20081009-Daiwa-China Coal Sector

Spot-contract price gap narrowing – Sell Yanzhou, Buy Shenhua
Summary
􀂃 In our view, the coal cycle is now at a tipping point, with Qinhuangdao (QHD) inventory hitting
an historical high of 9.1m tonnes on 21 September, up 99% YoY. Benchmark spot prices
seem to have peaked and are now at a 9% premium to regional spot prices of US$132.5/tonne
on 26 September. Signs of economic weakness are apparent, yet coal supplies are still rising.
We now forecast 15% YoY and 5% YoY declines in spot thermal-coal prices for 2009 and
2010, respectively, and a 10% YoY decline in coking-coal prices for each of those years.
􀂃 We expect thermal-coal contract prices to rise in 2009, given that China’s contract prices are
at a perceived low 59% discount to domestic spot prices of Rmb975/tonne as of 15 September.
We forecast 15% YoY and 6% YoY rises in domestic contract-coal prices for 2009 and 2010,
respectively, and believe China Shenhua (Shenhua) would benefit the most.
􀂃 We have downgraded our rating for Yanzhou Coal to 4 (Underperform), from 1 (Buy), and
lowered our six-month target price to HK$7.98, from HK$21.70. Amid a potential correction in
spot-thermal and coking-coal prices, we think Yanzhou Coal would be particularly vulnerable, due
to its 50% leverage to spot prices and larger exposure to Met coal than its peers.
􀂃 We retain our 2 (Outperform) rating for Shenhua, but have lowered our six-month target price
to HK$22.69, from HK$39.26. We believe Shenhua would benefit from a rise in contract prices,
could insulate itself from a meltdown in spot prices, and would strengthen its low-cost status
amid the government’s ‘clean energy mandate’ and potential resource tax shake-up.
􀂃 We keep our 3 (Hold) rating for China Coal Energy (China Coal) and have lowered our sixmonth
target price to HK$8.59, from HK$16.59. With limited downside protection, despite its
consistent double-digit-percentage volume growth, China Coal is less able than Shenhua to
cushion itself against price risk in a downcycle, in our view.