|Shares Out. (in M):||20||P/E||12.5x||14.0x|
|Market Cap (in M):||90||P/FCF||0.0x||0.0x|
|Net Debt (in M):||-10||EBIT||0||0|
Shenhua is the largest and lowest cost producer of thermal coal in China. It has an integrated model where it owns transportation infrastructure and utilties that give it exposure to the entire coal supply chain. However, thermal coal production is the largest piece of its business, representing over 60% of gross profits. There are three key drivers to the cash flow generated by teh coal business: (1) the price of spot market coal, (2) the mix of coal sold on a contract basis on price regulated by the governemnt, and (3) the quality of the caol they sell. Contract prices are far lower than spot prices and so a mix shift to spot coal has been a big driver to cash flow for the company as has the increases in spot prices that have begun to roll over.
I believe that (1) due to supply/demand dynamcis the price of spot coal will be secularly challenged from here, the mix to contract coal and plateaued, and the quality of coal produced has deteriorated. So recenty, the NDRC has announced that they will cap the price of spot coal at 800RMB for the benchmark grade (spot was north of 900Rmb when this was announced). While clearly a negative, many have said that given the extremely fragmented nature of the industry, this will never be enforced. I agree except that Shenhua is an SOE and so will be tough to report violations of the policy in print. Second, I believe market dynamics will impari the price of coal anyway. The price of contract coal was also raised by 5% for various reasons and while this is a positive and received attention, a second comment was made that received little attention: i.e. that more strict enforcement of fulfillment of contract volumes will be enforced. This will be a headwind that people are not acknowledging. Finally, if we look at the gross profit per ton on the contract coal business in 2011, we see clear deterioration in price suggesting that the quality of the firm's prodution has been deteriorating.
In short, I think consensus estimate of Rmb2.60 will be more like Rmb2.00 next year and the multiple will contract to 8-10x as the market realizes the secular issues with the coal indsutry. Why pay more for chinese coal, albeit low cost coal, if the upside to the commodity is capped and the downside is steep due to issues I address below. So targert price is HKD is 2.00 x 9 x 1.22 or lows 20s HKD (must convert RMB EPS to HKD).
Key points of the thesis is below.
Chinese coal supply is growing well in excess of demand
Chinese language report noted that 1 billion tons of coal production capacity is currently under construction in China. To put that in context, total coal production in Australia, Indonesia, Mozambique, and South Africa combined in 2009 was ~950 million tons, according to the EIA.
|Subject||RE: RE: update?|
|Entry||01/22/2014 11:49 PM|
i would nto cover this unless you are really bullish china for some reason. coal demand is secularly challenged, transportation gets better every day and supply is therefore plentifulwith falling cost curves...