Coal :China trip takeaways;negative for thermal near term

China trip negative for thermal coal near term。

    We recently toured China meeting with coal companies such as Shenhua andChina Coal, power companies and coal traders. Industry participants seeslowing demand for thermal coal in the coming months and increased supplywith mines operating at 330 days, leading to thermal coal prices declining fromthe current RMB590/t (vs. Newcastle at US$73/t) to the bottom end of thegovernment’s targeted price band of RMB530-570/t (US$65-70/t NEWC Eq).

    Inventory at IPPs (19 days) and port stocks (19-20Mt) are at normal levels. Coalstocks already seem to be pricing in the likely drop in thermal coal. Our Topsector picks are Shenhua and China Coal.

    Entering the weak season for coal demand。

    Chinese power demand increased 6% in 1Q17 with thermal coal demandincreasing by 4% (c. 100Mt increase). However, coal and power companies areseeing weaker demand in May due to strong hydro power. Over the mediumterm coal demand is expected to slow (net additions of 20Gw per annum) dueto competition from wind (35Gw p.a.) and natural gas (10Gw p.a.) with coalfalling from 60% to 55% of the total energy mix by 2020. Market participantssee the top 5 power producers as currently break-even (gross margin 2c/kwhr),Mergers between coal producers and IPPs is a possibility, as well as thegovernment raising power tariffs slightly.

    Thermal price seen dropping into RMB530-570/t green band on strong supply。

    With most thermal mines operating at 330 days or higher, industry participantsexpect the thermal coal price will fall from current spot of RMB590/t into thegovernment “green band” of RMB530-570/t and perhaps even as low asRMB470/t (US$60/t NEWC Eq). Inspection times seems to have beenshortened but and trucking restrictions at Northern ports continue to remain inplace. Over the medium term, new mines are still required to meet demandand most SOEs production targets for 2017 are unchanged due tounderinvestment. There is still 300-500Mt of unlicensed capacity and c. 1Bt ofnew capacity under construction across the coal industry. The government isclosing lower efficiency higher cost mines with lower cost larger mines. The nonew mine for 3 years policy was relaxed in 4Q16, although the NDRC is stillencouraging a “new for old policy”. Coal companies expect industry。

    production growth of 2% p.a or 300Mt over the next 5 years. This is slightlyahead of our domestic demand forecasts, and would expect Chinese netthermal coal imports to continue easing lower. For coking coal, domesticproduction is expected to be flat in 2017.

    Global coal stock valuations and sensitivities

    The global miners with exposure to coal are; pure plays Shenhua (BUY,thermal 41% of FY18 EBITDA, discounting flat RMB480/t), China Coal (BUY,52% of FY18 EBITDA, discounting flat RMB470/t), and WHC (HOLD, thermal66%/semi-soft 34% of FY18 EBITDA, discounting US$60/t flat), and diversifiedminers; GLEN (HOLD, 22% of CY17 EBITDA), S32 (HOLD, 7% of FY18 EBITDA),AAL (HOLD, 11% of CY17 EBITDA), BHP (HOLD, 6% of FY18EBITDA).