Equity Research - Shenhua

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Equity Research

Shenhua

Shenhua’s FY17 NP of RMB47.8bn is in line with the consensus (RMB47bn). The 35% hike almost entirely drove the 92% YoY growth in net profit in coal price in 2017. Profit contribution from other segments was slightly up (transportation, port, shipping), while power was down. 4Q net profit was down by 17% from 3Q despite a higher coal price environment due to impairment charges. While 1Q18 earnings growth momentum should remain decent on 18% YoY growth in coal price, earnings growth momentum should slow in 2Q18 and potentially decline in 2H18 as coal prices ease. I expect coal prices to fall to ~ RMB600/ton by the end of 2018.

  • Strong 2017 profitability driven by higher coal prices: Commercial coal production grew slightly from 289.6 mt in 2016 to 295.4 mt (1.9% YoY), and coal sales increased by 12.4% YoY and reached 443.8 mt. Coal revenue sales were up by 49% YoY, driven by ~35% YoY increase in ASP.
    • 4Q17 net profit was up by 74% YoY driven by improvement in the coal segment;
    • Power segment: gross power generation was up 11.4%. However, profit was down 44% YoY due to a 27% increase in power costs;
    • Transportation segment: in 2017, transportation shipment was up by 27.6% YoY and reached a record high turnover volume of 273.0 billion tonne-km of the self-owned railway turnover volume.
  • Cutting CAPEX: Shenhua’s 2017 CAPEX was RMB26.2bn, substantially lower than the initial plan of RMB35bn. 2018 CAPEX guidance is lowered to RMB29bn.
    • 14% of the CAPEX will be spent on coal, 57% on power, and 28% on transportation;
    • Capex cuts seem to be an industry-wide phenomenon. I see this in leading coal, cement, and steel companies. As a result, cash flows improved substantially for most companies;
    • Free cash flow reached RMB79bn, of which operating cashflows are RMB 95bn.

  • Dividend: The company declared a final dividend of RMB0.91/shr, implying a payout ratio of 40.2% and a dividend yield of ~5%.

  • 2018 guidance: In 2018, Shenhua expects its commercial coal production will reach 290 million tons (down ~2% YoY), coal sales will be 430 million tons (down 3% YoY), and power output dispatch will be 248.6 billion kWh (up ~1% YoY).

2018 Coal price outlook

  • While I highlighted in February that China's coal price should have peaked at about RMB750/ton, the speed of the fall was faster than the expectation. The thermal coal price fell by ~RMB100/ton (or 15%) (Figure 1).

Figure 1: QHD 5,500Kcal thermal coal price: fell to RMB645/ton (or down by 10% from peak)

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  • On the demand side, consumption from major IPPs has fallen quickly after the Chinese New Year, and as the temperature gradually normalized (Figure 2).

Figure 2: Average daily coal consumption of major IPPs in China: falling quickly from Jan-Feb high

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  • Inventories at major IPPs are recovering to ~20 days after hitting a dangerously low level of <15 days in February (Figure 3). And current Qinghuangdao inventory of ~6.5mn ton is >20% higher than the same period last year (Figure 4).

Figure 3: Major IPP's coal inventory: gradually building up in the past few weeks

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Figure 4: QHD Coal inventory: substantially higher than last year but lower than 2015 peak

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  • On the raw coal production front, Jan-Feb 2018 production growth rebounded to ~6%, driven by the increase in Shaanxi and other provinces outside of the core production region.

  • With the increase in production growth and normalizing inventory, I believe coal prices will continue to fall throughout 2Q18.

Figure 5: China's raw coal production: up by ~6% YoY in Jan-Feb 2018 driven by the increase in Shaanxi and other provinces

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Figure 6: China raw coal production: up by ~6% in Jan-Feb 2018 but still ~7% below 2015 peak

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Figure 7: China coal price forecast (QHD 5,500 Kcal)

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Investment Thesis

I have the UW rating on CSE-H –I am concerned a fall in coal price will trigger a de-rating of Shenhua’s share given the current high valuation. Furthermore, if I would like to play on the potential power tariff hike and its positive impact on the power generation business, I prefer to play on the IPPs at cheaper valuations.

Valuation

The Dec-18 PT of HK$16.5 is based on SOTP as follows, and the PT implies ~0.8x PB:

ERT

Risks to Rating and Price Target

Upside risks to the UW rating and price target include higher-than-expected thermal coal prices, unexpected tariff hikes on coal-fired IPPs, better-than-expected discipline on production control by coal producers, and better-than-expected power demand, which will increase thermal coal demand.

Disclaimer

The information contained herein does not constitute investment advice or an offer to sell or the solicitation of any offer to buy any securities of Shenhua or any other security.