China Coal Industry:Higher for longer

Further upgrade of QHD price forecasts; we re-iterate Buy on coal stocks

    Coal prices in China have stayed above Chinese government guidance ofRMB535/t for an extended period and our recent checks lead us to believe thecoal price will likely remain at elevated levels through 2017 and into 2018 dueto slow ramp-ups of new supply and resilient demand. We upgrade our QHDprice forecasts by 2%, 11%, and 12% for 2017, 2018, and 2019, to RMB620/t,RMB600/t, and RMB580/t. We believe consensus remains too low in its coalprice and coal company earnings forecasts. We raise our earnings forecasts by11-140% and reiterate Buy on coal stocks. Our top pick is Shenhua, with a newtarget price of HK$26.5 (+6%) and 36% potential share price upside.

    QHD 5500kcal price remains above RMB600/t for longer than expected

    The QHD 5500kcal price (FOB, VAT-included) has gone above RMB630/t sincelast week and has recorded a YTD average of RMB611/t. This is well above theChinese government’s expected central price of RMB535/t. While the market islikely to view this as a short-term spike driven by temporary factors such asweather, safety inspections, etc., we disagree. Our recent checks haveconvinced us that structural change is taking place in the demand/supplybalance. As such, unless we see sustained strong capex spend in the coalindustry, the coal price will likely remain at over RMB600/t even into late 2018.

    Multiple factors to hold off rapid supply ramp-ups

    We attribute the current better-than-expected demand/ supply balance tomultiple factors: (1) the market mechanism weeded out plenty of capacity in2015/2016 (we estimate c.90mt and c.300mt were shut down in 2015 and2016, respectively) and it is difficult for that capacity to return; (2) a decline ininvestment in the coal industry in the previous three years led to less ramp-upof new capacity than expected by the government; (3) government guidanceabout keeping the coal price within a RMB500/t to RMB570/t range and aboutimport restrictions have made Chinese and international miners less willing toreinvest; and (4) more regular safety inspections.

    Revised earnings forecasts 50% above consensus; introducing 2019 estimates

    Based on our new Chinese coal demand/supply model, we upgrade our 2017/2018/ 2019 QHD 5500kcal (FOB, VAT-included) per tonne price forecasts toRMB620/ RMB600/ RMB580, from RMB610/ RMB540/ RMB520. Consequently,we raise our earnings forecasts and target prices for Shenhua, China Coal, andFushan (details in Figure 9 and Figure 10). Our earnings forecasts for coalcompanies are generally 50% higher than market consensus. We reiterate Buyon coal stocks and our top pick remains China Shenhua, which offersconsistent 15% ROAE and 18%-plus FCF yields but is only trading close tobook value. We set our target prices using PB/ROE methodology; we upgradeour China Shenhua target price to HK$26.5, and our Fushan and target price toHK$2.4. Major risks: significant capex increases by coal companies to boostsupply and weaker demand due to China macro.