC policy intervention may weigh on near-term coalprices, we expect domestic thermal coal prices to stay strong in FY11F-FY12F, giventhe structurally tight supply and demand outlook, lingering transportation bottleneckand rising production costs. 2011F: We expect the key contract price to be frozen; non-key contract price to rise 7% from 2Q11F onwards (implying 5% weighed average growth in FY11F); blended contract price to rise 3%; spot price to rise 8%; key contract-to-spot price discount of 29%. 2012F: We expect the key contract and non-key contract price to rise 7%; spot price to rise 5%; key contract-to-spot price discount of 28%.Exhibit 17. QHD spot price vs. contract price (RMB/t) Spot price refers to Shanxi blend Peaked at RMB995/t after (5,500kcal/kg) at Qinghuangdao port government announced spot 1,200 price cap on July 23 Spot Price Contract Price 1,000 Spot price down 22.1% from the 800 peak in July 2008, at RMB775/tonne on 10 Jan 2011 600 gap: RMB20~30/t 570 540 400 458 200 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Jun-02 Sep-02 Dec-02 Jun-03 Sep-03 Dec-03 Jun-04 Sep-04 Dec-04 Jun-05 Sep-05 Dec-05 Jun-06 Sep-06 Dec-06 Jun-07 Sep-07 Dec-07 Jun-08 Sep-08 Dec-08 Jun-09 Sep-09 Dec-09 Jun-10 Sep-10 Dec-10Source: China Coal Transport and Distribution Association (CCTD), Nomura researchExhibit 18. Nomura’s China coal price projectionRMB/tonne 2009 2010F 2011F 2012FKey contract price (FOB) -40% of total contract sales 540 570 570 610y-y (%) 6 0 7Non-key contract price (FOB) -60% of total contract sales Price is in between spot and contract price; different on each company; moving with spot coal price trendy-y (%) 6 5 7Blended contract price (FOB) increase (%) 6 3 7Spot price 600 744 804 844y-y (%) (17) 25 8 5Note: coal price refer to Shanxi blend (5,500 kcal/kg) FOB priceSource: Nomura estimates2011 contract price capGiven inflationary pressure, the frozen power tariff since 2009 and strong appeals frompower companies, the NDRC froze the 2011 KEY contract coal price for powercompanies. Contract prices, production volume and railway capacity for coaltransportation were discussed at the “2011 national coal production and transportationvolume meeting” (“the annual meeting”) held in late December 2010 and it was agreedto keep the key contract price for power companies unchanged from the 2010 level(RMB570/tonne), according to the China Coal Transport and Distribution Association(CCTD).Nomura 15 18 January 2011
  17. 17. Coal | China Ivan Lee, CFA / Matty ZhaoPrice cap only applies to key contracts (40% of contracts)The price cap only applies to KEY contract sales to power companies rather than to allcontract sales. Although the NDRC has not defined “key contracts”, we believe ‘’keycontracts’’ include annual contract quotas allocated to coal companies in thegovernment-controlled part of the economy, to be signed at the annual meeting, andwhich have secured railway capacity.According to the “2011 railway capacity allocation framework” issued on 6 December2010, the NDRC has assured railway capacity for 769mn tonnes of coal to be sold tothe power industry. Based on our communications with CCTD and several big coalcompanies, we estimate key contract volume accounts for only 40% of total contractsales in China in 2011, taking into account contracts signed at and outside the annualmeeting.Ways to mitigate contract price risksWe believe coal companies could adopt various steps to offset the contract price risks: Cut exposure to contract sales in 2011 — Shenhua has been doing so since 2010, with contract sales dropping from 71% in FY09 to 58% in FY10F. Reducing contract fulfilment rates or providing lower quality coal to key contract customers. Adjusting the customer base for contract sales, shifting from power companies to companies in other industries.Potential upside — the price cap may be short-lived?While we assume a 2011 key contract price of RMB570/ tonne (5,500 Kcal/kg), in lightof the NDRC’s intervention, there may be potential upside to our projection given: SOE coal companies only account for 50% of the annual coal production (source: CCTD ; period 2009). This, in addition to the strong pricing (bargaining) power of coal companies over independent power producers (IPPs) and the prevailing 26% discount of key contract price to spot (Shanxi 5,500Kal/kg QHD FOB price at RMB775/tonne as at 10 January 2011), it is impossible for the central government to control the implementation at the working level in our view. In 2008, the NDRC implemented the price cap policy twice for spot prices. However, only three months after the second price cap did the Qinhuangdao (QHD) price fall to the level desired by the government (see policy development section in this report). Although the price cap for 2011 applies to key contracts rather than spot, its effectiveness arguably hinges on implementation. We think many of these contracts will be renegotiated or fulfilment rates will fall substantially in 2H11F.No price control on non-key contractsDespite the “key contract” price being unchanged, China has not intervened on non-key contracts this year, though railway capacity is not guaranteed and was notallocated during the annual meeting.Non-key contract price to stay flat in 1Q11…In 1Q11, we expect the non-key contract price to be unchanged from the 2010 level,given: Coal companies hope to secure railway capacity through signing key and non-key contracts (in the “2011 railway capacity allocation framework” some of the railway capacity has not been specifically allocated to certain coal producers). The government might watch non-key contract prices during the expected peak in inflation around end-2010 and early 2011.Nomura 16 18 January 2011
  18. 18. Coal | China Ivan Lee, CFA / Matty Zhao…but to rise 7% in 2Q-4Q11However, in light of the high correlation with the spot price and with the spot priceprojected by us to climb by 8% in 2011, we believe the price of non-key contracts —many of which are signed on a quarterly or monthly basis — will rise in 2Q-4Q11,narrowing the differential with the spot price.Given the prevailing 26% contract-spot-price spread, contract fulfilment rates shouldfall substantially from 2Q onwards and many non-key contracts are likely to berenegotiated when CPI inflation retreats. We expect non-key contract prices to rise by7% y-y in 2Q11. In our eyes, with no change in 1Q11 and a 7% y-y increase in 2Q-4Q11, the yearly weighted average change in the non-key contract price is 5% y-y.This implies the blended contract price will rise by 3% in FY11F.2012F contract price to increase by 7% y-yOn the assumption of no government intervention in the 2012 contract price, webelieve contract price will catch up and increase by a bigger 7% y-y or RMB40/tonnegiven: Coal companies will pass on the new resources tax, if implemented, to customers given it is a sellers’ market and their strong pricing power over IPPs. We have factored in RMB15/tonne (3%-5% on the ex-mine price) resources tax for the 2012 contract price (see the cost section in this report for details). Based on the current spot price of RMB775/ tonne (10 January 2011), the spot-to- contract price spread is RMB205/tonne — 95% higher than the historical (from Jan 2003) average of RMB105/tonne. With the spot price further strengthening in 4Q11F while the key contract price was unchanged from the FY10F level, the gap will widen at end 2011, leaving enough room for contracts to be hiked in 2012, in our opinion.Strong spot price with seasonality fluctuationBig price jump in FY10Due to the two price caps imposed by the government in 2008 and the global financialcrisis, the spot coal price at Qinhuangdao port for 5,500kcal/kg bottomed atRMB451/tonne in December 2008 (source: CCTD). With the economic recoveryspurring strong coal demand growth, the spot coal price has rebounded.In 2010, the average spot coal price rose to RMB744/tonne (up 25% y-y). Demand forwinter warming, intensified by truck transport bottlenecks due to snow blocking roadsin the north, further pushed up the price in 4Q10 and 1Q11, culminating in a QHD spotprice (10 January 2011) of RMB775/tonne.Exhibit 19. QHD FOB spot thermal coal price (RMB/tonne) Shanxi 5,500 kal/kg 1,200 Datong 5,800kal/kg 1,000 General 4,500kal/kg 800 600 400 200 0 Mar-03 Jun-03 Dec-03 Mar-04 Jun-04 Dec-04 Mar-05 Jun-05 Dec-05 Mar-06 Jun-06 Dec-06 Mar-07 Jun-07 Dec-07 Mar-08 Jun-08 Dec-08 Mar-09 Jun-09 Dec-09 Mar-10 Jun-10 Dec-10 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10Source: CCTD, Nomura researchNomura 17 18 January 2011
  19. 19. Coal | China Ivan Lee, CFA / Matty ZhaoContinued upside trends in 2011-12F…After a robust run in FY10, we expect the spot price to stay strong with growth of 8% inFY11F to RMB804/tonne and 5% in FY12F to RMB844/tonne, given: Tight supply outlook for the next two years. On the back of fast growing demand and limited supply growth due to small mines’ consolidation and transport bottlenecks, we see upside for the spot price in the next two years. Strong international coal price in the next two years. Our international metal and mining team forecasts that the Australian thermal coal price will rise 43% to US$140/tonne (around RMB930/tonne) in 2011.Exhibit 20. Nomura Australia coal price forecast 2008 2009 2010F 2011F 2012FThermal coal (US$/tonne) 125 70 98 140 170y-y (%) - (44) 40 43 21Source: Nomura research... but weaker spot price in 2Q- 3Q due to seasonal effectAlthough we expect the average spot coal price to rise 8% y-y to RMB804/ tonne for2011, given the current coal price at RMB775/tonne (10 January 2011), the price isexpected to move between RMB735-865 for the rest of the year, with seasonalweakness (strength) in February to May (June to August) and September to October(November to January), in our view.Exhibit 21. Projected price trend in 2011 – 12 FY12F avg. spot RMB844/t (+5% y-y) FY11F avg. spot RMB804/t (+8% y-y) spot price non-key contract 7% rise in 2012F key contract 7% rise from Q211 RMB610/t (+7% y-y) RMB570/t (unchanged) May-11 May-12 Mar-11 Nov-11 Mar-12 Nov-12 Jan-11 Jul-11 Sep-11 Jan-12 Jul-12 Sep-12 Spot Key contract Non-key contractSource: Nomura est.We do not expect the spot price to be significantly stronger during the year, oranywhere close to RMB900-1,000 level, given the prevailing high coal inventory days(17 days as of 27 December 2010, source: sxcoal) at direct-supply power plants. Thiscompares with an average of 15 days since July 2007 and 10 days on 23 July 2008when the spot coal price peaked at RMB995/tonne (source: CCTD).Nomura 18 18 January 2011
  20. 20. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 22. National coal inventory Exhibit 23. Coal inventory at direct supply power plant (mn tonne) National coal inventory (LHS) (%) Inventory Days 250 15 30 Days of coal inventory (RHS) Inventory MoM growth rate (RHS) 10 25 200 5 20 150 0 15 100 Average: 15.4 days (5) 10 50 (10) 5 0 (15) 0 May-06 May-07 May-08 May-09 May-10 Mar-06 Nov-06 Mar-07 Nov-07 Mar-08 Nov-08 Mar-09 Nov-09 Mar-10 Jan-06 Jul-06 Sep-06 Jan-07 Jul-07 Sep-07 Jan-08 Jul-08 Sep-08 Jan-09 Jul-09 Sep-09 Jan-10 Jul-10 Sep-10 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Feb-09 Jun-08 Aug-08 Oct-08 Dec-08 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10Source: Nomura estimates Source: CCTD, sxcoal, Nomura ResearchMinimal impact from flooding in AustraliaWe think the recent Queensland, Australia, flooding will have limited impact on China’sthermal coal market, given 1) Queensland mainly produces coking coal as opposed tothermal coal, 2) China is almost self-sufficient on coal supply, with over 96% of coalsupply come from the domestic market, while net imports are only 4% (source CEIC,sxcoal). Therefore, even though the international coal price has been pushed up,China’s QHD spot coal price has remained soft. 3) In 2010, Indonesia overtookAustralia to be the biggest coal exporter to China; China’s 9M10 imports from Australiawere less than 1% of coal supply. According to our Indonesia coal analyst IsnaputraIskandar, Indonesia is more competitive in coal exports to China given: 1) its closerproximity to southern China, with lower transport costs to China (US$7/tonne versusUS$11/tonne for Australia and US$19/tonne for South Africa, according to AustralianMineral Economics); 2) growing production capacity; and 3) Indonesian coal producerstypically do not prioritise domestic demand over exports. We think China will lift importsfrom Indonesia, while paring the significance of Australian coal to China givenAustralia’s capacity constraints and higher transport costs to China.Nomura 19 18 January 2011
  21. 21. Coal | China Ivan Lee, CFA / Matty ZhaoDemandSolid coal demand growth…driven by power, steel and cementCoal consumption in China increased from 2,319mnt in 2005 to 3,020mnt in 2009,indicating a CAGR of 6.8%. According to BP statistical review of world energy June2010, although China only accounts for 13.9% of total coal reserves in the world,China consumed 46.9% of the world’s total coal in 2009 in terms of energy output. Thepower industry accounted for most coal consumption in 2009 (48%), followed by steel(17%), cement (12%) and chemicals (3%).Exhibit 24. China coal consumption (FY05-09) Exhibit 25. China coal consumption by industries (mnt) (%) Power Steel Cement Chemicals Others CAGR(05-09F) : 6.8% 3,210 100 90 24% 20% 20% 19% 3,020 28% 2,568 2,811 80 3% 3% 3% 2,727 2,551 70 3% 3% 11% 11% 12% 2,319 11% 11% 1,926 60 17% 16% 17% 15% 16% 50 1,284 40 30 43% 45% 49% 49% 48% 642 20 10 0 0 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009Source: CEIC, Nomura Research Source: CEIC, Nomura ResearchWe forecast 2010F coal consumption to reach 3.3bn tonnes, up 9.2% y-y, based on abottom-up approach driven by projected growth in thermal power generation, steel,cement and chemical production. In 2011F and 2012F, we forecast 6.5% and 5.5%growth based on a similar approach.Exhibit 26. Coal consumption projection breakdown by downstream industries(mnt) 2006 2007 2008 2009 2010F 2011F 2012FPower 1,159 1,326 1,365 1,463 1,616 1,754 1,862y-y growth (%) 14 3 7 10 9 6Steel 408 462 461 525 591 620 660y-y growth (%) 13 0 14 13 5 6Cement 272 299 319 377 430 471 508y-y growth (%) 10 7 18 14 10 8Chemicals 87 92 90 92 92 92 92y-y growth (%) 6 (2) 2 0 0 0Others 625 549 575 563 570 578 585y-y growth (%) (12) 5 (2) 1 1 1Total coal consumption 2,551 2,727 2,811 3,020 3,299 3,515 3,707y-y growth (%) 10 6.9 3.1 7.4 9.2 6.5 5.5Source: CEIC, CCTD, Nomura ResearchRobust thermal power output growthChina heavily relied on thermal power for its power generation. At 2009, thermal power We estimate coal used in theaccounted for 82% of the total generation, followed by hydro (16%) (per CEIC). thermal power industry will riseThermal power generation experienced a 10.1% CAGR during FY05-09. For 11M10, by 9% in FY11F and 6% in FY12Fthermal generation was up 13.2% y-y (source: CEC) and we forecast 13.5% y-y growthfor FY10.Nomura 20 18 January 2011

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