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 offering 18% upside. We are upbeat on its dividend payments, M&As, and valuation improvement going forward, given its optimized balance sheet and abundant cash flow.
　　Why an OUTPERFORM rating?
　　Anticipating HoH earnings growth in 2H24, as coal prices should stabilize; rebound and the potential increase in coal output may lower costs. Declines in coal prices have narrowed, and prices of coal with high calorific value rebounded from a bottom in 2Q24. The ASP of Newcastle thermal coal dropped 15% YoY (up 7% QoQ) to US$136/t, while Australian 5,500kcal thermal coal fell 13% YoY (5% QoQ) to US$89/t. We expect demand to improve marginally in 2H24. pushing up coal prices.
　　In our view, coal output at Yancoal will likely continue growing while costs decline. We anticipate a CAGR of 8.1% in the output of attributable saleable coal, from 2023 to 2025, and a CAGR of -7.3% in per-tonne coal production costs. We expect earnings of the firm to improve in 2H24.
　　Attractive dividend yields. With an average dividend payout ratio of around 54% over the past five years and an annual average dividend payment of around HK$4.2bn, the stock price as of July 31 suggests a current dividend yield of 8.9%. The firm has a relatively high dividend payment compared to other energy companies listed on the Hong Kong Stock Exchange. We believe the firm is likely to maintain a dividend payout ratio of at least 50% going forward. Hence, given its July 31 stock price, we anticipate a dividend yield of 7.0% in 2024 and 7.8% in 2025.
　　Improving M&A capabilities. M&As supported Yancoal’s previous growth. We believe the firm has stronger M&A capabilities at present as it has paid off most debts and has booked net cash. We are optimistic about 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 would still be the third highest since the company’s founding in 2004, only surpassed by 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-to-long term, we expect its valuation to approach the average level of its main industry peers. 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, given that Yancoal’s pace of production should be more stable in 2025. Our target price implies 8.5x 2024e and 7.6x 2025e P/E and offers 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.