Investment positives
　　We initiate coverage on Yancoal Australia Ltd (Yancoal) with an OUTPERFORM rating and a target price of HK$42.00, implying 7.6x 2025e P/E with 18% upside. We are upbeat on its dividend payments, M&A, and valuation improvement going forward, given its optimized balance sheet and abundant cash flow.
　　Why an OUTPERFORM rating?
　　We anticipate HoH earnings growth at Yancoal in 2H24, because we think coal prices may stabilize and rebound and the potential increase in coal output may drag down costs in 2H24. Declines of coal prices have narrowed, and prices of coal with high calorific value rebounded from the bottom in 2Q24. ASP of Newcastle thermal coal in 2Q24 dropped by 15% YoY and grew by 7% QoQ to US$136/t, and that of Australian 5,500kcal thermal coal fell by 13% YoY and 5% QoQ to US$89/t. We expect demand to improve marginally in 2H24 and to push up coal prices.
　　In our view, coal output of Yancoal will likely continue to grow and costs will likely decline. We anticipate a 2023-2025 CAGR of 8.1% in the output of attributable saleable coal and a CAGR of -7.3% in per- tonne coal production cost. We think earnings of the firm will improve in 2H24.
　　Attractive dividend yields. The average dividend payout ratio of around 54% in recent five years, annual average dividend payment of around HK$4.2bn, and the stock price as of July 31 suggest a current dividend yield of 8.9% for Yancoal. Its dividend yield is higher than dividend yield of most energy companies listed on the Hong Kong Stock Exchange. We think the firm will likely maintain a dividend payout ratio of no less than 50% going forward. Hence, given its current stock price (as of July 31), we anticipate a dividend yield of 7.0% in 2024 and 7.8% in 2025.
　　Improving M&A capabilities. M&As supported Yancoal’s growth in the past. We believe the firm has stronger M&A capabilities at present because it has paid off most debts and has booked net cash. We are　upbeat on its expansion through M&As.
　　How do we differ from the market? The market has relatively low expectations for coal demand and is concerned that Yancoal may face earnings pressure as a result. We expect coal prices to stabilize and rebound in 2H24, bolstering the firm’s earnings improvement.
　　Potential catalysts: Short-term supply-demand mismatch may drive up coal prices; Yancoal will likely be included in the S&P/ASX 200 Index.
　　Financials and valuation
　　We estimate the EPS of Yancoal at AUD0.94 in 2024 and AUD1.02 in 2025. Although the firm’s earnings may continue to decline in 2024, the estimated earnings in 2024 are still the third highest since the firm was founded in 2004, only lower than earnings in 2022 and 2023. The stock is trading at 7.2x 2024e and 6.4x 2025e P/E, which we think is relatively attractive. In the medium and long term, we expect its valuation to approach the average level of its main peers in the industry. We initiate coverage on Yancoal with an OUTPERFORM rating and assign a target price of HK$42.00 based on comparable companies’ average 2025e P/E valuation of 7.6x, considering that the pace of its production will be more stable in 2025. Our target price implies 8.5x 2024e and 7.6x 2025e P/E with 18% upside.
　　Risks
　　Coal demand pressure caused by sharper-than-expected declines in natural gas prices and/or operation resumption of Japan’s nuclear power plants; sharper-than-expected declines in energy demand due to global economic recession.