47375199 nomura-coal-china-18-jan-2011
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  • 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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
  • 22. Coal | China Ivan Lee, CFA / Matty ZhaoFor 2011F and 2012F, we forecast thermal power output growth to reach 9.8% and7.6%, respectively, on the back of robust GDP growth of 9.8% for 2011F and 9.5% for2012F, as per our China economist. This assumes a power/GDP growth beta of 1 and0.9 for 2011F and 2012F, respectively, down from 1.3x in 2010, mainly due to thegovernment’s effort to reduce energy intensity. Beijing aims to reduce carbon intensityby 40-45% in 2020, from 2005 levels. According to the China Daily (November 2010),in reference to Xie Zhenhua, Vice-Chairman of NDRC, energy intensity should fall by20% as of end-2010 from 2005 level, on track with targets.Exhibit 27. China: power generation forecast(bn kwh) 2009 2010F 2011F 2012F 2013F 2014F 2015F 2016F 2017F 2018F 2019F 2020FThermal/Coal 3011.7 3,359 3,664 3,929 4,183 4,437 4,688 4,864 5,046 5,199 5,356 5,517 Growth rate (%) 11.5 9.1 7.3 6.5 6.1 5.7 3.8 3.7 3.0 3.0 3.0Hydro 571.7 662 716 763 805 847 888 933 981 1,025 1,071 1,118 Growth rate (%) 15.8 8.2 6.4 5.6 5.2 4.8 5.1 5.1 4.4 4.4 4.4Nuclear 70.1 85 125 169 218 272 331 376 424 473 525 581 Growth rate (%) 21.3 47.0 35.3 28.9 24.8 21.7 13.5 12.9 11.5 11.1 10.6Others (Solar/Wind, etc) 27.8 71 82 93 104 116 128 157 189 223 258 297 Growth rate (%) 155.7 15.3 13.1 12.0 11.4 10.8 22.9 20.3 17.5 16.0 14.8Total 3681.2 4,177 4,587 4,954 5,310 5,672 6,034 6,330 6,640 6,919 7,210 7,513 Growth rate (%) 13.5 9.8 8.0 7.2 6.8 6.4 4.9 4.9 4.2 4.2 4.2Contribution (%)Thermal/Coal 81.8% 80.4% 79.9% 79.3% 78.8% 78.2% 77.7% 76.8% 76.0% 75.1% 74.3% 73.4%Hydro 15.5% 15.8% 15.6% 15.4% 15.2% 14.9% 14.7% 14.7% 14.8% 14.8% 14.8% 14.9%Nuclear 1.9% 2.0% 2.7% 3.4% 4.1% 4.8% 5.5% 5.9% 6.4% 6.8% 7.3% 7.7%Others (Solar/Wind, etc) 0.8% 1.7% 1.8% 1.9% 2.0% 2.0% 2.1% 2.5% 2.9% 3.2% 3.6% 3.9% Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Source: CEIC, Nomura estiamtesExhibit 28. Thermal power output forecast (08-12F) Exhibit 29. Power and industrial output growth (bn kwh) (%) GDP growth (LHS) (x) Power output growth - 3 month running (LHS) 5,000 Industrial output growth - 3 month average (LHS) 3,929 30 3 4,200 3,664 Beta - "power output growth/GDP growth" (RHS) 25 3,359 3,400 3,012 20 2 2,790 15 2,600 1 10 1,800 5 0 1,000 0 (5) (1) 200 (10) (600) (15) (2) 2008 2009 2010F 2011F 2012F 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009Source: CEIC, Nomura estiamtes Source: CEIC, Nomura estimatesConsistent with the government’s target of reducing energy intensity and improvingefficiency, small and inefficient power plants have been replaced by bigger sized units(critical and super critical with 600MW or above). Coupled with technologyadvancement, unit coal consumption for power generation has been reduced by 2-3gram/kwh (1%) pa (source china power statistics year book). Thus, we believe coalconsumption by thermal power generation will increase by a slower 10%, 9% and 6%in FY10F, FY11F and FY12F respectively.Nomura 21 18 January 2011
  • 23. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 30. China power generation forecastChina: Power supply and demandSupply 2009 2010F 2011F 2012F 2013F 2014F 2015F 2016F 2017F 2018F 2019F 2020FInstalled capacity (GW) 874 954 1,039 1,124 1,209 1,294 1,377 1,465 1,553 1,638 1,723 1,808Capacity launched (GW) 81 80 85 85 85 85 83 88 88 85 85 85Capacity growth 10.2% 9.2% 8.9% 8.2% 7.2% 6.7% 6.3% 6.0% 5.0% 5.0% 5.0% 5.0%Capacity breakdownThermal 74.4% 74.9% 75.5% 74.8% 72.9% 71.0% 69.1% 67.9% 66.7% 65.6% 64.4% 63.2%Hydro 22.5% 21.0% 19.7% 19.6% 20.2% 20.9% 21.5% 21.4% 21.3% 21.2% 21.1% 21.0%Nuclear 1.0% 1.4% 1.3% 1.3% 2.0% 2.6% 3.2% 3.5% 3.7% 4.0% 4.2% 4.4%Winds 1.8% 2.6% 3.4% 4.1% 4.8% 5.4% 6.1% 6.5% 7.0% 7.4% 7.9% 8.3%Others 0.2% 0.2% 0.2% 0.2% 0.2% 0.1% 0.1% 0.7% 1.3% 1.9% 2.5% 3.0% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%Electricity supply - fuel mixThermal 82% 80% 80% 79% 79% 78% 78% 77% 76% 75% 74% 73%Hydro 16% 16% 16% 15% 15% 15% 15% 15% 15% 15% 15% 15%Nuclear 2% 2% 3% 3% 4% 5% 5% 6% 6% 7% 7% 8%Winds 1% 2% 2% 2% 2% 2% 2% 2% 3% 3% 4% 4%Others 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%DemandElectricity generation (bn KWh) 3,681 4,177 4,587 4,954 5,310 5,672 6,034 6,330 6,640 6,919 7,210 7,513Generation growth 6.2% 13.5% 9.8% 8.0% 7.2% 6.8% 6.4% 4.9% 4.9% 4.2% 4.2% 4.2%Real GDP growth 8.5% 10.2% 9.8% 9.5% 9.0% 8.5% 8.0% 7.0% 7.0% 6.0% 6.0% 6.0%Demand growth/ Real GDP growth (i.e. beta) 0.7 1.3 1.0 0.9 0.8 0.8 0.8 0.7 0.7 0.7 0.7 0.7UtilisationPlant utilisationNational average 51.7% 53.5% 53.8% 53.5% 53.0% 52.7% 52.5% 51.7% 51.1% 50.3% 49.7% 49.2%Thermal 55.2% 57.7% 57.3% 56.3% 56.2% 56.9% 57.8% 57.8% 57.4% 56.8% 56.5% 56.4%Hydro 37.3% 38.3% 40.7% 41.8% 40.8% 38.7% 36.8% 35.5% 35.3% 35.0% 34.8% 34.7%Equivalent utilisation hoursNational average 4,527 4,685 4,715 4,683 4,647 4,619 4,598 4,533 4,473 4,402 4,352 4,313Thermal 4,839 5,055 5,020 4,932 4,922 4,988 5,065 5,064 5,027 4,977 4,952 4,940Hydro 3,264 3,352 3,563 3,661 3,574 3,389 3,221 3,113 3,093 3,064 3,050 3,044OthersPeak demand (GW) 828 940 1,032 1,115 1,195 1,276 1,358 1,424 1,494 1,557 1,622 1,690Shortage (pent-up demand, GW) 46 14 7 10 14 18 19 41 59 81 101 118Reserve margins (%) 5% 1% 1% 1% 1% 1% 1% 3% 4% 5% 6% 7%Market equilibrium Balance Balance Balance Balance Balance Balance Balance Balance Balance Balance Balance BalanceSource: CEIC, Nomura est.Steady increase in steel productionDue to power rationing since August 2010, China’s total crude steel output dropped to50.3mt in October. However, steel prices recovered, backed by supply cuts, by 2.2-6.3% q-q in 4Q10. Our steel analyst forecasts China’s total crude steel output to reach646mnt in 2010F, up 13.7% y-y.Given China’s enhanced control over steel oversupply, we are looking for steadyproduction growth for 2011-12F at 6.0% and 8.0% y-y to 685mt and 739mt,respectively. By applying a 1% decrease in unit coal consumption (million tonnes ofcoal used per million tonnes steel production), coal demand from the steel industry willlikely rise by 5% in 2011F and 6% in 2012F.Strong cement output growth expected…China’s cement output has increased dramatically since 2Q10. Our cement analystforecasts total cement output to hit 1.8bn tonnes for FY10F (up 15.2% y-y), and 2.0bntonnes for FY11F (up 10.7% y-y) owing to rapid demand growth. We expect a muchtighter market in FY10F-11F with surplus supply at 1mt and 4mt respectively versus38mt in 2009. Our cement analyst is now working on her 2012F output forecast. Weassume 2012F cement output growth to be in line with 9.5% GDP growth. Assumingunit coal consumption decreases by 1% per year, the cement industry will use 10%more coal in 2011F and 8% more in 2012F.Nomura 22 18 January 2011
  • 24. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 31. Steel output forecast (08-12F) Exhibit 32. Cement output forecast (08-12F) (mnt) (mnt) 1,000 2,500 2,162 1,974 739 2,000 1,784 750 685 646 1,548 568 1,388 502 1,500 500 1,000 250 500 0 0 2008 2009 2010F 2011F 2012F 2008 2009 2010F 2011F 2012FSource: CEIC, Nomura estimates Source: CEIC, Nomura estimatesThe CAGRs for coal consumption by the chemical industry and others between 2007and 2009 were -0.1% and 1.3% respectively (source CEIC, CCTD). For FY10F-FY12F,we assume the same growth rate in projecting their respective coal demand.…so coal demand will rise by 6.5 % in 11F and 5.5% in 12FTherefore, based on our analysis, we expect coal demand to rise to 3.3bn tonnes inFY10F, up 9% y-y. Demand will grow to 3.5bn tonnes in 2011F (up 6.5% y-y) and to3.7bn tonnes in 2012F (up 5.5% y-y), backed by strong demand from power, steel andcement, in our eyes.12th FYP: coal drops to 63% of total energy consumptionIn 2009, coal represented 70% of China’s primary energy consumption, significantlyhigher than the world average of 29% and the OECD average of 20% (source BPStatistical Review of World Energy June 2010). China’s reliance on coal is muchhigher than the second most coal dependent country, India (52% of primary energycomes from coal) (source BP Statistical Review of World Energy June 2010). In 2009,China accounted for 47% of the world’s total coal consumption, three times more thanthe second largest coal consumer, the US, according to BP Statistical Review of WorldEnergy June 2010.In order to realize a “low carbon” economy, China has two targets for energy and theenvironment. They are to increase the use of non-fossil energy to 15% of primaryenergy consumption in 2020, and to reduce carbon intensity by 40-45% by 2020, from2005 levels. Energy intensity should have fallen by 20% as of end-2010 (according toChina Daily), on track with targets, thanks to the power rationing introduced to 19 highenergy intensive and restricted industries in 2H10 to curb energy usage.In the 12th Five Year Plan (FYP) (2011-2015), we expect a significant part of energypolicy will be on how to achieve the two targets. According to Xinhua, the NDRC mightimplement a policy about reducing coal from 70% of primary energy used in 2009 to63% by the end of the 12th FYP in 2015 (see policy section for details).Other than policies to reduce energy consumption and CO2 generation, we believenew energy will be highlighted in the 12th FYP and emphasis will be on, in sequence,nuclear, natural gas, small hydro, wind, solar and biomass energy. The EnergyResearch Institute (ERI) of the NDRC forecasts non-fossil fuel to represent 11-13% ofprimary energy consumption in 2015 (from currently ~9%). Also, ERI expects the 2020target for nuclear is likely to increase to 70-80GW, from 40GW. Other issues expectedto be discussed in the plan should include tariff reform (power pooling), smart-gridsand imbalanced power supply between regions.Nomura 23 18 January 2011
  • 25. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 33. China: primary energy consumption Exhibit 34. The world, OECD and India primary(FY05-09) energy consumption (2009) (%) Coal Crude Oil Natural Gas Hydro Power (%) Oil Natural gas Coal Nuclear Hydro 7% 7% 7% 8% 8% 5.1% 5.7% 6.6% 100 100 3% 3% 3% 4% 0.8% 90 4% 90 9.7% 5.5% 80 20% 19% 19% 18% 18% 80 19.9% 29.4% 70 70 52.4% 60 60 50 50 25.0% 23.8% 40 40 71% 71% 71% 70% 70% 10.0% 30 30 20 20 39.7% 34.8% 31.7% 10 10 0 0 2005 2006 2007 2008 2009 India OECD Total WorldSource: CEIC, Nomura Research Source: BP Statistical Review of World Energy June 2010, Nomura research… but absolute coal demand will continue to outpace supplyEven with the conservative assumption of China achieving the goal of 1) reduction onreliance on coal of the primary energy consumption to 63% by 2015 and 2) energyintensity to fall by 16% from 2010 level by 2015, coal demand growth would be 4.6%and 4.4% for 2011F and 2012F from this top-down approach (versus supply growth of4.2% for 2011F and 2012F). This suggests that the coal market will remain tight overnext two years. We see upside for these numbers as well, given 1) the projectedstrong GDP growth, 2) the majority of economic activity continue to be represented bysecondary industry (industrial production) and 3) coal-fired power generation remainsthe cheapest and is China’s main energy source.Exhibit 35. Top down coal consumption projection 2009 2010 2011 2012 Assuming a 16% energyGDP growth 10.2% 9.8% 9.5% intensity reduction target by 2015 from 2010 level,Energy Intensity reduction -3% -3% representing ~3% CAGRTotal energy consumption (Index to 100 for base year) 100.0 106.5 113.1Coal as primary energy consumption 70.0% 68.8% 67.6% 66.4%CAGR -1.7%Coal consumption (Index to 68.8 for the base year: 2010) 68.8 72.0 75.1Projected Growth 4.6% 4.4%Source: Nomura est. Assuming China reduces coal reliance from 70% (2009) to 63% (2015), representing a ~1.7% CAGR reduction in reliance per year… and it is difficult to replace coal in the near termWe believe coal will continue to account for majority of China’s energy consumption atleast for the next two decades. We don’t think coal can be easily replaced by othertype of energy in the near term given "structural issues" including: Abundant coal reserves in China, while it is only sufficient on gas and is short of oil (source BP Statistical Review of World Energy June 2010). China has the third largest coal reserves in the world with 114.5bn tons of coal reserves (source: BP Statistical Review of World Energy 1H10), after Russia and the US. This equals toNomura 24 18 January 2011
  • 26. Coal | China Ivan Lee, CFA / Matty Zhao 38 years of production based on the 2009 run rate, compared with oil at 11 years and gas at 29 years. Regulated power tariff without fuel cost pass through and coal remains the cheapest source of energy. Therefore, the majority of power generation will continue to rely on coal in the next 5-10 years in our view. Compared with other major energy sources, such as gas, LPG and diesel (which are more closely correlated with crude oil prices in our view), coal enjoys a 100%-340% cost advantage. Even though we forecast coal prices to increase, it will still maintain its pricing competitiveness in China over other major energy sources in our view. It takes more time to build other base-load and low cost fuel type power plants, like nuclear. Renewable energy (wind, solar, biomass) are not base-load power. They are less scalable and affordable in China in our view.Exhibit 36. China: fossil fuel lifetime (yrs) 40 37.5 35 28.8 30 25 20 15 10.7 10 5 0 Coal Oil GasNote: Lifetime defined as reserves / productionSource: BP Statistical Review of World Energy 2010Exhibit 37. China: Energy price comparison (Sep 2010) Electricity 144 206 Diesel 169 188 LPG 106 134 Coal 18 64 Natural Gas 72 87 0 50 100 150 200 250 Price per heat content (RMB per gigajoule)Source: CEIC, China coal associationNomura 25 18 January 2011
  • 27. Coal | China Ivan Lee, CFA / Matty ZhaoSupplyTight supply remainsIn the past 10 years, China witnessed a rapid growth in coal output, with a CAGR of In the next two years, demand9%. In 2009, total production in China reached 3.05bn tonnes, more than double growth outpacing supply growthproduction in 2000. According to the BP statistical review of world energy June 2010, could lead to tight supplyChina produced nearly 46% of total world coal output. In the next two years, demandgrowth outpacing supply growth could lead to tight supply, in our view.Exhibit 38. China: coal supply forecasts(mnt) 2005 2006 2007 2008 2009 2010F 2011F 2012FCoal production 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 142Source: CEIC/NBS, Nomura estimateExpect coal supply to see 4.2% CAGR for 2010-15FFor 2010F, we project coal production to rise to 3,261mn tonnes, +6.9% y-y, based on9M10’s actual output of 2,446mn tonnes (source: CCTD). We forecast productiongrowth to slow to 4.2% y-y for both 2011F and 2012F, yielding 3,397mn and 3,539mntonnes of coal output in the respective year based on our industry checks and analysisof the current market environment: Government intervention on capacity expansion Geographically imbalanced supply Depletion of eastern coal mines Small mines consolidating causing short term tightnessGovernment restriction on capacity expansionAccording to Reuters “King coal” report in Jan 2011, China accounts for 46% of the China accounts for 46% of theworld’s total coal supply but is responsible for about 80% of global mining fatalities. world’s total coal supply but is responsible for about 80% ofTherefore, in light of the government’s efforts to reduce energy consumption per unit of global mining fatalitiesGDP in 12th FYP and reducing coalmining casualties, Beijing has introduced morerigorous requirements for safety and approval of new coal capacity.According to Global Times (3 November, 2010), China Coal Research Institute’sdirector He Youguo said that China may limit annual coal production to 3.6-3.8bntonnes in the 12-FYP (by 2015F). Although we agree that output growth will slowunder government’s stringent control measures, we think that Mr He’s outputprojection (implying a CAGR of 3.7% in 09-15F) is too conservative, compared with aproduction CAGR of 6.7% from FY05-09. Our industry check with CCTD and Shenhuaconfirms our projection of around 4bn tonnes in 2015F, a CAGR of 4.2%.We believe production growth disruption would not be a major concern for leading coalplayers such as Shenhua and China Coal. We believe their output growth should runfaster than the national growth of 4.2% CAGR given their existing sufficient reserves,recent acquisitions of resources, potential pipelines from asset injections and beingbeneficiaries of small mines’ consolidation. In particular, Shenhua’s captive logisticsnetwork could facilitate third-party trade, which supports double-digit volume salesgrowth over our forecast horizon. However, the said restriction, coupled with depletingcoal resources in Shandong, prompted Yanzhou Coal to move away from its hometown, like investing in Australia, in our view.Nomura 26 18 January 2011
  • 28. Coal | China Ivan Lee, CFA / Matty ZhaoGeographically imbalanced supplyChina is rich in coal resources but most of the resources are located in the Northwestpart of China, and top 10 coal production provinces are all in North or Northwest partof China (source: CEIC).Exhibit 39. China: Top 10 provinces by raw coal production (mnt) 2009 2008 700 601 594 600 645 500 502 400 296 300 230 200 144 137 128 242 213 104 87 85 100 137 113 116 95 98 81 0 Shanxi Shaanxi Mongolia Guizhou Henan Shandong Sichuan Heilongjiang Anhui Hebei InnerSource: CEIC, Nomura ResearchGrowing reliance on Shanxi and Inner MongoliaShanxi and Inner Mongolia are critical to domestic coal supply. Contribution from the Shanxi and Inner Mongolia aretwo provinces has risen from 34.5% (FY05) to 46.0% (FY10F basing on 1H10 actual). critical to domestic coal supplyPrior to 2009, Shanxi was the biggest producing province, with a CAGR of 5% inFY05-08. Although supply in Shanxi dropped to 594mn tonnes in 2009 (down 8% y-y)due to the closure of small mines policy, we expect FY10 raw coal output to recoverback to 720mn tonnes based on 11M10 output of 660mn tonnes.Inner Mongolia has the largest thermal coal resources in China according to WoodMackenzie. In the past few years, due to the upgrade of railway regional lines, whichfeed into the Daqin or Shenhuang lines (see “transportation” sector for details),production grew very fast and overtook Shanxi in 2009 as the largest coal producingprovince. According to Inner Mongolia Economic and Information TechnologyCommission (source: hncost.com), Inner Mongolia’s coal output may reach 880mntonnes in FY11; while Shanxi’s coal output is expected to be 780-800mn tonnes(source: CCTD and Shanxi Coal Industry Office). We expect contribution from thesetwo provinces to grow due to their rich coal resources and slowing growth (or decline)at other production bases due to depleting resources. Henan had a production decline(source: cctd) while Shandong saw slow growth (source: steelinfo) in 2010.Assuming Shanxi and Inner Mongolia contribute some 50% of national coal output inFY11 (46% in FY10F), and total output of 1.66bn tonnes, total coal output in Chinashould reach around 3.32bn tonnes in FY11, in line with our top-down projections of3.4bn in FY11 and 4bn in 2015F — representing a CAGR of 4.2% for 2010-15F.Nomura 27 18 January 2011
  • 29. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 40. Shanxi vs. Inner Mongolia production Exhibit 41. Shanxi / IM’s total % of China Production (mn t) (%) Shanxi Inner Mongolia (%) 700 630 645 50 24 23 594 25 23 23 554 581 600 40 601 19 500 30 20 502 20 400 20 18 15 300 354 10 298 13 200 256 0 10 12 11 100 (10) 0 (20) 5 2005 2006 2007 2008 2009 Shanxi (LHS) Inner Mongolia (LHS) 0 y-y (Shanxi) (RHS) y-y (Inner Mongolia) (RHS) 2005 2006 2007 2008 2009Source: CEIC, Nomura Research Source: CEIC, Nomura ResearchSmall mines consolidations cause short term tightnessConsolidation limit supply….Compared with the overseas market, China’s coal market remains fragmented. In 2009,the large stated-owned mines accounted for 50% of China total coal output; local SOEproduced 12%, while the township mines produced the remaining 38% (source CCTD).Exhibit 42. Production breakdown by miners (%) 100 Key SOE Local SOE City & Town owned 90 37% 31% 80 38% 38% 38% 70 60 15% 14% 13% 13% 12% 50 40 30 54% 48% 49% 51% 50% 20 10 0 2006 2007 2008 2009 20101HSource: CCTD, Nomura ResearchUnder the 11th FYP and the coming 12th FYP, the Chinese government is pushingmines to consolidate, aiming to create major mining firms with working capital to installand run safety equipment and to enhance more efficient use of resources (to improveproduction yield).Over 9,000 small mines have been closed by the end of 2010. By 2015, thegovernment plans to shutdown a further 7,000-plus mines, resulting in only 4,000mines remaining (see policy development section for details). The consolidation, in ourview, will limit supply in the near term given: Following the closure of small mines for consolidation and safety checks, coal production in Shanxi fell 8% to 594mn tonnes in 2009 (source CEIC). Given the success in Shanxi, similar policies on closures of small mines (below 300,000 tonnes of capacity) have been announced in Inner Mongolia and Henan provinces. We expect such policies to be rolled out to other major coal production provinces.Nomura 28 18 January 2011
  • 30. Coal | China Ivan Lee, CFA / Matty Zhao Wu Yin, Vice-Minister of the National Energy Administration, disclosed that 7,466 small mines have been closed during 2006-09 nationwide. Another 1,539 are expected to be closed by FY10, totalling more than 9,000 small mines closure during the 11-FYP period and statistics on accidents & fatalities have been improved. (Source: cnstock). Even though the mines are consolidated into bigger coal players’ portfolio, it takes 1-2 years for them to ramp-up production.… but favour big playersAccording to Zhang Ping’s (NDRC chairman) speech at the national coal conference inNovember 2010, China targets to form 10 super large-scale coal enterprises of 100mntonnes annual capacity, and another 10 large coal companies with annual capacity of50mn tons by 2015. The12th FYP will increase annual production criteria for coalmines to: 1) at least 300,000 tonnes in all parts of China, 2) at least 0.6mn tonnes innational key planned mining areas, 3) over 1.2mn tonnes in major coal-producingprovinces, including Shanxi, Inner Mongolia, Shaanxi, Xinjiang and Ningxia.Although the consolidation is causing short-term tightness, the subsequent large scaleenterprises formation favours big SOE players, like Shenhua and China Coal. Ourview: 1) they are better-positioned in getting reserves across the nation, than non-SOEcoal players; 2) the policies bode well for enhancing market share for large scaleminers and, thereby, it would result in stronger pricing power for leading producers.Therefore, we expect the key companies to enjoy a double-digit production CAGRduring FY09-12F, more than double of China’s coal industry production growthaverage.Exhibit 43. Market share projection Exhibit 44. Production CAGR growth (09-12F) (%) FY09 FY12F (%) 9 14 8.1 12.1 8 12 11.3 6.9 10.7 7 10 6 5 8 4.0 4 3.3 6 5.1 3 4 2 1.2 1.1 2 1 0 0 Shenhua China Coal Yanzhou Coal Shenhua China Coal Yanzhou Coal TotalNote: measured by raw coal production Note: Yanzhou figure includes Australia productionSource: Company, Nomura est. Source: CEIC, Nomura est.Nomura 29 18 January 2011
  • 31. Coal | China Ivan Lee, CFA / Matty ZhaoTransportationTransportation bottlenecks to persist until2014FThe geographical disparity in supply and demand regions, with most suppliers in thenorthwest and consumers in costal areas, means that coal transportation is a keyelement of China’s coal industry. This is intensified by the depleting resources in theold and eastern coal bases. Coal is transported by rail or truck from the “Three West”regions to the main ports and then to downstream customers in the Yangtze RiverDelta and Pearl River Delta. According to the Ministry of Railways (MoR), coalaccounted for 53% of total freight goods carried by railway in 2009 in tonnage terms.Exhibit 45. Major production and consumption provincesSource: CEIC, Nomura ResearchWith railway capacity growth lagging production growth, transportation bottleneckshave become a major roadblock for China’s coal industry in the past few years. Andwe believe this problem will persist for some years given: Limited railway capacity expansion in the two backbone railway lines (Daqin and Shenhuang lines); Regional lines cannot solve the bottleneck issue; Trucking is too expensive and inefficient; and New major railway lines, dedicated to coal transportation, will not be completed until 2014-15F.Nomura 30 18 January 2011
  • 32. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 46. Major railway capacity increase in Shanxi and Inner Mongolia(mn tonnes) 2010F 2011F 2012F 2013F 2014F 2015FErdos – Caofeidian 100 100Lvliang- Rizhao 50 100Chisui line 20 60 80Total 20 210 280y-y change 20 190 70y-y chg from Daqin and 80 30 30 20 20 0Shenhuang lineTotal capacity rise y-y 80 30 30 40 210 70Note: Only major railways includedSource: Ministry of Railway, Inner Mongolia Science Technology & Economy magazineLimited capacity expansion from the two backbone linesThe Daqin line and Shenhuang line are the two backbones of the West-to-East railwaysystem in China, connecting key coal production provinces to the two main coalloading ports (Qinhuangdao and Huanghua ports). We expect limited expansion forthese two lines in short to medium term. Daqin line (Line 1 in Exhibit 48): Stretching 653km, linking Datong of Shanxi province and Qinhuangdao port, Daqin line is the most important railway line dedicated to coal transportation. Its freight volume more than tripled from 100mn tonnes in 2002 to 330mn tonnes in 2009 (source sxcoal). After freight volume growth in 2010F to 400mn tonnes due to growing demand for coal transportation, future growth should be limited. Subject to the Ministry of Railway’s approval, we expect freight volume to increase by 20mn tonnes in 2011F and by 30mn tonnes to reach full capacity of 450mn tonnes in 2013F. Shenhuang line (Line 2 in Exhibit 48): Stretching 815km, Shenhuang line is the second largest line in terms of coal freight volume. The Shenhuang (Shenshuo- Shuohuang lines) line, which runs from Shenmu of Shaanxi through Shuozhou to Huanghua port, is owned by China Shenhua Energy. It is primarily designed to carry coal produced by Shenhua, and will only serve third-party coal players when it has spare capacity. In the short to medium term, we expect freight volume to gradually increase to 200mn tonnes in 2014F from 140mn tonnes in 2009. However, the extra capacity could be absorbed by Shenhua’s own output growth as we expect self production to rise by 120-150mn tonnes from 2009 to 2014F.Exhibit 47. Key existing lines capacity expansion(mn tonnes) 2009 2010F 2011F 2012F 2013F 2014F 2015FDaqin lines 330 400 420 440 450 450 450Shuohuang lines 140 150 160 170 180 200 200Increase by 80 30 30 20 20 0Source: sxcoal, Nomura estimatesTrucks too expensive and less efficientTrucking is another way to transport coal. However, we don’t think it will replacerailway as it is too expensive and less efficient. Also, in an effort to reduce dust, coaltrucks have been barred from travelling within 1km of the city’s boundaries andoverloading is penalised. The higher charges are due to the lack of scale and toll roadcharges. Trucking is also much slower, especially during peak season. The local pressreported that coal trucks were stuck in the Tibet-Beijing highway for over 14 days inSeptember and pointed to coal trucks being slowed down due to severe a traffic jamthis summer from Shanxi to other provinces. Also, snowing can block roads and affectcoal truck transportation during the winter peak demand season.Nomura 31 18 January 2011
  • 33. Coal | China Ivan Lee, CFA / Matty ZhaoRegional lines link Inner Mongolia but cannot solve the problemCoal from Inner Mongolia is mainly transported through regional lines that feed into thetwo backbone lines: Dazhun line (Line 3 next Exhibit): Stretching 264km, linking Inner Mongolia to Daqin line, Dazhun line is owned by China Shenhua Energy. It carried 60mn tonnes in 2009. Dabao line (Line 4 next Exhibit): Stretching 452km, from Baotou to Datong, Dabao line is another linkage between Inner Mongolia and Daqing line. The line upgraded its capacity to 120mnt in 2009. Baoshen line (Line 5, next Exhibit): Stretching 170km, from Baotou to Shenmu of Shanxi, Baoshen line is also owned by Shenhua Energy. It connects coal from Inner Mongolia to Shenhuang line. The freight volume exceeds 22mn tonnes.These regional lines cannot solve the bottleneck issue as they still feed into the Daqinand Shenhuang lines, increasing their burden. With completion of new major linespending, transportation bottlenecks may continue to be a serious constraint for InnerMongolia coal producers as it is land locked and trucking distance to major ports (QHDport and Huanghua port) is even longer than Shanxi.New railways to ease the bottleneck in 2014F/ 2015FTo ease the transportation bottleneck, we understand that the MoR is working on threemajor lines to ease the transportation bottleneck, adding over 500mn tonnes oftransportation capacity from Inner Mongolia and Shanxi to the ports. The Third line for West-to-East system, from Erdos to Caofeidian port, would add additional capacity of 200mn tonnes when it is completed. China would invest RMB40bn into phase 1, the Zhangtang line, 542km, from Zhangjiakou of Hebei province to Caofeidian. Phase 1 started in November 2010, and estimated construction time is 4.5 years. The construction work for phase 2, from Zhunge’er to Zhangjiakou, has not been officially started yet. Due to the long construction time, we expect it will only help to ease the transportation burden of 100mn tonnes in 2014F (as it should start operation in mid-2014) and 200mn tonnes in 2016F. Central-southern line, running from Lvliang (Watang town) of Shanxi province to Rizhao port in Shandong province, is designed for a capacity of 200mn tonnes per year. The over 1000km line is estimated to be completed in late 2013. We expect it to be operational in 2014F, with initial capacity of 50mn tonnes, and to reach 200mn tonnes of capacity by 2016F. Chisui line, stretching 357km and with designed capacity of 114mn tonnes, builds a link between Chifeng of Inner Mongolia and Suizhong port near Hulu Island. Construction started in October 2010 and should be finished in September 2013. We expect the line to come into full operation in 2016F/2017F.Nomura 32 18 January 2011
  • 34. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 48. Major railway lines to transport coal Chisui line (2013) No.3 line Phase II No.3 line Phase I (2014) (2015) Dabao line Zhangjiakou 4 1 3 Daqin line Baoshen line 5 2 Shenhuang line Central-southern line (2014) New line Existing lineNote: Route is estimated basing on information from the Ministry of RailwaySource: Ministry of Railway, ditu.baidu.comNomura 33 18 January 2011
  • 35. Coal | China Ivan Lee, CFA / Matty ZhaoImportsIncreasing imports to fill the supply gapChina becomes a net coal importer in 2009China is rich in coal resources. According to BP statistical review of world energy, inJune 2010, China ranked third in proven coal reserves as of end-2009, having 13.9%of the world’s total proven reserves, following the US with 28.9% and the RussianFederation at 19.0%. The reserves-to-production ratio of China is 38 years. However,in recent years, China’s coal supply growth has lagged its soaring coal demand andthe country has become a net coal importer since 2009, with imports of 126mn tonnesand exports of 23mn tonnes for the year, according to CCTD.Exhibit 49. China’s total coal imports and exports Exhibit 50. China’s net imports of coal (mn t) Import Volume Export Volume (mn t) Net Import Net Import 18 20 16 15 14 10 12 5 10 0 8 (5) 6 (10) 4 (15) 2 0 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10Source: CCTD, Nomura research Source: CCTD, Nomura researchSupply gap to be filled by imports in 10F-12FRapid economic growth, depleting resources, transportation bottlenecks and restrictedsupply (Beijing, Guangzhou, Jiangsu and Shanghai have shut down their own minesaccording to Reuters “King coal” report in Jan 2011) have forced the developed eastand southern coasts to rely more on coal imports. In FY10-12F, we expect China toremain a net importer of coal, owing to the tight supply-demand situation. Fast growingdemand in China drove up coal imports significantly in 2010. Based on 9M10 netimports of 106mn tonnes (up 51% y-y), we expect full-year imports for 2010 to be142mn tonnes.Rising local demand and tight supply constraints imply that China’s coal exportsshould remain weak at 20mn tons/year in FY11F and 12F, on our estimates, whileimports should remain strong with projected net imports at 172mn tonnes in FY11Fand 217mn tonnes in FY12F. Nevertheless, this only represents 5% and 6% of totalcoal consumption in China respectively during the same period. The 17% import valueadded tax remains one of the major hindrances (source: PRC Ministry of Finance).Exhibit 51. Net imports/export forecasts(mnt) 2005 2006 2007 2008 2009 2010F 2011F 2012FConsumption 2,319 2,551 2,727 2,811 3,020 3,299 3,515 3,707y-y chg (%) 10.0 6.9 3.1 7.4 9.2 6.5 5.5Production (2,350) (2,529) (2,692) (2,802) (3,050) (3,261) (3,397) (3,539)y-y chg (%) 7.6 6.4 4.1 8.9 6.9% 4.2% 4.2%Changes in inventory and others (15) (47) (38) (14) 133 105 55 49Net Import / (export) (46) (25) (2) (5) 103 142 172 217Source: CEIC and NBS unless otherwise stated (2009 production data from CCTD) Nomura estimatesNomura 34 18 January 2011
  • 36. Coal | China Ivan Lee, CFA / Matty ZhaoIndonesia and Australia as main suppliersIn 2009, the four biggest coal exporters to China were Australia, Indonesia, Russia andMongolia. For 9M10, China imported most of its coal from Indonesia, Australia, Russiaand South Africa (source:sxcoal).According to Australian Mineral Economics (AME), China ranked No. 3 in seabornethermal coal imports in Asia in 2009. With growing requirements of coal imports to fillthe supply gap, China’s seaborne thermal coal imports ranked second (122mn tonnes)in Asia in 2010F, between Japan (128mn tonnes) and Korea (81mn tonnes) accordingto our global metal and mining team. Although coal imports to China only account forsingle digit percentage of China’s total annual consumption, this represents over 1/4 ofseaborne coal market imports in Asia. Therefore, the expected 20mnt-30mnt (10% oftotal seaborne market in Asia) increase in thermal coal imports should edge upseaborne coal prices further, in our view. Our estimate is based on Australia’sproduction of 409mnt and exports of 142mnt in 2009, followed by Indonesia (252mnt,202mt), Russia (298mnt, 81mt) and South Africa (250mnt, 62mt).Exhibit 52. China thermal coal imports (9M10) Exhibit 53. China thermal coal imports (FY09) Others, 5% Mongolia, Others, 15% 5% Indonesia, Russia, South 42% 16% Australia, Africa, 11% 41% Russia, 11% Australia, Indonesia, 22% 34%Source: SXCOAL, Nomura research Source: SXCOAL, Nomura ResearchExhibit 54. Coal production and imports of major countries(mnt) 2007 2008 2009Australia 393 398 409 Export (seaborne thermal coal) 115 124 142Indonesia 217 229 252 Export (seaborne thermal coal) 191 197 202Russia 314 329 298 Export (seaborne thermal coal) 88 86 81South Africa 248 253 250 Export (seaborne thermal coal) 65 61 62Note: Production account for solid fuels (incl. bituminous coal and anthracite (hard coal), and lignite and brown (sub-bituminous) coalSource: AME, BP Statistical Review of World Energy 2010Nomura 35 18 January 2011
  • 37. Coal | China Ivan Lee, CFA / Matty ZhaoCostRising costs aheadFees and levies edging up production costCoal production costs in China have increased from RMB156/tonne in January 2007 toRMB294/tonne in July 2009, according to CCTD. Although part of the cost increasecan be attributed to higher wages and material costs under inflation pressure, we think,the main cost driver is growing levies and fees.While such cost increases do not provide a positive backdrop, the strong pricing powerof coal companies and a seller’s market nowadays would allow coal firms to pass oncost increases to its users, thus extending the strength in spot coal prices, in our view.Exhibit 55. China Coal: Unit production cost (RMB/t) 400 350 300 250 200 150 100 50 0 May-07 May-08 May-09 May-10 Mar-07 Nov-07 Mar-08 Nov-08 Mar-09 Nov-09 Mar-10 Jan-07 Jul-07 Sep-07 Jan-08 Jul-08 Sep-08 Jan-09 Jul-09 Sep-09 Jan-10 Jul-10Note: From 2009, CCTD only announce production cost data periodically.Source: CCTD, Nomura ResearchCoal price adjustment fund and coal sustainable development fundMajor coal production provinces such as Inner Mongolia, Shaanxi, Hunan, Guizhouand Sichuan have introduced a coal price adjustment fund (“CPAD”). For raw coal, theCPAD ranges from RMB8/tonne to RMB40/tonne, while the charge is betweenRMB25/tonne and RMB60/tonne for clean coal.Exhibit 56. China: Coal price adjustment fund (current) Raw coal Clean coal CokeProvince Year effective (RMB/tonne) (RMB/tonne) (RMB/tonne)Inner Mongolia 2009 8 or 15 * 20 n/aSichuan 2008 40 60 70Chongqing 2008 40 60 70Hunan 2008 35 35 35Shaanxi 2005 15 25 25Guizhou 2004 20** 20** 20*** RMB8/ tonne in Inner Mongolia apply to Lignite and RMB15/tonne apply to other type of raw coal. **Guizhou reduced CPAD from RMB50/t to RMB20/t in 2008Source: Xinhuanet, ccoalnew, fert.cn, chongqing government website, shaanxi government website, Nomura ResearchAlthough Shanxi is not charging the CPAD, it started to charge a levy in March 2007,after passing the proposal in 2006 and the ordinance in 2007; the proceeds flow to asustainable development fund (“SDF”). As of 2010, an RMB13-20/ tonne SDF chargeis applied to a regular coal mine and RMB40/tonne for unqualified coal mines. In 2009,Inner Mongolia received approval from the State Council for SDF, which might beintroduced soon. The CPAD and SFD charges for “Three West” areas add up RMB20-40/tonne to production costs.Nomura 36 18 January 2011
  • 38. Coal | China Ivan Lee, CFA / Matty ZhaoResources tax reformsCurrently, the local governments charge RMB3-5/tonne as resources tax, representingless than 1% of the spot price. According to our industry checks in early November2010, the coal resources tax reform, if imposed, would probably change from thecurrent volume-based format to a price-based and from 3% to 5% on the sales price.Currently, there is less clarity on the implementation timetable or which price the taxwill be based on. Ex-mine price approach: by applying 5% to the FY10 average ex-mine price (Shanxi Shuozhou gas coal 4,800kcal/kg) of RMB309/tonne, the new resource tax is RMB15/tonne in FY11F for domestic coal production. Thus, the incremental cost to a coal producer would be around RMB10-12/tonne. In our company analysis, we have taken the ex-mine price approach to calculate the cost. QHD spot price approach: the new resources tax is estimated to be RMB37/tonne by applying 5% to the FY10 average QHD spot price (Shanxi 5,500 Kcal/tonne), leading to an incremental cost of RMB32-34/tonne. However, we believe, the net effects to coal companies might not be very substantial as the costs are likely to be passed on to customers, such as IPPs, given that it is a sellers market these days. Given the prevailing high inflation and recent coal price hike, we believe the resources tax changes will only be released after 2011 contract price negotiations.Transportation costs is a big partAs discussed in the previous sections, given the demand- supply imparity, coal needsto be transported from Northwest to Southeast China by rail and sea. Given the longdistances, transportation costs are a major cost head for coal players: Railway cost from Shanxi to Qinghuangdao port is around RMB85-98/tonne (by applying RMB0.13-0.15 per ton per km for the Daqin line of 653km). Railway cost from Inner Mongolia is even higher due to the longer distance of around 300-500km to Datong. However, the higher transportation cost in Inner Mongolia is offset by lower production costs. Shipping costs vary from RMB50/ton to RMB100/ton in 2010, and peaked in Nov 10 due to winter stocking. Other fees: according to David Fang of China Coal Transport and Distribution Association, coal producers (especially small miners) need to pay RMB50-100/ tonne wagon fees to get railway capacity at the major coal producing provinces. We also estimate a loading fee and port handling fee of RMB50 per ton.Exhibit 57. Nomuras estimate of total unit costCost Item RMB/tonneCash production cost (including tax & fees) 260Depreciation 40Railway cost 90Shipping 50Others (wagon fees and loading fees) 100Total cost 540Note: The cost estimates are based on 5,500 Kcal/ tonne thermal coal and FOB spot sales. Cost for ex-mines salesand key contract sales would be lower.Source: Nomura researchNomura 37 18 January 2011
  • 39. Coal | China Ivan Lee, CFA / Matty ZhaoGovernment policyAppendix I: Policy development on coalDevelopment on the price intervention policyExhibit 58. Price intervention policy and news flow2008 price interventionTimeframe Particulars19 Jun, 2008 China announced a cap on thermal coal prices through the end of the year at the 19 June 2008 level (RMB830/tonne for 5,500Kcal/kg), while hiking diesel, gasoline and jet fuel prices immediately and raising retail electricity tariffs beginning 1 July 2008. However, the policy did not have an immediate impact on the spot price and coal price kept rising to RMB995/tonne as of 21 July 2008.24 Jul, 2008 NDRC issued another price cap policy. It required that the 5,500Kcal/kg thermal coal FOB price in QHD port and Tianjin port should not exceed RMB860/tonne and RMB840/tonne from the policy date to 31 Dec 2008. The spot price started to come down after the policy announcement. However, only until 27 Oct 2008, three months after this second price cap, did the QHD price come down to RMB860/tonne.Mid-2010 price interventionTimeframe Particulars25 Jun, 2010 In view of the large spread between contract and spot prices, some coal companies increased the contract price by RMB40-50/tonne in early 2010. In June, NDRC issued a document that required coal companies to honour the contract signed at the beginning of 2010 without increasing the price. Coal companies that raised prices, needed to return the extra amount back to customers.End 2010 key contract price interventionTimeframe ParticularsMid-Nov The Bureau of Economic Operations Adjustment of NDRC urged coal producing provinces and enterprises to help stabilise the supply chain this winter and self-regulate coal prices. In order to contain the impact of a spot price increase on downstream industries, it also urged coal enterprises to honour coal contracts.1 Dec, 2010 According to news on Xinhua, Cao Changhing, head of the Department of Price of NDRC, said during an internal conference that 2011 thermal contract price of key contract sales should be unchanged from the 2010 levels and any form of price increase is not allowed.6 Dec, 2010 NDRC issued the “2011 National coal production – transportation-demand” notice, reiterating its effort and intent to control prices of key coal contracts. As coal transportation bottlenecks are yet to be resolved in China, NDRC uses “railway transportation capacity allocation” as a tool to ensure that coal companies fulfil their key contracts. In the notice, NDRC said it would favour those corporations which have mid-long term contracts for 2011 and those which possess a history of high contract fulfilment rate when allocating railway transportation capacity. For FY11F, NDRC projects railway transportation capacity of 932mn tons, of which, 769 mn tons of capacity has been allocated for thermal coal transportation to IPPs, 94.53mn tons for non-ferrous metal production, 34.84mn tons for the chemical industry (fertilizers) and 33.63mn tons for residential use. The notice further mentioned that all key coal contracts above 300,000 tons in 2010 should be carried forward into 2011. (Source: CCTD)Source: NomuraCoal and energy consumption reduction initiativesExhibit 59. Recent news flow on coal/energy reduction initiativesTimeframe ParticularsMid-2010 According to Xinhua news, during its 12th FYP, the government is determined to drive its low-carbon development strategy and NDRC may target to reduce coal consumption from 70% of primary energy used now to 63% in 2015.3 Nov, 2010 According to Xinhua news, China’s coal association officials estimate Chinas coal demand to reach 3.8bn tons in 2015F. This represents an increase of 800mn tonnes from 2009, which translates into a CAGR of 3.9% for the 2009-15 period. Such a forecast is not only the unofficial view, but also too conservative and unlikely to be implemented, according to our industry checks.7 Jan, 2011 According to Xinhua, Zhang Ping, director of the National Development and Reform Commission (NDRC), said that China could meet its goal of reducing energy consumption per unit of gross domestic product (GDP) by around 20 percent from the 2005 levels by the end of 2010.Source: NDRC, XinhuaNomura 38 18 January 2011
  • 40. Coal | China Ivan Lee, CFA / Matty ZhaoDevelopment on resources tax and other surchargesExhibit 60. Resources tax, coal price adjustment fund and sustainable development fundDevelopment on coal resources taxTimeframe Particulars27 Oct, 2010 According to Xinhua news, the 12-FYP proposal published by the CPC Central Committee, quoted Chinese Premier Wen Jiabao saying that China should strengthen its reforms on resources and factor pricing, as well as undertake full-scale reforms on the resources tax on key commodities, such as coal. Currently, local governments charges RMB2-5/tonne as resources tax, representing less than 1% of the spot price. The coal resource tax reform, if imposed, would probably change from the current volume-based to price-based and from 3% to 5% on the sales price, in our view.Coal price adjustment fundYear effective Province Raw coal (RMB/tonne) Clean coal (RMB/tonne) Coke (RMB/tonne)2009 Inner Mongolia 8 or 15 * 20 n/a2008 Sichuan 40 60 702008 Chongqing 40 60 702008 Hunan 352005 Shaanxi 15 25 252004 Guizhou 20** RMB8/ tonne in Inner Mongolia apply to Lignite and RMB15/tonne apply to other type of raw coal. Guizhou reduced CPAD from RMB50/tonne toRMB20/tonne in 2008Sustainable development fund in Shanxi and Inner MongoliaTimeframe Particulars2006 Proposal for charging sustainable development fund (“SDF”) in the province of Shanxi passed.2007 The local government ordinance for SDF in Shanxi passed; charging of SDF became effective on 7 Mar, 20072009 Inner Mongolia received approval from the State Council for SDF.As at 2010 RMB13-20/ tonne SDF applied to regular coal mines and RMB40/tonne for unqualified coal mines in Shanxi.Source: Nomura research, xinhuanet, ccoalnew, fert.cn, Chongqing government web-site, Shaanxi government web-site, Nomura Research, gov.cnSmall mine consolidationExhibit 61. Policy and news flow on small mines consolidationPolicies and development in the Eleventh Five-Year PlanMining rights are only granted to coal mining projects of above 300,000 tons per annum.Phase out all mine shafts with less than 30,000 tons per annum by 2007.Phase out mine shafts of low capacity after 2007 through consolidation and technology upgrade with the following threshold:- Shanxi, Inner Mongolia, Shaanxi: 300,000 tons p.a.- Xinjiang, Gansu, Qinghai, Ningxia, Beijing, Hebei, N.E. and Easter regions: 150,000 tons p.a.- S.E. and Southern regions: 90,000 tons p.a.Reduce the number of small coal mines to 10,000 by the year 2010 by consolidating and closing down small coal mines under the threshold capacity of300,000 tons per annumClose down coal mines that are deemed unsafeReduce the total production of small coal mines to below 27% of national production from the 45% level in 2005.After a few high profile accidents in early 2009. Shanxi has imposed a stricter consolidation policy than the national requirement, in which the minimumproduction threshold to obtain a new license was 900,000 tons per annum. Moreover, the increased intensity of small mine crackdowns has led to a sharpdecline in the number of small mines by 60% to 1,053 from 2,598.Potential policies/targets in the Twelfth Five-Year PlanAccording to CCTD, further industry consolidation is a likely direction for China’s coal industry and the number of coal mines may be reduced to 4,000 bythe end of the Twelfth Five-Year Plan period.The Twelfth Five-Year Plan is likely to specify that the designed annual production capacity of coal mines should not be less than 300,000 tonnes/ year inall parts of China, and 600,000 tonnes/ year in national key planned mining areas, and 1.2mn tonnes/ year in major coal-producing provinces, includingShanxi, Inner Mongolia, Shaanxi, Xinjiang and Ningxia.The Twelfth Five-Year Plan policy can extend to the formation of big coal companies.The National Coal Conference, conducted in early November with Zhang Ping (Chairman of NDRC), has concluded the formation of ten super large scalecoal enterprises, with annual capacity of 100mn tons and above, followed by another 10 large scale coal enterprises with annual capacity of 50mn tons by2015 to be the strategic choice for China.Source: Cnstock, China.com.cn, Gov.cn, Chinasafety.gov.cn, Nomura researchNomura 39 18 January 2011
  • 41. Coal | China Ivan Lee, CFA / Matty ZhaoClassificationAppendix II: Industry knowhowExhibit 62. Coal classification in China SpecificationsType Symbol Vdaf PMAnthracite (无烟煤) WY <10.0%Bituminous (烟煤) YM >10.0%Lignite (褐煤) HM >37.0% <50% SpecificationsSub-Type of Anthracite (无烟煤) Symbol Vdaf HdafAnthracite no.1 (无烟煤一号) WY1 0 - 3.5% 0 - 2.0%Anthracite no.2 (无烟煤二号) WY2 >3.5% - 6.5% >2.0% - 3.0%Anthracite no.3 (无烟煤三号) WY3 >6.5% - 10.0% >3.0% SpecificationsSub-Type of Bituminous (烟煤) Symbol Vdaf G Y bMeager coal (贫煤) PM >10.0% - 20.0% =<5Meager lean coal (贫瘦煤) PS >10.0% - 20.0% >5 - 20Lean coal (瘦煤) SM >10.0% - 20.0% >20 - 50 >10.0% - 20.0% >50 - 65Coking coal (焦煤) JM >10.0% - 20.0% >65 <25.0mm <150% >20.0% - 28.0% >50 - 65 >20.0% - 28.0% >65 <25.0mm <150%Fat coal (肥煤) FM >0.0 - 20.0% >85 >25.0mm >150% >20.0% - 28.0% >85 >25.0mm >150% >28.0% - 37.0% >85 >25.0mm >220%1/3 Coking coal (1/3焦煤) 1/3JM >28.0% - 37.0% >65 <25.0mm <220%Gas-fat coal (气肥煤) QF >37.0% >85 >25.0mm >220%Gas coal (气煤) QM >28.0% - 37.0% >50 - 60 >37.0% >35 - 50 >37.0% >50 - 65 >37.0% >65 <25.0mm <220%1/2 Weakly caking coal (1/2中粘煤) 1/2ZN >20.0% - 28.0% >30 - 50 >28.0% - 37.0% >30 - 50Weakly caking coal (弱粘煤) RN >20.0% - 28.0% >5 - 30 >28.0% - 37.0% >5 - 30Non-caking coal (不粘煤) BN <30.0% - 28.0% <5 >28.0% - 37.0% <5Long flame coal (长焰煤) CY >37.0% <5 >37.0% <5 - 35 SpecificationsSub-Type of Lignite (褐煤) Symbol PM Q-A.GNLignite no. 1 (褐煤一号) HM1 0 - 30 -Lignite no. 2 (褐煤二号) HM2 >30 - 50 <24MJ/kgSource: coalprice.cn, Nomura ResearchExhibit 63. Coal classificationType Sub-type Major use Heat content PriceAnthracite (无烟煤) Domestic/industrial High HighBituminous (烟煤) Coking coal (焦煤) Manufacture of iron and steel Thermal coal (动力煤) Power generation, industrial useLignite (褐煤) Largely power generation/domestic Low LowSource: ccwestc, world coal institute, sxcoal, Nomura estNomura 40 18 January 2011
  • 42. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 64. Price type Ex-wash (出 厂 价 ) Price after processing (such as w ashing) Include: Ex-mine price, plus processing (w ashing) fee F.O.B. (Railway) F.O.B. (Ship) Ex-mine (坑 口 价 ) (车板价) (平 仓价) Price at the mine mouth Price w hen coal is on freight Referred as port price train User Coal Mine Include: Tax and surcharges Include: F.O.B. (Railw ay) from the government Include: Ex-mine or ex-w ash plus railw ay & vehicle price plus transportation fee, port Exclude: Any transportation loading/transportation costs handling and ship loading nor misc. fee (mine to railw ay) and misc. fee cost charged by railw ay station Exclude: Shipment fee Exclude: Railw ay transportation feeSource: CCTD, Nomura ResearchNomura 41 18 January 2011
  • 43. Coal | China Ivan Lee, CFA / Matty ZhaoSector valuationSector valuationExhibit 65. Asia ex-Japan utilities stocks valuation summary (1/3) Reporting Share Free Price target Price Market cap EPS (local $) DPS (local $) Net profit (local $ m)Company Type Ticker currency o/s (mn) float Rating Local ($) Local ($) (US$mn) 09 10F 11F 09 10F 11F 09 10F 11FHongkong Electric Integrated 6 HK HKD 2,134.26 61.12 Buy 57.30 49.35 13,548.64 3.14 3.42 4.00 2.11 2.11 2.11 6,697.00 7,306.68 8,540.58CLP Holdings Integrated 2 HK HKD 2,406.14 78.42 Neutral 65.20 64.65 20,010.19 3.41 4.19 4.01 2.48 2.48 2.45 8,195.96 10,083.15 9,647.96Hong Kong & China Gas Gas 3 HK HKD 7,182.32 98.17 Reduce 16.50 18.24 16,851.97 0.79 0.67 0.74 0.35 0.35 0.40 5,175.00 4,838.54 5,294.60CKI Integrated 1038 HK HKD 2,254.21 15.17 Neutral 38.60 36.20 10,496.97 2.47 2.24 3.31 1.14 1.20 1.23 5,568.00 5,060.37 7,466.26HK utilities average 15,226.94 2.45 2.63 3.02 1.52 1.53 1.55 6,408.99 6,822.18 7,737.35Datang Intl IPP 991 HK CNY 12,480.04 33.03 Neutral 3.10 2.77 11,213.03 0.14 0.13 0.16 0.03 0.06 0.05 1,612.32 1,560.42 2,045.24Huaneng Power Intl IPP 902 HK CNY 12,055.38 44.22 Buy 5.30 4.19 11,040.74 0.41 0.25 0.31 0.10 0.23 0.14 4,929.54 2,974.71 3,746.24Huadian Power Intl IPP 1071 HK CNY 6,771.08 36.09 Neutral 1.80 1.55 3,389.74 0.19 0.11 0.10 - 0.06 0.03 1,157.17 682.55 709.23China Power Intl IPP 2380 HK CNY 5,083.91 44.15 Neutral 1.70 1.61 1,243.46 0.14 0.09 0.13 - 0.03 0.03 519.01 466.42 643.33China Resources Power IPP 836 HK HKD 4,683.43 33.60 Buy 18.90 13.40 8,135.08 1.20 0.98 1.17 0.25 0.27 0.23 5,317.39 4,604.08 5,465.72China power average 7,004.41 0.41 0.31 0.37 0.08 0.13 0.09 2,707.09 2,057.64 2,521.95China Shenhua Energy Coal 1088 HK CNY 19,890.00 27.00 Buy 41.00 34.40 87,946.00 1.59 1.91 2.29 0.53 0.64 0.76 31,706.00 37,998.73 45,585.29China Coal Energy Coal 1898 HK CNY 13,258.66 44.00 Neutral 13.90 12.90 21,984.00 0.59 0.79 0.87 0.15 0.21 0.23 7,834.30 10,515.78 11,594.90Yanzhou Coal Mining Coal 1171 HK CNY 4,918.40 40.00 Buy 30.40 25.45 16,089.00 0.84 1.52 1.87 0.40 0.45 0.56 4,117.28 7,459.37 9,189.89China coal average 42,006.33 1.01 1.41 1.68 0.36 0.43 0.52 14,552.53 18,657.96 22,123.36Suntech Solar STP US USD 179.05 70.47 Buy 11.00 9.23 1,662.77 0.49 0.86 1.02 - - - 87.72 154.05 182.77Canadian Solar Solar CSIQ US USD 41.35 69.50 Neutral 17.00 14.23 607.83 0.51 1.59 1.67 - - - 21.18 65.78 68.93Trina Solar Solar TSL US USD 69.93 70.00 Buy 36.00 27.40 2,163.13 2.28 3.01 3.46 - - - 123.99 210.55 241.79Yingli Green Solar YGE US USD 149.43 63.17 Buy 15.00 10.85 1,610.32 (3.31) 7.85 9.82 - - - (459.24) 1,172.99 1,466.80LDK Solar Solar LDK US USD 131.42 29.00 Neutral 14.00 12.69 1,667.84 (1.72) 2.00 1.74 - - - (223.18) 262.95 228.25JA Solar Solar JASO US USD 162.67 63.17 Neutral 10.00 7.88 1,324.12 (0.11) 1.31 1.38 - - - (13.24) 213.01 225.20Solargiga Solar 757 HK CNY 1,627.54 - Reduce 1.10 1.78 486.47 (0.06) 0.16 0.19 0.02 - - (98.14) 278.11 314.58GCL Poly Solar 3800 HK CNY 15,471.55 47.50 Neutral 2.45 3.32 7,769.16 (0.00) 0.08 0.08 - - - (175.98) 3,318.80 3,357.70China solar average 2,161.45 (0.24) 2.11 2.42 0.00 - - (92.11) 709.53 760.75China Everbright Intl Water 257 HK HKD 3,639.32 51.57 Buy 6.10 4.03 1,893.44 0.11 0.16 0.21 0.02 0.02 0.03 367.04 593.05 759.66Guangdong Investment Water 270 HK HKD 6,253.69 38.88 Buy 5.50 4.21 3,374.38 0.32 0.38 0.40 0.10 0.11 0.13 2,007.79 2,340.92 2,494.82China Water Affairs Water 855 HK HKD 1,327.67 81.51 Buy 4.10 3.00 526.56 0.02 0.11 0.15 - 0.03 0.05 25.13 141.02 197.89Beijing Enterprises Water Water 371 HK HKD 7,860.85 38.65 Buy 3.30 3.21 1,885.71 0.07 0.10 0.13 - - - 207.37 417.61 785.87Hyflux Limited Water HYF SP SGD 570.51 68.57 Neutral 2.33 2.38 1,586.97 0.14 0.14 0.18 0.02 0.03 0.03 75.04 76.53 100.87Sound Global Ltd Water 967 HK CNY 1,385.38 45.60 Buy 6.40 4.99 973.47 0.22 0.25 0.32 0.04 0.04 - 280.54 322.77 427.08Tianjin Capital Water 1065 HK CNY 1,427.23 90.03 Reduce 2.10 2.94 1,454.93 0.17 0.20 0.16 0.04 0.08 0.10 242.98 289.49 222.77China water average 1,472.49 0.15 0.19 0.22 0.03 0.04 0.05 457.98 597.34 712.71ENN Energy Gas 2688 HK CNY 1,050.15 0.64 Neutral 24.10 25.65 4,073.55 0.78 0.97 1.14 0.16 0.19 0.24 800.63 1,016.48 1,194.91Towngas China Gas 1083 HK HKD 2,443.36 0.24 Neutral 3.40 4.05 1,275.75 0.14 0.16 0.19 0.01 0.02 0.03 265.09 352.11 469.85China Resources Gas Gas 1193 HK HKD 1,831.07 0.25 Buy 14.80 10.84 2,553.30 0.31 0.46 0.60 - 0.06 0.08 443.59 743.13 1,101.75China Gas Gas 384 HK HKD 4,357.95 0.57 Reduce 3.70 3.39 1,911.34 0.03 0.26 0.19 0.01 0.01 0.01 103.68 875.64 747.40Beijing Enterprises Gas 392 HK HKD 1,187.60 0.46 Buy 70.50 47.20 6,905.66 2.11 2.67 3.11 0.65 0.65 0.82 2,398.88 3,030.65 3,538.48China gas average 3,343.92 0.67 0.90 1.05 0.17 0.19 0.24 802.38 1,203.60 1,410.48China High Speed Wind 658 HK CNY 1,375.06 78.00 Buy 22.00 12.66 2,632.65 0.78 1.02 1.33 0.22 0.26 0.31 966.38 1,401.61 1,828.64China Longyuan Wind 916 HK CNY 7,464.29 71.60 Reduce 7.60 7.58 8,556.42 0.15 0.25 0.35 - - - 894.13 1,881.95 2,594.98China wind average 5,594.53 0.46 0.64 0.84 0.11 0.13 0.15 930.25 1,641.78 2,211.81China Yangtze Power Hydro 600900 CH CNY 11,000.00 32.32 Buy 11.00 7.70 19,213.61 0.58 0.72 0.73 0.22 0.30 0.42 5,689.61 7,932.83 7,978.28Korea Electric Power Integrated 015760 KS KRW 641.57 45.97 Buy 43,000.00 28,750.00 16,480.95 (197.33) (399.30) 1,451.04 - - - (126.60) (256.18) 930.94Korea Gas Gas 036460 KS KRW 72.61 32.00 Buy 52,000.00 46,550.00 3,209.21 3,277.85 2,810.06 3,870.08 1,170.00 983.36 843.02 238.00 204.03 281.00Korea utilities average 9,845.08 1,540.26 1,205.38 2,660.56 585.00 491.68 421.51 55.70 (26.07) 605.97E-Ton Solar Tech Solar 3452 TT TWD 204.65 72.66 Reduce 37.00 46.85 401.83 (11.43) (1.98) 2.11 0.50 - - (2,339.94) (404.70) 432.54Motech Industries Solar 6244 TT TWD 376.44 60.90 Neutral 119.00 117.00 1,530.07 0.11 12.14 13.20 3.00 2.00 2.00 33.19 4,568.55 4,967.73Taiwan solar average 965.95 (5.66) 5.08 7.66 1.75 1.00 1.00 (1,153.38) 2,081.93 2,700.14IndonesiaPerusahaan Gas Negara Gas PGAS IJ IDR 23,782.02 43.04 Buy 5,100.00 4,200.00 11,234.06 221.39 268.61 305.21 43.54 130.96 137.71 5,265.09 6,388.19 7,258.61Glow IPP GLOW TB THB 1,439.00 24.97 Buy 55.00 43.00 2,072.59 2.53 3.52 3.63 1.74 1.82 1.91 3,699.00 5,067.12 5,219.67Electricity Generating IPP EGCO TB THB 526.47 39.81 Buy 110.00 109.00 1,890.76 14.26 13.27 12.63 5.00 5.00 5.05 7,506.42 6,984.84 6,651.61Ratchaburi Generating IPP RATCH TB THB 1,450.00 34.46 Buy 41.00 40.50 1,934.93 4.64 3.97 4.02 2.21 2.25 2.28 6,731.72 5,758.57 5,824.68Thai power average 1,966.09 7.14 6.92 6.76 2.98 3.02 3.08 5,979.05 5,936.84 5,898.65Tenaga Nasional Integrated TNB MK MYR 4,337.05 40.65 Neutral 9.60 6.55 11,687.19 0.50 0.59 0.64 0.15 0.13 0.25 2,157.10 2,569.00 2,795.91YTLP Integrated YTLP MK MYR 6,753.12 39.21 Neutral 2.28 2.42 5,759.17 0.11 0.18 0.19 0.11 0.13 0.11 646.59 1,126.40 1,264.11Malaysia utilities average 8,723.18 0.31 0.39 0.42 0.13 0.13 0.18 1,401.85 1,847.70 2,030.01Energy Development Corp Power EDC PM PHP 18,750.00 58.19 Buy 6.40 5.95 2,534.59 0.39 0.45 0.47 0.28 0.10 0.11 7,380.90 8,347.50 8,731.91Meralco Power MER PM PHP 1,127.71 69.10 Reduce 134.10 290.00 7,427.04 2.05 13.33 16.58 1.78 2.50 4.00 2,272.00 15,028.18 18,693.52Philippines utilities average 4,980.81 1.22 6.89 8.52 1.03 1.30 2.05 4,826.45 11,687.84 13,712.72Suzlon WTG SUEL IN INR 1,556.72 37.01 Neutral 88.80 53.65 2,112.68 9.09 7.67 1.33 1.03 - - 13,153.10 11,327.70 2,025.30NTPC IPP NATP IN INR 8,245.47 11.97 Buy 228.00 191.50 34,984.09 7.46 9.67 10.41 - 4.21 4.44 61,547.00 79,767.47 85,857.50JSW Energy Integrated JSW IN INR 1,640.06 31.15 Neutral 100.00 91.85 3,337.52 5.06 4.55 7.34 - - 0.87 2,766.88 7,454.90 12,042.91Adani Power Integrated ADANI IN INR 2,180.04 26.55 Neutral 148.00 122.60 5,921.62 (0.03) 0.78 3.82 - - - (49.87) 1,701.07 8,325.99Power Grid Grid PWGR IN INR 4,629.73 18.88 Buy 128.00 97.25 9,975.42 4.18 5.08 6.06 - 1.40 1.75 17,609.70 21,372.10 26,345.50Reliance Power Integrated RPWR IN INR 2,805.08 18.40 Reduce 136.00 149.80 9,309.88 1.02 2.85 3.03 - - - 2,445.10 6,838.95 7,752.07Lanco Infratech Integrated LANCI IN INR 24,078.05 25.90 Buy 7.60 56.45 3,011.42 1.26 2.05 3.22 - - - 2,803.63 4,585.73 7,762.83India average 5,611.42 3.43 3.83 4.13 0.17 0.23 0.44 6,454.76 8,880.07 10,709.10AustraliaAGL ENERGY LTD Integrated AGK AU AUD 4,582.23 99.09 Buy 17.85 15.15 7,009.59 0.85 0.96 1.03 0.53 0.54 0.59 378.80 428.90 471.56Note: Ratings and Price Targets are as of the date of the most recently published report rather than the date of this document. Priced on 12 Jan, 11 market close.Market cap est. using H-Shares price alone, may have minor variance with other est. presented in this report Source: Bloomberg, Nomura est.Nomura 42 18 January 2011
  • 44. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 66. Asia ex-Japan utilities stocks valuation summary (2/3) EPS growth (%) DPS growth (%) Net earnings growth (%) Net Gearing (%) EV/MW (local $) P/E (x) Yield (%)Company 09 10F 11F 09 10F 11F 09 10F 11F 09 10F 11F 09 10F 11F 09 10F 11F 09 10F 11FHongkong Electric (16.59) 9.10 16.89 - - 4.32 (16.59) 9.10 16.89 13.72 32.09 24.25 NA NA NA 15.73 14.42 12.33 4.28 4.28 4.46CLP Holdings (21.31) 23.03 (4.32) (0.07) (1.15) 1.41 (21.37) 23.03 (4.32) 44.43 40.77 58.65 NA NA NA 19.00 15.44 16.14 3.83 3.79 3.84Hong Kong & China Gas 21.89 (14.37) 9.43 (0.01) 14.28 12.50 20.28 (6.50) 9.43 22.07 22.45 22.94 NA NA NA 23.18 27.08 24.74 1.92 2.19 2.47CKI 25.89 (9.12) 47.54 5.78 2.82 34.13 25.89 (9.12) 47.54 net cash 9.35 9.96 NA NA NA 14.66 16.13 10.93 3.32 3.41 4.57HK utilities average 2.47 2.16 17.39 1.43 3.99 13.09 2.05 4.13 17.39 26.74 26.16 28.95 NA NA NA 18.14 18.26 16.04 3.34 3.42 3.84Datang Intl 111.22 (3.70) 24.33 111.77 (8.65) 31.07 111.77 (3.22) 31.07 515.63 583.45 607.44 6.13 5.57 5.38 18.05 19.76 15.08 2.29 2.09 2.74Huaneng Power Intl NA (39.66) 25.94 127.35 (39.66) 25.94 NA (39.66) 25.94 295.43 289.87 287.93 3.57 3.29 3.06 9.14 15.15 12.03 6.08 3.67 4.62Huadian Power Intl NA (44.47) (1.85) NA (47.55) 3.91 NA (41.02) 3.91 415.41 474.64 541.07 2.49 1.82 1.47 7.19 13.72 13.20 4.34 2.27 2.36China Power Intl NA (34.09) 37.93 NA (10.13) 37.93 NA (10.13) 37.93 271.97 166.28 190.06 2.12 1.75 1.65 14.07 15.65 11.35 2.13 1.92 2.64China Resources Power 189.46 (17.77) 18.71 9.49 (17.77) 18.71 209.61 (13.41) 18.71 134.43 124.62 114.07 5.50 5.09 4.65 11.80 13.63 11.48 2.05 1.69 2.00China power average 150.34 (27.94) 21.01 82.87 (24.75) 23.51 160.69 (21.49) 23.51 326.58 327.77 348.11 3.96 3.50 3.24 12.05 15.58 12.63 3.38 2.33 2.87China Shenhua Energy 19.01 19.85 19.97 15.21 19.85 19.97 19.01 19.85 19.97 6.00 1.16 net cash NA NA NA 19.04 15.32 12.00 1.75 2.17 2.77China Coal Energy 3.71 34.23 10.26 147.56 34.23 10.26 9.86 34.23 10.26 net cash 13.61 21.94 NA NA NA 19.26 13.84 11.79 1.35 1.88 2.21Yanzhou Coal Mining (36.55) 81.16 23.20 135.29 12.84 23.20 (36.55) 81.17 23.20 47.98 53.53 50.54 NA NA NA 26.82 14.28 10.89 1.78 2.08 2.73China coal average (4.61) 45.08 17.81 99.36 22.31 17.81 (2.56) 45.08 17.81 26.99 22.77 36.24 NA NA NA 21.71 14.48 11.56 1.63 2.05 2.57Suntech (62.39) 75.62 18.64 NA NA NA (56.26) 75.62 18.64 38.93 59.83 51.77 NA NA NA 19.18 10.92 9.21 - - -Canadian Solar (26.17) 210.55 4.79 NA NA NA (3.29) 210.55 4.79 26.13 65.82 79.70 NA NA NA 28.50 9.18 8.76 - - -Trina Solar 41.50 32.31 14.84 NA NA NA 54.11 69.81 14.84 15.80 net cash net cash NA NA NA 13.84 10.22 8.90 - - -Yingli Green (163.55) NA 24.99 NA NA NA (170.24) NA 25.05 13.33 50.65 68.74 NA NA NA NA 9.34 7.30 - - -LDK Solar (356.68) NA (13.20) NA NA NA (417.81) NA (13.20) 157.13 182.39 263.36 NA NA NA NA 6.34 7.31 - - -JA Solar (125.95) NA 5.70 NA NA NA (119.12) NA 5.72 net cash 18.96 16.15 NA NA NA NA 6.04 5.71 - - -Solargiga (147.32) NA 18.49 (100.00) NA NA (148.26) NA 13.11 9.09 net cash 13.98 NA NA NA NA 9.08 7.66 - - -GCL Poly (109.07) NA 0.27 NA NA NA (109.15) NA 1.17 28.08 7.93 0.73 NA NA NA NA 13.77 12.61 - - -China solar average (118.70) 106.16 9.31 NA NA NA (121.25) 118.66 8.77 41.21 64.26 70.63 NA NA NA 20.51 9.36 8.43 - - -China Everbright Intl 18.52 50.58 28.09 29.16 59.47 28.09 28.05 61.58 28.09 23.55 41.00 60.77 NA NA NA 37.83 24.91 19.31 0.51 0.82 1.05Guangdong Investment (0.08) 15.93 6.23 10.00 14.18 6.20 0.81 16.59 6.57 23.31 15.84 7.27 NA NA NA 13.22 11.34 10.64 2.61 2.98 3.17China Water Affairs (42.72) 441.80 33.94 NA 67.04 5.00 (43.22) 461.26 40.33 53.41 71.55 74.88 NA NA NA 144.10 28.24 21.50 1.00 1.67 1.75Beijing Enterprises Water 38.01 57.77 21.88 NA NA NA 436.38 101.39 88.18 88.34 121.91 40.63 NA NA NA 45.57 30.93 25.38 - - -Hyflux Limited 26.76 (2.33) 26.94 80.79 (13.47) 49.78 27.10 1.99 31.81 63.95 136.35 166.28 NA NA NA 16.98 17.43 14.05 1.43 1.24 1.86Sound Global Ltd 32.72 15.05 27.60 4.11 (100.00) NA 37.75 15.05 32.32 net cash net cash net cash NA NA NA 20.14 17.51 13.72 0.84 - -Tianjin Capital 5.16 19.14 (23.05) 100.00 19.14 (23.05) 5.16 19.14 (23.05) 78.07 40.76 36.31 NA NA NA 15.54 13.05 16.95 3.02 3.60 2.77China water average 11.20 85.42 17.38 44.81 7.73 13.21 70.29 96.71 29.18 55.11 71.23 64.36 NA NA NA 41.91 20.49 17.37 1.35 1.47 1.51ENN Energy 24.38 24.52 17.55 22.06 26.96 17.55 26.94 26.96 17.55 61.45 49.89 28.97 NA NA NA 30.57 23.69 19.24 0.82 1.09 1.34Towngas China 31.03 18.15 20.20 99.99 44.11 33.44 31.05 32.83 33.44 27.99 20.59 18.29 NA NA NA 29.95 25.75 21.39 0.49 0.71 0.95China Resources Gas (49.57) 46.02 31.39 NA 35.28 48.26 49.37 67.53 48.26 48.94 net cash net cash NA NA NA 34.57 23.67 18.02 0.55 0.75 1.11China Gas (29.23) 741.87 (26.05) 3.50 15.75 20.00 (26.50) 744.56 (14.64) 256.39 229.05 69.18 NA NA NA 115.67 16.67 23.59 0.35 0.41 0.49Beijing Enterprises 5.21 26.34 16.76 0.01 26.31 11.84 5.13 26.34 16.76 4.91 8.38 3.47 NA NA NA 22.95 18.50 15.84 1.38 1.74 1.95China gas average (3.63) 171.38 11.97 31.39 29.68 26.22 17.20 179.64 20.27 79.94 76.98 29.97 NA NA NA 46.75 21.66 19.61 0.72 0.94 1.17China High Speed 39.56 31.32 30.47 20.00 15.83 30.47 39.57 45.04 30.47 78.40 0.81 16.79 NA NA NA 14.28 11.10 8.31 2.40 2.87 3.83China Longyuan 119.09 70.54 37.89 NA NA NA 165.00 110.48 37.89 76.73 140.02 182.23 NA NA NA 44.61 25.81 18.16 - - -China wind average 79.33 50.93 34.18 20.00 15.83 30.47 102.29 77.76 34.18 77.56 70.42 99.51 NA NA NA 29.44 18.45 13.23 1.20 1.43 1.91China Yangtze Power 38.90 24.33 0.57 40.18 39.43 0.57 44.76 39.43 0.57 148.40 127.30 124.31 NA NA NA 14.89 10.68 10.62 3.93 5.48 5.51Korea Electric Power NA NA NA NA NA NA NA NA NA 78.88 80.16 77.49 NA NA NA NA NA 20.30 - - 1.59Korea Gas (28.06) (14.27) 37.72 (15.95) (14.27) 37.72 (28.06) (14.27) 37.72 403.35 510.39 543.02 NA NA NA 14.20 16.57 12.03 2.11 1.81 2.49Korea utilities average (28.06) (14.27) 37.72 (15.95) (14.27) 37.72 (28.06) (14.27) 37.72 241.12 295.27 310.25 NA NA NA 14.20 16.57 16.16 1.06 0.91 2.04E-Ton Solar Tech (196.62) NA NA (100.00) NA NA (292.84) NA NA 87.79 82.79 82.20 NA NA NA NA NA 22.17 - - -Motech Industries (98.80) 10,912.01 8.74 (33.37) - - (98.55) 13,666.50 8.74 24.82 net cash net cash NA NA NA 1,061.61 9.64 8.87 1.71 1.71 1.71Taiwan solar average (147.71) 10,912.01 8.74 (66.69) - - (195.69) 13,666.50 8.74 56.30 82.79 82.20 NA NA NA 1,061.61 9.64 15.52 0.85 0.85 0.85IndonesiaPerusahaan Gas Negara 39.29 21.33 13.63 200.78 5.15 12.93 44.35 21.33 13.63 38.27 6.49 net cash NA NA NA 18.97 15.64 13.76 3.12 3.28 3.70Glow (2.34) 39.33 3.01 5.01 5.00 5.00 (2.28) 36.99 3.01 131.25 184.11 197.57 NA NA NA 17.02 12.21 11.86 4.24 4.45 4.67Electricity Generating 0.21 (6.95) (4.77) - 1.00 1.00 0.21 (6.95) (4.77) 9.61 1.41 net cash NA NA NA 7.64 8.22 8.63 4.59 4.63 4.68Ratchaburi Generating 3.20 (14.46) 1.15 1.80 1.50 1.50 3.20 (14.46) 1.15 35.63 25.65 17.95 NA NA NA 8.72 10.20 10.08 5.56 5.64 5.72Thai power average 0.35 5.98 (0.20) 2.27 2.50 2.50 0.38 5.19 (0.20) 58.83 70.39 107.76 NA NA NA 11.13 10.21 10.19 4.79 4.91 5.03Tenaga Nasional (15.77) 19.03 8.83 (10.74) 84.99 (37.68) (15.73) 19.10 8.83 63.26 44.89 41.67 NA NA NA 13.17 11.06 10.16 2.03 3.76 2.34YTLP (43.24) 56.71 5.22 15.05 (11.17) 1.50 (37.76) 74.21 12.23 277.77 206.23 202.96 NA NA NA 29.43 16.84 15.25 5.35 4.75 4.82Malaysia utilities average (43.25) 29.46 6.88 (13.82) 24.61 (8.36) (13.62) 33.30 3.65 160.16 115.32 108.82 NA NA NA 18.89 13.70 13.36 3.83 4.36 3.92Energy Development Corp 26.21 13.10 4.61 (64.75) 11.63 25.53 26.49 13.10 4.61 125.84 81.68 69.80 NA NA NA 15.12 13.36 12.78 1.68 1.87 2.35Meralco (19.18) 549.92 24.39 40.82 59.87 45.12 (18.86) 561.45 24.39 51.96 53.40 30.34 NA NA NA 141.43 21.76 17.49 0.86 1.38 2.00Philippines utilities average 3.51 281.51 14.50 (11.96) 35.75 35.32 3.82 287.27 14.50 88.90 67.54 50.07 NA NA NA 78.27 17.56 15.14 1.27 1.62 2.17Suzlon (15.62) (82.71) 329.60 (100.00) NA NA (13.88) (82.12) 337.87 137.25 105.38 112.95 NA NA NA 7.36 42.70 9.75 - - -NTPC NA 29.60 7.63 NA 5.50 5.06 NA 29.60 7.63 net cash 34.23 43.30 NA NA NA 25.66 19.80 18.39 2.20 2.32 2.44JSW Energy NA (10.21) 61.54 NA NA (100.00) NA 169.43 61.54 net cash 126.27 118.81 NA NA NA 18.14 20.21 12.51 - 0.95 -Adani Power NA NA 389.46 NA NA NA NA NA 389.46 net cash 162.77 293.10 NA NA NA NA 157.12 32.10 - - -Power Grid NA 21.37 19.32 NA 24.72 19.87 NA 21.37 23.27 net cash 195.37 152.34 NA NA NA 23.24 19.15 16.05 1.44 1.80 2.16Reliance Power NA 179.70 6.35 NA NA NA NA 179.70 13.35 net cash net cash 16.42 NA NA NA 146.84 52.50 49.36 - - -Lanco Infratech NA 62.24 57.61 NA NA NA NA 63.56 69.28 net cash 197.92 360.74 NA NA NA 44.77 27.92 17.51 - - -India average (15.62) 34.08 143.98 (100.00) 24.72 (40.07) (13.88) 70.39 149.13 137.25 157.54 175.72 NA NA NA 48.07 53.27 22.88 0.24 0.46 0.36AustraliaAGL ENERGY LTD 4.12 12.47 8.15 1.89 9.26 5.08 6.55 13.23 9.95 8.50 7.25 9.24 NA NA NA 17.85 15.87 14.68 3.56 3.89 4.09Note: Ratings and Price Targets are as of the date of the most recently published report rather than the date of this document. Priced on 12 Jan, 11 market close.Market cap est. using H-Shares price alone, may have minor variance with other est. presented in this report Source: Bloomberg, Nomura est.Nomura 43 18 January 2011
  • 45. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 67. Asia ex-Japan utilities stocks valuation summary (3/3) Dividend payout (%) BV/share (local $) P/B (x) EV/EBIDTA (x) EBIDTA Margin (%) RoIC (%) RoE (%) RoA (%)Company 09 10F 11F 09 10F 11F 09 10F 11F 09 10F 11F 09 10F 11F 09 10F 11F 09 10F 11F 09 10F 11FHongkong Electric 67.25 61.64 52.73 24.43 25.75 27.55 2.02 1.92 1.79 12.59 13.05 10.84 71.20 70.41 69.56 10.44 9.88 10.60 13.47 13.65 15.02 9.34 8.98 9.72CLP Holdings 72.79 59.13 61.09 29.38 31.11 32.65 2.20 2.08 1.98 10.73 10.32 9.54 29.66 28.47 27.59 8.13 9.20 8.00 12.27 13.85 12.57 5.66 6.30 5.47Hong Kong & China Gas 44.49 51.95 54.26 5.03 4.92 5.27 3.63 3.71 3.46 19.05 17.83 16.75 38.03 38.36 37.17 10.76 9.58 10.32 16.30 14.19 14.46 8.77 7.29 7.76CKI 45.96 53.49 37.28 18.73 23.13 24.56 1.93 1.56 1.47 19.93 16.88 11.54 7.78 22.62 26.93 10.55 8.46 11.83 14.12 10.73 13.89 11.51 8.77 11.56HK utilities average 57.62 56.55 51.34 19.39 21.23 22.51 2.44 2.32 2.18 15.57 14.52 12.17 36.67 39.97 40.31 9.97 9.28 10.19 14.04 13.10 13.98 8.82 7.84 8.63Datang Intl 19.52 42.92 31.54 2.22 2.23 2.32 1.11 1.11 1.06 11.08 16.75 12.91 29.73 22.55 26.25 1.37 1.02 1.15 6.18 5.78 7.20 0.94 0.77 0.89Huaneng Power Intl 24.46 92.14 44.15 3.49 3.60 3.74 1.07 1.04 1.00 9.16 10.71 9.94 23.13 17.79 17.22 4.09 2.26 2.74 12.49 6.95 8.46 2.71 1.47 1.79Huadian Power Intl - 56.17 30.02 2.67 2.45 2.52 0.52 0.57 0.55 8.73 9.88 9.55 23.02 21.34 22.00 1.95 1.02 0.91 8.41 4.18 4.22 1.24 0.62 0.56China Power Intl - 33.38 21.75 2.45 2.51 2.60 0.59 0.57 0.55 17.04 6.04 5.53 19.81 28.32 28.76 1.64 1.30 1.99 5.06 3.70 4.95 1.35 0.98 1.47China Resources Power 21.01 27.97 19.37 8.03 8.78 9.68 1.67 1.53 1.38 9.49 6.65 5.58 30.96 32.05 31.92 7.56 6.00 6.73 16.41 11.70 12.64 5.36 3.77 4.22China power average 13.00 50.52 29.37 3.77 3.91 4.17 0.99 0.96 0.91 11.10 10.00 8.70 25.33 24.41 25.23 3.32 2.32 2.70 9.71 6.46 7.49 2.32 1.52 1.79China Shenhua Energy 33.25 33.25 33.25 8.58 9.86 11.39 3.54 2.97 2.42 10.52 8.28 6.57 48.11 45.34 44.37 14.89 15.39 16.21 19.94 20.73 21.58 13.72 14.47 15.11China Coal Energy 26.08 26.08 26.08 4.84 5.43 6.08 2.35 2.02 1.70 11.05 8.27 7.21 25.44 26.34 26.15 10.78 12.31 12.05 12.76 15.44 15.20 9.06 10.13 9.24Yanzhou Coal Mining 47.78 29.76 29.76 5.93 6.99 8.30 3.79 3.10 2.45 17.14 9.20 7.11 35.29 38.39 39.62 12.31 12.05 13.60 14.73 23.48 24.43 10.58 12.27 12.61China coal average 35.70 29.70 29.70 6.45 7.43 8.59 3.22 2.70 2.19 12.91 8.58 6.96 36.28 36.69 36.71 12.66 13.25 13.95 15.81 19.88 20.40 11.12 12.29 12.32Suntech - - - 8.93 8.46 9.48 1.03 1.09 0.97 9.51 7.57 6.29 14.20 12.92 14.05 3.73 (3.86) 7.33 6.06 (5.63) 11.38 2.38 (2.20) 4.44Canadian Solar - - - 11.27 12.26 13.93 1.26 1.16 1.02 17.46 7.88 7.14 6.62 8.73 8.27 4.42 7.15 10.63 5.87 8.41 12.73 2.91 3.31 4.40Trina Solar - - - 12.43 15.24 18.72 2.20 1.80 1.46 12.07 5.75 5.63 22.25 24.54 22.45 8.84 13.99 13.67 17.58 24.16 20.37 7.84 11.86 11.23Yingli Green - - - 48.17 52.61 62.40 1.51 1.32 1.11 13.94 4.57 4.56 11.72 26.70 24.46 (5.32) 10.72 10.15 (8.01) 16.13 17.07 (3.36) 6.32 6.42LDK Solar - - - 6.84 8.77 10.51 1.85 1.45 1.21 NA 8.31 11.25 (13.38) 18.87 15.62 (13.15) 10.80 6.15 (26.83) 25.77 18.02 (5.75) 5.34 3.78JA Solar - - - 6.00 5.56 6.94 1.31 1.42 1.14 32.20 4.41 3.98 7.16 20.12 17.83 (1.27) 15.80 13.81 (1.91) 26.72 22.16 (1.23) 17.25 14.87Solargiga (25.35) - - 0.85 0.98 1.22 1.69 1.47 1.18 NA 3.60 5.11 (12.73) 19.27 18.66 (6.27) 14.67 29.59 (7.40) 18.22 17.25 (5.13) 11.98 11.57GCL Poly - - - 91.14 0.83 1.09 0.03 3.28 2.49 33.99 10.87 10.64 31.54 27.04 24.32 (1.21) 16.99 14.52 - - - (1.10) 12.81 11.15China solar average (3.17) - - 23.20 13.09 15.54 1.36 1.62 1.32 19.86 6.62 6.83 8.42 19.77 18.21 (1.28) 10.78 13.23 (1.83) 14.22 14.87 (0.43) 8.33 8.48China Everbright Intl 14.78 12.68 15.78 1.26 1.39 1.56 3.21 2.90 2.59 22.69 17.17 14.07 39.25 31.56 31.84 5.27 7.41 8.14 10.06 12.31 14.16 4.97 6.52 7.29Guangdong Investment 30.82 29.24 31.43 2.74 2.99 3.26 1.54 1.41 1.29 7.22 6.50 5.74 68.58 70.45 71.97 7.96 9.25 9.28 12.61 13.13 12.80 6.59 7.37 7.39China Water Affairs - 26.96 33.62 1.55 1.92 1.99 1.93 1.56 1.51 26.98 13.35 8.96 16.27 31.12 39.67 3.46 7.57 4.35 6.33 13.63 7.63 2.31 4.53 2.51Beijing Enterprises Water - - - 0.75 0.79 1.25 4.26 4.05 2.57 33.29 21.67 12.21 23.17 9.14 13.79 3.93 4.28 4.35 8.80 13.37 11.71 3.15 4.53 4.04Hyflux Limited 13.23 24.49 16.69 0.69 0.58 0.68 3.44 4.09 3.49 12.72 12.01 10.66 21.84 20.15 20.12 11.91 8.90 8.90 24.01 23.43 29.79 7.82 6.12 6.39Sound Global Ltd 16.22 14.68 - 1.20 1.45 1.98 3.66 3.03 2.22 13.92 11.60 7.57 25.36 22.56 21.88 16.44 11.76 10.99 19.64 18.92 18.55 11.71 10.06 10.03Tianjin Capital 23.50 39.44 61.07 2.31 2.42 2.50 1.15 1.10 1.06 9.01 7.72 9.96 57.39 51.67 43.33 4.17 5.12 4.11 7.59 8.59 6.35 3.29 4.24 3.48China water average 14.08 21.07 22.65 1.50 1.65 1.89 2.74 2.59 2.10 17.98 12.86 9.88 35.98 33.81 34.66 7.59 7.76 7.16 12.72 14.77 14.43 5.69 6.20 5.88ENN Energy 20.09 19.69 21.27 4.92 5.64 6.49 4.60 3.87 3.17 12.58 10.70 8.18 23.65 19.84 18.13 8.42 9.04 9.22 17.00 18.34 18.75 5.13 5.63 5.61Towngas China 7.39 12.50 14.99 3.29 3.45 3.61 1.23 1.17 1.12 17.52 13.54 10.97 22.61 20.90 19.37 2.77 3.23 4.10 3.84 4.45 5.12 2.44 2.85 3.42China Resources Gas - 13.10 13.49 0.73 3.33 3.81 14.87 3.25 2.84 25.99 12.51 8.24 20.71 19.33 20.37 10.01 8.75 10.97 27.21 20.85 16.85 6.77 6.16 6.50China Gas 37.27 4.58 7.17 0.97 1.23 1.83 3.51 2.76 1.85 21.67 14.86 9.52 16.67 17.13 14.46 1.03 6.41 4.91 3.26 23.84 12.35 0.71 4.27 3.10Beijing Enterprises 30.82 24.39 26.39 27.52 29.48 32.22 1.71 1.60 1.46 10.37 9.14 7.80 17.51 16.73 15.09 6.21 6.78 7.20 7.87 9.35 9.86 4.33 4.91 5.26China gas average 19.11 14.85 16.66 7.48 8.63 9.59 5.18 2.53 2.09 17.63 12.15 8.94 20.23 18.78 17.48 5.69 6.84 7.28 11.84 15.36 12.58 3.88 4.76 4.78China High Speed 28.34 25.90 22.99 3.55 5.46 6.48 3.06 1.90 1.60 11.92 7.47 6.36 27.45 24.38 24.51 12.63 13.36 14.81 23.71 23.51 22.28 10.33 10.44 10.65China Longyuan - - - 3.62 3.19 3.53 1.80 2.04 1.74 16.64 13.86 11.47 39.77 42.58 53.75 2.26 4.25 4.27 6.94 8.24 10.35 1.72 2.61 2.90China wind average 14.17 12.95 11.50 3.59 4.32 5.01 2.43 1.97 1.67 14.28 10.67 8.92 33.61 33.48 39.13 7.44 8.80 9.54 15.32 15.87 16.31 6.02 6.52 6.77China Yangtze Power 37.21 41.96 58.17 5.46 5.76 6.06 1.41 1.34 1.27 15.85 8.08 8.09 87.05 88.65 89.04 5.17 5.40 5.39 11.66 12.86 12.27 5.19 4.96 4.94Korea Electric Power - - - 64,169.95 70,307.59 78,815.95 0.45 0.41 0.36 7.46 7.75 6.41 19.52 17.63 19.58 (0.18) (0.33) 1.08 (0.31) (0.59) 1.95 (0.14) (0.26) 0.88Korea Gas 35.69 34.99 21.78 58,279.12 60,105.82 63,132.88 0.80 0.77 0.74 13.49 13.96 12.70 7.36 6.66 7.16 1.48 1.12 1.37 5.73 4.75 6.28 1.03 0.76 0.90Korea utilities average 17.85 17.50 10.89 61,224.53 65,206.70 70,974.41 0.62 0.59 0.55 10.48 10.85 9.55 13.44 12.15 13.37 0.65 0.39 1.23 2.71 2.08 4.11 0.44 0.25 0.89E-Ton Solar Tech (4.37) - - 43.41 41.64 43.75 1.08 1.13 1.07 NA 29.77 10.62 2.03 8.82 7.99 (13.32) (13.77) 2.50 (29.83) (26.56) 4.95 (11.65) (11.29) 2.05Motech Industries 2,723.59 16.48 15.16 42.45 62.20 74.65 2.76 1.88 1.57 34.00 5.36 4.86 7.85 21.14 18.62 0.14 14.62 13.80 0.25 25.24 19.29 0.14 14.51 12.01Taiwan solar average 1,359.61 8.24 7.58 42.93 51.92 59.20 1.92 1.50 1.32 34.00 17.57 7.74 4.94 14.98 13.30 (6.59) 0.42 8.15 (14.79) (0.66) 12.12 (5.76) 1.61 7.03IndonesiaPerusahaan Gas Negara 19.67 48.75 45.12 493.32 637.77 811.08 8.51 6.59 5.18 11.43 9.58 8.27 51.58 56.19 56.50 25.35 24.79 25.67 66.14 48.70 42.93 22.98 21.68 22.13Glow 68.70 51.78 52.78 21.14 23.13 24.84 2.03 1.86 1.73 12.78 13.09 12.87 23.04 25.09 25.67 6.09 5.88 4.96 13.80 15.78 15.12 5.42 5.33 4.50Electricity Generating 35.07 37.69 39.97 96.06 104.28 111.81 1.13 1.05 0.97 5.57 5.57 5.54 58.00 55.32 51.25 11.62 10.52 9.53 14.80 13.25 11.69 11.67 10.77 9.72Ratchaburi Generating 47.61 56.65 56.85 30.71 32.39 34.09 1.32 1.25 1.19 6.81 7.00 6.29 26.14 19.66 19.82 10.53 9.14 9.52 15.77 12.59 12.08 9.70 8.17 8.21Thai power average 50.46 48.71 49.87 49.30 53.27 56.92 1.50 1.38 1.30 8.38 8.55 8.23 35.72 33.36 32.25 9.41 8.51 8.00 14.79 13.87 12.97 8.93 8.09 7.47Tenaga Nasional 29.94 22.45 38.16 6.00 6.64 7.10 1.09 0.99 0.92 6.47 5.30 4.96 23.98 25.56 25.87 1.87 6.46 6.45 3.55 11.69 10.71 1.30 4.40 4.36YTLP 99.05 72.72 61.39 1.03 1.13 1.20 2.34 2.15 2.02 10.88 10.58 10.17 43.45 20.64 20.63 2.72 4.14 5.08 10.34 16.44 16.11 2.07 3.23 3.59Malaysia utilities average 64.81 51.09 53.38 5.06 5.74 6.08 2.04 1.81 1.71 8.73 7.90 7.77 32.21 24.98 24.49 3.39 6.10 6.07 9.33 15.73 14.04 2.38 4.39 4.28Energy Development Corp 71.85 22.39 23.90 1.54 2.01 2.33 3.87 2.96 2.55 13.97 9.27 9.03 47.96 57.43 56.17 5.50 14.57 11.18 11.86 31.32 21.37 4.30 12.81 10.86Meralco 86.60 18.76 24.12 50.87 57.33 68.10 5.70 5.06 4.26 26.53 12.48 10.16 7.14 12.68 14.44 2.26 13.43 15.32 4.13 24.63 26.43 1.33 8.81 10.65Philippines utilities average 79.22 20.58 24.01 26.20 29.67 35.22 4.79 4.01 3.40 20.25 10.88 9.59 27.55 35.06 35.30 3.88 14.00 13.25 8.00 27.97 23.90 2.82 10.81 10.76Suzlon 11.31 - - 57.61 57.39 63.09 0.93 0.93 0.85 6.23 8.95 7.43 12.42 9.29 10.74 1.12 0.85 3.51 2.83 2.31 9.46 0.73 0.58 2.58NTPC - 43.50 42.64 69.58 75.72 81.76 2.75 2.53 2.34 17.51 14.59 13.83 24.63 26.57 24.25 10.58 8.61 7.96 - 14.57 13.59 15.74 8.05 7.40JSW Energy - - 11.91 27.07 29.15 36.49 3.39 3.15 2.52 38.35 17.38 10.77 29.58 51.54 43.45 4.54 6.07 7.73 - 23.82 22.37 5.97 6.22 7.39Adani Power - - - 12.37 26.50 30.32 9.91 4.63 4.04 NA 148.20 32.75 NA 56.07 58.89 (0.08) 1.22 3.48 - 4.22 13.44 (0.13) 1.32 3.37Power Grid - 27.65 28.90 34.73 37.87 46.38 2.80 2.57 2.10 15.49 12.98 10.77 80.61 82.35 83.46 5.73 4.07 4.61 - 13.36 14.88 6.22 3.46 3.95Reliance Power - - - 57.49 60.34 61.26 2.61 2.48 2.45 NA NA 128.75 NA (517.87) 26.82 1.65 3.88 3.09 - 4.84 4.90 3.15 4.16 3.16Lanco Infratech - - - 9.43 13.89 17.12 5.98 4.06 3.30 20.32 13.24 9.39 14.63 18.83 27.01 5.08 4.28 4.67 - 16.85 20.80 4.86 3.33 3.47India average 1.89 4.61 6.80 33.12 37.52 42.44 4.27 2.97 2.54 20.10 40.15 33.31 34.31 (49.96) 41.73 3.01 3.39 4.52 0.47 10.90 14.31 3.47 3.18 3.99AustraliaAGL ENERGY LTD 62.37 56.51 57.09 13.06 12.89 13.28 1.16 1.18 1.14 9.22 9.17 8.54 11.40 11.93 11.88 9.66 5.12 6.48 13.27 6.12 7.80 7.77 4.02 5.18Note: Ratings and Price Targets are as of the date of the most recently published report rather than the date of this document. Priced on 12 Jan, 11 market close. Marketcap est. using H-Shares price alone, may have minor variance with other est. presented in this report Source: Bloomberg, Nomura est.Nomura 44 18 January 2011
  • 46. Coal | China Ivan Lee, CFA / Matty ZhaoValuation and RiskValuation methodology and key risksExhibit 68. Valuation methodology and key risks (1/3)Company Ticker Valuation methodology RisksAdani Power ADANI IN FCFF based using a 13% cost of equity (Rf =8%, Rm=6%, Beta=0.8x), we peg Risks for an upgrade – (1) 50% of 13.2GW target capacity attracts fuel security the milestone adjusted FCFE-based value of APL’s 13,200 MW generation risk. If APL secures fuel for the remaining 6.6GW capacity, our price target would capacity comprising Mundra (4620MW), Tiroda (3300 MW), Kawai (1320MW), see upside risk. (2) If APL defers/rescinds the 1,000MW PPA with GUVNL Chhindwara (1320MW) and Dahej (2640MW) at Rs148/share. @Rs2.35/kWh, currently set to become effective from the start-up of Mundra Phase-II in June 2011, then our forecast earnings and price target would rise sharply. Risks for a downgrade – (1) Lower-than-expected merchant tariff realisations; we assume Rs4.75/kWh, Rs4/kWh for FY12F/13F. (2) Ambiguity over delivered coal grade/cost at Mundra and margin of safety for AEL to supply at US$36/ton CIF are fuel-related concerns, which could result in higher effective cost/consumption of coal, thus impacting earnings negatively.AGL Energy AGK AU DCF (with a WACC of 9.3%, risk-free rate of 5.5%, terminal growth rate of 3.5% Competitors and customer loss, Electricity & gas supply and price, weather and equity market-risk premium of 6.0%) dependent, environmental concerns, Emissions trading scheme or carbon tax, potential source of funding.BJE 392 HK Our PT of HK$70.5 is based on a sum-of-the-parts (SOTP) valuation, which takes Risks to our positive view include: Risks to our positive view include: into account the different business nature and risk profile of BJE’s investments. 1) slower-than-expected sales growth for the gas, water and brewery businesses; We divided BJE into five parts: Piped gas operation. We value the piped gas 2) unfavourable regulatory changes to the above three segments; and 3) value- operation business using a DCF model, which assumes 0% terminal growth and destructive asset acquisitions. a WACC of 7.6%. Brewery. We value the brewery business using the current market value of 56.48%-owned Yanjing Beer. Water treatment. We value BEW using our price target for the stock. For Beijing No. 9 and the 10 Water Treatment Plant concession, we value the assets using a DCF model, assuming 0% terminal growth and a WACC of 7.6%. Expressway & toll road. We value the toll road business using a DCF model, assuming 0% terminal growth and a WACC of 7.6%.Other. We value the other businesses using EV/EBITDA and market value approaches.Beijing Enterprises Water 371 HK Our valuation methodology is based on DCF, assuming a WACC of 10.5% and a Our target prices are subject to growth assumptions in treatment volumes terminal growth rate of 2%. (including tap water supply, wastewater treatment, and waste-to-energy), tariffs, capacity and capex. Changes in the macro landscape and government regulations over the water industry may result in key changes in our forecasts, and hence our target prices.Canadian Solar CSIQ US We derive our new price target of US$17.0 (from US$12.20) based on a target Upside risks to our price target include: 1) Canadian Solar expanding margins multiple of 10.4x to FY11F earnings. ahead of our expectations on the back of faster cost reductions; and 2) faster sales diversification enabling it to improve market share. Downside risks to our price target: 1) Execution delays at its upstream integration into wafers; and 2) faster-than-expected subsidy reductions at European countries resulting in our worst-case demand scenario.China Coal 1898 HK Our PT is based on SOTP valuation, with a WACC of 11.6% and terminal growth Upside risk includes: 1) Bigger-than-expected output growth and 2) higher-than- rate of 2.5% for coal business DCF, while employing 9.4% WACC and 1% growth expected contract price. Downside risk includes: 1) lower-than-expected spot rate for equipment operation; 11.6% WACC and 1% terminal growth rate for price increase; 2) weaker coal demand due to weaker-than-expected economic coking operation growth in China and 3) higher-than-expected cost hike due to resource tax and inflation.China Everbright Intl 257 HK Our price target is derived using DCF, with a WACC of 10.0% and a 2% terminal Our target prices are subject to growth assumptions in treatment volumes growth rate (including tap water supply, wastewater treatment, and waste-to-energy), tariffs, capacity and capex. Changes in the macro landscape and government regulations over the water industry may result in key changes in our forecasts, and hence our target prices.China Gas 384 HK Our price target of HK$3.70 is based on DCF valuation, assuming 0% terminal Upside risks to our price target include: 1) higher than-expected gas volume growth, and a WACC of 7.6%. We do not incorporate any unapproved or sales to higher margin C&I and vehicle users; 2) value constructive acquisition; unannounced development projects or future acquisitions, or any projects without 3) continuous picking up for the LPG business margin and volume; and 4) specified commencement date. possibility of being an acquisition target amid industry consolidation in the long- term.China High Speed 658 HK Based on DCF valuation, with a WACC of 9.5% and terminal growth of 1% after Uncertainty of government policies for wind power; tightening global credit FY2020F. market; development of direct-drive wind turbine technology; the companys failure to improve technology to compete with foreign competitors; severe shortage of raw materials; delay in capacity expansion.China Power Intl 2380 HK DCF, (with a WACC of 9% and 2% terminal growth rate for 2023 and thereafter), Risks includes: Profit margins of the Chinese independent power producers are plus a 15% discount due to low market visibility, and 25% discount as risk not protected by contracts or regulatory regimes. Without any automatic pass- premium for its smaller market capitalisation. through mechanism, major cost items (eg, fuel cost) are subject to market price fluctuations. Competition and the macroeconomic downturn could also have a negative impact on generation output and plant utilisation over time.China Resources Gas 1193 HK Our price target of HK$14.8 is based on a sum-of-the-parts (SOTP) valuation, of We have a positive view on the company’s overall operation, but are wary of a which HK$12.29 comes from the existing 41 projects and HK$2.50 from to-be- macro slowdown and the implications on commercial and industrial (C&I) injected projects. For the to-be-injected projects, we assign a 50% discount to demand. Meanwhile, the value from future asset injections would be hurt by DCF value to reflect uncertainty over the timing and consideration. higher-than-expected considerations, in our view.China Resources Power 836 HK DCF (with a WACC of 9% and 2% terminal growth rate for 2023 and thereafter), Risks includes: Profit margins of the Chinese independent power producers are plus a 15% discount due to low market visibility. not protected by contracts or regulatory regimes. Without any automatic pass- through mechanism, major cost items (eg, fuel cost) are subject to market price fluctuations. Competition and the macroeconomic downturn could also have a negative impact on generation output and plant utilisation over time.China Shenhua 1088 HK Our PT is based on SOTP valuation, with a WACC of 11.4% and terminal growth Upside risk to our PT includes: (1) Higher-than-expected coal prices while rate of 2.5% for coal segment DCF valuation, while employing 10.0% WACC and downside risk includes: (1) weaker than expected economy recovery; (2) higher 1.0% terminal growth rate for non-coal segments. than expected cost hike and (3) higher coal import boosted by a unexpected RMB appreciationChina Water Affairs 855 HK Our price target is based on the sum-of-the-parts valuation methodology. We Our target prices are subject to growth assumptions in treatment volumes value the core business from water and infrastructure to deliver a DCF value of (including tap water supply, wastewater treatment, and waste-to-energy), tariffs, HK$3.10/share by employing a WACC of 10.5% with a 2% terminal growth rate capacity and capex. Changes in the macro landscape and government (up from 0% growth rate). Our price target factors in value from CWA’s land bank regulations over the water industry may result in key changes in our forecasts, – at HK$1.0/share. and hence our target prices.China Yangtze Power 600900 CH Sum-of-the-parts valuation, in which we value the hydropower business and 1) fluctuation in utilisation hours; 2) the pace and magnitude of potential tariff holding securities at RMB15.23 and RMB1.28, respectively, based on the number hikes; 3) A-share market trends; and 4) potential interest rate hikes. of shares post private placement to the parent, concluded on 29 September 2009CKI 1038 HK SOTP valuation based on 8.5% cost of equity for assets in Australia, Canada, Strengthening of US dollar and the Japanese yen, lower-than-expected SOC New Zealand and the UK, and a 10% cost of equity for its China and HK capex spent during FY08-13F, poor operating performance at overseas projects. materials businesses.CLP Holdings 2 HK SOTP valuation, which values CLP’s core electricity business at HK$60.3/share Lower SOC capex in Hong Kong, poor operating results from overseas with a reduction of HK$3.8/share to reflect the potential writedown on Yallourn investments, potential writedown on its Yallourn plant and earnings risks from the and earnings risk from Australia’s carbon trading scheme. carbon trading scheme in Australia.Datang Intl 991 HK DCF (with a WACC of 9% and 2% terminal growth rate for 2023 and thereafter), Risks includes: Profit margins of the Chinese independent power producers are plus a 15% discount due to low market visibility. not protected by contracts or regulatory regimes. Without any automatic pass- through mechanism, major cost items (eg, fuel cost) are subject to market price fluctuations. Competition and the macroeconomic downturn could also have a negative impact on generation output and plant utilisation over time.Source: Nomura researchNomura 45 18 January 2011
  • 47. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 69. Valuation methodology and key risks (2/3)Company Ticker Valuation methodology RisksEDC EDC PM FCFF with WACC = 9.9% and terminal growth assumption of 2.0% Over the near term, we see significant discontinuities in the regulatory environment as the key downside risk for the sector and EDC. On a firm specific level, while our PT is by no means predicated on success in bidding for Bacman and a portion of the 559MW Unified Leyte contracted capacity (we currently assume EDC wins neither bid), EDC’s share price may be adversely impacted by a sentiment-related sell-down should its bids 1) either fail, or 2) should competitive forces prompt the company to over-pay. Risks associated with EDC’s Miyazawa II bullet repayment due in FY10 have been mitigated through hedging.Electricity Generating EGCO TB We value EGCO using a discounted FCFF valuation methodology with a WACC Delays to projects pipelines and sentiment-related sell downs on political of 7.5% and 1.5% terminal growth assumption. instability.ENN Energy 2688 HK Our price target of HK$24.1 is based on DCF valuation, assuming 0% terminal Downside risks to our price target include: 1)slower than-expected new growth, a one-year forward FX rate of HK$1.25:RMB1 and a WACC of 8.3%. We connection and gas sales growth 2) margin squeeze by cost pass-through delay. do not incorporate any unapproved or unannounced development projects or Upside risks include: 1) higher-than-expected gas volume sales to higher margin future acquisitions, or any projects without a specified commencement date C&I and vehicle users;2) value-constructive asset injection / acquisition. (such as the Vietnam project).E-Ton 3452 TT We use the industry average P/B and apply a 20% discount to reflect the Upside risks to our price target: 1) E-Ton raising additional funding at attractive companys stretched balance sheet and get a target P/BV of 0.85x (previously: 0.9x). Our rates; and 2) a faster-than-expected ramp-up of new R&D projects helping to new price target of NT$37.0 (earlier: NT$38.5) implies potential downside of 6.4%. meaningfully improve the cost structure.GCL Poly 3800 HK our valuation of GCL Poly based on the average of FY10 and FY11F P/B for Risks to our call include expiration of lock-up arrangements, poor execution of global peers at 2.2x (previously 1.4x in May 2010). the companys in-house wafer production ramp up, approval to procure electricity directly from power producers, goodwill impairment charges, potential change in technology platform and uncertainties from solar subsidies and policies. Upside risks include: better-than-expected margins due to an improved cost structure and faster ramp of in-house wafer capacity.Glow GLOW TB We value Glow using a discounted FCFF valuation methodology with a WACC of We view construction delays brought on by regulatory issues in the Map Tha Put 8.0% and 1.5% terminal growth assumption industrial estate, where all of Glow’s operations are concentrated, as the key downside risk to this call.Guangdong Investment 270 HK Our PT is derived from DCF using a WACC of 9.5% and a 2% terminal growth rateOur target prices are subject to growth assumptions in treatment volumes (including tap water supply, wastewater treatment, and waste-to-energy), tariffs, capacity and capex. Changes in the macro landscape and government regulations over the water industry may result in key changes in our forecasts, and hence our target prices.Hong Kong & China Gas 3 HK SOTP valuation, which implies 22x FY10F P/E (3.1x book) for the Hong Kong Upside risks include acquisitions of more projects in China and share buy-backs. Towngas business, 32x FY10F P/E (2.1x book) for the China business and no Other risks include regulatory risks, larger-than-expected mark-to-market loss of NAV discount for the property portfolio. investment securities and investment property write-down.Hongkong Electric 6 HK Our price target for HKE remains unchanged and is derived using the DCF Risks to our investment view include a strengthening of the US dollar and the methodology, assuming an SOC return of 9.99%, WACC of 6.2% and a terminal Japanese yen, lower-than-expected SOC capex spent during FY08-13F and poor growth rate of 2%. operating performance at overseas projects.Huadian Power Intl 1071 HK DCF (with a WACC of 9% and 2% terminal growth rate for 2023 and thereafter), Risks includes: Profit margins of the Chinese independent power producers are plus a 15% discount due to low market visibility, and 25% discount as risk not protected by contracts or regulatory regimes. Without any automatic pass- premium for its smaller market capitalisation. through mechanism, major cost items (eg, fuel cost) are subject to market price fluctuations. Competition and the macroeconomic downturn could also have a negative impact on generation output and plant utilisation over time.Huaneng Power Intl 902 HK DCF (with a WACC of 9% and 2% terminal growth rate for 2023 and thereafter), Risks includes: Profit margins of the Chinese independent power producers are plus a 15% discount due to low market visibility. not protected by contracts or regulatory regimes. Without any automatic pass- through mechanism, major cost items (eg, fuel cost) are subject to market price fluctuations. Competition and the macroeconomic downturn could also have a negative impact on generation output and plant utilisation over time.Hyflux Limited HYF SP Our price target is based on DCF valuation, with a WACC of 7.5% and a terminal Our target prices are subject to growth assumptions in treatment volumes growth rate of 4.5%.Our valuation methodology is DCF based on a WACC of (including tap water supply, wastewater treatment, and waste-to-energy), tariffs, 7.8% and a terminal growth rate of 2%. capacity and capex. Changes in the macro landscape and government regulations over the water industry may result in key changes in our forecasts, and hence our target prices.JA Solar JASO US To value JA Solar, we use the average forward P/E of cell peers in YTD-FY10 Upside risks to our price target include: JA Solar being able to expand margins and get a target P/E of 7.2x. ahead of our expectations as it increases its module business Downside risks to our price target: 1) slower market share gains in new regions; and 2) demand at new growth centers being unable to offset lower demand from Germany. 1) Blue-sky scenario post CIC acquisition would raise our PT by ~20%; 2) JSWE Risk adjusted FCFE-based value (using a 14% cost of equity) of JSWE’s addresses near-term exposure to imported spot coal; 3) Fall in spot prices ofJSW Energy JSW IN 12.1GW target generation capacity. imported coal; 4) Merchant tariff realisations.Korea Electric Power 015760 KS Our price target of W43,000 is based on an EV/MW target (valuation 1) essentially all of KEPCO’s earnings are denominated in won, while almost all methodology unchanged) of US$850,000, near the median of KEPCO’s post-IPO of its fuel costs are in US dollars, exposing earnings to the volatility of the forex 20-year EV/MW capacity range. With the impending fuel cost escalation scheme and energy markets; and 2) changes in the government’s electricity tariff policy (implementation in July 2011), we think this new positive tariff scheme will exert and the macro backdrop can also have a large impact on KEPCO’s earnings. more impact on KEPCO’s share price than short-term earnings disappointments Further, earnings are highly leveraged to revenue growth, which poses a direct such as that expected in FY10F. Our valuation method and price target are not risk if the street cuts the sales forecasts. affected by FY10F earnings, as those are not earnings-based measures.Korea Gas 036460 KS SOTP methodology based on NAV estimate of W52,091 per share, which 1) Government policies, 2) interest expenses, and 3) execution risk in E&P comprises W26,267 for Kogas’ core NG business, W24,071 for its E&P projects projects. and W1,753 for its affiliates. Each of the first two parts is separately calculated using a discounted cashflow (DCF) methodology, while the last part is calculated based on 1x of book value.Lanco Infratech LANCI IN SOTP value at Rs89/share, comprising the value of its power business (Rs61), Execution, interlinked business lines, high dependence on supply under linkages EPC business (Rs22), real estate (Rs1), toll roads (Rs4) and power trading are key risks (Rs1). We apply a 15% discount to capture risks to earnings from interlinked business lines.LDK LDK US We derive our new price target of US$14 (from US$8) based on a target multiple Downside risks: 1) execution risks and cost over-runs for LDKs polysilicon of 8.3x FY11F earnings. production plant and expansion into the downstream segment; 2) negative surprises from government policy changes; and 3) earnings dilution from any equity offering. Upside risks: 1) stake sale in polysilicon plant which could help reduce balance sheet issues; and 2) faster-than-expected cost reduction in their downstream operations. DCF with a WACC of 11.8% and a terminal growth assumption of 1% after CER VER registration risks, resolution of grid connection bottleneck in China,Longyuan 916 HK FY2019F uncertainties from wind subsidies and policiesSource: Nomura researchNomura 46 18 January 2011
  • 48. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 70. Valuation methodology and key risks (3/3)Company Ticker Valuation methodology Risks Further inflated bids for Meralcos sharesMeralco MER PM DCF with WACC= 9.1% and terminal growth assumption of 1.5%Motech 6244 TT We use the average forward P/E of cell peers in YTD-FY10 to value the company Upside risks to our price target include: Motech being able to expand margins and give Motech a 25% premium, due to its strong balance sheet and stake- ahead of our expectations on the back of faster cost reductions and stronger holding by TSMC, to get a target P/E of 9.0x. ASPs in FY11F. Downside risks to our price target: 1) slower market share gains in new regions; and 2) demand at new growth centers being unable to offset lower demand from Germany.NTPC NATP IN Sum-of-the-parts methodology, valuing the company’s core business using DCF Execution, interlinked business lines, high dependence on supply under linkages to equity holders, with a cost of equity of 12% and terminal growth rate of 2%. are key risksPerusahaan Gas Negara PGAS IJ We use a 10-year DCF and adopt a WACC of 10.7% and a terminal growth rate The gas supply bottleneck; derivative revaluation losses; the 4% stake to be of 2.0%, given the strong potential of gas in the long term, PGN’s relatively strong unwound by the government from April 2010. A long-term risk is gradually rising positioning and its ability to maintain a market share of more than 90%. gas costs.Power Grid PWGR IN Our RI model assumes a 12% cost of equity, 17% terminal RoE and 3% (1) lower-than-expected capex / capitalization of transmission assets due to perpetual growth in core-business income. At our target price and FY13F execution delays by PWGR, (2) push-back of generation capacity additions earnings forecast, PWGR would trade at a P/E of 16.2x and P/BV of 2.3x. delaying capitalization of related transmission assets, and (3) a significant dent in PWGR’s dominance status and/or IRRs in long-distance transmission following the switch to the competitive bidding regime in securing incremental projects.Ratchaburi Generating RATCH TB We value RATCH using discounted FCFF valuation methodology, with a WACC Political unrest, problems with the execution of RATCHs growth pipeline in Laos of 7.0% and a terminal growth rate of 1.5%.Reliance Power RPWR IN FCFE-based valuation methodology with 15% cost of equity (Rf =8%, Rm=6%, 1) Unadjusted for milestone discounts, of Rs186/share; ceteris paribus, our PT Beta=1.17) could rise as projects achieve milestones. 2) We factor feasible capacity of 25.7GW in our earnings forecasts, greater visibility on planned capacity addition of around 17GW could merit its inclusion in our earnings forecast, potentially lifting our PT. 3) We assume no third party sale of ‘surplus’ coal from Rowers domestic captive coal mines or from coal concessions in Indonesia.Solargiga 757 HK We roll forward our valuation of Solargiga based on 6x FY11F earnings, theUpside risks to our price target: 1) Margin expansion ahead of our expectations average P/E multiple of Greater China peers. on the back of faster cost reductions; and 2) earnings upside from the Qinghai Chenguang investment.Sound Global 967 HK Our valuation methodology is based on DCF, assuming a WACC of 10.5% and a Our price target is subject to growth assumptions in treatment volumes (including terminal growth rate of 2%. tap water supply, wastewater treatment, and waste-to-energy), tariffs, capacity and capex. Changes in the macro landscape and government regulations over the water industry may result in key changes in our forecasts, and hence our target price.Suntech Power STP US We derive our new price target of US$11 (from US$12.20) based on a target Downside risks to our price target: 1) Slower market share gains in new regions multiple of 10.4x to FY11F earnings. and 2) demand at new growth centers being unable to offset lower demand from Germany.Suzlon SUEL IN One-year forward P/E multiple of 16xFY11F earnings. Uncertainty from government’s policy supports, failure in migrating technology forward, higher-than-expected product liability provisions, delay in recovery of WTG demand, and failure in enhancing cashflow and balance sheet quality.Tenaga Nasional TNB MK We value TNB using a 14.5x forward P/E multiple applied to our FY12F We believe the key downside risks to our view include weaker than-anticipated normalised EPS estimate (methodology and multiple unchanged). volumes and higher-than-expected coal costs without an upward adjustment to Tenaga’s tariffs. On the upside, an automatic pricing mechanism and or base tariff review should support a strong re-rating of this name.Tianjin Capital 1065 HK Our price target is derived using DCF, with a WACC of 10.0% and a 2% terminal Our target prices are subject to growth assumptions in treatment volumes growth rate (including tap water supply, wastewater treatment, and waste-to-energy), tariffs, capacity and capex. Changes in the macro landscape and government regulations over the water industry may result in key changes in our forecasts, and hence our target prices.Towngas China 1083 HK Our new price target of HK$3.4 is based on DCF valuation, assuming 0% Downside risks to our price target include: 1) slower than-expected new terminal growth, and a WACC of 6.4%. We do not incorporate any unapproved or connection and gas sales growth; 2) margin squeeze due to cost pass-through unannounced development projects or future acquisitions, or any projects withoutdelay Upside risks include: 1) higher-than-expected gas volume sales to higher specified commencement date. margin C&I and vehicle users; and 2) value-constructive asset injection / acquisition.Trina Solar TSL US We use the average forward P/E of vertically integrated peers in YTD-FY10 to Downside risks to our price target: 1) slower market share gains in new regions; value the company, and give Trina a 10% discount to the average multiples for a and 2) demand at new growth centers being unable to offset lower demand from target P/E of 10.4x. The discount reflects market concerns of slowing growth. Germany.Yanzhou Coal 1171 HK Our PT is based on SOTP valuation, with a WACC of 10.9% and terminal growth Key risk includes: 1) lower than expected spot price increase, 2) weaker coal of 2.5% for coal segment DCF, while employing 9.2% WACC and 1.0% terminal demand due to weaker than expected China economy growth, and 3) higher than growth rate for non-coal segments. expected cost hike due to resources tax, smaller than expected cost cutting in Felix and Zhaolou and inflation risk and 4) FX riskYingli Green YGE US We use the average forward P/E of vertically integrated peers YTD-FY10 to value Downside risks to our price target: 1) slower market share gains in new regions, the company and assign a 10% discount (to reflect market concerns about and; 2) demand at new growth centers being unable to offset lower demand from slowing growth) to Yingli to arrive at a target P/E of 10.4x. Germany.YTL Power International YTLP MK We value YTLP using a SOTP valuation based on COE of 9.0% for Malaysia, Key risks include the Malaysian regulatory environment; exchange rate risk, and 17% for Indonesia. We value Wessex Water at 1.08x FY11F RAB and specifically relating to YTLPs Wessex Water in the UK. PowerSeraya at 11.5x EV/EBITDA. Our target price is based on DCF valuation (WACC= 8.5%, terminal growth 0%). Xstrata is exposed to commodity price risk (especially coal, copper, chrome,Xstrata XTA LN We discount back to the latest reporting period (FY 09). The benchmark index for nickel and zinc), various operational risks common to all mining companies and this stock is FTSE 350 Mining Index. political risks in different parts of the world. Our target price for Rio Tinto is based on our NPV estimate (WACC 8%, terminal Rio Tinto is exposed to commodity price risk (especially iron ore, copper andRio Tinto RIO LN growth rate 0%). We discount back to the latest reporting period (FY09). The aluminum), operational risks common to all miners and exchange rate risk benchmark index for this stock is FTSE 350 mining index. (especially the Australian and Canadian dollar versus US dollar). Our target price for BHP Billiton is based on our DCF valuation (WACC 9%, BHP Billiton produces a wide array of commodities. Lower than-expectedBHP Billiton BLT LN terminal growth 0%). We discount back to the latest reporting period (1H 2010). commodity prices are therefore a risk to our earnings and cash flow estimates The benchmark index for this stock is FTSE 350 Mining Index. and our target price. Currency risk, operating risk at mines and political risk are Our target price is based on DCF valuation (WACC= 8.5%, terminal growth 0%). Anglo American is exposed to commodity price risk (especially coal, platinum,Anglo American AAL LN We discount back to the latest reporting period (FY09). The benchmark index for iron ore, diamonds, copper and nickel), operational risks common to all miners this stock is FTSE 350 Mining Index. and exchange rate risk (especially South African rand/US dollar). We set our target price using a DCF methodology with a 11.9% weighted Key risk factors include coal price volatility, disconnection between coal and oilBukit Asam PTBA IJ average cost of capital (WACC). Our target price implies 2011-12F EV/EBITDA prices, weather, regulation, high reliance on a single customer and on railway of 16.1-8.8 and PER of 23.0-13.2x. performance. We derive our target price using a DCF methodology, with discount rates of Key risk factors to our target price include coal price volatility, a decoupling 10.0% and 11.3% for the coal and non-coal businesses, respectively. We set 8% between coal prices and oil prices, weather conditions, regulation and projectAdaro ADRO IJ and 0% terminal value growth rates for coal and non-coal businesses, execution. respectively. For ADRO’s stake at the IndoMet Coal project, our valuation is Our target price of Rp4,300 implies 2011-12F EV/EBITDA of 8.8-4.0x. Key risks include coal price volatility, coal price and oil price decoupling,Bumi BUMI IJ regulatory risk, tax dispute risk We set our target price based on average of 11.8x 2011F EV/EBITDA and 16.9x Key risks include coal price volatility, coal price and oil price decoupling,ITMG ITMG IJ 2011F earnings. regulatory risk, mining contractor riskSource: Nomura researchNomura 47 18 January 2011
  • 49. CONVICTION CALL CONVICTION CALL CONVICTION CALL CONVICTION CALL China Shenhua Energy 1 0 8 8 H K B AS I C M AT E R I AL S / M E T AL & M I N I N G | C H I N A Maintained NOMURA INTERNATIONAL (HK) LIMITED Ivan Lee, CFA +852 2252 6213 ivan.lee@nomura.com Matty Zhao +852 2252 1397 matty.zhao@nomura.com Alan Hon +852 2252 2193 alan.hon@nomura.com BUY Action Closing price on 12 Jan HK$34.40 Shenhua’s distinctive integrated business model, with a captive logistics network Price target HK$41.00 (f rom HK$44.60) and sufficient reserves, helps facilitate third-party trade and sustain double-digit Upside/downside 19.2% growth and above-average ROE despite slowing self-production. The potential non- Difference from consensus -2.5% key contract price revision and whole group listing are near-term catalysts. The stock is trading at 12x FY11F P/E, in line with industry average of 12.2x FY11F FY11F net profit (RMBmn) 45,585 P/E; its higher ROE is attractive. Reiterate BUY. This is our top pick in the sector. Difference from consensus 5.7% Source: Nomura Catalysts Stronger spot coal price; higher portion of spot sales; upward revision of non-key Nomura vs consensus contract; asset injections; railway expansion; whole group listing. We think consensus has not Anchor themes captured output from the acquisitions We stay positive on the China coal sector despite government intervention, driven announced Dec 10 and likelihood of by: 1) solid demand backed by GDP growth and price competiveness; 2) ongoing higher spot sales as a % of sales tight supply due to safety concerns, accelerating industry consolidation and given contract price caps. transportation bottleneck. Key financials & valuations Distinctive integrated coal giant 31 Dec (RMBmn) FY09 FY10F FY11F FY12F Revenue 121,312 155,638 187,715 213,719 Integrated model secures margin and third-party trade Reported net profit 31,706 37,999 45,585 53,174 Normalised net profit 31,706 37,999 45,585 53,174 Shenhua’s integrated model secures its market share in the higher Normalised EPS (RMB) 1.59 1.91 2.29 2.67 margin seaborne sales and provides a hedge against coal business Norm. EPS growth (%) 19.0 19.8 20.0 16.6 cyclicality. The expanding transportation networks (Shuohuang line, Norm. P/E (x) 19.0 15.3 12.0 9.8 Zhunchi line and Huanghua port expansion) allow it to grow from both EV/EBITDA (x) 10.5 8.3 6.6 5.3 Price/book (x) 3.5 3.0 2.4 2.0 own output and third-party trade, aiming to become a fully fledged Dividend yield (%) 1.7 2.2 2.8 3.4 coal trading company. ROE (%) 19.9 20.7 21.6 21.8 Net debt/equity (%) 6.0 1.2 net cash net cash Leading player with sufficient reserves to fuel growth Earnings revisions Previous norm. net profit 37,494 42,090 45,381 As an SOE and China’s leading coal producer, Shenhua is a potential Change from previous (%) 1.3 8.3 17.2 beneficiary of the accelerating mine consolidations. The sufficient Previous norm. EPS (RMB) 1.89 2.12 2.28 reserves, particularly vital under supply constraint policy, sustain the Source: Company, Nomura estimates company’s long-term output growth. Share price relative to MSCI China Recent asset injection hints a whole group listing (HK$) Price 42 Rel MSCI China 105 The asset injections announced in Dec 2010 not only boost 40 100 marketable reserves and FY11F annual output by 24% and 6%, 38 95 36 90 respectively, but also pave the way for a possible whole group listing 34 32 85 in the near term. 30 80 28 75 26 70 Improving sales mix and competitive production cost Mar10 Jan10 Feb10 May10 Jun10 Aug10 Sep10 Nov10 Dec10 Apr10 Jul10 Oct10 Despite the price control, we remain upbeat on Shenhua’s superior net margin of 24%, highest among peers, in FY11F, underpinned by 1m 3m 6m its increasing spot sales proportion (45% in FY11F vs 29% in FY09), Absolute (HK$) 13.5 (1.7) 17.6 Absolute (US$) 13.5 (1.9) 17.6 strong spot price and competitive unit production cost. ASP upsides Relative to Index 10.7 (2.9) 5.1 should arise from a potential non-key contract price revision later in Market cap (US$mn) 88,005 the year. Estimated free float (%) 27.0 52-week range (HK$) 39.50/27.55 Valuation undemanding 3-mth avg daily turnover (US$mn) 78.4 Stock borrowability Easy The stock currently trades at 12x FY11F P/E, in line with the market, Major shareholders (%) and its higher ROE is attractive. Reiterate our BUY with a new PT of China Shenhua Group 73.0 HK$41. Our sum-of-the-parts PT implies a FY11F P/E of 14.3x, still a 13% discount to its historical average (from Jan 07) P/E of 16.5x. Source: Company, Nomura estimates Nomura 48 18 January 2011
  • 50. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoCompany profileCompany profile Shareholder structure Turnover breakdown (2011F)Shenhua Energy is dual-listed in HK (1088 HK) and China (601088 CH). Others1. It is 73% owned by state-owned enterprise Shenhua Group Rail & 0.8% A Share po rts Investors2. th It is the largest coal provider in China, the 4 largest in the world, 1.5% 10% with coal production of 210mnt and sales of 255mnt in 2009. It has H Share P o wer sufficient coal reserve with 33 years mine-life to sustain production Investors revenue 17% 29% growth3. It has established a distinct business model, with integrated Co al exposure to coal, downstream power generation and its own coal Shenhua Revenue Group 68.7% railway and ports network 73%4. Its sales mix improved from 29% in FY09 to 40% spot sales in 1H10, which drove up the ASP and marginSales trend (2009-2012F) Net profit trend (2009-2012F) (RMBmn) Sales revenue (LHS) (y-y %) (RMBmn) Net Profit (LHS) (y-y %) Growth (RHS) Growth (RHS) 240,000 30 60,000 21 200,000 25 50,000 20 19 160,000 20 40,000 18 120,000 15 30,000 53,174 17 45,585 80,000 10 20,000 37,999 31,706 16 40,000 5 10,000 15 0 0 0 14 2009 2010F 2011F 2012F 2009 2010F 2011F 2012FSWOT analysis 2011F net profit growth driversStrength —1) Distinct business model provides internal hedge between (%)coal and power. Its captive railway and ports network eases the 25transportation bottleneck problem and allows the company to dominate 20the higher-margin seaborne sales and avoid possible volatility. -6.1% 4.8% 8.9%2) Compared with Yanzhou Coal and China Coal, Shenhua has the 15lowest unit production cost, thanks to its production scale, mining 10 20.0%conditions (shallower mine depth) and lower staffing cost. 15.2% 12.4% 5Weakness — Due to the inland location of Shenhua, its transportation 0cost is higher than that of its peers. Given the high base, the production Increase Increase Increase Coal Power Groupgrowth rate is lower than that of its peers. in coal in sales in coal business and ASP volume cost OthersOpportunity — The small mine consolidation policy in the 11th FYP and12th FYP provides opportunity for big players, such as Shenhua, to P/E bandimprove its reserve basis. China’s balanced to tight supply market and Price (HK$)growing demand in the seaborne market provide support Shenhua’s 100seaborne coal sales price. Avg: 16.5x 30x 80Threat — In light of the high CPI pressure, NDRC might provide 25x 60 20xguidance for 2011F contract price, leading to a lower-than-expectedcontract price. The potential changes in the resource tax and 40 15xgovernment-imposed safety provisions exert upside pressure on costs. 10x 20 5x 0 Jan-07 Feb-08 Mar-09 Apr-10Source: Company data, Nomura researchNomura 49 18 January 2011
  • 51. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoValuationReiterate BUY with new PT of HK$41.0We reiterate our BUY rating on Shenhua and raise our FY11F earnings by 8% to factor Our PT implies 14.3x FY11F P/E,in a growing spot proportion of total sales, the strong spot price and additional output which we think is reasonablevolume from mines purchased from its parent company Shenhua Group and Baotoumining. Our new PT of HK$41.0 (from HK$44.6), which offers 19.2% upside potentialfrom current levels, is based on sum-of-the-parts valuation. Our PT implies a FY11FP/E of 14.3x. We employ WACC of 11.4% (up from 9%) and terminal growth rate of2.5% for coal segment DCF valuation, while we use assumptions of 10% WACC and1% terminal growth rate for non-coal segments (power and others).The stock is now trading at 12x FY11F P/E, a 27% discount to historical average of16.5x P/E, but at a slight premium to China Coal and Yanzhou Coal. We think thepremium is justified given Shenhua’s above-industry-average ROE, under-gearedbalance sheet (net cash in FY11F) and position as China’s largest coal company.Shenhua is our sector top pick given it is less vulnerable to potential seasonal spotprice adjustment, while leveraging on potential non-key contract price upward revisionslater in the year. Other merits include:1) its distinctive integrated business model, which allows growth through third-party trade2) its solid leading position in China’s coal industry with a visible growth profile underpinned by sufficient reserves and potential asset injections3) superior margins driven by better sales mix and low production costs4) its power segment has above-industry profitabilityExhibit 71. Valuation and sensitivity table Power &Key Assumptions COAL OthersRisk Free Rate 3.3% 3.3%Beta 1.45 1.20Market risk premium (rm - rf) 6.5% 6.5%Cost of Equity (re) 12.7% 11.1%Cost of Debt 5.8% 5.8% Sensitivity table (Power & Others)Effective Tax Rate 21.0% 21.0% --- Terminal Growth Rate ---D/E Ratio 20.0% 20.0% 0.25% 0.50% 0.75% 1.00% 1.25% 1.50% 1.75%Weight Average Cost of Capital (WACC) 11.4% 10.0% 9.2% 41.3 41.4 41.6 41.7 41.8 42.0 42.2Terminal Growth Rate 2.5% 1.0% 9.4% 41.1 41.3 41.4 41.5 41.6 41.8 41.9 ---WACC--- 9.6% 41.0 41.1 41.2 41.3 41.4 41.6 41.7 Power &Discounted Free Cash Flow Valuation COAL Others Total 9.8% 40.8 40.9 41.0 41.1 41.2 41.4 41.5PV of FCFF during 2011-2020 259,929 29,096 10.0% 40.7 40.7 40.8 41.0 41.1 41.2 41.3Continuing value on CF beyond Year 2020 305,970 56,378 10.2% 40.5 40.6 40.7 40.8 40.9 41.0 41.1Total Enterprise Value (Operating Value) 565,899 85,474 10.4% 40.4 40.4 40.5 40.6 40.7 40.8 40.9Add: Excess Cash & Non-operating Investments 54,965 43,742 10.6% 40.2 40.3 40.4 40.5 40.6 40.7 40.8Add: Cash from Share Options - - 10.8% 40.1 40.2 40.3 40.3 40.4 40.5 40.6Total Firm Value 620,864 129,216 750,080 Sensitivity table (Coal)Equity Valuation --- Terminal Growth Rate ---Total Firm Value 620,864 129,216 750,080 1.75% 2.00% 2.25% 2.50% 2.75% 3.00% 3.25% Less: Value of Interest Bearing Debt (98,886) 10.6% 43.1 43.8 44.5 45.2 46.0 46.8 47.7Less: value of preferred stock 10.8% 42.1 42.7 43.4 44.0 44.8 45.6 46.4 ---WACC---Value of Common Equity 651,195 11.0% 41.1 41.7 42.3 43.0 43.7 44.4 45.2 11.2% 40.2 40.7 41.3 41.9 42.6 43.3 44.0Number of Share Outstanding (mn) 19,890 11.4% 39.3 39.8 40.4 41.0 41.6 42.2 42.9Share Options (mn) 11.6% 38.5 39.0 39.5 40.0 40.6 41.2 41.8Fully diluted no. of shares (mn) 11.8% 37.7 38.1 38.6 39.1 39.7 40.2 40.8Equity Value per share (RMB) 32.7 12.0% 36.9 37.3 37.8 38.3 38.8 39.3 39.9Equity Value per share (HKD) 41.0 12.2% 36.1 36.6 37.0 37.4 37.9 38.4 38.9Source: Nomura estimatesNomura 50 18 January 2011
  • 52. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoExhibit 72. Valuation comparisons Price Market target Price cap Fiscal P/E (x) PEG P/B (x) Yield (%) Net debt/equity (%) RoE (%)Company Ticker Rating L. Curr. L. Curr. (US$mn) Y/E 10F 11F 12F 10-12F 10F 11F 12F 10F 11F 12F 10F 11F 12F 10F 11F 12FCoalAsiaHong Kong - Thermal CoalShenhua Energy-H 1088 HK BUY 41.00 34.40 87,945.5 Dec 15.3 12.0 9.8 1.0 3.0 2.4 2.0 2.2 2.8 3.4 1 net cash net cash 20.7 21.6 21.8China Coal-H 1898 HK NEUTRAL 13.90 12.90 21,984.2 Dec 13.8 11.8 8.9 1.0 2.0 1.7 1.4 1.9 2.2 2.9 14 22 24 15.4 15.2 17.0Yanzhou Coal-H 1171 HK BUY 30.40 25.45 16,089.1 Dec 14.3 10.9 9.4 1.0 3.1 2.5 2.0 2.1 2.7 3.2 54 51 33 23.5 24.4 22.8Average 14.5 11.6 9.3 1.0 2.7 2.2 1.8 2.0 2.6 3.2 23 36 29 19.9 20.4 20.5Hong Kong - Coking CoalFushan 639 HK Not rated n.a. 6.11 4,228.5 Dec 17.4 15.2 13.6 1.8 1.9 1.7 1.6 2.6 3.2 3.6 net cash net cash net cash 11.6 12.4 12.7Hidili 1393 HK Not rated n.a. 7.47 1,979.3 Dec 17.3 11.1 9.0 0.5 2.0 1.7 1.5 1.3 2.0 2.7 41 41 35 11.5 14.5 16.6Average 17.4 13.2 11.3 1.0 2.4 2.0 1.7 2.0 2.6 3.2 26 37 30 17.1 18.1 18.6Hong Kong average 15.6 12.2 10.1 1.1 2.4 2.0 1.7 2.0 2.6 3.2 27 38 31 16.5 17.6 18.2ChinaDatong Coal 601001 CH Not rated n.a. 20.59 5,211.6 Dec 24.1 20.9 17.4 1.8 4.0 3.7 3.5 2.0 2.4 2.7 n.a. n.a. n.a. 13.2 15.1 15.7Pingdingshan Tianan Coal Mining Co. 601666 CH Not rated n.a. 21.31 5,853.3 Dec 16.3 14.1 12.6 1.6 3.5 2.9 2.6 2.9 3.1 3.1 n.a. n.a. n.a. 25.6 24.6 22.6Shanxi Guoyang 600348 CH Not rated n.a. 28.10 10,220.1 Dec 24.5 21.0 19.3 2.5 8.3 6.6 4.9 1.9 2.2 2.4 n.a. n.a. n.a. 33.8 29.8 26.6Shanghai Energy 600642 CH Not rated n.a. 7.70 3,671.0 Dec 15.0 13.8 12.9 2.7 1.3 1.2 1.2 2.0 2.5 2.7 n.a. n.a. n.a. 9.3 8.7 9.3Hengyuan Coal 600971 CH Not rated n.a. 50.01 3,316.2 Dec 20.0 18.1 17.3 3.7 4.4 3.7 2.9 n.a. n.a. n.a. n.a. n.a. n.a. 19.7 18.9 17.0Luan Environmental Energy 601699 CH Not rated n.a. 58.55 10,187.4 Dec 22.3 19.0 16.4 1.7 6.2 5.1 3.8 2.0 3.1 3.5 n.a. n.a. n.a. 31.1 29.8 27.5SDIC Xinji 601918 CH Not rated n.a. 14.08 3,940.0 Dec 18.7 14.7 11.8 0.9 3.8 3.1 2.5 n.a. 2.1 2.9 n.a. n.a. n.a. 18.9 20.4 21.5China Average 20.1 17.4 15.4 2.1 4.5 3.8 3.0 2.2 2.6 2.9 n.a. n.a. n.a. 21.6 21.1 20.0S.E. AsiaBanpu BANPU TB Not rated n.a. 846 7,564.9 Dec 12.3 11.6 10.5 2.1 3.4 2.9 2.4 2.2 2.6 3.0 58 39 13 34.6 27.0 25.4Bumi BUMI IJ BUY 4,300 3,075 7,097.6 Dec 48.3 28.9 7.2 0.3 3.7 3.3 2.3 0.8 0.4 0.7 195 166 80 8.7 12.1 37.8ITMG ITMG IJ BUY 73,000 54,600 6,854.9 Dec 22.5 13.3 7.3 0.3 7.4 5.4 3.6 2.4 2.7 4.5 net cash net cash net cash 35.5 47.1 59.2Bukit Asam PTBA IJ BUY 30,000 23,100 5,872.8 Dec 28.7 17.7 10.1 0.4 8.6 6.4 4.4 2.6 1.7 2.8 net cash net cash net cash 31.1 41.5 51.8Indika Energy INDY IJ Not rated n.a. 4,975 2,858.4 Dec 21.8 12.9 11.1 0.5 4.2 3.4 2.8 1.3 2.1 3.1 9 net cash net cash 20.2 27.1 26.9Adaro ADRO IJ BUY 3,700 2,625 9,264.4 Dec 27.5 13.9 7.5 0.3 4.2 3.3 2.4 0.9 0.6 0.7 21 6 net cash 15.5 26.8 37.2S.E. Asia Average 26.9 16.4 9.0 0.7 5.3 4.1 3.0 1.7 1.7 2.5 71 71 47 24.3 30.3 39.7Asia Average 21.1 15.6 11.8 1.3 4.2 3.4 2.7 1.9 2.3 2.8 49 54 37 21.1 23.2 26.1AustraliaWhitehaven Coal WHC AU Not rated n.a. 6.80 3,393.8 Jun 62.4 36.8 17.1 0.7 3.1 3.1 2.8 0.8 1.3 2.6 net cash net cash net cash 5.9 8.7 17.5New Hope Corp NHC AU Not rated n.a. 4.90 4,112.5 Jul 21.3 21.7 17.3 3.0 1.7 1.7 1.6 2.7 3.6 3.3 net cash net cash net cash 7.1 8.5 9.5Gloucester Coal GCL AU Not rated n.a. 12.87 1,827.3 Jun 25.3 27.2 17.9 2.2 5.6 2.7 2.4 0.4 0.5 0.9 net cash net cash net cash 25.6 16.4 18.4Stanmore Coal SMR AU Not rated n.a. 1.35 169.4 Jun 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 MCC AU Not rated n.a. 13.55 4,102.2 Jun 27.9 17.5 13.2 0.6 3.0 2.3 2.1 1.5 2.6 3.4 net cash net cash net cash 11.5 15.0 17.3Australia Average 34.2 25.8 16.4 1.6 3.4 2.5 2.2 1.4 2.0 2.5 n.a. n.a. n.a. 12.5 12.1 15.6North AmericaArch Coal ACI US Not rated n.a. 35.53 5,773.0 Dec 30.4 12.5 9.4 0.3 2.6 2.2 1.8 1.1 1.1 1.1 71 42 22 8.8 19.0 22.5Consol Energy Inc. CNX US Not rated n.a. 53.04 11,978.8 Dec 23.6 17.4 11.9 0.7 3.7 3.1 2.5 0.8 0.8 0.8 106 85 56 15.6 18.3 23.0Peabody Energy Corp. BTU US Not rated n.a. 63.34 17,078.9 Dec 20.9 13.2 10.9 0.5 3.7 3.0 2.3 0.5 0.5 0.6 27 11 net cash 19.3 24.6 23.6N. America Average 25.0 14.4 10.7 0.5 3.3 2.8 2.2 0.8 0.8 0.8 68 46 39 14.6 20.6 23.0Note: pricing as of 12 Jan 2011 closing. Indonesia Coal report published on the same day uses 11 Jan, 2011 closing price for pricing Bloomberg estimates for Notrated stocks.Source: Bloomberg, Nomura estimatesNomura 51 18 January 2011
  • 53. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoIntegrated business modelAn integrated model allows growththrough third-party salesShenhua’s vertically integrated business model, with exposure to coal, downstreampower and its own railway and ports, forms a distinct advantage over its peers, in ourview: Internal hedging between coal and power business. Covering the complete Shenhua’s integrated model value chain in coal, power and its own transportation, Shenhua has not only built an hedges risk and protects margin internal hedge against risk to coal sales, but also has provided its power business with stable and quality coal supply on the back of its captive railway and port networks. Captive networks allow sales-mix enhancement with higher margin: The inter- connected railways and ports not only alleviate transportation bottleneck problems, but also provide the company with flexibility to adjust transportation methods and coal sales to get more market share within the higher-margin coastal market. In FY09, Shenhua sold 60% of its domestic coal through the seaborne market. Transportation networks secure third-party trade: Leveraging the strong coastal demand and its logistic (railways and ports) arms, Shenhua has the ability to enhance third-party trade volume when supply is affected by policy.Captive networks secure third-party tradeRailways: Shenhua runs five interconnected self-owned railways, with turnover of138.2bn tonne km in 2009 (up 12.1% y-y). The Shenhuo-Shuohuang line is one of thetwo backbone lines dedicated to west-to-east coal transportation in China. In 2009 and1H10, coal transported through self-owned railways accounted for 77% and 78% of thetotal turnover of the company’s.Ports: Shenhua operates Huanghua Port, the second-largest port for seaborne coal,and Shenhua Tianjin Coal Dock. In 2009 and 1H10, coal transported through self-owned ports accounted for 63% and 68% of the total coal transported throughdomestic ports.On 15 Dec 2010, NDRC approved Shenhua to build the “Zhunchi line” at RMB13.5bn NDRC approved Shenhua to buildand to expand the Huanghua port with RMB4.4bn. The new line connects the existing “Zhunchi line”Dazhun and Shenhuang lines. It will be operational in 2013, with initial freight volumeof 50mn tonnes to reach 200mn tonnes capacity by 2016. The new railway and portexpansion would expand the company’s transportation network.Per our industry outlook, we estimate that coal supply will be tight in the near term dueto policy constraints and railway bottlenecks. Thanks to its captive network, Shenhua,in our view, should be better positioned than its peers to weather these developmentsgiven:1. Captive networks provide Shenhua flexibility to adjust transportation methods and coal sales to get more market share within the higher-margin coastal market.2. Shenhua has changed its strategy from solely relying on production growth to increasing sales volume from both third-party trade and own output, with a long- term target of becoming a full-fledged coal trading company.3. In light of the development strategy shift and the compatible transportation network, we estimate third-party trade will become an increasingly visible portion of Shenhua’s sales mix from 48mn tonnes in FY09 to 75mn tonnes in FY12F.Nomura 52 18 January 2011
  • 54. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoExhibit 73. Shenhuas major operationsSource: Company dataNomura 53 18 January 2011
  • 55. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoCoal productionStrong output growth underpinned bysufficient reserve and asset injectionAs China’s biggest coal producer, Shenhua had 6.9% market share in terms of raw We estimate 2014F output will becoal production in FY09, more than double that of China Coal and nearly 6 times that 349mn tonnes, reaching the highof Yanzhou Coal. end of its targetDuring our metal and mining trip in November 2010, management revised its coaloutput target down to 320-350mn tonnes by 2014F (previous target was to double2009 output by 2014F. Despite the reduced target, we remain upbeat on thecompany’s output growth (see previous Exhibit), underpinned by 1) its adequatereserves to sustain the organic output growth for 33 years; and 2) the recentlyannounced asset injections by the parent.Exhibit 74. Management guidance vs. Nomura’s forecasts Previous Mgt. Mgt. guidance guidance Nov, 2010 Our forecast Our rationaleProduction Vol. Doubling 2009 output Target to produce 349mn tonnes in Strong output growth underpinned by recent asset injection by 2014F 320-350mnt by 2014F 2014F and sufficient reserves.Spot sales (%) Increasing spot sales FY10F: Spot sales to FY10F: Spot sales Spot sales contributed 42% in 9M10, we expect FY10F spot contribute 40%-42% contributes 42% of sales portion to be consistent with 9M10. In view of a of sales total sales widening spot contract price spread due to a 2011 contract FY 11-15F: A few FY11-15F: Spot sales price cap, we project Shenhuas spot sales portion will more percentage contributes 45% of increase to 45% (upper end of management guidance) and point increase but total sales stay at that level. spot sales should not exceed 45%Source: CompanyExhibit 75. Market share in China by raw coal Exhibit 76. Shenhua: commercial coal productionproduction (FY09) projections (2009-2012F) (%) (mnt) 09-12F CAGR 10.7% 8 300 6.9 7 250 6 200 5 4 3.3 150 285 257 3 210 226 100 2 1.2 50 1 0 0 Shenhua China Coal Yanzhou Coal 2009 2010F 2011F 2012FSource: CCTD, Company data, Nomura research Source: Company data, Nomura researchSufficient reserves to sustain growthBy 1H10, Shenhua owned marketable coal reserves of 7,394mn tonnes under the By 1H10, Shenhua ownedJORC standard, translating into 33 years of reserve life based on FY10F annual output. marketable reserves of 7,394mnt,Given these mines are all in traditionally coal resource-rich areas, we are optimistic translating to 33 years mine-lifeabout potential resource upgrades by geological exploration.Nomura 54 18 January 2011
  • 56. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoExhibit 77. Shenhua: coal mine snapshotCoal mines Shendong Zhungeer Shengli TotalMine type Underground Open-pit Open-pitCoal type Thermal Coal Thermal Coal Thermal CoalLocation Shaanxi and Inner Mongolia Inner Mongolia Inner MongoliaShenhuas stake (%) 100 57.8 62.8Recoverable Coal reserve (mnt) (PRC standard) 7,498 2,594 1,481 11,573% of total 65 22 13Marketable reserve (mnt) (JORC standard) 4,667 1,891 836 7,394% of total 63 26 11Annualized output (FY09) (mn tonnes) 162.6 37.2 10.5 210Source: Company data, Nomura researchFollowing a strong push to close smaller, more dangerous and less efficient coal minesin the 11th FYP; China will continue promoting mine consolidation in the upcoming 12thFYP. Shenhua, as a state-owned enterprise and the largest domestic coal player,should be better positioned to gain access to reserves across the nation, thus, in ourview, making it the most likely beneficiary of the consolidation process.In our view, the Shenhua’s sufficient reserves should sustain organic output growth of: 90mnt growth from current operating mines (management guidance: 85-100mnt). In light of government’s policy in supply restriction and the more rigorous safety requirements, our projected output growth from 210mnt in 2009 to 300mnt in 2014F is at the lower end of management guidance. Greenfield projects contributing 20mnt to output growth by 2014F (20-30mnt per management guidance). Factoring in the more rigorous safety requirements and slower government approvals, we assume a slower pace of greenfield project completion, with 12mn tonnes from Xinjie and 8mn tonnes from Yushen by 2014F. Australia Watermark to start production of 10mnt in 2014F (5-10mnt per guidance). Shenhua invested in Watermark mines in Australia in late 2008 as its first overseas investment.Production upside from asset injectionOn 20 December 2010, Shenhua announced that it would: 1) pay RMB5.6bn to itsparent company for equity interests in nine coal, power and other supportingcompanies; and 2) pay RMB3.1bn to Baotou Mining for three mines in Inner Mongolia.Shenhua will hold an EGM on 25 February 2011m and we expect the transactions tobe completed by 1Q11. Boost reserves and production: the transactions will boost Shenhua’s The company obtained 1.75bn marketable reserves under JORC standards by 24% or 1.75bnt (1.13bnt tonnes of JORC-certified reserves in recent acquisitions attributable to Shenhua) from 7.394bnt as at 30 June 2010 to 9.148bnt. Recoverable coal reserves under PRC standards will be raised by 21% from 11.57bnt to 14bnt. The annual production is estimated to be 14.6mnt in FY11F, over 70% of which is low-quality lignite coal from Shenbao mines. Fair valuation in terms of P/E and P/B: The transactions implies 15x FY10F P/E (12% ROE) for its parent’s assets and18x FY11F P/E (12% ROE) for the Baotou Mining assets. These compare unfavourably to Shenhua’s FY11F12x P/E and 21.6% ROE, but we view the deals as fair when compared with prevailing market valuations. Also, the coal mines are still in ramping up phase, while higher production return is expected in the longer term. Cheaper valuation in terms of reserves and production: The deals look cheaper based on coal reserves (RMB5/tonne) and coal productionNomura 55 18 January 2011
  • 57. China Shenhua Energy Ivan Lee, CFA / Matty Zhao (RMB295/tonne), when compared with the latest average global transactions of RMB40/tonne reserve and RMB1,660/tonne production, according to the M&A deals tracked by our global metals and mining team. The substantial discount is partly attributable to over 70% of the marketable reserves purchased is lignite coal, which has a lower heat content and selling value. Even adjusting for the heat content and price difference between lignite and high-quality coal (like coking and long flame), the discount is attractive and the deals are favourable to Shenhua, in our view. Capital efficiency improvement: The deals should improve Shenhua’s capital efficiency given the RMB8.7bn consideration will be financed from the company’s internal cash, which has been set aside for acquisition since its IPO and earning less than 2% pa. Limited earning and net asset impact: Based on the reported 9M10 profit of the included companies and the funding cost of acquisition (interest income), we estimate the annualized profit attributable to Shenhua at RMB363mn, equivalent to less than 1% of Shenhua’s FY11F earnings. Also, the net assets attributable to Shenhua equivalent to 1.3% of Shenhua’s FY11F net assets. The size and return of the acquisitions are in line with the company’s earlier announcements. More potential upside in the long run: Despite the limited short-term earning impact, we believe there will be more upside in subsequent years when production volume increases, capital structure improves and synergies arising from economies of scale and cost savings. The acquisitions are another step in leverage on the integrated strengths of coal and power businesses, in our view. Supporting an larger group, paving the way for a possible whole group listing: The deals comprise supporting companies like the clean coal company (lignite coal processing), Tianhong (coal sales company) and Beiyao Company (exploration), which have not contributed significant earnings so far but are essential to support the growing group, especially as parent, China Shenhua Group, is considering a whole group listing in the future on a “step-by-step” basis, in our view.Nomura 56 18 January 2011
  • 58. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoExhibit 78. Shenhua: Mines assets details of recently announced acquisitions Equity JORC Output FY09 9M10(mn tonnes) acquired (%) Location Type of coal reserves capacity output outputShenbao companiesOpencast mine 56.61 Inner Mongolia Lignite 49 10Opencast mine continuation area 56.61 Inner Mongolia Lignite 1,367 0Baoyan mine 56.61 Inner Mongolia Lignite 12 0.33Mine 3 continuation 56.61 Inner Mongolia Lignite 5 10Shenbao subtotal 1,432 20 13.3 11.9Chaijiagou 95 Shaanxi Long-Flame 4 1 1.0 0.7Baotou MiningAdaohai Mine Assets Inner Mongolia Coking coal 4 1Shuiquan Opencast Mine Inner Mongolia Weak coking 22 1 AssetsLijiaohao Mine Assets Inner Mongolia Non-coking Long-flame 290 6Baotou subtotal 316 8 2.6 2.4Total 1,752 29 16.8 15.1Source: Company data, Nomura researchNomura 57 18 January 2011
  • 59. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoCoal marginBetter margins driven by improved salesmix and low production costHistorically, Shenhua has delivered the highest net margin among its peers. DespiteNDRC’s price control on 2011 key contract sales, we remain positive on Shenhua’simpressive net margin of 24%and 25% in FY11-12F, respectively, given:1. better sales mix and high spot price offsetting contract price cap’s negative effect2. lowest unit production cost among peersHigh spot price and better sales mix offset contract price capNDRC price control as near-term headwindWe reckon NDRC will place price controls over 2011 key contract prices amid highinflationary pressure. As a state-owned group and the largest contract coal supplier,Shenhua will likely be under policy pressure to stabilise coal supply and its FY11Fcontract price, in our view. Management suggested that key contracts accounted foraround 40% and 45% of Shenhua’s FY09 and FY10F total contact sales, respectively.In line with our industry view, we believe Shenhua’s key contract prices will freeze forFY11F; while non-key contract prices will rise by 5% on a weighed-average basis andlook for the non-key contract portion of total contract sales to be 55% of FY11F totalcontract sales. Thus, the increase in non-key contract portion and the increase in non-key contract price would imply average contract coal price would increase by 2.6% in2011F and further 6.5% in 2012F, in our viewHigher spot sales portionShenhua has shifted its focus to spot sales since 2010, with management guidance of40% spot sales in FY10F, compared to 29% in FY09. Management expects a fewmore percentage-point increases in spot sales in the next few years.Based on the 9M10 spot sales portion of 42% and the wide spread between spot priceand contract price, we expect the FY10F spot portion to be consistent with 9M10. Wealso look for the spot portion of domestic sales to further rise to 45% in FY11F in thelight of the widening spot-contract coal price spread due to the 2011 contract price capand NDRC not restricting contract volume. We think Shenhua will keep its spot portionat 45% in FY12F, so as to secure earning visibility and long-term customerrelationships.Exhibit 79. Domestic sales mix (07-12F) Exhibit 80. Contract and spot price (07-12F) (%) Contract Spot (RMB/t) Contract Spot 100 600 539 518 90 20% 23% 29% 477 500 438 80 42% 45% 45% 421 427 391 401 70 362 400 60 336 311 50 300 265 40 80% 77% 71% 200 30 58% 55% 55% 20 100 10 % 0 0 2007 2008 2009 2010F 2011F 2012F 2007 2008 2009 2010F 2011F 2012FSource: Company data, Nomura estimates Source: Company data, Nomura estimatesNomura 58 18 January 2011
  • 60. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoExpected strong spot price in FY11F and FY12FIn the light of growing demand and the tight supply outlook, we forecast Shenhua’saverage spot price will rise by 8.6% and 4% in FY11F and FY12F, respectively, largelyin line with our industry forecast of 8% and 5% y-y increases. The slight premium inFY11F over industry is justified by Shenhua’s dominance in the seaborne market, withhigher price than direct arrival. We estimate that after a strong run in FY10F (up by11%), the average sales price for Shenhua will rise by 6% y-y to RMB457/tonne inFY11F and 5% y-y to RMB479/tonne in FY12F, with a likely FY11 key contract pricecap offset by the strong spot price and more spot sales.Lowest unit costs among peersShenhua’s FY09 production cost was RMB98/ tonne and RMB144/tonne lower thanthat of China Coal and Yanzhou Coal, respectively, reflecting Shenhua’s 1) lower unitstaffing cost due to its large production scale; 2) shallower mine than China Coal; and3) lower blending cost due to lower sulphur/ash content and lower calorific values. Thelow production cost likely offset its marginally higher unit transportation cost related toits longer distance to customers.Leveraging its production scale, the favourable mining conditions and the captivetransportation networks, Shenhua’s unit cost discount to China Coal is expected togrow to 38%, 40% and 41% in FY10F, FY11F and FY12F, respectively; on ourestimates, while the gap between Shenhua and Yanzhou Coal will be 32-35% duringthe same period.Exhibit 81. Unit production cost (self-produced coal) Exhibit 82. Total unit cost (self-produced coal) (RMB/t) (RMB/t) Shenhua China Coal Yanzhou Shenhua China Coal Yanzhou 350 400 343 300 350 324 315 303 299 246 300 283 328 250 286 230 311 213 297 244 199 245 250 231 207 219 200 256 200 150 119 128 101 109 150 100 100 50 50 0 0 2009 2010F 2011F 2012F 2009 2010F 2011F 2012FSource: Company data, Nomura estimates Source: Company data, Nomura estimatesResources tax — only moderate impactPer our industry overview, the resources tax will probably change from the current Resource tax to rise byvolume-based to price-based and from 3% to 5% on the sales price. In line with RMB4/tonne after reformmanagement guidance, we assume a resources tax of RMB7/tonne in FY11F forShenhua, based on 5% of the estimated ex-mine price of RMB140/tonne, comparedwith RMB2-3/ton currently. We have factored in additional resources tax ofRMB4/tonne in our FY11 forecast. Given the prevailing low production cost and theseller’s market, Shenhua is confident it can pass on the cost increase.Nomura 59 18 January 2011
  • 61. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoPower businessPower segment has an above-industryprofitabilityAs at 30 June 2010, Shenhua operated 14 coal-fired power plants, with installed gross Shenhua’s power businesscapacity of 26.7GW and equity installed capacity of over 15GW. The power segment enjoys higher EBIT than HK-listed IPPsrecorded FY09 EBIT of RMB7,106mn and an EBIT margin of 21% — higher than theaverage EBIT margin of 13.8% for the five Hong Kong-listed IPPs. The above-industryprofitability, in our view, is due to: 1) higher utilisation hours; 2) its lower unit fuel cost;and 3) strategic capacity layout.Exhibit 83. 2009 EBIT margin comparison vs IPPs Exhibit 84. Utilisation Hours (Shenhua vs. IPPs) (%) FY08 FY09 (%) Shenhua 30 Coal-fire power plant industry average 7,000 6,302 25 5,995 21 21 6,000 5,615 5,465 20 5,000 14 15 12 12 10 4,000 10 2,785 17 3,000 5,633 5,316 4,911 11 4,839 5 8 2,000 0 2,534 1,000 -2 -2 0 (5) 0 Datang Huaneng Huadian CR CPI Shenhua Power 2006 2007 2008 2009 1H10Source: Company data, Nomura research Source: Company data, Nomura researchHigher utilisation hoursThanks to its effective capacity layout in higher power demand areas, Shenhua’sutilisation hours are higher than the industry average. Shenhua registered averageutilisation hours of 5,465 hours in FY09 and 2,785 hours in 1H10, compared withindustry average of 4,839 hours and 2,534 hours, respectively.Lower unit fuel cost on synergies with upstream coalOn the back of over 90% of coal supplied by its own coal business, Shenhua enjoys alower unit fuel cost than the average of the five Hong Kong-listed IPPs. Although theprice of Shenhua’s internal coal sales to its power business is the same as that offeredto external clients, subject to coal quality and transportation distances, self-producedcoal enables the firm to secure steady coal supply and shorten delivery times, whichhelps to stabilise its power business operations, especially during peak demandperiods in winter.Strategic power plant layoutBased on the company’s principle of “proximity to market, customers and production”,Shenhua’s power plants are located either: 1) close to its coal mines or rail lines, so asto secure coal supply and save transportation costs; or 2) in high power demand areassuch as east China (including Zhejiang and Guangdong) and north China (includingBeijing, Tianjin and Hebei), which are the most developed areas in China and thushave stronger power demand and higher power tariffs.Nomura 60 18 January 2011
  • 62. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoFinancial analysisRobust earnings outlookCoal as key profit contributorWe forecast Shenhua’s revenue to rise by 28% in FY10F and 21% and 14% in thefollowing two years, driven by the rising ASP due to an improved sales mix, strong spotprice and robust third-party trade and output volume growth. The primary source ofearnings at present is coal mining, accounting for around 80% of the company’s netprofit, with power growing rapidly as the second-largest contributor. Thanks toShenhua’s low unit production cost, the coal business should maintain its high grossmargin of 50-51% from FY10F to FY12F, while power segment offers an above-industry gross margin of 28% during the same period, based on our estimates.Exhibit 85. Shenhua: revenue breakdown (FY11F) Exhibit 86. Shenhua: gross margin trend (09-12F) (%) Group Coal business Power business Others, 60 Rail and 53 0.8% 50 50 51 Ports, 1.5% 50 46 44 44 44 Power, 40 28.9% 30 20 25 28 28 28 Coal Sales, 10 68.7% 0 2009 2010F 2011F 2012FSource: Nomura estimates Source: Company data, Nomura estimatesKey profit drivers and sensitivityWe expect Shenhua’s normalised net profit to increase by 20% y-y to RMB38bn in Coal business set to drive marginFY10F. We forecast FY11F earnings growth to be 20% to RMB45.6bn with 6% ASP improvement in FY11Fgrowth as the biggest driver. On consolidated basis, we forecast the coal business tocontribute 15.2% of the net profit growth in FY11F, while power and other businessescontribute 4.8%.Exhibit 87. Shenhua: 2011F net profit growth driver Exhibit 88. Shenhua: EPS (2009-22F) (%) (RMB) 25 3.0 2.67 20 2.5 2.29 -6.1% 4.8% 8.9% 1.91 15 2.0 1.59 10 20.0% 1.5 15.2% 12.4% 1.0 5 0 0.5 Increase Increase Increase Coal Power Group in coal in sales in coal business and 0.0 ASP volume cost Others 2009 2010F 2011F 2012FSource: Nomura research Source: Company data, Nomura estimatesNomura 61 18 January 2011
  • 63. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoFrom the sensitivity table below, we note that Shenhua is the least sensitive to unitcost change relative to its peers.Exhibit 89. 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 estimatesAmong different earning drivers, Shenhua is more sensitive to spot price and unit costchange. Given that contract represents a smaller portion of its sales mix, Shenhua isless sensitive to contract price change in comparison to China Coal.Balance sheet and cashflowTo achieve its output growth target and maintain its integrated advantages, Shenhua isaggressively expanding its coal output, rail and port facilities and power generation.For Shenhua to achieve its targeted the 59mn tonnes in coal output growth in the nexttwo years and 7,000MW growth during the same period, we expect total capitalexpenditure to reach RMB48.3bn (18% y-y) in FY11F and RMB55.6bn (15% y-y) inFY12F.Despite the significant capex needs, we believe Shenhua has no need for additionalequity financing given its under-geared balance sheet (net cash in FY11F), ample cashposition, rich operating cash inflow and strong credit pipeline from banks.Nomura 62 18 January 2011
  • 64. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoWhere could we be wrong?Risks to our investment viewHigher-than-expected coal prices. Coal prices are the most sensitive factor to If coal contract prices and spotearnings. If coal contract prices and spot prices are higher than our forecasts, prices are higher than our forecasts, Shenhua’s earningsShenhua’s earnings could greatly deviate from our forecasts. Key upside risks include: could greatly deviate from our1) stronger-than-expected coal-fired power generation, mainly due to a strong forecastseconomic recovery, 2) the implementation of coal-power linkage scheme, 3) higher-than-expected supply cuts caused by industry consolidation or big coal miningaccidents; and 4) tightened transportation caused by unexpected accidents or badweatherWeaker-than-expected recovery in China’s economy. If China’s economy recoversmore slowly than we expect, we believe coal demand from the four key sectors —power, steel, building materials and chemicals — will deteriorate and exert pressure oncoal prices, leading to lower earnings growth for Shenhua.Higher-than-expected cost hikes. We believe the surprise of higher cost hikes couldbe mainly from policy-related cost increases. For FY11F, we believe the Chinesegovernment 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 coalproducers, including Shenhua. Even though we have factored in additional resourcestax of RMB4/tonne in our FY11 forecast, more severe policy could result in downsidepressure to earnings.Higher coal import boosted by a strengthening renminbi. Our economics teamexpects 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 coastalimport volume would increase, putting further pressure on domestic coal prices.Nomura 63 18 January 2011
  • 65. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoExhibit 90. Shenhua: key assumptions 2008 2009 2010F 2011F 2012FCoalProduction volumeTotal self-production (mnt) 186 210 226 257 285Sales volumeSelf-produced (mnt) 187 210 226 257 2853rd party (mnt) 46 45 68 70 75Total (mnt) 233 254 294 327 360Contract sales as a % of domestic sales (%) 77 71 58 55 55Seaborne sales as a % of domestic sales (%) 56 60 61 61 61Domestic contract (mnt) 164 172 164 173 193Domestic spot (mnt) 48 69 119 141 158Subtotal of domestic (mnt) 212 241 283 314 350Export Sales (mnt) 21 14 11 13 10Total (mnt) 233 254 294 327 360PriceDomestic contract price (RMB/t) 336 362 391 401 427Domestic spot price (RMB/t) 438 421 477 518 539Domestic sales average (RMB/t) 359 379 427 454 477Export price - China (RMB/t) 577 552 524 529 534Average realized price (RMB/t) 379 388 431 457 479CostUnit cost of self-produced coal (RMB/t) 95 101 109 119 128Total unit cost – self-produced (RMB/t) 195 207 219 231 244Unit profitUnit gross profit - self (RMB/t) 184 181 212 225 234PowerInstalled capacity (MW) 18,001 22,724 27,224 30,724 34,224Contribution capacity (MW) 17,380 19,169 23,140 29,188 32,513Gross generation (GWh) 97,590 104,760 137,843 173,866 193,672Total output dispatch (GWh) 90,290 97,410 128,172 161,667 180,084Avg. utilization hours (hrs) 5,615 5,465 5,957 5,957 5,957Avg. realized tariff (excl. VAT) (RMB/MWh) 335 336 336 336 336Source: Company data, Nomura estimatesNomura 64 18 January 2011
  • 66. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoFinancial statementsIncome statement (RMBmn)Year-end 31 Dec FY08 FY09 FY10F FY11F FY12FRevenue 107,133 121,312 155,638 187,715 213,719Cost of goods sold (59,378) (65,492) (86,973) (105,227) (119,174)Gross profit 47,755 55,820 68,665 82,488 94,546SG&A (8,080) (8,712) (11,115) (14,157) (16,118)Employee share expenseOperating profit 39,675 47,108 57,550 68,331 78,428 We include output from the asset injection announced in Dec 10 in our earning forecastEBITDA 49,430 58,360 70,560 83,296 95,824 from FY11F onwardsDepreciation (9,755) (11,252) (13,010) (14,965) (17,396)AmortisationEBIT 39,675 47,108 57,550 68,331 78,428Net interest expense (3,393) (2,038) (3,461) (3,684) (3,015)Associates & JCEsOther income 693 742 815 896 984Earnings before tax 36,975 45,812 54,904 65,543 76,397Income tax (7,076) (9,626) (11,536) (13,772) (16,053)Net profit after tax 29,899 36,186 43,368 51,771 60,345Minority interests (3,258) (4,480) (5,369) (6,185) (7,171)Other itemsPreferred dividendsNorm alised NPAT 26,641 31,706 37,999 45,585 53,174Extraordinary itemsReported NPAT 26,641 31,706 37,999 45,585 53,174Dividends (9,149) (10,541) (12,633) (15,155) (17,678)Transfer to reserves 17,492 21,165 25,366 30,430 35,495Valuation and ratio analysisFD normalised P/E (x) 22.7 19.0 15.3 12.0 9.8FD normalised P/E at price target (x) 27.0 22.7 18.3 14.3 11.6Reported P/E (x) 22.7 19.0 15.3 12.0 9.8Dividend yield (%) 1.5 1.7 2.2 2.8 3.4Price/cashflow (x) 14.9 11.3 9.6 7.8 6.4Price/book (x) 4.1 3.5 3.0 2.4 2.0EV/EBITDA (x) 12.5 10.5 8.3 6.6 5.3EV/EBIT (x) 15.6 13.0 10.2 8.0 6.5Gross margin (%) 44.6 46.0 44.1 43.9 44.2EBITDA margin (%) 46.1 48.1 45.3 44.4 44.8EBIT margin (%) 37.0 38.8 37.0 36.4 36.7Net margin (% ) 24.9 26.1 24.4 24.3 24.9Effective tax rate (%) 19.1 21.0 21.0 21.0 21.0Dividend payout (%) 34.3 33.2 33.2 33.2 33.2Capex to sales (%) 33.4 25.6 26.4 25.7 26.0Capex to depreciation (x) 3.7 2.8 3.2 3.2 3.2ROE (% ) 19.2 19.9 20.7 21.6 21.8ROA (pretax %) 19.8 20.4 21.9 22.7 22.7Growth (%)Revenue 30.5 13.2 28.3 20.6 13.9EBITDA 22.2 18.1 20.9 18.1 15.0EBIT 22.1 18.7 22.2 18.7 14.8Normalised EPS 20.7 19.0 19.8 20.0 16.6Normalised FD EPS 29.4 19.0 19.8 20.0 16.6Per shareReported EPS (RMB) 1.34 1.59 1.91 2.29 2.67Norm EPS (RMB) 1.34 1.59 1.91 2.29 2.67Fully diluted norm EPS (RMB) 1.34 1.59 1.91 2.29 2.67Book value per share (RMB) 7.41 8.58 9.86 11.39 13.17DPS (RMB) 0.46 0.53 0.64 0.76 0.89Source: Nomura estimatesNomura 65 18 January 2011
  • 67. China Shenhua Energy Ivan Lee, CFA / Matty ZhaoCashflow (RMBmn)Year-end 31 Dec FY08 FY09 FY10F FY11F FY12FEBITDA 49,430 58,360 70,560 83,296 95,824Change in working capital 651 1,326 5,346 4,670 3,982Other operating cashflow (9,463) (6,341) (14,986) (17,445) (19,057)Cashflow from operations 40,618 53,345 60,920 70,521 80,750Capital expenditure (35,784) (31,040) (41,130) (48,312) (55,559)Free cashflow 4,834 22,305 19,790 22,209 25,191Reduction in investments - - - - -Net acquisitions (463) (78) - (5,633) -Reduction in other LT assets (3,076) (2,239) - (0) 0Addition in other LT liabilities (538) (452) - - -Adjustments 2,928 (4,457) 804 885 973Cashflow after investing acts 3,685 15,079 20,594 17,461 26,164Cash dividends (9,325) (9,149) (12,633) (15,155) (17,678)Equity issue - - - - -Debt issue 11,899 2,115 13,525 8,971 9,868Convertible debt issueOthers (609) (1,155) - - -Cashflow from financial acts 1,965 (8,189) 892 (6,184) (7,810)Net cashflow 5,650 6,890 21,487 11,276 18,353Beginning cash 53,404 59,054 65,944 87,431 98,707Ending cash 59,054 65,944 87,431 98,707 117,060Ending net debt 15,204 10,239 2,278 (28) (8,513)Source: Nomura estimatesBalance sheet (RMBmn)As at 31 Dec FY08 FY09 FY10F FY11F FY12FCash & equivalents 59,054 65,944 87,431 98,707 117,060Marketable securities - - - - -Accounts receivable 8,236 8,781 11,266 13,587 15,470Inventories 7,842 7,727 10,261 12,415 14,061Other current assets 2,774 10,007 10,710 11,367 11,899Total current assets 77,906 92,459 119,667 136,076 158,490LT investments 3,876 4,308 4,308 9,941 9,941Fixed assets 178,270 196,690 224,810 258,157 296,320GoodwillOther intangible assets 2,435 2,928 2,928 2,928 2,928Other LT assets 13,053 15,292 15,292 15,292 15,292Total assets 275,540 311,677 367,005 422,394 482,971Short-term debt 18,213 22,252 26,070 28,677 31,544Accounts payable 9,642 13,890 18,446 22,317 25,275Other current liabilities 14,801 19,542 26,054 31,985 37,070Total current liabilities 42,656 55,684 70,570 82,979 93,889Long-term debt 56,045 53,931 63,639 70,002 77,003Convertible debtOther LT liabilities 5,096 4,644 4,644 4,644 4,644Total liabilities 103,797 114,259 138,853 157,626 175,536Minority interest 24,311 26,757 32,126 38,312 45,483Preferred stockCommon stock 19,890 19,890 19,890 19,890 19,890Retained earnings 127,542 150,771 176,137 206,567 242,062Proposed dividendsOther equity and reservesTotal shareholders equity 147,432 170,661 196,027 226,457 261,952Total equity & liabilities 275,540 311,677 367,005 422,394 482,971Liquidity (x)Current ratio 1.83 1.66 1.70 1.64 1.69Interest cover 11.7 23.1 16.6 18.5 26.0LeverageNet debt/EBITDA (x) 0.31 0.18 0.03 net cash net cashNet debt/equity (%) 10.3 6.0 1.2 net cash net cashActivity (days)Days receivable 25.4 25.6 23.5 24.2 24.9Days inventory 43.7 43.4 37.7 39.3 40.7Days payable 57.7 65.6 67.9 70.7 73.1Cash cycle 11.4 3.4 (6.6) (7.2) (7.5)Source: Nomura estimatesNomura 66 18 January 2011
  • 68. China Coal Energy 1 8 9 8 H K B AS I C M AT E R I AL S / M E T AL S & M I N I N G | C H I N A Initiation NOMURA INTERNATIONAL (HK) LIMITED Ivan Lee, CFA +852 2252 6213 ivan.lee@nomura.com Matty Zhao +852 2252 1397 matty.zhao@nomura.com Alan Hon +852 2252 2193 alan.hon@nomura.com NEUTRAL Action Closing price on 12 Jan HK$12.90 While we like China Coal’s long-term output growth story, backed by resources Price target HK$13.90 gained through recent acquisitions and industry consolidation, we are concerned Upside/downside 7.8% about its near-term performance as it is the biggest victim of 2011 contract price Difference from consensus -12.7% cap and lack of near-term catalysts. Trading at 11.8x FY11F P/E, in line with the industry, we believe it is fairly valued. Initiate with NEUTRAL and PT of HK$13.9. FY11F net profit (RMBmn) 11,595 Difference from consensus -4.1% Catalysts Source: Nomura Potential raising of key contract price when CPI inflation eases. Production growth, improving sales mix and potential asset injections are long-term catalysts. Nomura vs consensus Anchor themes We have factored the freezing of key We remain positive on China coal despite government intervention, driven by: contract prices and 2011 key contract 1) solid demand backed by GDP growth and price competiveness of coal, and allocations to China Coal into our 2) ongoing tight supply given increasing safety concerns, accelerating industry forecasts, which do not seem to be consolidation and transportation bottlenecks. fully reflected by consensus. Attractive long-term picture but Key financials & valuations 31 Dec (RMBmn) FY09 FY10F FY11F FY12F lacking near-term catalysts Revenue Reported net profit 53,187 7,834 71,280 10,516 81,909 11,595 95,170 14,627 Normalised net profit 7,834 10,516 11,595 14,627 Normalised EPS (RMB) 0.59 0.79 0.87 1.10 Output to double, but most growth likely after 2013 Norm. EPS growth (%) 3.7 34.2 10.3 26.2 China Coal’s target to double 2009 raw coal output by 2014F is Norm. P/E (x) 19.3 13.8 11.8 8.9 underpinned by: 1) robust reserves, 2) recent resource acquisitions, EV/EBITDA (x) 11.1 8.3 7.2 5.7 Price/book (x) 2.3 2.0 1.7 1.4 3) resources gained via industry consolidation by itself and the parent Dividend yield (%) 1.4 1.9 2.2 2.9 and 4) potential asset injections. However, most of China Coal’s ROE (%) 12.8 15.4 15.2 17.0 output growth will likely come after 2013 when production ramps up Net debt/equity (%) net cash 13.6 21.9 24.5 Earnings revisions from new acquisitions and greenfield projects coming on stream. Previous norm. net profit na na na Change from previous (%) na na na Biggest impact from 2011 contract price cap Previous norm. EPS (RMB) na na na Source: Company, Nomura estimates Despite management’s intention of improving sales mix, China Coal is most vulnerable to the 2011 key contract price control policy since its Share price relative to MSCI China exposure to contract sales (65% in FY11F) and proportion of 2011 key Price (HK$) contracts signed is the highest compared to peers. 16 Rel MSCI China 110 15 100 14 Improving ASP to offset rising cost pressure 13 90 12 80 Despite a 7% projected cost hike in 2011 owing to resource tax reform 11 70 and inflation, margin pressure is partially offset by rising ASP due to 10 9 60 strengthening spot prices and a higher proportion of coking coal sales. Mar10 Aug10 Sep10 Nov10 Dec10 Jan10 Feb10 Apr10 May10 Jun10 Jul10 Oct10 However, with the highest unit production cost in the industry, China Coal’s gross margin is only half that of Shenhua and Yanzhou Coal. 1m 3m 6m Absolute (HK$) 12.2 (8.0) 23.6 Absolute (US$) 12.2 (8.2) 23.6 Valuation in line with industry average; NEUTRAL Relative to Index 9.3 (9.2) 11.0 The stock is trading at 11.8x FY11F P/E, in line with industry average. Market cap (US$mn) 21,998 Estimated free float (%) 44.0 We initiate coverage with a NEUTRAL rating and sum-of-the-parts PT 52-week range (HK$) 15.00/9.45 of HK13.9, implying 12.7x 2011F P/E. This is at an 11% discount to 3-mth avg daily turnover (US$mn) 50.5 Shenhua’s PT implied FY11F P/E of 14.3x, which we believe is Stock borrowability Easy justified by its low EPS growth in 2011F of 10% (vs Shenhua’s 20% Major shareholders (%) China National Coal Group 56.0 and Yanzhou’s 23%). Despite the near-term caution, the stock is attractive in the long term on output growth, improving margin and Source: Company, Nomura estimates industry-leading EPS growth in FY12F. Nomura 67 18 January 2011
  • 69. China Coal Energy Ivan Lee, CFA / Matty ZhaoCompany profileCompany profile Shareholder structure Turnover breakdown (2011F)China Coal Energy Company Limited (1898HK) A-Share Others1. Is a 56%-owned subsidiary of China National Coal Group; Investors 5% 13% Equipment2. Is the second largest coal producer in China, with raw coal 10% production of 101mn tones in FY09; Coking3. Runs four business segments: coal business, coking business, 7% China manufacture of coal mining equipment and other operations; National H-Share Coal Investors Coal4. Coal business, the most profitable segment, contributes to 77% of operation Group 31% 79% the revenue and 88% of the gross profit in FY09; 56%Sales mix in FY09: Thermal 98% vs Coking 2%; Contract 72% vs spot28% of domestic sale;Sales trend (2009-12F) Net profit trend (2009-12F) (RMBmn) Sales Revenue (LHS) (y-y %) (RMBmn) (y-y %) Net Profit (LHS) Growth (RHS) Growth (RHS) 120,000 40 16,000 40 35 35 30 12,000 30 80,000 25 25 20 8,000 20 14,627.4 15 11,594.9 15 40,000 10,515.8 10 4,000 7,834.3 10 5 5 0 0 0 0 2009 2010F 2011F 2012F 2009 2010F 2011F 2012FSWOT analysis 2011F net profit growth driversStrength (%)1) Robust reserves pipeline; 2) potential parent injections, together with 253) recent acquisitions provide a stronger base for China Coal’s long-term 20 1.7%growth than some other coal companies, especially at a time when thegovernment is slowing down new capacity approvals due to rigorous 15 -12.1% 1.5%safety requirements. 10 19.2%Weakness 10.3% % 5 8.8%Due to the depth and sulphur content of its major coal mines, China % 0Coal’s unit production cost has been higher than that of the largest player Increase Increase Increase Coal Non-coal Groupin the sector, Shenhua. in coal in sales in coal business business ASP volume unit costOpportunity P/E bandIn view of our expected 12-FYP mine consolidation development, ChinaCoal, being the second-largest player with robust reserves pipeline, can Price (HK$)benefit from favorable policies and expand its base from both acquisition 35 Avg: 16.4x 30xand organic growth. 30 25x 25Threat 20x 20 15 15xDue to its high sales mix on key contracts, China Coal is the most 10 10xexposed to the 11F key contract price cap among its peers. Its earnings 5 5xwill be impacted more than others should the government impose a moresevere price cap. 0 Jan-07 Feb-08 Mar-09 Apr-10Source: Company data, Nomura estimatesNomura 68 18 January 2011
  • 70. China Coal Energy Ivan Lee, CFA / Matty ZhaoInvestment ThemeRobust long-term output growth whilemost vulnerable to price capWe initiate coverage of China Coal with a NEUTRAL rating and a 12-month price Initiate coverage with a NEUTRALtarget of HK$13.90 based on a sum-of-the-parts (SOTP) valuation and implying rating and PT HK$13.9potential upside of 7.8%. Our PT implies 12.7x FY11F P/E.China Coal offers an attractive long-term picture backed by its robust resource pipeline,strong production growth and improving sales mix (with more spot sales and cokingcoal sales). However, among China’s three coal majors, China Coal is most vulnerableto the FY11 contract price cap, and given that the majority of its output growth is likelyonly after 2013, we find limited share price catalysts in the near term. The only catalystmay be the potential upward revision of non-key contract price post 2Q11 when CPIinflation is likely to ease, in our view. However, we prefer playing this theme throughShenhua, which has a better track record on contract revisions.Output to double by 2014, most growth to materialise in 2013During our company visit in November 2010, China Coal management reiterated itstarget of doubling its 2009 raw coal output by 2014. We remain upbeat about thecompany’s long-term output growth, underpinned by: 1) its robust reserves pipeline,2) recent acquisition of 10bn tonnes of resources and 3) potential asset injections(which are not factored into our model). However, unlike Yanzhou Coal, where themajority of production growth is likely in the next two years, most of China Coal’soutput growth will come after 2013 when production likely ramps up with newacquisitions and greenfield projects coming on stream.Most vulnerable to 2011 contract price capFollowing government intervention, FY11 key contract price will remain unchanged Highest contract proportionfrom FY10 levels. China Coal, with the highest contract sales exposure among peers, among its China peerswill likely be the biggest victim of the price control, and will benefit least from thestrengthening spot price. Although China Coal aims to lower the proportion of contractsales in its sales mix, and thus mitigate the impact of the key contract price to someextent, key contracts still account for 43% of its FY11F output, while non-key contractsand spot sales take up 22% and 35%, respectively.Improving ASP to offset rising cost pressureChina Coal has the highest unit cost among peers, as a result of which its gross profitmargin is only half that of Shenhua and Yanzhou Coal. We expect costs to increase by7% in 2011 driven by resource tax reform and inflation. However, the cost risepressure should be counteracted by rising ASP due to continued upsides in spot priceand a higher proportion of coking coal sales.Fair valuationChina Coal is trading at 11.8x 2011F P/E, in line with the industry average of 12.2x.Our PT implies 12.7x 2011F P/E, an 11% discount to Shenhua PT implied FY11F P/Eof 14.3x. We think the discount is justifiable given China Coal’s lack of near-termcatalysts and low EPS growth in 2011F of 10% (vs Shenhua’s 20% and Yanzhou’s23%). Despite our near-term caution, the stock is attractive in the long term backed byoutput growth and improving margin, in our view.Risks to our investment view: Upside risks include: 1) greater-than-expected outputgrowth and 2) higher-than-expected contract prices. Downside risks include: 1) lower-than-expected spot price increases, 2) weaker coal demand due to weaker-than-expected economic growth in China and 3) higher-than-expected cost hikes due toresource tax and inflation.Nomura 69 18 January 2011
  • 71. China Coal Energy Ivan Lee, CFA / Matty ZhaoValuationInitiating with NEUTRAL, PT of HK$13.9We initiate coverage of China Coal, with NEUTRAL rating and PT of HK$13.9, which Our PT implies 12.7x FY11F P/E,implies potential upside of 7.8%. Our PT is based on a sum-of-the-parts (SOTP) which we think is reasonablevaluation, taking into account the nature of the company’s different businesses andtheir risk profile.We value the individual businesses using DCF methodology: WACC of 11.6% andterminal growth rate of 2.5% for coal business; WACC of 9.4% and terminal growthrate of 1% for equipment manufacture and WACC of 11.6% and terminal growth rateof 1% for the coking business.As of 12 January 2011, the stock is trading at 11.8x FY11F P/E, and 1.7x FY11F P/B,Our target price implies FY11F P/E of 12.7x, a 11% discount to Shenhua’s PT impliedof FY11 P/E of 14.3x.Exhibit 91. Valuation and sensitivityKey Assumptions Coal Equipment CokingRisk Free Rate 3.3% 3.3% 3.3%Beta 1.55 1.10 1.55Market risk premium (rm - rf) 6.5% 6.5% 6.5%Cost of Equity (re) 13.4% 10.5% 13.4% Sensitivity Analysis (Equipment)Cost of Preferred Equity (rp) 0.0% 0.0% 0.0% --- Terminal Growth Rate ---Cost of Debt 3% 3% 3% 0.25% 0.50% 0.75% 1.00% 1.25% 1.50% 1.75%Effective Tax Rate 23% 23% 23% 8.6% 14.0 14.0 14.1 14.1 14.1 14.1 14.2Market Value Preferred Stock/E Ratio 0.0% 0.0% 0.0% 8.8% 14.0 14.0 14.0 14.0 14.1 14.1 14.1 --- WACC ---Market Value D/E Ratio 35.0% 35.0% 35.0% 9.0% 13.9 14.0 14.0 14.0 14.0 14.1 14.1Weight Average Cost of Capital (WACC) 11.6% 9.4% 11.6% 9.2% 13.9 13.9 13.9 14.0 14.0 14.0 14.0Terminal Growth Rate 2.5% 1.0% 1.0% 9.4% 13.9 13.9 13.9 13.9 14.0 14.0 14.0 9.6% 13.8 13.9 13.9 13.9 13.9 13.9 14.0Discounted Free Cash Flow Valuation Coal Equitpment Total 9.8% 13.8 13.8 13.8 13.9 13.9 13.9 13.9PV of FCFF during 2011-2020 66,484 3,212 69,696 10.0% 13.8 13.8 13.8 13.8 13.9 13.9 13.9Continuing value based on cash flows beyond Year 16 87,991 7,584 95,575 10.2% 13.8 13.8 13.8 13.8 13.8 13.8 13.9Total Enterprise Value (Operating Value) 154,475 10,795 165,270Add: Excess Cash & Non-operating Investments 3,509 204 3,712Add: Cash from Share Options - - - Sensitivity Analysis (Coal)Total Firm Value 157,984 10,999 168,983 --- Terminal Growth Rate --- - 1.75% 2.00% 2.25% 2.50% 2.75% 3.00% 3.25%Equity Valuation - 10.8% 14.8 15.1 15.4 15.7 16.0 16.4 16.7Total Firm Value 157,984 10,999 168,983 11.0% 14.4 14.7 14.9 15.2 15.5 15.8 16.2 --- WACC --- Less: Value of Interest Bearing Debt (21,388) 11.2% 14.0 14.2 14.5 14.8 15.1 15.4 15.7 Less: minority interest - 11.4% 13.6 13.8 14.1 14.3 14.6 14.9 15.2Value of Common Equity 147,594 11.6% 13.2 13.5 13.7 13.9 14.2 14.4 14.7 - 11.8% 12.9 13.1 13.3 13.5 13.8 14.0 14.3Number of Share Outstanding (mn) 13,259 12.0% 12.5 12.7 12.9 13.2 13.4 13.6 13.9Share Options (mn) 12.2% 12.2 12.4 12.6 12.8 13.0 13.2 13.5Fully diluted no. of shares (mn) 13,259 12.4% 11.9 12.1 12.3 12.5 12.7 12.9 13.1 -Equity Value per share (RMB) 11.13Equity Value per share (HKD) 13.92Source: Nomura estimatesNomura 70 18 January 2011
  • 72. China Coal Energy Ivan Lee, CFA / Matty ZhaoExhibit 92. Valuation comparison Price Market target Price cap Fiscal P/E (x) PEG P/B (x) Yield (%) Net debt/equity (%) RoE (%)Company Ticker Rating L. Curr. L. Curr. (US$mn) Y/E 10F 11F 12F 10-12F 10F 11F 12F 10F 11F 12F 10F 11F 12F 10F 11F 12FCoalAsiaHong Kong - Thermal CoalShenhua Energy-H 1088 HK BUY 41.00 34.40 87,945.5 Dec 15.3 12.0 9.8 1.0 3.0 2.4 2.0 2.2 2.8 3.4 1 net cash net cash 20.7 21.6 21.8China Coal-H 1898 HK NEUTRAL 13.90 12.90 21,984.2 Dec 13.8 11.8 8.9 1.0 2.0 1.7 1.4 1.9 2.2 2.9 14 22 24 15.4 15.2 17.0Yanzhou Coal-H 1171 HK BUY 30.40 25.45 16,089.1 Dec 14.3 10.9 9.4 1.0 3.1 2.5 2.0 2.1 2.7 3.2 54 51 33 23.5 24.4 22.8Average 14.5 11.6 9.3 1.0 2.7 2.2 1.8 2.0 2.6 3.2 23 36 29 19.9 20.4 20.5Hong Kong - Coking CoalFushan 639 HK Not rated n.a. 6.11 4,228.5 Dec 17.4 15.2 13.6 1.8 1.9 1.7 1.6 2.6 3.2 3.6 net cash net cash net cash 11.6 12.4 12.7Hidili 1393 HK Not rated n.a. 7.47 1,979.3 Dec 17.3 11.1 9.0 0.5 2.0 1.7 1.5 1.3 2.0 2.7 41 41 35 11.5 14.5 16.6Average 17.4 13.2 11.3 1.0 2.4 2.0 1.7 2.0 2.6 3.2 26 37 30 17.1 18.1 18.6Hong Kong average 15.6 12.2 10.1 1.1 2.4 2.0 1.7 2.0 2.6 3.2 27 38 31 16.5 17.6 18.2ChinaDatong Coal 601001 CH Not rated n.a. 20.59 5,211.6 Dec 24.1 20.9 17.4 1.8 4.0 3.7 3.5 2.0 2.4 2.7 n.a. n.a. n.a. 13.2 15.1 15.7Pingdingshan Tianan Coal Mining Co. 601666 CH Not rated n.a. 21.31 5,853.3 Dec 16.3 14.1 12.6 1.6 3.5 2.9 2.6 2.9 3.1 3.1 n.a. n.a. n.a. 25.6 24.6 22.6Shanxi Guoyang 600348 CH Not rated n.a. 28.10 10,220.1 Dec 24.5 21.0 19.3 2.5 8.3 6.6 4.9 1.9 2.2 2.4 n.a. n.a. n.a. 33.8 29.8 26.6Shanghai Energy 600642 CH Not rated n.a. 7.70 3,671.0 Dec 15.0 13.8 12.9 2.7 1.3 1.2 1.2 2.0 2.5 2.7 n.a. n.a. n.a. 9.3 8.7 9.3Hengyuan Coal 600971 CH Not rated n.a. 50.01 3,316.2 Dec 20.0 18.1 17.3 3.7 4.4 3.7 2.9 n.a. n.a. n.a. n.a. n.a. n.a. 19.7 18.9 17.0Luan Environmental Energy 601699 CH Not rated n.a. 58.55 10,187.4 Dec 22.3 19.0 16.4 1.7 6.2 5.1 3.8 2.0 3.1 3.5 n.a. n.a. n.a. 31.1 29.8 27.5SDIC Xinji 601918 CH Not rated n.a. 14.08 3,940.0 Dec 18.7 14.7 11.8 0.9 3.8 3.1 2.5 n.a. 2.1 2.9 n.a. n.a. n.a. 18.9 20.4 21.5China Average 20.1 17.4 15.4 2.1 4.5 3.8 3.0 2.2 2.6 2.9 n.a. n.a. n.a. 21.6 21.1 20.0S.E. AsiaBanpu BANPU TB Not rated n.a. 846 7,564.9 Dec 12.3 11.6 10.5 2.1 3.4 2.9 2.4 2.2 2.6 3.0 58 39 13 34.6 27.0 25.4Bumi BUMI IJ BUY 4,300 3,075 7,097.6 Dec 48.3 28.9 7.2 0.3 3.7 3.3 2.3 0.8 0.4 0.7 195 166 80 8.7 12.1 37.8ITMG ITMG IJ BUY 73,000 54,600 6,854.9 Dec 22.5 13.3 7.3 0.3 7.4 5.4 3.6 2.4 2.7 4.5 net cash net cash net cash 35.5 47.1 59.2Bukit Asam PTBA IJ BUY 30,000 23,100 5,872.8 Dec 28.7 17.7 10.1 0.4 8.6 6.4 4.4 2.6 1.7 2.8 net cash net cash net cash 31.1 41.5 51.8Indika Energy INDY IJ Not rated n.a. 4,975 2,858.4 Dec 21.8 12.9 11.1 0.5 4.2 3.4 2.8 1.3 2.1 3.1 9 net cash net cash 20.2 27.1 26.9Adaro ADRO IJ BUY 3,700 2,625 9,264.4 Dec 27.5 13.9 7.5 0.3 4.2 3.3 2.4 0.9 0.6 0.7 21 6 net cash 15.5 26.8 37.2S.E. Asia Average 26.9 16.4 9.0 0.7 5.3 4.1 3.0 1.7 1.7 2.5 71 71 47 24.3 30.3 39.7Asia Average 21.1 15.6 11.8 1.3 4.2 3.4 2.7 1.9 2.3 2.8 49 54 37 21.1 23.2 26.1AustraliaWhitehaven Coal WHC AU Not rated n.a. 6.80 3,393.8 Jun 62.4 36.8 17.1 0.7 3.1 3.1 2.8 0.8 1.3 2.6 net cash net cash net cash 5.9 8.7 17.5New Hope Corp NHC AU Not rated n.a. 4.90 4,112.5 Jul 21.3 21.7 17.3 3.0 1.7 1.7 1.6 2.7 3.6 3.3 net cash net cash net cash 7.1 8.5 9.5Gloucester Coal GCL AU Not rated n.a. 12.87 1,827.3 Jun 25.3 27.2 17.9 2.2 5.6 2.7 2.4 0.4 0.5 0.9 net cash net cash net cash 25.6 16.4 18.4Stanmore Coal SMR AU Not rated n.a. 1.35 169.4 Jun 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 MCC AU Not rated n.a. 13.55 4,102.2 Jun 27.9 17.5 13.2 0.6 3.0 2.3 2.1 1.5 2.6 3.4 net cash net cash net cash 11.5 15.0 17.3Australia Average 34.2 25.8 16.4 1.6 3.4 2.5 2.2 1.4 2.0 2.5 n.a. n.a. n.a. 12.5 12.1 15.6North AmericaArch Coal ACI US Not rated n.a. 35.53 5,773.0 Dec 30.4 12.5 9.4 0.3 2.6 2.2 1.8 1.1 1.1 1.1 71 42 22 8.8 19.0 22.5Consol Energy Inc. CNX US Not rated n.a. 53.04 11,978.8 Dec 23.6 17.4 11.9 0.7 3.7 3.1 2.5 0.8 0.8 0.8 106 85 56 15.6 18.3 23.0Peabody Energy Corp. BTU US Not rated n.a. 63.34 17,078.9 Dec 20.9 13.2 10.9 0.5 3.7 3.0 2.3 0.5 0.5 0.6 27 11 net cash 19.3 24.6 23.6N. America Average 25.0 14.4 10.7 0.5 3.3 2.8 2.2 0.8 0.8 0.8 68 46 39 14.6 20.6 23.0Note: Pricing as of 12 Jan 2011 closing / Indonesia Coal report published on the same day uses 11 Jan, 2011 closing price for pricingSource: Bloomberg consensus data for not rated stocks, Nomura estimates for rated stocksNomura 71 18 January 2011
  • 73. China Coal Energy Ivan Lee, CFA / Matty ZhaoCoal productionOn track to double production by 2014but most growth to materialise after 2013As China’s second-largest coal provider, China Coal had a 3.3% market share, in China coal had a 3.3% marketterms of raw coal production volume in FY09 (vs Shenhua’s 6.9% and Yanzhou Coal’s share in FY091.2%). During our visit to China Coal in November 2010, management reiterated itstarget to double FY09 raw coal output volume (101mn tonnes) by 2014.We are optimistic and believe China Coal’s raw coal output will reach 180mn tonnesby 2014 through organic growth, underpinned by its robust reserves pipeline andrecent acquisitions of mines. With the addition of potential parent injections (withannual output of 20mn tonnes, based on our company checks), management’s targetshould be met, in our view. However, we assume most of the output growth will comeafter 2013 when the new acquisitions and greenfield projects come onstream.Pingshuo is the only key driver for near-term output growthChina Coal has five main operating coal mines – Pingshuo, Datun, Liliu, Dongpo and 90% of the FY10F output growthNanliang. As of 31 December 2009, recoverable coal reserves owned by the company was from Pingshuo upgradesamounted to 8.7bn tonnes under PRC standards.Pingshuo, China Coal’s most important operating mine, contributed to over 85% of rawcoal output in FY07-FY09. Through operational upgrades, Pingshuo mines continuedto set new benchmarks, achieving over 53mn tonnes of production in 1H10. Whileoutput was affected slightly by quality issues in 3Q10, management believes that theproblems were resolved in 4Q10, as evidenced by the high volume in October andNovember 2010.Although operating mines in Pingshuo would have reached full capacity of 104mntonnes (up 20% y-y) in FY10, Pingshuo East open-pit mines (a greenfield project), with1.6bn tonnes recoverable reserve, will start production in mid-2011F, serving as theengine for output growth in the next two years.Given Datun, Dongpo and Nanliang nearly produced to full capacity in 2009, we onlyexpect an aggregated 1mn tonnes growth from FY09 to 2012F from these mines.New resource acquisitions underpin long-term growthA-share proceeds to be used in new mines with 2bn tonne reservesIn 1H10, China Coal announced changes in the use of A-share proceeds to developfour new coal mines (Nalin River No.2, Muduchaideng, Xiaohuigou and Hecaogou),Yulin Energy Chemical and Zhangjiadou CME industrial park. The transaction boostedChina Coal’s recoverable reserves of 1.98bn tonnes, with 1bn tonnes equitable toChina Coal. The new mines bring an additional 20mn tonnes capacity to the company.10 tonnes of new resources acquired in 1H10China Coal has been active in acquiring new resources. In 1H10, the company addedover 10bn tonnes of coal resources in Xinjiang, Inner Mongolia, Shanxi and Shaanxi toits pipelines. (as of 2009-end). Another 2bn tonnes of resources were added to thegroup level, which might be injected into the listed company at the appropriate time(See exhibit below for location of new coal mines and resources acquired).Nomura 72 18 January 2011
  • 74. China Coal Energy Ivan Lee, CFA / Matty ZhaoExhibit 93. China Coal: Key mines and coal resources of minesSource: Company data, Nomura researchHowever, most of the output growth will materialise only in 2013Following the Wangjialing accident in 2010, production at Wangjialing has beendelayed to mid 2011. Management guided that it should ramp up in 2012. However,factoring in the more rigorous safety requirements after the accident, we estimateslower output growth, reaching full capacity only in 2013.Based on the average of two years taken to construct a mine and slower governmentapprovals, we expect the four new coal mines to start production only in 2013, in linewith management’s guidance provided during our company visit in November 2010.Of the 10bn tonnes of new resources added, two-thirds is from Xinjiang. Infrastructurein Xinjiang is less developed than in China Coal’s other mine bases; we do notanticipate much production from these mines in the next four to five years. Despite thelimited short-term output growth, we view the acquisitions as a strategic long-termmove, providing the company with a sustainable growth profile, at a time when thegovernment has stated its intention to slow down approval for mining resources.Potential upsides from asset injectionsFollowing its significant efforts in closing smaller, more dangerous and less efficient Beneficiary of China’s industrycoal mines in the 11th Five-Year Plan (FYP), we believe China will continue to promote consolidationconsolidation in the upcoming 12th FYP.China Coal Group (the parent company), as a state-owned enterprise, is better-positioned to obtain access to reserves across the nation, than non-SOE coal players,in our view. We believe the resources would finally be injected into the listco. Theparent company obtained around 20 small mines through consolidation in FY08-09,with current annual output capacity of 20mn tonnes. These small mines, afterproduction upgrades, can reach 40mn tonnes output, according to management.Despite the uncertainty of timing, we believe the Jinhaiyang project (with eight smallmines) is most likely to be injected into the listco after capacity upgrade in 2012F,resulting in potential capacity upside of over 20mn tonnes to China Coal in the longterm, which is not factored in our model yet.Nomura 73 18 January 2011
  • 75. China Coal Energy Ivan Lee, CFA / Matty ZhaoExhibit 94. China Coal: raw coal production projection 2009A 2010F 2011F 2012F 2013F 2014F (mnt) (mnt) (mnt) (mnt) (mnt) (mnt)Existing projectsPingshuo Mining Area Thermal Shanxi 87.0 104.0 104.0 104.0 104.0 104.0Antaibao Open Pit Mine 100 22.7Anjialing Open Pit Mine 100 20.3Anjialing No.1 Underground Mine 100 16.0Anjialing No.2 Underground Mine 100 15.5Antaibao Underground Mine 100 6.7Jingdong Mine 100 5.7Datun Mining Area Thermal Jiangsu 8.6 9.0 9.0 10.0 10.0 10.0Yaoqiao Mine 62.43 4.1Kongzhuang Mine 62.43 1.4Xuzhuang Mine 62.43 1.8Longdong Mine 62.43 1.3Liliu Mining Area Coking Shanxi 1.7 3.0 4.0 6.0 6.0 6.0Shaqu Mine 50 1.7 3.0 4.0 6.0 6.0 6.0Dongpo Coal 100 Thermal Shanxi 1.9 2.0 2.0 2.0 2.0 2.0Nanliang Coal 55 Thermal Shannxi 1.7 2.0 2.0 2.0 2.0 2.0Greenfield projectsPingshuo East * Thermal - - 8.0 15.0 20.0 20.0Wangjialing - Liliu* Coking - 1.0 3.0 6.0 6.0 -Use of A shares proceedsNalin River No. 2 Coal Mine* 51 Thermal Inner Mongolia - - - - 4.0 8.0Muduchaideng Coal Mine* 51 Thermal Inner Mongolia - - - - 3.0 6.0Xiaohuigou Coal Mine* 55 Coking Shaanxi - - - - 3.0 3.0Hecaogou Coal Mine* 50 Coking Shaanxi - - - 3.0 3.0 -OthersOther coal resources 100 Thermal - - - 10.0 10.0 -Total 100.8 120.0 130.0 142.0 173.0 180.0(y-y %) 19.0 8.3 9.2 21.8 4.0Source: Company data, Nomura estimatesNomura 74 18 January 2011
  • 76. China Coal Energy Ivan Lee, CFA / Matty ZhaoCoal pricingBiggest impact from 2011 contract pricecapHigher-than-peers’ contract price risk exposureGiven the high inflation pressure and requests from power companies to lower prices 2011 key contract price to remaindue to the cost pressure, the National Development and Reform Committee (NDRC) unchanged at RMB570/t; Chinadecided to freeze 2011 key contract thermal coal prices at the end of 2010. Coal, with largest exposure to contract sales, is affected mostThe contract prices preliminarily agreed between coal and power companies in the among peers“2011 national coal production and demand meeting” held in the last week ofDecember 2010 stayed at the 2010 RMB570/tonne level, according to China CoalTransportation and Marketing Association.We believe China Coal is likely to be most impacted by the 2011 contract price cap:1. Despite management’s efforts to improve sales mix, China Coal still has the largest exposure to contract sales (71% of FY10F domestic sales), compared to its peers Shenhua (58%) and Yanzhou Coal (28%).2. China Coal’s management also indicated that key contracts account for 60-70% of total contract sales, leading to key contract sales accounting for 40-50% of total domestic sales (vs around 30% for Shenhua and less than 10% for Yanzhou Coal).3. As a partially state owned enterprise, China Coal bears more responsibilities in stabilising coal supply and coal price.Decreasing proportion of contract sales will partly ease pressureOn enlarging contract-spot price spread, China Coal is determined to improve its salesmix. According to management guidance during our company visit in November 2010,we assume 80-90% of new output will be sold in the spot market in 2011 and 2012,resulting in a lower proportion of contract sales, from 71% in 2010F to 65% in 2011Fand further to 62% in 2012F.Although the lower proportion of contract sales in 2011F will partly ease contract pricepressure, China Coal will remain worst-affected by the contract price cap among itspeers, in our view.Exhibit 95. China Coal: contract sales proportion comparison (2009-12F) (%) Shenhua China Coal Yanzhou 80 73 71 71 70 65 62 60 58 55 55 50 40 28 30 23 25 25 20 10 0 2009 2010F 2011F 2012FNote: We only include self-produced coal domestic sales. Yanzhou Coal excludes Yancoal Australia’s salesSource: Company data, Nomura estimatesNomura 75 18 January 2011
  • 77. China Coal Energy Ivan Lee, CFA / Matty ZhaoKey contracts to account for 43% of 2011 raw coal productionPer our communication with the company, total key contract coal volume signed byChina National Coal Group (the parent company) at the end of December 2010, was inline with the railway capacity volume secured by NDRC in early December 2010 ofaround 70mn tonnes. Although the key contract volume for the listed company wasn’tdisclosed at the time of writing this report, we assume 80% of the key contract signedwill be allocated to the listco, based on our discussion with China Coal andmanagement’s intention of adjusting the listco’s customer base.Therefore, we estimate key contracts’ volume will account for 43% of our forecasted2011F raw coal production volume (130mn tonnes). In line with our industry overview,we assume no change in key contract price and a 5% price increase in non-keycontract price, resulting in a 2% y-y rise in China Coal’s 2011 contract price.Nomura 76 18 January 2011
  • 78. China Coal Energy Ivan Lee, CFA / Matty ZhaoMarginHigher ASP offsets rising cost pressuresDespite the increasing cost pressure, we expect China Coal’s gross margin to improve Strong spot price and higherslightly by 0.4% and 1.4% respectively in FY11-12F, on higher proportion of coking coking coal sales portion partly offset the key contract price riskcoal sales and spot sales.Higher ASP driven by higher spot price and coking coal salesDespite the short-term headwinds caused by the 2011 key contract price cap, we seean upside trend in China Coal’s ASP underpinned by: Continued upside in spot price We expect the strengthening spot price trend (up 25% y-y in FY10) to continue in the next two years, on tight supply and soaring demand. Along with a higher proportion of spot sales (from 27% of domestic sales in 2009 to 38% in FY12F) and the continued spot price uptrend, China Coal’s thermal coal ASP should rise by 5% pa in the next two years. Higher proportion of coking coal sales Historically, China Coal has relied heavily on thermal coal sales, which accounted for 98% of its coal production in 2009. With Wangjialing mine starting production and Shaqu mine expanding output in the next two years, we expect the proportion of coking coal sales to be 4% and 6% of self-produced coal sales in 2011 and 2012, respectively. Given the wide price spread between coking coal and thermal coal, the increase in the proportion of coking coal is the biggest driver for China Coal’s rising ASP.Exhibit 96. China Coal: thermal vs coking coal Exhibit 97. Thermal vs coking coal price (09-10F)production (2007-2012F) (mnt) Thermal coal Coking coal (RMB/t) Thermal coal price Coking coal price 140 133.0 1,200 1100 125.0 117.0 120 1,000 99.2 829 100 89.0 80.6 800 80 600 60 456 408 400 40 20 9.0 200 2.5 3.0 5.0 2.7 1.7 0 0 2007 2008 2009 2010F 2011F 2012F 2009 2010FSource: Company data, Nomura estimates Source: Company data, Nomura estimatesNomura 77 18 January 2011
  • 79. China Coal Energy Ivan Lee, CFA / Matty ZhaoRising cost pressure driven by resource tax and inflationHighest unit cost lowers profitCompared with Shenhua, China Coal enjoys a lower transportation cost, benefitingfrom the shorter distance between its mines and the ports. We believe China Coal hasbetter access to railway capacity since it is a shareholder in the Daqin rail line, thebackbone for coal transportation in China.However, its much higher unit production cost than Shenhua counteracts its marginallybetter unit transportation cost. China Coal’s production cost is much higher given: 1) itsaverage mine depth is nearly double that of Shenhua and 2) it has a higher blendingcost since its raw coal has higher sulphur and ash content but lower calorific valuesthan Shenhua. Given its unit cost is the highest among peers, China Coal’s gross profitmargin is only half that of Shenhua and Yanzhou Coal.Exhibit 98. China Coal: unit cost breakdown (07-12F) Exhibit 99. Total unit cost (self produced coal) (RMB/t) Materials Staff cost (RMB/t) Shenhua China Coal Yanzhou 400 Depn. Others 400 Transportation 343 350 350 324 328 303297 311 300 283 300 97 94 256 244 250 90 250 231 88 84 207 219 86 200 98 200 92 68 80 85 150 59 23 150 13 21 13 24 18 20 35 100 19 30 33 100 28 50 81 99 78 84 90 50 73 0 0 2007 2008 2009 2010F 2011F 2012F 2009 2010F 2011F 2012FSource: Company data, Nomura estimates Source: Company data, Nomura estimatesResource taxCurrently, China Coal pays a resource tax of RMB3.2 for each tonne of raw coal output We factored in RMB10/tonne extrain Shanxi province. As discussed in the industry overview section, resource tax reform resources tax into our modelwould probably change the tax base from volume to price, i.e., 3% to 5% of the salesprice. While it is uncertain which price the new resource tax would be based on, wetake the ex-mine price approach. Applying 5% to the FY10 average ex-mine price(Shanxi Shuozhou gas coal 4,800kcal/kg) of RMB309/tonne, we assume a newresource tax of RMB15/tonne in FY11 for domestic coal production.As we expect the resource tax reform to be implemented in 1Q11, we factor in theextra resource tax of RMB10/tonne for China Coal’s domestic output in our 2011Fforecast. In the long run, given the prevailing seller’s market and China Coal’s positionas the second-largest player, we think it can pass on the extra cost, if any, todownstream customers.Given the rapid growth in output scale, we believe maintenance cost and mining costs,etc., should be well under control. This would partially offset the upward cost pressureon materials, staff cost and government charges due to CPI growth.Nomura 78 18 January 2011
  • 80. China Coal Energy Ivan Lee, CFA / Matty ZhaoFinancial analysisRelatively low margin and lowest EPSgrowth among peers in 2011FWe estimate China Coal’s 2011 gross profit margin to be 26%, much lower than Being affected by high portion ofShenhua’s 44% and Yanzhou’s 48%, mainly due to lower-than-peers unit profit of self key contract sales, its FY11F EPSproduced coal sales. In view of the higher-than-peer contract risk exposure and with growth is only 10%most of its enhanced production set to come onstream only in 2013, China Coal’snormalised EPS growth rate will be the lowest among peers at 10% in 2011F,compared to Shenhua’s 20% and Yanzhou Coal’s 23%. However, on strong contractprice growth in 2012F and a lower base, its EPS growth rate in 2012F will be thehighest among peers, according to our estimates.With higher gross margin than the non-coal segment, the coal segment remains thekey earning driver, generating 79- 80% of the total revenue in FY10F and FY11F, onour estimates.Exhibit 100. China Coal: gross margin of the group, Exhibit 101. EPS comparison (2009-2012F)coal and non-coal business (2009-2012F) (%) Group Coal business Non coal business (RMB) Shenhua China Coal Yanzhou 50 3.0 2.67 2.5 2.29 40 1.91 31 2.0 28 29 1.59 30 27 26 27 25 23 1.5 1.10 20 0.87 13 13 14 1.0 0.79 1.87 2.05 12 0.59 1.52 10 0.5 0.84 0 0.0 2009 2010F 2011F 2012F 2009 2010F 2011F 2012FSource: Company data, Nomura estimates Source: Company data, Nomura estimatesKey driver and sensitivity analysisWe expect China Coal’s net profit to grow by 10.3% to RMB11.6bn in FY11, largely Coal business set to drive margindriven by 7% ASP growth. We expect the coal business to contribute 8.8% to net profit improvementgrowth, and the non-coal business to contribute the remaining 1.5%.Exhibit 102. Net profit growth driver (2011F) (%) 25 20 1.7% 15 -12.1% 1.5% 10 19.2% % 5 8.8% 10.3% % 0 Increase in Increase in Increase in Coal Non-coal Group coal ASP sales volume coal unit business business costSource: Company data, Nomura estimatesNomura 79 18 January 2011
  • 81. China Coal Energy Ivan Lee, CFA / Matty ZhaoFrom the sensitivity table below, we conclude that China Coal is most sensitive tocontract price change with the highest exposure to contract sales among peers, due tothe proportion of contract sales in its sales mix.Exhibit 103. 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 estimatesNomura 80 18 January 2011
  • 82. China Coal Energy Ivan Lee, CFA / Matty ZhaoWhere could we be wrong?Risks to our investment viewLower-than-expected spot price: Coal prices are the most sensitive factor for China If coal contract prices and spotCoal’s earnings. Our coal price forecast is based on the tight supply and demand prices are lower or higher than our forecasts, China coal’soutlook for the next two years. If spot prices are lower than our forecasts, China Coal’s earnings could deviateearnings could deviate considerably from our forecasts. Key downside risks include: considerably from our forecasts1) weaker-than-expected coal-fired power generation; 2) Higher-than-expected supplycuts caused by industry consolidation or big coal mining accidents, 3) lower-than-expected global coal prices and 4) tightened transportation caused by unexpectedweatherHigher-than-expected contract price: We assume that there will be no change tokey contract price in 2011 from the 2010 level in light of government intervention and a5% change in non-key contract price. If contract fulfilment rates drop significantly andcontracts are re-negotiated, contract prices might be higher than our projection,leading to a higher EPS for China Coal.Lower-than-expected production: Implementation of stricter mine safety regulationsand the Wangjianing incident earlier this year affected China Coal’s production growth.Similar incidents or policies or delays in greenfield projects / progress on mineupgrades, could lower production from the levels we estimate.Weaker-than-expected recovery in China’s economy. If China’s economy recoversmore slowly than we expect, we believe coal demand from the four key sectors —power, steel, building materials and chemicals — will deteriorate and exert pressure oncoal prices, leading to lower earnings growth for China Coal.Higher-than-expected cost hikes. We believe higher-than-expected increase in cost,if any, would be policy-related. We believe the new resource tax is likely to beimplemented in 2011, which could raise costs for all Chinese coal producers, includingChina Coal. The extent of increase in costs could be higher than we estimate or similarpolicy changes could lead to hikes that we have not factored in.Higher coal import boosted by a strengthening renminbi. Our economics teamexpects the renminbi to appreciate 6% and 5% against the dollar in 2011 and 2012,respectively. If the appreciation is faster than we expect, we believe coastal importvolume would increase, putting further pressure on domestic coal prices.Nomura 81 18 January 2011
  • 83. China Coal Energy Ivan Lee, CFA / Matty ZhaoCompany profileBusiness descriptionChina Coal Energy Company Limited engages principally in coal production anddistribution. China Coal was the China’s second largest coal producer, measured interms of raw coal production, in 2009 (Source: China National Coal Association). Thecompany primarily manages three major business units: 1) coal business (producing,selling and distributing coal domestically and overseas), 2) coking business (providingcustomers with metallurgy coke and forging coke) and 3) manufacture of miningequipment (products include hydraulic supports, scraper, conveyors, etc). As of end-FY09, coal, coking and mining equipment contributed 77%, 7% and 10%, respectively,to the company’s total revenue.Exhibit 104. China Coal: FY09 revenue breakdown Others, 6% Coal mining equipment, 10% Coking operation, 7% Coal operation, 77%Source: Company dataCoal businessAs at end-2009, China Coal produced 100.8mnt raw coal, of which, 87mnt came fromthe Pingshuo mining area, the most important operating mines of the company. Thecompany currently has three major mining areas in operation: Pingshuo: Located in Shanxi, these are the most important of China Coal’s operating mines, contributing to over 85% of raw coal production in FY07-FY09. In 2010, Pingshuo mines continued to set new benchmarks by achieving over 53mn tonnes of production in 1H10. Production was affected slightly due to quality issues in 3Q10. With the evidence of high production in Oct 2010, we agree with management that the problem has been resolved in 4Q10. We anticipate full-year production of 104mn tonnes for Pingshuo in 2010. Liliu: The Liliu mines, also located in Shanxi, contributed 1.65mn tonnes to China Coal’s total production in FY09. We estimate the Shaqu mine will reach full production capacity in FY12F with an output of 6mn tonnes. Datun: Located in Jiangsu, this mining area has been operational since the 1970s. We don’t see much growth potential in Datun and expect production to ramp up to 10mn tonnes in FY12 from 8.61mn tonnes in FY09.As of end-FY09, China Coal had 15.82bn tonnes of coal reserves and its coal minesprimarily produced thermal coal, which made up 98% of total coal production in 2009;most of its self-produced thermal coal is sold domestically. The company sold78.97mnt of self-produced commercial coal in 2009, representing a wash rate of 78%.China Coal also engaged in proprietary coal trading and import and export agency,amounting to 15mnt and 2.99mnt, respectively, for 2009.Nomura 82 18 January 2011
  • 84. China Coal Energy Ivan Lee, CFA / Matty ZhaoExhibit 105. China Coal: 2009 thermal coal sales mix Exhibit 106. China Coal: 2009 self produced coal mix Export, 2% Coking, 2% Domestic spot, 27% Domestic contract, 71% Thermal, 98%Note: Self-produced thermal coal Note: Self-producedSource: Company data Source: Company dataCoking operationThe coking operation involves processing coking coal into coke. The coking businessin China is pretty difficult as margins are being squeezed by upstream coking coalprice and downstream coke demand fluctuation. In the past, the coke market in Chinaexperienced large fluctuations in sales price and raw material cost.Since it has the advantage of owning coking coal resources, China Coal can keepabreast of the frequently fluctuating market and make timely adjustments to production.Therefore, its coking operation performs better than companies focusing purely oncoking operations. The company’s coking operation provided positive EBIT in 2009,while many of its competitors suffered operating losses.Given the unfavourable industry outlook, we don’t expect high profitability for cokingoperation in 2010F-2012F, with gross profit margin and EBIT margin to remain steadyat 5% and 2% respectively.Mining equipmentChina National Coal Mining Equipment Co Ltd, a wholly owned subsidiary of ChinaCoal, was ranked number one in the PRC coal mining equipment industry in 2009 interms of revenue. It has a 40% share in China’s high-end equipment market. Its mainproducts include armoured face conveyor, shearer, hydraulic roof support and electricmining motor, etc.Exhibit 107. China Coal: mining machinerySource: Company dataNomura 83 18 January 2011
  • 85. China Coal Energy Ivan Lee, CFA / Matty ZhaoWe are positive on the outlook for the equipment business. We believe coal industryrestructuring during the 12th Five-Year plan will provide significant opportunities for thebusiness as the mechanisation rate of coal mining would increase further during mineconsolidation, driving greater demand for mining equipment.We estimate the revenue and EBIT of this business will almost double in 2012F,compared with 2009, registering a CAGR of 23%.Shareholding structureExhibit 108. Major shareholders of China Coal A-Share Investors, 13% China National H-Share Coal Group Corp, Investors, 31% 56%Source: Company dataNomura 84 18 January 2011
  • 86. China Coal Energy Ivan Lee, CFA / Matty ZhaoKey assumptionsExhibit 109. China Coal: Key assumptions 2008 2009 2010F 2011F 2012FCoalProduction VolumeTotal raw-coal production (mnt) 91 101 120 130 142Total commercial coal production (mnt) 74 79 94 101 111Wash rate (%) 81 78 78 78 78Sales VolumeSelf-produced thermal (mnt) 72 77 91 98 104Self-produced coking (mnt) 2 2 2 4 7Proprietary coal trading (mnt) 5 15 20 20 20Import and export agency (mnt) 9 3 3 3 3Total (mnt) 89 97 117 124 134Contract sales as a % of domestic sales (%) 84 73 71 65 62Domestic contract -Thermal (mnt) 55 56 64 63 64Domestic spot - Thermal (mnt) 11 21 26 34 39Subtotal of Domestic - Thermal (mnt) 66 76 90 98 104Export Sales - Thermal (mnt) 7 1 2 0 0Coking Coal (mnt) 2 2 2 4 7Total (Self produced) (mnt) 74 79 94 101 111PriceDomestic contract price (Thermal) (RMB/t) 365 402 423 431 453Domestic spot price (Thermal) (RMB/t) 612 417 525 562 584Export ASP (Thermal) (RMB/t) 694 522 653 666 679Thermal coal ASP (RMB/t) 432 408 456 477 503y-y % (5) 12 5 5Coking coal ASP (RMB/t) 1,011 829 1,100 1,200 1,200ASP Self-Produced coal (RMB/t) 447 416 472 505 547y-y % (7) 13 7 8CostUnit production cost - self produced (RMB/t) 204 199 213 230 246Total unit cost of self produced coal (RMB/t) 292 283 303 324 343Unit cost for coal trading (RMB/t) 733 514 617 661 687Unit profitUnit gross profit-self produced (RMB/t) 155 133 169 181 204Unit gross profit - coal trading (RMB/t) 30 11 13 13 14Source: Company, Nomura estimatesNomura 85 18 January 2011
  • 87. China Coal Energy Ivan Lee, CFA / Matty ZhaoFinancial statementsIncome statement (RMBmn)Year-end 31 Dec FY08 FY09 FY10F FY11F FY12FRevenue 51,753 53,187 71,280 81,909 95,170Cost of goods sold (38,187) (40,696) (53,239) (60,879) (69,344)Gross profit 13,566 12,491 18,042 21,030 25,826SG&A (2,167) (1,219) (2,273) (3,589) (4,046)Employee share expenseOperating profit 11,399 11,272 15,769 17,440 21,780EBITDA 13,041 13,529 18,778 21,420 26,731Depreciation (1,590) (2,198) (2,913) (3,848) (4,783)Amortisation (53) (59) (97) (132) (167)EBIT 11,399 11,272 15,769 17,440 21,780Net interest expense (1,006) (445) (1,115) (1,283) (1,397)Associates & JCEs 106 90 - - -Other income - - - - -Earnings before tax 10,498 10,917 14,653 16,157 20,383Income tax (2,494) (2,536) (3,404) (3,753) (4,734)Net profit after tax 8,004 8,381 11,250 12,404 15,648Minority interests (873) (547) (734) (809) (1,021)Other itemsPreferred dividendsNorm alised NPAT 7,131 7,834 10,516 11,595 14,627Extraordinary itemsReported NPAT 7,131 7,834 10,516 11,595 14,627Dividends (825) (2,044) (2,743) (3,025) (3,816)Transfer to reserves 6,305 5,791 7,773 8,570 10,812Valuation and ratio analysisFD normalised P/E (x) 21.2 19.3 13.8 11.8 8.9FD normalised P/E at price target (x) 22.8 20.8 14.9 12.7 9.6Reported P/E (x) 20.0 19.3 13.8 11.8 8.9Dividend yield (%) 0.5 1.4 1.9 2.2 2.9Price/cashflow (x) 14.7 12.9 10.6 8.4 6.4Price/book (x) 2.6 2.3 2.0 1.7 1.4EV/EBITDA (x) 11.7 11.1 8.3 7.2 5.7EV/EBIT (x) 13.4 13.2 9.9 8.9 7.0Gross margin (%) 26.2 23.5 25.3 25.7 27.1EBITDA margin (%) 25.2 25.4 26.3 26.2 28.1EBIT margin (%) 22.0 21.2 22.1 21.3 22.9Net margin (% ) 13.8 14.7 14.8 14.2 15.4Effective tax rate (%) 23.8 23.2 23.2 23.2 23.2Dividend payout (%) 11.6 26.1 26.1 26.1 26.1Capex to sales (%) 24.1 29.8 33.0 28.7 24.7Capex to depreciation (x) 7.8 7.2 8.1 6.1 4.9ROE (% ) 16.5 12.8 15.4 15.2 17.0ROA (pretax %) 17.8 13.1 15.2 13.9 15.0Growth (%)Revenue 45.2 2.8 34.0 14.9 16.2EBITDA 25.0 3.7 38.8 14.1 24.8EBIT 26.7 (1.1) 39.9 10.6 24.9Normalised EPS 11.4 3.7 34.2 10.3 26.2Normalised FD EPS 5.2 9.9 34.2 10.3 26.2Per shareReported EPS (RMB) 0.57 0.59 0.79 0.87 1.10Norm EPS (RMB) 0.57 0.59 0.79 0.87 1.10Fully diluted norm EPS (RMB) 0.54 0.59 0.79 0.87 1.10Book value per share (RMB) 4.42 4.84 5.43 6.08 6.89DPS (RMB) 0.06 0.15 0.21 0.23 0.29Source: Nomura estimatesNomura 86 18 January 2011
  • 88. China Coal Energy Ivan Lee, CFA / Matty ZhaoCashflow (RMBmn)Year-end 31 Dec FY08 FY09 FY10F FY11F FY12FEBITDA 13,041 13,529 18,778 21,420 26,731Change in working capital (21,716) 7,442 (514) (48) (288)Other operating cashflow 18,349 (9,283) (4,487) (5,037) (6,133)Cashflow from operations 9,674 11,688 13,777 16,336 20,310Capital expenditure (12,449) (15,858) (23,498) (23,498) (23,498)Free cashflow (2,775) (4,170) (9,721) (7,162) (3,188)Reduction in investments - - - - -Net acquisitions (1,345) (1,915) - - -Reduction in other LT assets 266 (8,359) (2,038) (2,029) (2,019)Addition in other LT liabilities (440) 2,108 - - -Adjustments (17,352) 17,493 4,389 4,379 4,370Cashflow after investing acts (21,646) 5,158 (7,370) (4,812) (838)Cash dividends (825) (2,044) (2,743) (3,025) (3,816)Equity issue 25,671 - - - -Debt issue 701 1,227 6,314 2,798 1,903Convertible debt issueOthers (327) 398 (39) (39) (39)Cashflow from financial acts 25,220 (418) 3,532 (266) (1,952)Net cashflow 3,574 4,740 (3,838) (5,078) (2,789)Beginning cash 4,314 7,888 12,628 8,790 3,712Ending cash 7,888 12,628 8,790 3,712 923Ending net debt 3,192 (352) 9,801 17,676 22,368Source: Nomura estimatesBalance sheet (RMBmn)As at 31 Dec FY08 FY09 FY10F FY11F FY12FCash & equivalents 7,888 12,628 8,790 3,712 923Marketable securitiesAccounts receivable 5,635 4,964 6,652 7,644 8,882Inventories 4,240 4,978 6,513 7,447 8,483Other current assets 33,422 28,337 30,215 31,319 32,696Total current assets 51,185 50,907 52,170 50,123 50,984LT investments 1,932 2,475 2,442 2,442 2,442Fixed assets 29,010 36,729 52,615 67,565 81,580GoodwillOther intangible assets 41 42 257 446 609Other LT assets 6,343 14,702 16,741 18,769 20,789Total assets 88,512 104,855 124,225 139,345 156,404Short-term debt 887 990 1,295 1,480 1,686Accounts payable 10,777 13,887 18,167 20,774 23,663Other current liabilities 1,329 643 951 1,326 1,799Total current liabilities 12,993 15,519 20,412 23,581 27,149Long-term debt 10,194 11,287 17,296 19,908 21,605Convertible debtOther LT liabilities 2,498 4,606 4,606 4,606 4,606Total liabilities 25,685 31,412 42,315 48,095 53,360Minority interest 4,250 9,215 9,909 10,679 11,661Preferred stockCommon stock 13,259 13,259 13,259 13,259 13,259Retained earnings 36,545 37,299 58,743 67,313 78,125Proposed dividends 2,044 1,987 - - -Other equity and reserves 6,730 11,684 - - -Total shareholders equity 58,577 64,228 72,001 80,572 91,383Total equity & liabilities 88,512 104,855 124,225 139,346 156,404Liquidity (x)Current ratio 3.94 3.28 2.56 2.13 1.88Interest cover 11.3 25.3 14.1 13.6 15.6LeverageNet debt/EBITDA (x) 0.24 net cash 0.52 0.83 0.84Net debt/equity (%) 5.4 net cash 13.6 21.9 24.5Activity (days)Days receivable 35.1 36.4 29.7 31.9 31.8Days inventory 36.2 41.3 39.4 41.8 42.0Days payable 73.9 110.6 109.9 116.7 117.3Cash cycle (2.7) (32.9) (40.7) (43.0) (43.5)Source: Nomura estimatesNomura 87 18 January 2011
  • 89. Yanzhou Coal 1 1 7 1 H K B AS I C M AT E R I AL S / M E T AL S & M I N I N G | C H I N A Initiation NOMURA INTERNATIONAL (HK) LIMITED Ivan Lee, CFA +852 2252 6213 ivan.lee@nomura.com Matty Zhao +852 2252 1397 matty.zhao@nomura.com Alan Hon +852 2252 2193 alan.hon@nomura.com BUY Action Closing price on 12 Jan HK$25.45 We like Yanzhou Coal as a pure play on our bullish view on coal prices given its Price target HK$30.40 expansion into Australia and high exposure to the local spot/seaborne market. The Upside/downside 19.4% Felix acquisition and planned stake increase in Ashton mine underpin production Difference from consensus 19.0% and 23% EPS growth projection for 2011F. Valuation at 10.9x FY11F P/E is undemanding compared to Asian players at 15.6x FY11F P/E. BUY, although we FY11F net profit (RMBmn) 9,190 caution that the stock price may react to seasonal coal price weakness. Difference from consensus 2.7% Source: Nomura Catalysts Strengthening spot price and high international coal price. Strong winter demand. Nomura vs consensus Yanzhou has only 4.2mn tonnes of coal output (less than 10%) under price cap. We factor in output from its plans to Anchor themes acquire a 30% equity interest in Positive on China coal despite government intervention, driven by: 1) solid demand Ashton mines and dispose of its 51% backed by GDP growth and price competiveness, 2) ongoing tight supply due to stake in Minvera mines, announced safety concerns, accelerating industry consolidation and transportation bottleneck. on 30 Dec 2010. Best-positioned in pricing trends; Key financials & valuations 31 Dec (RMBmn) FY09 FY10F FY11F FY12F well-deserved re-rating Revenue Reported net profit 20,253 4,117 35,095 7,459 42,566 9,190 46,959 10,105 Normalised net profit 4,117 7,459 9,190 10,105 Biggest beneficiary of rising spot price Normalised EPS (RMB) 0.84 1.52 1.87 2.05 Norm. EPS growth (%) (36.5) 81.2 23.2 10.0 Backed by the highest spot sales proportion (75% of 2011F domestic Norm. P/E (x) 26.8 14.3 10.9 9.4 sales) among peers, we believe Yanzhou is best positioned to benefit EV/EBITDA (x) 17.1 9.2 7.1 5.9 from strong domestic spot prices and is least vulnerable to the 2011 Price/book (x) 3.8 3.1 2.5 2.0 contract price cap. Its exposure to higher-priced coking coal and Dividend yield (%) 1.8 2.1 2.7 3.2 ROE (%) 14.7 23.5 24.4 22.8 robust seaborne and Australian coal markets widen its ASP spread to Net debt/equity (%) 48.0 53.5 50.5 32.6 peers, underpinning its 23% EPS growth in FY11F (vs Shenhua 20%, Earnings revisions China Coal 10%). Previous norm. net profit na na na Change from previous (%) na na na Previous norm. EPS (RMB) na na na Robust output growth driven by Australian operations Source: Company, Nomura estimates The Felix acquisition in Dec 09 turned around Yanzhou Coal’s output constraints (26% growth in FY10F vs only 1-3% in FY08-09). We Share price relative to MSCI China Price expect robust output growth in 2011-12F fuelled by: 1) the Moolarben (HK$) Rel MSCI China 27 140 mine capacity expansion, 2) the recently announced A$909mn capital 25 130 investment in Yancoal Australia for a 30% equity interest in Ashton, 23 120 21 and 3) improving production yield of its Australian operations. 19 110 17 100 15 90 Improving margin through cost cutting 13 80 Mar10 Jan10 Feb10 May10 Jun10 Aug10 Sep10 Nov10 Dec10 Larger production scale in Australia should allow Yancoal Australia Apr10 Jul10 Oct10 and Zhaolou mines’ unit cost to drop by 6% and 49% in 2011F, on our 1m 3m 6m estimates, which partially offsets rising costs in China due to Absolute (HK$) 14.6 18.4 61.1 resources tax and inflation. Thus, we expect Yanzhou’s margin to Absolute (US$) 14.6 18.2 61.1 improve, underpinned by rising ASP, competitive transportation costs Relative to Index 11.8 17.1 48.5 Market cap (US$mn) 16,099 and cost cutting. Estimated free float (%) 40.0 52-week range (HK$) 25.45/14.68 Transforming into an international coal company 3-mth avg daily turnover (US$mn) 51.1 Stock borrowability Easy Yanzhou has successfully transformed itself into an international play Major shareholders (%) and this deserves a re-rating, in our view. Trading at 10.9x 2011F P/E, Yankuang Group 52.9 it is at a discount of 11-31% to its local and international peers. We Source: Company, Nomura estimates initiate coverage with a BUY, and a sum-of-the-parts-based price target of HK$30.4, implying 13.0x FY11P/E. Nomura 88 18 January 2011
  • 90. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoCompany profileCompany profile Shareholder structure Turnover breakdown (2011F)Yanzhou Coal Mining Company Limited (1171HK), listed in 1998, islocated in Jining, Shandong province of East China. Heze A-Share1. It is a 52.86%-owned subsidiary of Yankuang Group, which is wholly Shanxi 5% Investors owned by the Shandong government. 7% 2% H-Share2. It had 36mn tonnes of saleable coal output in 2009, and coal sales Investors 40% volume of 38mn tonnes, with around 77% via in the spot market and 23% via contract sales. Yankuang Australia The Group3. Its main customers include power and steel companies in Shandong 53% 29% Company and the Yangtze Delta region, with 72% thermal coal sales and 38% 64% high quality metallurgical coal.Yanzhou Coal acquired Felix in Australia in Dec 2009, with 560mntonnes of Joint Ore Reserves Committee (JORC) reserves.Sales trend (2009-12F) Net profit trend (2009-12F) (RMBmn) Sales revenue (LHS) (% y-y) (RMBmn) (% y-y) Net profit (LHS) Growth (RHS) 60,000 Growth (RHS) 80 12,000 100 80 50,000 60 60 40,000 40 8,000 40 20 30,000 20 0 9,190 10,105 (20) 20,000 0 4,000 7,459 (40) 10,000 (20) 4,117 (60) (80) 0 (40) 0 (100) 2009 2010F 2011F 2012F 2009 2010F 2011F 2012FSWOT analysis 2011F net profit growth driversStrength (%) 301) Its clean coal products are of high quality with higher ASPs comparedwith Shenhua and China Coal; 2) its main operating mines are close to 25 -4.5% 0.5%end customers, which lowers its transportation costs; 3) flexible sales mix 20 19.2%with high spot sales; metallurgical coal sales helps Yanzhou to ride the 15favourable pricing momentum. 22.7% 23.2% 10Weakness 5 8.0%1) Existing mines in Shandong have limited expansion constraints, 0 Increase in Increase in Increase in Coal Other Group2) Yanzhou’s access to coal resources is not as good as key SOEs. sales ASP coal unit business businesses volume costOpportunity P/E bandYanzhou stands to be the biggest beneficiary among its peers from thefavourable pricing momentum with a strong spot price under China’s tight Price (HK$) 50supply market in the next two years and high international prices. 45 20x 40 Avg: 8.8xThreats 35 15x 30Potential changes in the resources tax and government-imposed safety 25 10xprovisions exert upside pressure on costs. NDRC’s price control exerts 20constraints on key contract price hikes but Yanzhou would be the least 15 10 5xaffected among peers. 5 0 Jan-07 Feb-08 Mar-09 Apr-10Source: Company data, Nomura estimatesNomura 89 18 January 2011
  • 91. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoInvestment themeTransforming into an international playWe initiate coverage of Yanzhou Coal with a BUY rating and a 12-month price target of Initiate coverage with Buy ratingHK$30.4 based on a sum-of-the-parts (SOTP) valuation offering 19.4% upside fromcurrent levels. Our price target implies 13.0x FY11P/E.We believe our price target is attainable on the back of the stock’s undemanding FY11F EPS growth of 23%,valuation and highest EPS growth of 23% (vs Shenhua 20% and China Coal 10%) in highest among peersFY11F, because: 1) we believe Yanzhou Coal is best positioned to benefit fromfavourable pricing trends, 2) its robust output growth driven by its Australian operations,and 3) margin improvement through cost cutting.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 seasonaladjustments), which may suppress Yanzhou’s share price performance in the nearterm.Best positioned to benefit from the favourable pricing trendsLeveraging on its highest spot sales proportion in 2011F (75% of domestic sales)compared with its peers, we believe Yanzhou Coal is well positioned to benefit frompotential strong domestic spot prices in FY11-12F, and correspondingly the leastvulnerable to the 2011 contract price cap. A strong seaborne market, underpinned byChina’s growing coal imports (China has been a net importer since 2009) would alsoprovide a positive backdrop for the domestic spot market, benefiting Yanzhou Coal. Inlight of its exposure to higher-priced coking coal and riding on a rising price trend inAustralia, due partly to the recent flooding, we expect Yanzhou Coal’s ASP premiumover its peers to widen in 2011F. Given that coal companies’ EPS is most sensitive tosales price, we expect rising ASP to provide solid ground for Yanzhou Coal’s superior23% EPS growth in 2011F.Robust output growth underpinned by Australian operationsThe Felix acquisition in Dec 09 has strategically turned around Yanzhou Coal’sslowing production growth (only 1-3% growth in FY08 and FY09) due to depletingproduction in its home town, Shandong. We believe the acquisition should help sustainYanzhou Coal’s growth momentum in 2010 and allow the company’s output toincrease 26% y-y in FY10F. For the next two years, we see robust output growthunderpinned by: 1) the Moolarben mine capacity expansion and 2) the recentlyannounced A$909mn capital investment in Yancoal Australia for a 30% equity interestin Ashton and 3) the improving production yield of its Australian operations.Superior margins via cost cutting and low transportation costOn the back of increasing production and economies of scale in Australia, we expectthe unit cost of Yancoal Australia and Zhaolou mines to drop by 6% and 49%,respectively in 2011F. This should partially help offset increasing costs in China due toresources tax and cost inflation. As a result, we expect Yanzhou’s overall unitproduction cost to rise at a slower pace than its peers. Underpinned by rising ASPs,competitive unit transportation costs (only 10-20% of the costs of Shenhua and ChinaCoal) and cost cutting, we expect Yanzhou Coal’s net profit margin to improve fasterthan its peers.Nomura 90 18 January 2011
  • 92. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoTransforming into an international play deserves a re-ratingYanzhou Coal’s current 10.9x 2011F P/E is relatively high, compared with its historical Valuation undemandingaverage 12-month forward P/E of 8.8x, but is undemanding compared with Shenhua’s compared peers12.0x FY11F P/E and China Coal’s 11.8x FY11F P/E. We believe the companydeserves a re-rating on the back of 81% EPS growth in FY10F and its successfulexpansion into Australia (transforming into an international coal company). Thevaluation also compares favourably with that of international peers at 15.7x FY11F P/E.Risks to our investment viewRisks to our BUY rating and price target include: 1) lower-than-expected spot priceincrease (seasonal spot coal price weakness in Feb-Aug), 2) weaker coal demandowing to weaker-than-expected growth of the Chinese economy and 3) a higher-than-expected cost hike due to resources taxes, smaller-than-expected cost cutting at Felixand Zhaolou and inflation risks, and 4) foreign exchange risks.Nomura 91 18 January 2011
  • 93. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoValuationInitiating with BUY and PT of HK$30.4We initiate coverage of Yanzhou Coal, with a BUY rating and a price target of HK$30.4, Our PT implies 13x FY11F P/E,which implies 19.4% potential upside at current levels. Our price target, which is based which we think is attainableon a sum-of-the-parts valuation, takes into account the diverse business nature andrisk profiles of its coal and non-coal businesses.We employ a WACC of 10.9% and a terminal growth rate of 2.5% for the DCFvaluation of its coal business, and assume a WACC of 9.2% and a terminal growthrate of 1% for its non-coal businesses (equipment segment and coking operationsegment).After the stock rally since September 2010, owing to impressive 3Q10 results and theacquisition of Haosheng mines, Yanzhou Coal is currently trading at 10.9x FY11F P/E,still at a discount to Shenhua’s 12.0x FY11F P/E and China Coal’s 11.8X FY11F PE.Our price target implies 13.0x FY11P/E (vs. implied target price P/Es of 14.3x forShenhua and 12.7x of China Coal). We believe the valuation is justifiable given itshighest EPS growth in 2011F and highest ROE among peers.Yanzhou Coal has transformed itself into an international coal company, with thecompany expecting 32% of its FY11F gross profit to come from Australia; however, webelieve its valuation is undemanding compared with that of global, regional andAustralian peers’ 15.6x-25.8x FY11 P/E.Exhibit 110. Valuation and sensitivity tablesKey assumptions Coal OthersRisk Free Rate 3.3% 3.3%Beta 1.45 1.05Market risk premium (rm - rf) 6.5% 6.5%Cost of Equity (re) 12.7% 10.1%Cost of Debt 5.0% 5.0% Sensitivity table (Others)Effective Tax Rate 27.0% 27.0% --- Terminal Growth Rate ---Market Value Preferred Stock/E Ratio 0.0% 0.0% 0.25% 0.50% 0.75% 1.00% 1.25% 1.50% 1.75%Market Value D/E Ratio 50.0% 50.0% 8.4% 30.5 30.5 30.6 30.6 30.6 30.6 30.7Weight Average Cost of Capital (WACC) 10.9% 9.2% 8.6% 30.5 30.5 30.5 30.5 30.6 30.6 30.6 --- WACC ---Terminal Growth Rate 2.5% 1.0% 8.8% 30.4 30.5 30.5 30.5 30.5 30.6 30.6 9.0% 30.4 30.4 30.4 30.5 30.5 30.5 30.5Discounted Free cash flow valuation Coal Others Total 9.2% 30.4 30.4 30.4 30.4 30.4 30.5 30.5PV of FCFF during 2011-2020 58,816 1,858 60,674 9.4% 30.3 30.4 30.4 30.4 30.4 30.4 30.5Continuing value based on cash flows beyond Year 16 57,396 2,489 59,885 9.6% 30.3 30.3 30.3 30.4 30.4 30.4 30.4Total Enterprise Value (Operating Value) 116,212 4,348 120,560 9.8% 30.3 30.3 30.3 30.3 30.3 30.4 30.4Add: Excess Cash & Non-operating Investments 16,744 19,734 36,478 10.0% 30.3 30.3 30.3 30.3 30.3 30.3 30.4Add: Cash from Share Options - - -Total Firm Value 132,956 24,082 157,038 Sensitivity table (Coal) --- Terminal Growth Rate ---Equity Valuation 1.75% 2.00% 2.25% 2.50% 2.75% 3.00% 3.25%Total Firm Value 157,038 10.1% 32.0 32.5 33.1 33.7 34.3 35.0 35.7 Less: Value of Interest Bearing Debt (37,389) 10.3% 31.2 31.7 32.2 32.8 33.4 34.0 34.7 --- WACC --- Less: Value of Preferred Stock - 10.5% 30.5 30.9 31.4 31.9 32.5 33.1 33.7Value of Common Equity 119,649 10.7% 29.8 30.2 30.6 31.1 31.6 32.2 32.8 10.9% 29.1 29.5 29.9 30.4 30.8 31.4 31.9Number of Share Outstanding (mn) 4,918 11.1% 28.4 28.8 29.2 29.6 30.1 30.6 31.1Share Options (mn) - 11.3% 27.8 28.2 28.5 28.9 29.4 29.8 30.3Fully diluted no. of shares (mn) 4,918 11.5% 27.2 27.5 27.9 28.3 28.7 29.1 29.5 11.7% 26.6 26.9 27.3 27.6 28.0 28.4 28.8Equity Value per share (RMB) 24.3Equity Value per share (HKD) 30.4Source: Nomura researchNomura 92 18 January 2011
  • 94. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoExhibit 111. Valuation comparison Price Market target Price cap Fiscal P/E (x) PEG P/B (x) Yield (%) Net debt/equity (%) RoE (%)Company Ticker Rating L. Curr. L. Curr. (US$mn) Y/E 10F 11F 12F 10-12F 10F 11F 12F 10F 11F 12F 10F 11F 12F 10F 11F 12FCoalAsiaHong Kong - Thermal CoalShenhua Energy-H 1088 HK BUY 41.00 34.40 87,945.5 Dec 15.3 12.0 9.8 1.0 3.0 2.4 2.0 2.2 2.8 3.4 1 net cash net cash 20.7 21.6 21.8China Coal-H 1898 HK NEUTRAL 13.90 12.90 21,984.2 Dec 13.8 11.8 8.9 1.0 2.0 1.7 1.4 1.9 2.2 2.9 14 22 24 15.4 15.2 17.0Yanzhou Coal-H 1171 HK BUY 30.40 25.45 16,089.1 Dec 14.3 10.9 9.4 1.0 3.1 2.5 2.0 2.1 2.7 3.2 54 51 33 23.5 24.4 22.8Average 14.5 11.6 9.3 1.0 2.7 2.2 1.8 2.0 2.6 3.2 23 36 29 19.9 20.4 20.5Hong Kong - Coking CoalFushan 639 HK Not rated n.a. 6.11 4,228.5 Dec 17.4 15.2 13.6 1.8 1.9 1.7 1.6 2.6 3.2 3.6 net cash net cash net cash 11.6 12.4 12.7Hidili 1393 HK Not rated n.a. 7.47 1,979.3 Dec 17.3 11.1 9.0 0.5 2.0 1.7 1.5 1.3 2.0 2.7 41 41 35 11.5 14.5 16.6Average 17.4 13.2 11.3 1.0 2.4 2.0 1.7 2.0 2.6 3.2 26 37 30 17.1 18.1 18.6Hong Kong average 15.6 12.2 10.1 1.1 2.4 2.0 1.7 2.0 2.6 3.2 27 38 31 16.5 17.6 18.2ChinaDatong Coal 601001 CH Not rated n.a. 20.59 5,211.6 Dec 24.1 20.9 17.4 1.8 4.0 3.7 3.5 2.0 2.4 2.7 n.a. n.a. n.a. 13.2 15.1 15.7Pingdingshan Tianan Coal Mining Co. 601666 CH Not rated n.a. 21.31 5,853.3 Dec 16.3 14.1 12.6 1.6 3.5 2.9 2.6 2.9 3.1 3.1 n.a. n.a. n.a. 25.6 24.6 22.6Shanxi Guoyang 600348 CH Not rated n.a. 28.10 10,220.1 Dec 24.5 21.0 19.3 2.5 8.3 6.6 4.9 1.9 2.2 2.4 n.a. n.a. n.a. 33.8 29.8 26.6Shanghai Energy 600642 CH Not rated n.a. 7.70 3,671.0 Dec 15.0 13.8 12.9 2.7 1.3 1.2 1.2 2.0 2.5 2.7 n.a. n.a. n.a. 9.3 8.7 9.3Hengyuan Coal 600971 CH Not rated n.a. 50.01 3,316.2 Dec 20.0 18.1 17.3 3.7 4.4 3.7 2.9 n.a. n.a. n.a. n.a. n.a. n.a. 19.7 18.9 17.0Luan Environmental Energy 601699 CH Not rated n.a. 58.55 10,187.4 Dec 22.3 19.0 16.4 1.7 6.2 5.1 3.8 2.0 3.1 3.5 n.a. n.a. n.a. 31.1 29.8 27.5SDIC Xinji 601918 CH Not rated n.a. 14.08 3,940.0 Dec 18.7 14.7 11.8 0.9 3.8 3.1 2.5 n.a. 2.1 2.9 n.a. n.a. n.a. 18.9 20.4 21.5China Average 20.1 17.4 15.4 2.1 4.5 3.8 3.0 2.2 2.6 2.9 n.a. n.a. n.a. 21.6 21.1 20.0S.E. AsiaBanpu BANPU TB Not rated n.a. 846 7,564.9 Dec 12.3 11.6 10.5 2.1 3.4 2.9 2.4 2.2 2.6 3.0 58 39 13 34.6 27.0 25.4Bumi BUMI IJ BUY 4,300 3,075 7,097.6 Dec 48.3 28.9 7.2 0.3 3.7 3.3 2.3 0.8 0.4 0.7 195 166 80 8.7 12.1 37.8ITMG ITMG IJ BUY 73,000 54,600 6,854.9 Dec 22.5 13.3 7.3 0.3 7.4 5.4 3.6 2.4 2.7 4.5 net cash net cash net cash 35.5 47.1 59.2Bukit Asam PTBA IJ BUY 30,000 23,100 5,872.8 Dec 28.7 17.7 10.1 0.4 8.6 6.4 4.4 2.6 1.7 2.8 net cash net cash net cash 31.1 41.5 51.8Indika Energy INDY IJ Not rated n.a. 4,975 2,858.4 Dec 21.8 12.9 11.1 0.5 4.2 3.4 2.8 1.3 2.1 3.1 9 net cash net cash 20.2 27.1 26.9Adaro ADRO IJ BUY 3,700 2,625 9,264.4 Dec 27.5 13.9 7.5 0.3 4.2 3.3 2.4 0.9 0.6 0.7 21 6 net cash 15.5 26.8 37.2S.E. Asia Average 26.9 16.4 9.0 0.7 5.3 4.1 3.0 1.7 1.7 2.5 71 71 47 24.3 30.3 39.7Asia Average 21.1 15.6 11.8 1.3 4.2 3.4 2.7 1.9 2.3 2.8 49 54 37 21.1 23.2 26.1AustraliaWhitehaven Coal WHC AU Not rated n.a. 6.80 3,393.8 Jun 62.4 36.8 17.1 0.7 3.1 3.1 2.8 0.8 1.3 2.6 net cash net cash net cash 5.9 8.7 17.5New Hope Corp NHC AU Not rated n.a. 4.90 4,112.5 Jul 21.3 21.7 17.3 3.0 1.7 1.7 1.6 2.7 3.6 3.3 net cash net cash net cash 7.1 8.5 9.5Gloucester Coal GCL AU Not rated n.a. 12.87 1,827.3 Jun 25.3 27.2 17.9 2.2 5.6 2.7 2.4 0.4 0.5 0.9 net cash net cash net cash 25.6 16.4 18.4Stanmore Coal SMR AU Not rated n.a. 1.35 169.4 Jun 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 MCC AU Not rated n.a. 13.55 4,102.2 Jun 27.9 17.5 13.2 0.6 3.0 2.3 2.1 1.5 2.6 3.4 net cash net cash net cash 11.5 15.0 17.3Australia Average 34.2 25.8 16.4 1.6 3.4 2.5 2.2 1.4 2.0 2.5 n.a. n.a. n.a. 12.5 12.1 15.6North AmericaArch Coal ACI US Not rated n.a. 35.53 5,773.0 Dec 30.4 12.5 9.4 0.3 2.6 2.2 1.8 1.1 1.1 1.1 71 42 22 8.8 19.0 22.5Consol Energy Inc. CNX US Not rated n.a. 53.04 11,978.8 Dec 23.6 17.4 11.9 0.7 3.7 3.1 2.5 0.8 0.8 0.8 106 85 56 15.6 18.3 23.0Peabody Energy Corp. BTU US Not rated n.a. 63.34 17,078.9 Dec 20.9 13.2 10.9 0.5 3.7 3.0 2.3 0.5 0.5 0.6 27 11 net cash 19.3 24.6 23.6N. America Average 25.0 14.4 10.7 0.5 3.3 2.8 2.2 0.8 0.8 0.8 68 46 39 14.6 20.6 23.0Note: pricing as of 12 Jan 2011 closing / Indonesia Coal report published on the same day uses 11 Jan, 2011 closing price for pricingSource: Bloomberg for not rated stocks, Nomura estimates for rated stocksNomura 93 18 January 2011
  • 95. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoCoal priceBest-positioned to benefit from strongcoal priceGiven its better coal quality and higher portion of spot sales, Yanzhou Coal enjoys a ASP premium over peers to widenhigher realised average sales price (ASP) than its peers. Its FY09 ASP (self produced) in 2011Fwas RMB506/tonne, 30% and 22% higher than Shenhua’s and China Coal’s,respectively. We remain upbeat that the ASP spread between Yanzhou Coal and itspeers will widen in FY11-12F, in view of the pricing momentum for Yanzhou Coal: Highest leverage to a strong domestic spot price. Least affected by the key contract price cap policy. Better product mix, with higher-priced products. Riding on Australia’s price rising trends.Highest leverage to a strong domestic spot priceYanzhou Coal has the highest exposure to the spot market, with spot sales accountingfor 72% of its FY10F domestic sales (excluding Yancoal Australia’s sales), comparedwith its peers Shenhua (42%) and China Coal (29%). Management expects a similardomestic sales mix for the next two years as that seen in FY10. In light of a wideningspot-contract price spread, we estimate its spot portion to rise slightly to 75% by 3%.Exhibit 112. Yanzhou Coal: spot sales portion of domestic sales (FY09-12F) (%) Shenhua China Coal Yanzhou 90 77% 75% 75% 80 72% 70 60 50 45% 45% 42% 38% 40 35% 29% 27% 29% 30 20 10 0 2009 2010F 2011F 2012FNote: China Coal excl. coking coal sales/Yanzhou excl. 3rd party purchased coal and Yancoal Australia salesSource: Company dataAfter a strong run in FY10 (up 25% y-y), we expect the strengthening spot price trendto continue over the next two years, on the back of tight supply and soaring demand.Given its high proportion of spot sales in the domestic market, we believe YanzhouCoal stands to be the biggest beneficiary of the continued spot price uptrend.Nomura 94 18 January 2011
  • 96. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoLeast affected by contract price capAccording to our industry checks, the National Development and Reform Commission Only 4.2mn tonnes of coal output(NDRC) is expected to place price controls over 2011 key contract prices under high (less than 10%) are under price capinflation pressure. However, we think, Yanzhou will be least affected by the price capsbecause: It has a much lower contract sales proportion than its peers. Out of the 10mn tonnes contracts signed in 2010, only 4.2mn tonnes were sold under key contracts. While the company’s FY11F key contract sales volumes will largely be in line with FY10 numbers, according to management, only 8% of its sales will likely be affected by the policy, based on our FY11F sales forecast. Yanzhou Coal’s non-SOE nature enables it to be more market-oriented and flexible in terms of adjusting sales mix.Better product mix drives up price premiumYanzhou Coal is less reliant on thermal coal than its peers. Although the companydoes not produce traditional hard coking coal, 26% of its FY09 domestic sales(excluding Yancoal Australia sales) are the higher-priced No.1 and No.2 clean coalfrom its headquarters and one-third coking coal from Heze Neng, which are sold tocustomers in the metallurgical sector. With Heze Neng Hua releasing more capacity,we expect its domestic metallurgical coal sales proportion to increase steadily to 32%in FY12F (vs Shenhua’s 0% and China Coal’s 6% in FY12F).Exhibit 113. Domestic sales mix comparison (2009) Exhibit 114. Domestic sales mix comparison (2012F) (%) Thermal Coking (%) Thermal Coking 120 120 0% 2% 26% 0% 6% 32% 100 100 80 80 60 60 100% 98% 100% 40 40 94% 74% 68% 20 20 0 0 Shenhua China Coal Yanzhou Shenhua China Coal YanzhouNote: The sales mix is based on domestic sales of self-produced coal. Note: The sales mix is based on domestic sales of self-produced coal.Source: Company data Source: Nomura estimatesDomestic coking coal price (Gujiao No.2 coking coal FOB) provides an RMB525-790/tonne premium over QHD FOB price (5,500 Kcal/kg). Backed by rising and moredisciplined steel production as per our steel analyst, we remain upbeat that the cokingcoal price premium will continue, which we believe will benefit Yanzhou most.Riding Australia’s rising price trendUnlike domestic annual contracts, Australia coal contracts are signed on a quarterlybasis, with prices varying little from market prices. Our global metal and mining teamforecasts the Australia coal market to witness a price up-cycle over the next two years,both in terms of thermal coal and semi-soft coking coal.Nomura 95 18 January 2011
  • 97. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoExhibit 115. Nomura Australia coal price forecast 2008 2009 2010F 2011F 2012FThermal coal (US$/ tonne) 125 70 98 140 170% y-y - (44) 40 43 21Semi-soft coking coal 196 124 134 182 186% y-y (37) 8 36 4Source: Nomura estimatesIn line with Australia’s coal price trend, we forecast Yancoal Australia’s 2010F ASP tobe RMB760/ tonne (up 14% y-y). Based on Yancoal Australia’s FY09 ASP being at a10-20% discount to Australia coal price, we assume Yancoal Australia’s coal salesprice at a 10% discount to our international team’s forecast price. As a result, YancoalAustralia’s average sales price of thermal coal and coking coal would be RMB983/tonne in FY11F (up 29% y-y) and RMB1069/ tonne (up 9% y-y) in FY12F.Widening ASP spread with peersGiven that Yanzhou Coal stands to be the biggest beneficiary of favourable coal pricetrends, we expect the ASP spread between Yanzhou Coal and its peers to widen overthe next two years.Exhibit 116. Yanzhou Coal: ASP (self produced) comparison (2009-2012F) (RMB/t) Shenhua China Coal Yanzhou 900 800 800 748 700 648 600 547 506 505 479 472 457 500 416 388 431 400 300 200 100 0 2009 2010F 2011F 2012FSource: Company data, Nomura estimatesNomura 96 18 January 2011
  • 98. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoProductionRapid output growth driven by AustralianoperationsWhile Yanzhou Coal showed only marginal output growth of 3% y-y in FY08 and 1% in Felix acquisition in Dec 2009FY09, due to smaller reserves and its main operating mines reaching full capacity, the helped to overcome outputacquisition of Felix Resources Ltd in Dec 2009 has helped it overcome output constraints, with growth of 26% in FY10Fconstraints, we believe. We are positive on production growth from FY10 to FY12Fgiven: Strong production growth from its Australian acquisitions. Domestic expansions will start to contribute in 2011F (Zhaolou mine), while its recent acquisitions (Wanfu and Haosheng-Shilawusu Mines) will become operational in 2014-15F.Strong production growth from Australian acquisitionsFelix: the main driver for output growth in 10FAustar was the main operating mine of Yancoal Australia before the Felix acquisition,with a capacity of 2mn tonnes of semi-hard coking coal and annual saleable coalproduction of 1.61mn tonnes in 2009.In December 2009, Yancoal Australia acquired Felix for a consideration of A$3,333mn.With the acquisition, the company gained access to four operating mines and twomines under construction, totalling 516mn tonnes of proven and probable reserves(JORC standard), 394mn tonnes attributable to Yanzhou (see below for a detailedbreakdown). While the Yarrabee, Minerva and Ashton mines were operational at thetime of the acquisition, the Moolarben mine became operational in May 2010.In our view, the acquisition of Felix Resources in Dec 2009 in Australia is a strategicbreakthrough for Yanzhou, which has helped raise its reserves and production. Thanksto contributions from Felix, we forecast 9mn tonnes of saleable coal output fromYancoal Australia in FY10F (vs 1.6mm tonnes in FY09).Future upside with A$909mn investment plan announced in Dec10Yanzhou Coal plans to increase its capital investment in Yancoal Australia Pty Limited,a wholly owned subsidiary, by A$909mn (approximately RMB5.9bn) with its owncapital, from A$64mn to A$973mn, according to a company announcement on30 December 2010.Some US$250mn of the capital investment would be spent on the acquisition of a 30%equity interest in the Ashton Coal Mine Joint Venture in Australia, thus increasing itsshare to 90%. The transaction would boost Yanzhou coal’s equitable JORC reservesby 29mn tonnes and equitable annual production capacity by 1.6mn tonnes. YanzhouCoal also announced a proposal regarding the disposal of a 51% equity interest inMinerva coal mine, with equitable JORC reserves of 12mn tonnes and equitableannual production capacity of 1.4mn tonnes for a consideration of A$201mn.Exhibit 117. Felix mines assets snapshot Current equity Equity stake on completion Recoverable DesignedMines stake (%) of the proposal (%) Mine type Coal type reserves (mnt) capacity (mnt)Yarrabee* 100 100 Open-cut PCI 39.1 1.7Minerva* 51 - Open-cut thermal 23.6 2.8Ashton* 60 90 Open-cut & underground Semi-soft coking 96.5 5.2Moolarben* 80 80 Open-cut & underground thermal 356.8 16.0* Reserves and capacity volume are from 2009 annual report; Ashton and Minerva reserves and capacity are based on company announcement on 30 Dec 2010Source: FY09 annual report and announcement on 30 Dec 2010Nomura 97 18 January 2011
  • 99. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoWith the incremental volume from the Moolarben and Ashton mines, we see furtheroutput upside from Felix in the next few years. We forecast Yancoal Australia’s outputto rise to 11mn tonnes in FY11F, with steady growth thereafter to 15mn tonnes in2014F. With strong production growth from Felix, we estimate Australia productionwould account for 27% of Yanzhou Coal’s production in FY14F, compared with only5% in FY09.Exhibit 118. Yanzhou Coal output volume (2009- Exhibit 119. Yanzhou Coal output breakdown-2014F2014F) (mnt) Domestic YanCoal YanCoal, 60 Domestic, 27% 73% 50 15 12 14 40 9 11 2 30 20 38 38 41 34 36 37 10 0 2009 2010F 2011F 2012F 2013F 2014FSource: Company data, Nomura estimates Source: Company data, Nomura estimatesTransportation not an issue for Yancoal AustraliaYancoal Australia became Newcastle Coal Infrastructure Group’s (NCIG) shareholderthough its acquisition of Felix Resources, since Felix owns 15.4% of NCIG. In May2010, NCIG’s No. 3 coal export terminal (stage 1) of 30 mn tonnes/year was officiallyopened. NCIG is currently building stage 2 of the port. Yancoal Australia’s stake inNewcastle No.3 port should help to secure the port delivery quota of Felix mines,especially the output from Moolarben mines.Domestic expansion starts to contribute – with more to comeStable outputs and ample cash inflows from headquartersThe primary source of Yanzhou Coal’s output at present is its headquarters in Headquarters’ output to stabilizeShangdong. By year-end 2009, the headquarters’ six mines had total proven and at current levelprobable reserves of 1,831.2mn tonnes and annual production of 33mn tonnes. Sincethese mines have been producing at full capacity since 2005 of 32-34mn tonnes perannum, we believe future output will stabilize at current level.Coal output is of a high quality thermal/pulverized coal injection (PCI) blend. No. 1 andNo. 2 clean coals are sold to steel producers while other blends are sold forconstruction, chemicals and power generation. Thanks to the high quality output andthe favourable mine locations, the coal is sold to end customers at much higher pricesthan its competitors, Shenhua and China Coal. Therefore, with limited capexrequirements, we believe the mines at the headquarters would remain to be the majorprofit and cash flow contributors in 2010-2012F.Nomura 98 18 January 2011
  • 100. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoDomestic expansions start to contributeOutside its headquarters, Yanzhou’s domestic expansion will start to contribute this Haosheng acquisition set to boostyear: output after 2015F Zhaolou Mine: Annual output capacity of 3mn tonnes, owned by Heze Neng Hua, a 96% stake of which was acquired by Yanzhou in 2005. Zhaolou mine, in Shandong, started production at the end of 2009, with output of 0.02mn tonnes in FY09. Based on the construction progress, we expect production to go up to 1.2mn tonnes in FY10F, further to 2.2mn tonnes in FY11F, and ramp up in FY12F. Wanfu Mine: Also owned by Heze Neng Hua. Yanzhou is in the final stage of getting mine rights approval from government. We expect it to start production of 1mn tonnes in 2014F and reach full capacity of 1.8mn tonnes in 2016F. Haosheng-Shilawusu Mine: On 6 September 2010, Yanzhou announced the acquisition of a 35.49% stake of Haosheng coal mining for a consideration of RMB4.62bn and that it is in the bidding process of another 15.51% stake for RMB2.02 bn. On completion of the transaction, Yanzhou would hold 51% of Haosheng Mining, which further holds Shilawusu mine field in Inner Mongolia, with annual capacity of 10mn tonnes. The acquisitions would boost Yanzhou’s equitable production capacity by 10mn tonnes (with 5.1mn tonnes equitable), 2mn tonnes of which will likely be operational by 2015F and then ramp up to 5mn tonnes in 2016F.Exhibit 120. Domestic saleable coal production breakdown by mines (09-14F) (mnt) The company Shanxi Neng Hua Heze Neng Hua Haosheng 45 2.0 40 1.2 2.2 3.0 3.0 4.0 35 1.5 1.5 1.0 1.5 1.5 1.5 30 25 20 33 34 33 33 33 33 15 10 5 0 2009 2010F 2011F 2012F 2013F 2014FSource: Company data, Nomura estimatesNomura 99 18 January 2011
  • 101. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoMarginRemarkable margin fuelled by cost cutsand low transportation costsCost-cutting in Australia and Heze Neng HuaDue to the slower-than-expected production growth in Australia, the 9M10 unit Lower unit cost growth rate thanproduction cost for Australia was high at RMB405/ tonne, compared to RMB392/tonne peers in FY11-12Fin FY09. On the back of production scale, we expect Yancoal Australia’s unit cost todrop to RMB370/ tonne in 2012F. Zhaolou mine of Heze Neng Hua is another sourceof potential cost savings. Due to the high fixed cost, we believe production volumegrowth can drive unit costs down significantly from RMB690/ tonne of 9M10 toRMB339/tonne in FY11F on the basis of economic of scale. While the lower cost fromFelix and Zhaolou partially offset the increasing costs from the headquarters,Yanzhou’s unit cost growth rate is lower than its peers.Exhibit 121. Total unit cost for self-produced coal Exhibit 122. Total unit cost growth rate comparison (11F-12F) (RMB/t) (%) The Company Shanxi Neng Hua Shenhua China Coal Yanzhou 700 660 8 Heze Neng Hua Yancoal Australia 6.8% 600 7 6.1% 5.9% 6 5.6% 5.5% 500 405 5 4.7% 380 366 370 400 339 312 4 300 258 289 263 244 217 3 200 2 100 1 0 0 2010F 2011F 2012F 2011F 2012FSource: Company data, Nomura estimates Source: Company data, Nomura estimatesHighest unit profit underpinned by lowest transportation costYanzhou’s unit production cost is higher than its peers given: 1) its high unit fix cost forHeze Neng Hua and Yancoal Australia, due to low initial outputs and 2) higherprocessing cost for PCI, semi-soft coking coal and semi-hard coking coal than forthermal coal.The higher unit production cost was counteracted by the competitive transportationcost of RMB11/tonne. Benefiting from much shorter distances from Shandong mines toQinhuangdao Port (QHD) port, Yanzhou enjoys much lower unit transportation cost ofRMB11/ tonne, than Shenhua’s RMB106/tonne and China Coal’s RMB84/tonne in2009.On the back of the competitive transportation cost and extraordinary ASP, YanzhouCoal enjoys the highest unit profit among its peers.Nomura 100 18 January 2011
  • 102. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoExhibit 123. Unit transportation cost (self produced Exhibit 124. Unit profit (self produced coal)coal) (RMB/t) (RMB/t) Shenhua China Coal Yanzhou Shenhua China Coal Yanzhou 140 500 472 116 438 120 113 450 106 109 97 400 351 100 90 94 84 350 80 300 250 225 234 250 204 60 212 181 169 181 200 133 40 150 100 20 11 11 12 12 50 0 0 2009 2010F 2011F 2012F 2009 2010F 2011F 2012FSource: Company data, Nomura estimates Source: Company data, Nomura estimatesResources taxCurrently, Yanzhou Coal pays RMB3.6 and RMB3.2 for each tonne of raw coal output Factored in RMB10/tonne extrain Shandong province and Shanxi province, respectively. resources tax for FY11FAs per our industry overview, we expect upcoming resource tax reforms to changefrom the current volume based to price based, charging 3-5% of the sales price. Whileit is uncertain on which price the new resources tax would be based, we take the ex-mine price approach. Applying 5% to the FY10 average ex-mine price (ShanxiShuozhou gas coal 4,800kcal/kg) of RMB309/tonne, we assume a new resource tax ofRMB15/tonne in FY11F for domestic coal production.We expect the resource tax reforms to be announced in 1Q11, therefore, we havefactored in the extra resources tax of RMB10/tonne for Yanzhou Coal’s domesticoutput in our 2011F forecasts. Given the prevailing seller’s market, we think YanzhouCoal should be able to pass on the cost increase.Nomura 101 18 January 2011
  • 103. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoFinancial analysisSuperior 2011F earnings outlookStrong revenue and EPS growthBacked by the strong coal price and Felix output contributions, we expect Yanzhou EPS growth of 81% and 23%Coal to post an extraordinary 81% normalized EPS growth in 2010F. respectively in FY10-11F, the highest among peersIn 2011F, we estimate Yanzhou Coal will continue to see the strongest EPS growth of23% in 2011F, compared to Shenhua’s 20% and China Coal’s 10% underpinned by:1) rapid output growth driven by Australian acquisitions and 2) its being best-positioned to benefit from strong spot price momentum and 3) cost cutting from theFelix and Zhoulou mines.We also expect Yanzhou’s ROE to take over Shenhua from 2010, with a larger spreadof 2.8% between Yanzhou Coal and Shenhua and of 9.2% between Yanzhou Coal andChina Coal in 2011F.Exhibit 125. Revenue growth (2009-12F) Exhibit 126. EPS comparison (2009-12F) (RMBmn) (RMB/t) Shenhua China Coal Yanzhou 50,000 46,959 3.0 CAGR: 32.4% 2.67 45,000 42,566 40,000 2.5 2.29 35,095 2.05 35,000 1.91 1.87 2.0 30,000 1.59 1.52 25,000 1.5 20,253 1.10 20,000 1.0 0.84 0.87 15,000 0.76 0.59 10,000 0.5 5,000 0 0.0 2009 2010F 2011F 2012F 2009 2010F 2011F 2012FSource: Company data, Nomura estimates Source: Company data, Nomura estimatesKey profit drivers and sensitivityAfter 81% y-y growth in FY10F net profit to RMB7.46bn, we expect a further 23% rise Net profit most sensitive to priceto RMB9.2bn FY11F, with a net profit margin of 22% (up from 20% in FY09 and 21% changein FY10F). Per our 2011 net profit driver analysis, ASP growth is the largest driver fornet profit. On a consolidated basis, we expect coal to contribute 22.7% of net profitgrowth while the other businesses contribute the remaining 0.5%.Exhibit 127. Net profit growth drivers (2011F) (%) 30 25 -4.5% 0.5% 20 19.2% 15 22.7% 23.2% 10 5 8.0% 0 Increase in Increase in Increase in Coal business Other Group sales volume ASP coal unit cost businessesSource: Company data, Nomura estimatesNomura 102 18 January 2011
  • 104. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoBy comparison with its peers, Yanzhou is most sensitive to coal price changes, givenits higher-than-peers’ ASP due to a higher spot sales mix.Exhibit 128. 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 ResearchBalance sheet and cash flowDue to the large consideration of A$3,333mn paid for Felix Resources in Dec 2009,Yanzhou Coal’s net debt-to-equity ratio will be higher than its peers in 2010F at 54%.In light of Yanzhou Coal’s proposed extra capital investment of A$909mn(approximately RMB5.9bn) in Yancoal Australia Pty Ltd in 2011F, the net debt-to-equity gearing will be at a relatively high level of 51%. To achieve the output growth,we forecast a 15% capex increase in FY11F. With rich operating cash inflow, amplecash position, and strong credit pipelines from banks, we believe Yanzhou Coal will beable to finance its capex needs and the RMB5.9bn capital investment needs withoutadditional equity financing.Nomura 103 18 January 2011
  • 105. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoWhere could we be wrong?Investment risksLower-than-expected spot price. Spot price is the most sensitive factor for YanzhouCoal’s earnings. Our coal price forecast is based on the tight supply and demandoutlook in the next two years. If coal spot prices are lower than our forecasts, YanzhouCoal’s earnings could deviate greatly from our forecasts. Key downside risks include:1) weaker-than-expected coal-fired power generation, due mainly to power constraintsat energy-intensive users, 2) lower-than-expected supply cuts caused by industryconsolidation or major coal mining accidents, and 3) lower-than-expected global coalpricesWeaker-than-expected growth in China’s economy. If China’s economy recoversmore slowly than we expect, we believe coal demand from the four key sectors –power, steel, building materials and chemicals – will deteriorate and exert pressure oncoal prices, leading to lower earnings growth for Yanzhou Coal.Higher-than-expected cost hikes. We believe the surprise of higher cost hikes couldbe mainly from policy-related cost increases. For 2011F, we believe the new resourcestax is likely to be implemented, which could raise costs for all Chinese coal producers.If China’s coal industry has balanced supply/demand in the next few years, YanzhouCoal may not be able to pass on all the extra cost to end users.Higher coal imports boosted by a strengthening RMB. Our economics teamexpects the RMB to appreciate by 6% and 5% against the US dollar in 2011F and2012F, respectively. If the appreciation is faster than we expect, we believe coastalimport volumes would increase, putting further pressure on domestic coal prices.Foreign exchange risk: Yancoal Australia entered into a US$3bn loan agreement in2009 for the Felix acquisition. Yanzhou Coal is exposed to FX risk.Nomura 104 18 January 2011
  • 106. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoCompany profileCompany profileBusiness descriptionYanzhou Coal is engaged primarily in the mining, preparation and sale of coal. Majorproducts include thermal coal (used in the electricity power sector), metallurgical coal(used with coking coal in the process of pulverized coal injection, PCI). Domestically,major customers for the coal products are located mainly around its mines. Thus,Yanzhou Coal enjoys the benefits of lowered transportation cost in comparison withother coal producers. The coal business generated over 96.5% of the company’s totalrevenue in 2009. On top of the mining business, Yanzhou is also engaged in coaltransportation (railway), coal chemicals, electricity and heat business.Exhibit 129. Yanzhou: revenue mix 2009 Electricity, 0.9% Methanol, 1.3% Heat supply, Railw ay, 1.3% 0.1% Coal Sales, 96.5%Source: CompanyCoal businessYanzhou produced a total of 37mnt of raw coal in 2009, of which 35.77mnt is saleable,implying a wash rate of 95%. As at FY09, domestic sales contributed over 95% of totalsales as Felix would only contribute starting in FY10. Spot sales generated over 77%of total domestic sales in 2009.Exhibit 130. Sales volume mix in 2009 Exhibit 131. Sales vol. mix in 2009 (spot vs contract) Contract Domestic 22.8% coking 25% Yancoal Australia Domestic 5% thermal 70% Spot 77.2%Note: Exclude 3rd party coal Note: Domestic salesSource: Company Source: CompanyNomura 105 18 January 2011
  • 107. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoHeadquarters’ minesThe company operates six major coal mines in the Shandong area with provenreserves of 1,831mn tonnes as at year-end 2009. Coal produced around the area is ofa high quality thermal/PCI blend. No. 1 and No. 2 clean coals are sold to steelproducers, while other blends are sold for construction, chemicals and powergeneration. As mines at the headquarters have been producing at full capacity since2005 of 32-34mn tonnes, we believe future production will stabilize at current levels.Exhibit 132. Yanzhou: Headquarters’ mines Equity Coal In-place proven and Designed capacity 2007 2008 2009Mines stake (%) type probable reserves (mnt) (mnt) (mnt) (mnt) (mnt)Nantun 100 thermal & PCI 118.2 2.4 3.9 3.5 3.8Xinglong Zhuang 100 thermal & PCI 326.1 3.0 6.8 6.6 6.6Baodian 100 thermal & PCI 288.4 3.0 5.8 6 5.7Dongtan 100 thermal & PCI 457.5 4.0 7.6 7 7.5Jining II 100 thermal & PCI 413.4 4.0 3.4 3.9 3.6Jining III 100 thermal & PCI 227.5 5.0 5.3 6.1 6.2Total 100 1831.2 21.4 32.8 33.1 33.4Note: Production figure refers to raw coal productionSource: Company, as of FY09Shanxi Neng HuaTianchi mine in Shanxi was acquired from its parents in 2006 for RMB730mn and hasbeen in operation since then. It has a thermal coal production capacity of 1.2mntonnes p.a. and recoverable reserves of 30.7mn tonnes at the time of the acquisition.Exhibit 133. Yanzhou: Shanxi mine Recoverable Designed capacity 2007 2008 2009Mines Mine type Equity stake (%) Coal type reserves (mnt) (mnt) (mnt) (mnt) (mnt)Tianchi Underground 98 thermal 27.7 1.2 1.2 1.1 1.0Note: Production figure refers to raw coal productionSource: Company, as of FY09Heze Neng HuaAcquired from its parent in 2005 for RMB584mn, Heze Neng Hua has two major coalmine assets, the Zhaolou mine and the Wanfu mine. Both mines produce 1/3 cokingcoal, with a price lower than hard coking coal but higher than thermal coal. Zhaoloumine commenced small-scale operations in 2009 and is expected to ramp up to 3mntonnes in 2012F.Exhibit 134. Yanzhou: Heze mine Equity stake Recoverable Designed 2007 2008 2009Mines Mine type (%) Coal type reserves (mnt) capacity (mnt) (mnt) (mnt) (mnt)Zhaolou Open-pit and underground 96 1/3 coking 105.8 3.0 - - 0.04Wanfu* n/a 96 1/3 coking 1.8 - - -Note: Production figure refers to raw coal production, *Wanfu had not commenced production as of FY09Source: Company, as of FY09Yancoal AustraliaYancoal Australia owns Astra and Felix. Yanzhou acquired the Astra coal asset fromSouthland Coal Pty Limited for a consideration of A$32mn and the coal mine hadrecoverable reserves of 41mn tonnes and production capacity of 2mn tonnes at thetime of the acquisition.Nomura 106 18 January 2011
  • 108. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoUpon Yanzhou’s acquisition of Felix Resources Ltd for an amount of A$3,333mn in2009, the company gained access to four operating mines (Yarrabee open-cut coalmine, Minerva open-cut coal mine, Ashton open-cut coal mine and Ashtonunderground coal-mine) and two mines under construction (Moolarben open-cut coalmine and the Moolarben underground coal mine), totalling 561mn tonnes ofrecoverable reserves (latest company disclosure). Moolarben mine started productionin 2010. Its open-pit annual production and underground annual production areexpected to reach 10mn tonnes and 3.5mn tonnes respectively when they ramp up.Exhibit 135. Yanzhou: Heze mine 09 saleable Current equity Equity Stake after Recoverable Designed coal outputMines Mine type stake (%) the transaction* (%) Coal type reserves (mnt) capacity (mnt) (mnt)Austra Underground 100 100 semi-hard 44.6 2.0 1.9Yarrabee Open-cut 100 100 PCI 39.1 1.7 -Minerva Open-cut 51 0 thermal 23.6** 2.8** -Ashton Open-cut & underground 60 90 Semi-soft 96.5** 5.2** -Moolarben Open-cut & underground 80 thermal 356.8 16.0 -Note: *Production figure refers to raw coal production. Austra, Yarrabee reserves based on recoverable reserves disclosed in FY09 annual report **Minerva, Ashtondata based on company announcement on 30 Dec 2010.Source: Company dataHaosheng Coal MiningYanzhou recently announced its acquisition of Haosheng Coal Mining in Sep 2010 inwhich Yanzhou is planning to acquire a 51% interest of Haosheng, which subsequentlyowned 1.644bn tonnes of coal resources in the Shilawusu Coal Field, thus Yanzhouwould gain 838.4mn tonnes of coal resources in the acquisition. According to acompany announcement, Yanzhou is planning to acquire a 35.49% stake for anamount of RMB4.62bn and would bid for another 15.51% stake in an open biddingprocess for about RMB2.02bn.Exhibit 136. Yanzhou: saleable coal production statistics (FY07-09)(000’s tonnes) 2007 2008 2009Headquarters No. 1 clean coal 713 363 694 No. 2 clean coal 7,260 7,431 8,362 No. 3 clean coal 8,616 2,916 1,717 Lump coal 693 1,161 1,402 Screened raw coal 11,358 17,934 17,100 Mixed coal & others 3,851 2,597 4,055 Total for company 32,490 32,402 33,330Shanxi Neng Hua Screened raw coal 1,193 1,099 986Heze Neng Hua No. 2 clean coal - - 5 Screened raw coal - - 2 Mixed coal & others - - 9Yancoal Australia Pty Semi-hard coking coal 1,423 1,484 1,627Source: CompanyNomura 107 18 January 2011
  • 109. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoShareholding structureExhibit 137. Major shareholders of Yanzhou Coal A-Share Investors, 7% H-Share Yankuang Group, Investors, 40% 53%Source: Company dataExhibit 138. Yanzhou: key assumptions 2008 2009 2010F 2011F 2012FCoalProduction volumeTotal raw coal production (mnt) 36 37 48 50 52Total commercial coal production (mnt) 36 36 45 48 50Wash rate (%) 98 98 95 95 95Sales volumeSelf-produced (Domestic) (mnt) 34 34 36 37 38Self-produced (Australia) (mnt) 1 2 9 11 123rd party (mnt) 3 2 5 6 6Total (mnt) 38 38 51 54 56Domestic contract* (%) 48 22 22 19 19Australia contract* (%) 4 5 20 23 24Domestic spot* (%) 48 74 58 58 57PriceASP-self produced coal (RMB/t) 633 506 648 748 800 rdASP (including 3 party and self produced) (RMB/t) 640 507 658 756 806y-y chgASP-self produced coal (%) 53.4 (20.2) 28.2 15.5 6.9 rdASP (including 3 party and self produced) (%) 55.0 (20.7) 29.7 14.8 6.7Unit profitThe company (RMB/t) 353 256 368 392 401Shanxi Neng Hua (RMB/t) 50 40 150 152 153Heze Neng Hua (RMB/t) na (1,780) 100 497 512Yancoal Australia Pty (Austar and Felix) (RMB/t) 597 276 355 603 699* Self-produced coalSource: Company data, Nomura estimatesNomura 108 18 January 2011
  • 110. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoFinancial statementsIncome statement (RMBmn)Year-end 31 Dec FY08 FY09 FY10F FY11F FY12FRevenue 24,903 20,253 35,095 42,566 46,959Cost of goods sold (12,452) (11,123) (18,846) (22,159) (24,260)Gross profit 12,451 9,130 16,248 20,407 22,699SG&A (3,832) (3,820) (5,264) (6,385) (7,044)Employee share expenseOperating profit 8,619 5,310 10,984 14,022 15,655EBITDA 9,796 7,148 13,472 16,863 18,731Depreciation (1,141) (1,793) (1,595) (1,817) (2,052)Amortisation (36) (44) (892) (1,024) (1,024) We have factored in outputEBIT 8,619 5,310 10,984 14,022 15,655 from its planned acquisition ofNet interest expense (38) (45) (1,104) (1,752) (2,183) 30% of Ashton mines andAssociates & JCEs (67) 110 110 110 110 dispose of its 51% stake inOther income 351 311 311 311 311 Minvera minesEarnings before tax 8,865 5,686 10,301 12,691 13,893Income tax (2,386) (1,553) (2,814) (3,467) (3,751)Net profit after tax 6,480 4,132 7,487 9,224 10,142Minority interests 9 (15) (27) (34) (37)Other itemsPreferred dividendsNorm alised NPAT 6,489 4,117 7,459 9,190 10,105Extraordinary itemsReported NPAT 6,489 4,117 7,459 9,190 10,105Dividends (836) (1,967) (2,220) (2,735) (3,007)Transfer to reserves 5,653 2,150 5,239 6,455 7,098Valuation and ratio analysisFD normalised P/E (x) 17.0 26.8 14.3 10.9 9.4FD normalised P/E at price target (x) 20.3 32.0 17.1 13.0 11.2Reported P/E (x) 17.0 26.8 14.3 10.9 9.4Dividend yield (%) 0.8 1.8 2.1 2.7 3.2Price/cashflow (x) 15.6 16.9 12.4 9.0 7.5Price/book (x) 4.1 3.8 3.1 2.5 2.0EV/EBITDA (x) 10.5 17.1 9.2 7.1 5.9EV/EBIT (x) 12.0 23.0 11.3 8.5 7.0Gross margin (%) 50.0 45.1 46.3 47.9 48.3EBITDA margin (%) 39.3 35.3 38.4 39.6 39.9EBIT margin (%) 34.6 26.2 31.3 32.9 33.3Net margin (% ) 26.1 20.3 21.3 21.6 21.5Effective tax rate (%) 26.9 27.3 27.3 27.3 27.0Dividend payout (%) 12.9 47.8 29.8 29.8 29.8Capex to sales (%) 8.3 10.3 11.6 11.0 10.0Capex to depreciation (x) 1.8 1.2 2.6 2.6 2.3ROE (% ) 26.9 14.7 23.5 24.4 22.8ROA (pretax %) 37.5 13.9 18.3 19.4 19.8Growth (%)Revenue 64.8 (18.7) 73.3 21.3 10.3EBITDA 73.9 (27.0) 88.5 25.2 11.1EBIT 96.9 (38.4) 106.9 27.7 11.6Normalised EPS 100.6 (36.5) 81.2 23.2 10.0Normalised FD EPS 100.6 (36.5) 81.2 23.2 10.0Per shareReported EPS (RMB) 1.32 0.84 1.52 1.87 2.05Norm EPS (RMB) 1.32 0.84 1.52 1.87 2.05Fully diluted norm EPS (RMB) 1.32 0.84 1.52 1.87 2.05Book value per share (RMB) 5.44 5.93 6.99 8.30 9.75DPS (RMB) 0.17 0.40 0.45 0.56 0.61Source: Nomura estimatesNomura 109 18 January 2011
  • 111. Yanzhou Coal Ivan Lee, CFA / Matty ZhaoCashflow (RMBmn)Year-end 31 Dec FY08 FY09 FY10F FY11F FY12FEBITDA 9,796 7,148 13,472 16,863 18,731Change in working capital 116 (1,326) (1,413) (966) (500)Other operating cashflow (2,816) 699 (3,499) (4,800) (5,515)Cashflow from operations 7,095 6,520 8,560 11,097 12,716Capital expenditure (2,066) (2,086) (4,085) (4,698) (4,698)Free cashflow 5,029 4,435 4,475 6,399 8,018Reduction in investments - - - - -Net acquisitions (747) (20,377) (6,677) (5,900) -Reduction in other LT assets 177 (1,417) - - -Addition in other LT liabilities (292) 1,807 - - -Adjustments 837 (2,771) - - -Cashflow after investing acts 5,004 (18,322) (2,202) 499 8,018Cash dividends (836) (2,015) (2,220) (2,735) (3,007)Equity issueDebt issue (72) 20,652 10,178 4,701 (2,020)Convertible debt issue We have factored in itsOthers (81) (231) - - - RMB5.9bn increase capitalCashflow from financial acts (989) 18,406 7,958 1,966 (5,028) investment in Yancoal Australia,Net cashflow 4,015 83 5,756 2,465 2,990 announced on 30 Dec10Beginning cash 4,425 8,440 8,522 14,279 16,744Ending cash 8,440 8,523 14,279 16,744 19,734Ending net debt (8,182) 13,987 18,409 20,645 15,634Source: Nomura estimatesBalance sheet (RMBmn)As at 31 Dec FY08 FY09 FY10F FY11F FY12FCash & equivalents 8,440 8,522 14,279 16,744 19,734Marketable securitiesAccounts receivable 2,977 4,724 8,186 9,928 10,953Inventories 820 886 1,502 1,766 1,933Other current assets 2,758 5,868 7,237 7,926 8,331Total current assets 14,995 20,001 31,203 36,364 40,952LT investments 830 940 940 6,840 6,840Fixed assets 14,149 18,877 21,444 24,325 26,971Goodwill 299 1,305 1,305 1,305 1,305Other intangible assets 1,040 18,867 24,574 23,550 22,526Other LT assets 1,026 2,442 2,442 2,442 2,442Total assets 32,339 62,432 81,909 94,827 101,036Short-term debt 82 1,598 1,732 2,048 2,243Accounts payable 910 1,367 2,316 2,723 2,981Other current liabilities 4,305 7,445 10,530 11,852 12,691Total current liabilities 5,297 10,410 14,578 16,624 17,916Long-term debt 176 20,912 30,956 35,341 33,125Convertible debtOther LT liabilities 49 1,856 1,856 1,856 1,856Total liabilities 5,522 33,178 47,390 53,820 52,897Minority interest 61 102 128 160 196Preferred stockCommon stock 4,918 4,918 4,918 4,918 4,918Retained earnings 21,837 24,233 29,473 35,928 43,025Proposed dividendsOther equity and reservesTotal shareholders equity 26,755 29,152 34,391 40,846 47,943Total equity & liabilities 32,339 62,433 81,909 94,826 101,037Liquidity (x)Current ratio 2.83 1.92 2.14 2.19 2.29Interest cover 224.7 117.7 9.9 8.0 7.2LeverageNet debt/EBITDA (x) net cash 1.96 1.37 1.22 0.83Net debt/equity (%) net cash 48.0 53.5 50.5 32.6Activity (days)Days receivable 42.1 69.4 67.1 77.7 81.4Days inventory 18.5 28.0 23.1 26.9 27.9Days payable 23.0 37.4 35.7 41.5 43.0Cash cycle 37.6 60.0 54.6 63.1 66.2Source: Nomura estimatesNomura 110 18 January 2011
  • 112. Coal | China Ivan Lee, CFA / Matty ZhaoNomura 111 18 January 2011
  • 113. Coal | China Ivan Lee, CFA / Matty ZhaoNomura 112 18 January 2011
  • 114. Coal | China Ivan Lee, CFA / Matty ZhaoANALYST CERTIFICATIONSAnalyst CertificationWe, Matty Zhao and Ivan Lee, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views aboutany or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly orindirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to anyspecific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other NomuraGroup company.Issuer Specific Regulatory DisclosuresMentioned companiesIssuer name Ticker Price Price date Stock rating Sector rating DisclosuresChina Coal Energy 1898 HK 12.44 HKD 17-Jan-2011 Not rated 4,12,50,58China Shenhua Energy 1088 HK 33.45 HKD 17-Jan-2011 Buy 4,58Yanzhou Coal 1171 HK 24.50 HKD 17-Jan-2011 Not rated 4,58Disclosures required in the U.S.50 Nomura Beneficial Ownership of Securities Disclosures Nomura Securities International, Inc and /or its affiliates beneficially owns 1% or more of the common equity securities of the company.Disclosures required in the European Union4 Market maker Nomura International plc or an affiliate in the global Nomura group is a market maker or liquidity provider in the securities / related derivatives of the issuer.12 Nomura 1% shareholdings Nomura International plc and/or its affiliates in the global Nomura group have shareholdings exceeding 1% of the total issued share capital of the issuer.Disclosures required in Hong Kong58 Nomura financial interest/business relationships disclosures: Nomura International (Hong Kong) Limited or an affiliate in the global Nomura group is a market maker or liquidity provider in the securities / related derivatives of the issuer.Previous RatingIssuer name Previous rating Date of changeChina Coal Energy NeutralChina Shenhua Energy Not Rated 27-Nov-2009Yanzhou Coal Not Rated 02-Aug-2006Important DisclosuresOnline availability of research and additional conflict-of-interest disclosuresNomura Japanese Equity Research is available electronically for clients in the US on NOMURA.COM, REUTERS, BLOOMBERG andTHOMSON ONE ANALYTICS. For clients in Europe, Japan and elsewhere in Asia it is available on NOMURA.COM, REUTERS andBLOOMBERG.Important disclosures may be accessed through the left hand side of the Nomura Disclosure web page http://www.nomura.com/research orrequested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please emailgrpsupport-eu@nomura.com for technical assistance.The analysts responsible for preparing this report have received compensation based upon various factors including the firms total revenues, aportion of which is generated by Investment Banking activities.Industry Specialists identified in some Nomura International plc research reports are employees within the Firm who are responsible for thesales and trading effort in the sector for which they have coverage. Industry Specialists do not contribute in any manner to the content ofresearch reports in which their names appear.Nomura 113 18 January 2011
  • 115. Coal | China Ivan Lee, CFA / Matty ZhaoDistribution of ratings (Global)Nomura Global Equity Research has 2027 companies under coverage.48% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 38% of companies with thisrating are investment banking clients of the Nomura Group*.38% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 48% of companies withthis rating are investment banking clients of the Nomura Group*.12% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 13% of companies withthis rating are investment banking clients of the Nomura Group*.As at 31 December 2010.*The Nomura Group as defined in the Disclaimer section at the end of this report.Explanation of Nomuras equity research rating system in Europe, Middle East and Africa, US and Latin America forratings published from 27 October 2008The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock.Analysts may also indicate absolute upside to target price defined as (fair value - current price)/current price, subject to limited managementdiscretion. In most cases, the fair value will equal the analysts assessment of the current intrinsic fair value of the stock using an appropriatevaluation methodology such as discounted cash flow or multiple analysis, etc.STOCKSA rating of Buy, indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months.A rating of Neutral, indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months.A rating of Reduce, indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months.A rating of Suspended, indicates that the rating and target price have been suspended temporarily to comply with applicable regulationsand/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transactioninvolving the company.Benchmarks are as follows: United States/Europe: Please see valuation methodologies for explanations of relevant benchmarks for stocks(accessible through the left hand side of the Nomura Disclosure web page: http://www.nomura.com/research);Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology.SECTORSA Bullish stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months.A Neutral stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months.A Bearish stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months.Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI EmergingMarkets ex-Asia.Explanation of Nomuras equity research rating system for Asian companies under coverage ex Japan published from30 October 2008 and in Japan from 6 January 2009STOCKSStock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price,subject to limited management discretion. In most cases, the Target Price will equal the analysts 12-month intrinsic valuation of the stock,based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc.A Buy recommendation indicates that potential upside is 15% or more.A Neutral recommendation indicates that potential upside is less than 15% or downside is less than 5%.A Reduce recommendation indicates that potential downside is 5% or more.A rating of Suspended indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/orfirm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving thesubject company.Securities and/or companies that are labelled as Not rated or shown as No rating are not in regular research coverage of the Nomura entityidentified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/orcompanies.SECTORSA Bullish rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positiveabsolute recommendation.A Neutral rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutralabsolute recommendation.A Bearish rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negativeabsolute recommendation.Explanation of Nomuras equity research rating system in Japan published prior to 6 January 2009 (and ratings inEurope, Middle East and Africa, US and Latin America published prior to 27 October 2008)STOCKSA rating of 1 or Strong buy, indicates that the analyst expects the stock to outperform the Benchmark by 15% or more over the next sixmonths.A rating of 2 or Buy, indicates that the analyst expects the stock to outperform the Benchmark by 5% or more but less than 15% over the nextsix months.A rating of 3 or Neutral, indicates that the analyst expects the stock to either outperform or underperform the Benchmark by less than 5% overthe next six months.A rating of 4 or Reduce, indicates that the analyst expects the stock to underperform the Benchmark by 5% or more but less than 15% overthe next six months.A rating of 5 or Sell, indicates that the analyst expects the stock to underperform the Benchmark by 15% or more over the next six months.Stocks labeled Not rated or shown as No rating are not in Nomuras regular research coverage. Nomura might not publish additionalresearch reports concerning this company, and it undertakes no obligation to update the analysis, estimates, projections, conclusions or otherinformation contained herein.Nomura 114 18 January 2011
  • 116. Coal | China Ivan Lee, CFA / Matty ZhaoSECTORSA Bullish stance, indicates that the analyst expects the sector to outperform the Benchmark during the next six months.A Neutral stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next six months.A Bearish stance, indicates that the analyst expects the sector to underperform the Benchmark during the next six months.Benchmarks are as follows: Japan: TOPIX; United States: S&P 500, MSCI World Technology Hardware & Equipment; Europe, by sector -Hardware/Semiconductors: FTSE W Europe IT Hardware; Telecoms: FTSE W Europe Business Services; Business Services: FTSE W Europe;Auto & Components: FTSE W Europe Auto & Parts; Communications equipment: FTSE W Europe IT Hardware; Ecology Focus: BloombergWorld Energy Alternate Sources; Global Emerging Markets: MSCI Emerging Markets ex-Asia.Explanation of Nomuras equity research rating system for Asian companies under coverage ex Japan published priorto 30 October 2008STOCKSStock recommendations are based on absolute valuation upside (downside), which is defined as (Fair Value - Current Price)/Current Price,subject to limited management discretion. In most cases, the Fair Value will equal the analysts assessment of the current intrinsic fair value ofthe stock using an appropriate valuation methodology such as Discounted Cash Flow or Multiple analysis etc. However, if the analyst doesntthink the market will revalue the stock over the specified time horizon due to a lack of events or catalysts, then the fair value may differ from theintrinsic fair value. In most cases, therefore, our recommendation is an assessment of the difference between current market price and ourestimate of current intrinsic fair value. Recommendations are set with a 6-12 month horizon unless specified otherwise. Accordingly, within thishorizon, price volatility may cause the actual upside or downside based on the prevailing market price to differ from the upside or downsideimplied by the recommendation.A Strong buy recommendation indicates that upside is more than 20%.A Buy recommendation indicates that upside is between 10% and 20%.A Neutral recommendation indicates that upside or downside is less than 10%.A Reduce recommendation indicates that downside is between 10% and 20%.A Sell recommendation indicates that downside is more than 20%.SECTORSA Bullish rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positiveabsolute recommendation.A Neutral rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutralabsolute recommendation.A Bearish rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negativeabsolute recommendation.Target PriceA Target Price, if discussed, reflect in part the analysts estimates for the companys earnings. The achievement of any target price may beimpeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if thecompanys earnings differ from estimates.DisclaimersThis publication contains material that has been prepared by the Nomura entity identified on the banner at the top or the bottom of page 1herein and, if applicable, with the contributions of one or more Nomura entities whose employees and their respective affiliations are specifiedon page 1 herein or elsewhere identified in the publication. Affiliates and subsidiaries of Nomura Holdings, Inc. (collectively, the Nomura Group),include: Nomura Securities Co., Ltd. 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  • 117. Coal | China Ivan Lee, CFA / Matty ZhaoNomura Group produces a number of different types of research product including, among others, fundamental analysis, quantitative analysisand short term trading ideas; recommendations contained in one type of research product may differ from recommendations contained in othertypes of research product, whether as a result of differing time horizons, methodologies or otherwise; it is possible that individual employees ofNomura may have different perspectives to this publication.NSC and other non-US members of the Nomura Group (i.e. excluding NSI), their officers, directors and employees may, to the extent it relatesto non-US issuers and is permitted by applicable law, have acted upon or used this material prior to, or immediately following, its publication.Foreign-currency-denominated securities are subject to fluctuations in exchange rates that could have an adverse effect on the value or price of,or income derived from, the investment. 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  • 118. Nomura Asian Equity Research GroupHong Kong Nomura International (Hong Kong) Limited 30/F Two International Finance Centre, 8 Finance Street, Central, Hong Kong Tel: +852 2536 1111 Fax: +852 2536 1820Singapore Nomura Singapore Limited 5 Temasek Boulevard #11-01, Suntec Tower Five, Singapore 038985, Singapore Tel: +65 6433 6288 Fax: +65 6433 6169Taipei Nomura International (Hong Kong) Limited, Taipei Branch 17th Floor, Walsin Lihwa Xinyi Building, No.1, Songzhi Road, Taipei 11047, Taiwan, R.O.C. Tel: +886 2 2176 9999 Fax: +886 2 2176 9900Seoul Nomura Financial Investment (Korea) Co., Ltd. 17th floor, Seoul Finance Center, 84 Taepyeongno 1-ga, Jung-gu, Seoul 100-768, Korea Tel: +82 2 3783 2000 Fax: +82 2 3783 2500Kuala Lumpur Nomura Securities Malaysia Sdn. Bhd. Suite No 16.5, Level 16, Menara IMC, 8 Jalan Sultan Ismail, 50250 Kuala Lumpur, Malaysia Tel: +60 3 2027 6811 Fax: +60 3 2027 6888India Nomura Financial Advisory and Securities (India) Private Limited Ceejay House, Level 11, Plot F, Shivsagar Estate, Dr. Annie Besant Road, Worli, Mumbai- 400 018, India Tel: +91 22 4037 4037 Fax: +91 22 4037 4111Indonesia PT Nomura Indonesia Suite 209A, 9th Floor, Sentral Senayan II Building Jl. Asia Afrika No. 8, Gelora Bung Karno, Jakarta 10270, Indonesia Tel: +62 21 2991 3300 Fax: +62 21 2991 3333Sydney Nomura Australia Ltd. Level 25, Governor Phillip Tower, 1 Farrer Place, Sydney NSW 2000 Tel: +61 2 8062 8000 Fax: +61 2 8062 8362Tokyo Equity Research Department Financial & Economic Research Center Nomura Securities Co., Ltd. 17/F Urbannet Building, 2-2, Otemachi 2-chome Chiyoda-ku, Tokyo 100-8130, Japan Tel: +81 3 5255 1658 Fax: +81 3 5255 1747, 3272 0869Caring for the environment: to receive only the electronic versions of our research, please contact your sales representative.