We revise up Yanzhou NP estimates by 23% for 2018E, 35% for 2019E and 23% for2020E, to incorporate updated seaborne coal price forecasts from Goldman Sachs’global commodities team, partly offset by a lower domestic PCI coal priceassumption. We expect domestic thermal coal prices to remain solid in 2019E（unchanged spot price forecast at Rmb650/t）， with upside risk in 4Q18E, driven bylower effective social inventory （when taking the elimination of unauthorized coalstorage into consideration）， combined with stronger seasonal strength. Thehigher-than-expected seaborne coal prices especially in the high-CV coal segment（NEWC 6000kCal）， driven by fundamental tightness of the seaborne market ratherthan China, also benefits Yanzhou （37% of the sales volume exposures, and most ofthat is high-CV thermal coal）。
Post the recent share price correction, we view the valuation of the stock as highlyattractive, at 3.6x P/E and 4.1x EV/EBITDA on earnings based on current spot coalprices and 8.9% dividend yield （based on the minimum payout of ~30%）。 Weupgrade the A and H shares to Buy from Neutral, with revised 12-month target prices of HK$12.0 for H-share （from HK$9.4） and Rmb14.6 for A-share （from Rmb12.5），implying 30-40% upside.
Key risks include: 1） Coal prices in both the domestic China and international seabornemarkets, which are affected by both the supply-demand balance in the Chinese andinternational markets; demand for coal is mostly driven by the power, steel and buildingmaterials sectors; transportation capacity for coal, including both rail and ports, is also akey factor affecting coal prices; 2） the Chinese government’s export policy on coal,including export VAT rebate changes, export tax changes, and import tariff; and 3）additional unexpected cost imposed on coal producers by the government, especiallyrelating to environmental concerns and resources.
Benchmark coal price assumptions
Our new revised thermal coal prices are NEWC 6000kCal at US$107 for 2018E （fromUS$94/t）， US$98/t for 2019E （from US$75/t） and US$85/t for 2020E （from US$70/t），based on Goldman Sachs’ global commodities team’s latest forecast changes （see Coal: The tail wagging the dog）， versus current spot of US$107/t. Our estimations on Chinathermal coal QHD5500-blended price and spot price remain unchanged at Rmb590/t andRmb650/t for 2019E respectively, versus current spot of Rmb587/t and Rmb665/t. ForPCI coal prices, the seaborne low-Vol PCI has been revised up by 4% to US$137/t for2018E and up by 14% to US$114/t for 2019E. Our China PCI coal price assumption is atRmb985/t for 2018E （9.5% lower from prior estimates）， and Rmb948/t for 2019E （8.7%lower from prior estimates）。
Feedback from our recent China visits suggests that the unauthorized coal storage alongthe coal transportation/logistics value chain has been most eliminated over the summer,on the back of government environmental efforts （see Takeaways from China trip）。 Whilethere are no official statistics on the total volume of the hidden inventory reduction, webelieve it would be comparable to the social inventory along the coal logistic chains. Thus we estimate the effective total social inventory is much lower than a year ago as aresult. On the demand side, the continued coal-to-power conversion efforts in reducingemissions from winter-heating coal usage should in fact translate into more thermal coaldemand for power generation for heating, when taking the energy conversion efficiencyrate of coal-fired power plant into consideration. In the context of 110mnt reduction target in winter residential heating coal for 2018-2020E set by MEE （Ministry of Ecologyand Environment）， we estimate the incremental thermal coal demand would be over200mnt, or nearly 10% of current thermal coal market in China, leading to strongerseasonal strength in the winter period as well.
Domestic new mines expanding, HQ and YAL are still key earnings driver
On the company level, we estimate HQ （Headquarter） and YAL （Yancoal Australia） remainthe key earnings drivers, accounting for 37.7% and 38.5% of gross profit in 2018E.
We expect the gradual ramps of two new mines to boost self-mined volume by 10mnt（raw coal） or 11.0% from the current level （2018E） in 2019E-2020E, while production atheadquarter and YAL to remain stable. Specifically, 1） the Ordos mine in Yingpanhao （营盘壕） has 12mnt total capacity, versus 2018E output of 4.8mnt, and 2） the Haoshengmine in Shilawusu （石拉乌素） has 10mnt total capacity, versus 2018E output of 2.9mnt. The mine is still in recovery from disruption related to safety and environmental factors.
Nevertheless, we highlight the unit gross profit of the new mines are lower than otherassets of Yanzhou, with an estimate at Rmb143/t in 2018E, versus Headquarter ofRmb321/t, and YAL at Rmb296/t, in our base case price assumptions. The lower unit GPis driven by a combination of lower ASP due to inland location, offset by lower production cost. Environmental related efforts has also led to higher cost pressure forinland coal assets, through higher discharge costs and/or production disruptions. Forexample, unit cost of Yingpanhao mine （in Ordos） for 1H18 increased 25.9% YoY orRmb30.9/t, much higher than the 0.46% cost hike for headquarter, of which nearly75.6% of the cost hike was related to investment in facilities for safety andenvironmental. Unit cost of Shilawusu mine （in Haosheng） increased Rmb36.9/t, up23.9% YoY, mainly driven by more investment in facilities for environment and safety butpartly offset by more use of special reserve.
Earnings revisions and rating changes
We revise our Yanzhou NP estimates up by 23% for 2018E, 35% for 2019E and 23% for2020E, to incorporate updated seaborne coal price forecasts from Goldman Sachs’ global commodities team, partly offset by a lower domestic PCI coal price assumption.On our higher revised estimates, our 12-month target price for Yanzhou-H increases toHK$12.0 （from HK$9.4） and for Yanzhou-A to Rmb14.6 （from Rmb12.5）。 We upgrade ourrating for both A and H shares to Buy from Neutral. Our target price methodologyremains unchanged, based on historical P/B vs. ROE correlation – or 2019E P/B of0.82X/1.19X at an ROE of 15.1% （from 0.70X/1.10X at an ROE of 11.7%）。