China Coal’s 1H14 mid-year NDR - all focus on production cut
At China Coal’s mid-year NDR in the past few days, most investors’ focus was on the coal industry’s production cuts. China Coal is make efforts to cut about 10% of its 2014 total planned production. Management believes the market mechanism itself will squeeze out some of the supply as most coal producers in China are loss making at the current coal price (5500kcal, QHD FOB, VAT incl.) of RMB480/t. Though the government of China might not be able to force all producers to make sustainable production cuts, China Coal believes the efforts will help relieve the over-supply situation.
Expectation of QHD prices - near term weak but recovery towards year-end
As for expectations about QHD coal price, management believes the coal price will remain at a low level in the coming weeks owing to the cool summer and strong hydro power utilization. Meanwhile China Coal still sees a high coal inventory level in the system (c.300mt). As such, the coal price should not recover strongly in the near term. However, China Coal believes its recent production cut, government policies aimed at reducing overcapacity, and seasonal demand should allow the QHD price to recover to the level of about RMB530/t.
Policies that China Coal is expecting
China Coal believes the government of China is quite serious about fighting the overcapacity situation in the coal industry, though execution remains to be seen. The key policies include (1) asking major coal producers to cut production; (2) making sure all producers are working according to the approved designed capacity and not over-producing; (3) trying to reduce coal import by setting coal quality standards and increasing coal import tax. With all these policies, China Coal thinks at least some of the supply can be reduced. Nevertheless, China Coal still thinks the market mechanism is the most critical driver for squeezing out inefficient producers. Management sees the coal industry remaining sluggish for at least one-to-two years.
Other guidance - cost, coal chemicals, capex, capital structure
Other key aspects discussed by management and investors: (1) China Coal will control its costs (similar as in 1H14), with 5% YoY decline (stripping out transportation cost over which China Coal cannot control well). (2) For coal chemicals, China Coal has confidence that new urea and methanol projects will yield good profits once fully ramped. China Coal will activate these projects in accounting terms maybe at the end of 2014. These might increase China Coal’s depreciation by c.RMB1bn. (3) China Coal will likely maintain its capex at c.RMB26bn in 2014/2015. (4) China Coal will maintain its gross D/A ratio below 60% (currently c.50%) and its cost of debt is slightly less than 6%.