Yanzhou Coal Mining Company’s (YZC) net income grew 127% in FY04, following the huge demand for coal in the People’s Republic of China (PRC), led by strong economic growth. The average selling price of coal increased 58% in FY04 YOY on account of demand-supply mismatch. In 1Q FY05, the average selling price further increased 31% against the FY04 average. Although the prices have marginally declined recently, the strong demand would result in a 14% increase in revenue and 26% increase in net income in FY05 and another 11% increase in revenue and 9% increase in net income in FY06. Our intrinsic valuation gives us a price of $42 per share at a P/E ratio of 9.3x to FY06 EPS. From the current ADR price (ex-bonus) of $36 per share, we see an upside. BUY.
Chinese economy and coal demand
The economy of PRC grew 9.5% in FY04 and as per the National Bureau of Statistics the growth rate is 9.5% in 1H FY05. Currently, China is power starved, and coal is the main resource used for generating electricity in the country. 75% of China’s 4,00,000MW of installed electricity is generated with the use of coal as fuel. Since China depends on coal for its major energy requirements, the overall growth in the economy would lead to increased energy requirement, thus keeping the demand for coal strong in the coming years.
Surging coal prices
The demand for coal has outpaced supply, leading to a surge in domestic coal prices. YZC’s average selling price in FY04 was 58% higher than the average selling price in FY03. The prices surged a further 31% in 1QFY05, compared with FY04.
Huge cash reserves facilitate capital expenditure
For the year ended December 31, 2004 YZC had a cash reserve of $630 million. This has enabled YZC to easily materialize its capital expenditure plans. So far in 2005 YZC has acquired 95.67% share in Yankuang Heze Power Chemical Company from its parent organization for $69.4 million. It plans to spend another $326 million in developing two mines in the Shangdong Province, namely Zhaolou Mine and Wanfu Mine. Both Zhaolou and Wanfu mines have estimated reserves of 106 million metric ton and 208 million metric ton, respectively, and are likely to begin production in 4Q FY07.
The location of a coal mine affects its competitiveness due to significant cost associated with coal transport. YZC is located in the eastern Province of China, which accounts for 69% of its sales. Given the rapid economic growth of this region, the insufficient supply of coal produced here, and the substantial cost involved in transporting coal from other parts in China, YZC has a unique advantage from operating in this region.
Robust growth in the economy is fuelling the price rise in the domestic coal market. Cash rich YZC is leveraging this opportunity by acquiring and developing new mines. Such capital expenditure, without deteriorating the quality of its balance sheet, would increase its production capacity in the coming years and help strengthen its position in the domestic market. According to our estimate, the company’s revenues will increase 14% and 11% in 2005 and 2006, respectively. The ADR is currently trading at $36. Our DCF values YZC at $42 per share, recommending a BUY with a 17% upside.