Yanzhou 3Q18A net profit was Rmb1.16bn （PRC GAAP）， down 28% YoY and 45%QoQ. 9M18A NP was Rmb5.5bn （PRC GAAP）， or 63% of full-year 2018E Bloombergconsensus and 57% of GS 2018E estimates （prior to revision）， behind expectation.Nevertheless, we estimate recurring 3Q18A NP would be Rmb1.92bn, nearly flatQoQ and up 54% YoY, adjusted by FX loss, one-off corporate expenses, and higherChina tax rate. The result is slightly behind our expectation, mostly due to thedelayed recovery in non-HQ （non-headquarter） China assets including Haosheng andOrdos, while core operations in HQ and YAL were on track. Nevertheless, wehighlight improvement is taking place at Ordos per recent updates, and gross profitof the segment, at 20% of 1Q18A, has reached a floor in 3Q18A in our view. Weremain positive on the spot coal price outlook in both domestic and seabornemarkets, and expect much improved earnings in 4Q18E, driven by higher ASP,normalization of expenses and tax rates, and QoQ improvement in non-HQ Chinaassets. We revise down our 2018E NP by 9.2% （or 3.0% on recurring basis） toreflect the one-off costs in 3Q18A, and slow recovery in Haosheng and Ordos, butmaintain 2019E and 2020E mostly unchanged with an assumption of most recovery in place in 2019E. Maintain Buy with unchanged 12-month target prices of HK$12.0 forYanzhou-H and Rmb14.6 for Yanzhou-A.
The one-offs in 3Q18A came to a total of Rmb757mn in NP reduction or nearly 65% ofthe reported NP in our estimates. The major one offs included:
Over Rmb300mn in FX loss in the third quarter, based on n the disclosure andmanagement comment of “Rmb365mn more FX losses in 9M18A”。
Higher-than-normal tax expenses for China operations, which has partly led to aneffective tax rate of 38% in 3Q18A, more than 10% higher than normalizedweighted average tax rate for Yanzhou. The implied China operation tax rate wasnearly 40% in our estimates, or over Rmb300mn higher than normal. Managementcommented the abnormal tax expense was a retroactive tax payment, on one-offbasis.
A one-off corporate expense of nearly Rmb300mn, related to the transfer of publicservices （heating and water supplies） from Yanzhou to local government, as part ofthe trend that moves public services from SOEs to local government.
Core operations in HQ and YAL remained solid. Sales volume in HQ （Headquarter）was 8.2mnt in 3Q18A and 24.6 mnt in 9M18A, up 4% YoY, mostly on track. ASP of selfmine coal at HQ was Rmb585/t, stable YoY and QoQ, inline with the QHD5500 blended（down 2% QoQ） and spot price （up 1% QoQ） trend over the period. Unit cost at HQ in9M18A increased 5% YoY, or 1% up versus the 1st half. Unit gross profit at HQ was 3%lower YoY in 9M18, mostly in line with our expectation. YAL sales was 8.6mnt for 3Q18Aand 25.0mnt in 9M18A, up 80% YoY and stable QoQ. ASP in 3Q18A was Rmb644/t, up23% YoY and 3% QoQ, partly in line with NEWC6000 benchmark prices, but still laggedon QoQ basis, given the quarterly pricing is partially based on spot of previous quarter.Unit production cost at YAL was Rmb280/t in 3Q18A, up 25% YoY, mostly stable throughthe past quarters, inline with expectation. We estimate overall gross profit from coalwas stable at HQ, and nearly doubled at YAL YoY, each accounts for more than 40% ofthe total gross profit.
The shortfall in 3Q18A results in “Other China operations”， mostly Haosheng andOrdos Nenghua. Total gross profit contribution from the segment declined 60-70% YoYand QoQ. The run rate of Rmb273mn gross profit in 3Q18A is more than Rmb1bn or80% lower than the levels in 1Q18A, when operations were normal. The deteriorationwas driven by lower volume combined of surging unit costs, due delay of the mininglicense approval for Haosheng, and disruption from the environmental and safetyinspection by local government for Ordos Nenghua. Specifically Haosheng mine hasreported an over Rmb200mn loss in gross profit in our estimates in 3Q18A, a swing ofover Rmb500-600mn versus its profit under more normal operation in 1Q18A. Grossprofit for Ordos Nenghua also fell to Rmb70mn in 3Q18A, versus Rmb554mn in 1Q18A,in our estimates. Yanzhou aims to get mining license approved by year end, amiduncertainty in timing remains. Ordos Nenghua, is on track of more visible QoQimprovement versus 3Q18A, as Yingpanhao mine recovered from 11% capacityutilization in 3Q18A to over 50% at present, per management updates.
We expect a much better 4Q18E, driven by higher ASP, less one-off expenses, andpartial recovery of other China operations. Specifically, we expect Rmb30-40/t higherQoQ prices on most operations, based on the spot price trend, including the catchups ofASP at YAL versus NEWC prices in 3Q18A and 4Q18E. We also expect a partial recoveryat Ordos Nenghua and Haosheng to lead to nearly Rmb300mn QoQ improvement inprofit.
There is a one-week long safety inspection currently taking place in Shandong, affectingthree mines in Yanzhou’s Shandong assets. We view the impact as limited - assumingone week of production suspension, the disruption would lead to a 0.3mnt output cut,or 0.32% of Yanzhou’s full-year 2018E output, and 0.3% of the earnings impact on 2018Ein our estimates. （Impact of Shandong safety inspection – marginal disruption onYanzhou）
Earning revisions: We revise down NP by 9.2% for 2018E （or 3.0% for recurring NP），0.4% for 2019E and 0.5% for 2020E, to reflect the one-off costs in 3Q18A, and slow recovery in Haosheng and disruption in Ordos Nenghua. We expect non-HQ operationsto mostly revert to normal, and maintain 2019E and 2020E mostly unchanged. Wemaintain Buy on both Yanzhou Coal H/A with respective target prices of HK$12.0 andRmb14.6 （unchanged）。 Our price target methodology is based on historical P/B vs. ROEcorrelation – or 2019E P/B of 0.86X/1.20X at an ROE of 15.2% （from 0.82X/1.19X at anROE of 15.1%）。
Key risks include: upside risks: 1） higher coal prices, mainly driven by tighter supply inthe Chinese market; 2） swift recovery on non-HQ China assets; downside risks: 1） lowercoal prices or price control imposed by NDRC; 2） additional unexpected costs imposedon coal producers by government, especially relating to environmental and resourceissues; and 3） a delay on approvals related to mining license and/or production disruptiondue to safety or environmental inspections.