Nomura China Coal

Double fault

Downgrading Shenhua and Yanzhou, as we cut our China coal price forecasts

After toning down our previous bullishness in November, we now have a neutral stance towards the China coal sector. The supply deficit should stay smaller in 2012-13F, and we expect a surplus market from 2014F as transportation bottlenecks ease.

We cut our spot coal price forecasts by 9% to CNY720-830/ton over 2012-15F. We also revise down our coal consumption forecast as we expect power generation to rely more on non-coal alternatives.

We downgrade Shenhua to Neutral and Yanzhou to Reduce. We upgrade China Coal to Buy, as it is less exposed to spot prices and has high visibility on production growth.

Key analysis in this anchor report includes:

• Expect coal price to fall 10-15% in 1H12F and 9.2% during 2011-15F.

• Bigger risk is for seaborne price given shrinking coal imports by China.

• We see volume growth as a bigger driver than pricing in 2012-13F.

• Depleted coal resources at home should mean M&A becoming pricier.

• Resource tax: not a near-term risk; we see abolition of levies as being in the cards.

EQUITY RESEARCH

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February 1, 2012

Research analysts

China Metals & Mining

Ivan Lee, CFA - NIHK [email protected] +852 2252 6213

China coal

See Appendix A-1 for analystcertification, important disclosures and the status of non-US analysts.

China coal

METALS & MINING

EQUITY RESEARCH

ANCHOR REPORT: Double fault

Downgrading Shenhua and Yanzhou, as we cut our China coal price forecasts

February 1, 2012

Supply deficit has improved China’s coal market is likely to remain in a slight “supply deficit” in 2012-13F, due to transportation constraints, but not production; however, the situation has improved modestly (albeit at a smaller 5-66mnt deficit vs 163-396mnt for 2005-11). Meanwhile, supply may exceed our expectations as six major coal production bases announced targets to increase their output by 57% during 12 FYP, and transportation bottlenecks ease from 2014F.

Coal price losing steam; 2011-15F China spot coal price cut by 9.2% We turn Neutral on the sector, from Bullish. Spot coal price is losing steam amid increasing supply (+11% in 2011), high coal inventory at IPPs (21 days), an 8% premium to Newcastle and sluggish demand growth (slowing GDP growth and Beijing efforts to cap CO2 and energy intensity). We believe coal prices peaked in Nov 2011 (CNY850/t) and will fall 15% to CNY720/t in April and rebound in 2H12 depending on how fast Beijing issues its stimulus policy and market supply growth. Key risk on coal price is from 2014F when market turns to a “surplus” post transportation easing. We cut our 2011-15F Chinese spot coal price by 9%, similar to our 10% cut for Newcastle price. We expect spot coal price to fall 9.2% in 2011-15F, while the key contract price should be more resilient, rising by 10%.

Coal miners’ pricing power is weakening … getting pricey on M&A Despite contract coal price currently at a 30% discount to spot, coal miners have been unable to raise prices in the past two years due to the NDRC’s control. Cost continues to rise due to inflation and increasing safety requirements; however, pass-through is becoming more difficult due to reduced pricing power and a surplus market from 2014F. Depleted coal resources at the home base likely means more M&A going forward, but inflated asset prices in China/overseas imply a lower return. Therefore, asset injection remains a key driver for capacity and earnings growth.

Not too far from the bottom; we expect another 10-15% downside The last sub-8% GDP growth in end-2008 drove coal and share prices to fall 55% and 74-80%, respectively. Thus far, coal and share prices have corrected by 7% and 32-55%, respectively, from the recent peaks in 2011. Current share prices imply a CNY700/t coal price, on our estimates, meaning downside is likely to be limited to 10-15%.

Turn “Neutral”; range-trading in 2012; we upgrade China Coal to Buy We cut sector earnings by 4-13% for 2011-13F and hold an opportunistic stance (and range trading) in 2012F, and use the potential falls in March/April as a way to accumulate, when poor 1Q12 figures on GDP and power demand are likely to be unveiled. Due to a less robust spot price and increasing pricy M&A, we prefer companies with strong self-production growth (and resources), asset injection opportunities, low production costs and less exposure to spot. We upgrade China Coal to Buy (from Neutral), downgrade Yanzhou Coal to Reduce (Buy) and Shenhua to Neutral (Buy).

Anchor themes

China remains in coal deficit in 2012-13F due to transportation constraints but not production. Coal price to fall by 10-15% in 1H12F and rebound in 2H due to slowing GDP growth and Beijing’s effort to cap CO2/energy intensity.

Nomura vs consensus

We are less bullish than market and expect coal price to fall by 10-15% in 1H12F and 9.2% for 2011-15F due to slowing GDP and Beijing’s effort to cap CO2/Energy intensity

Research analysts



See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | China coal February 1, 2012

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Contents

4 Executive summary

15 P/E comparison

16 P/B comparison

17 Operation metrics comparison

20 Valuation comparison

23 Coal price is losing steam – range-bound at CNY720-830/t in 2012-15F

32 Slowing coal demand growth

42 Turn from coal supply deficit to surplus from 2014F

49 What’s new from the NDRC’s energy conference

50 Transportation bottlenecks likely to persist until 2014F

56 Imports to remain at high levels to fill the supply deficit in 2012-13F

59 Rising costs ahead

63 Overview of seaborne coal market

69 Nomura Expert Series: China coal market 2012 outlook

70 Appendix I: Policy development on coal

73 Appendix II: Industry knowhow

75 Appendix III: Nomura 2012 China Economic Outlook

77 Appendix IV: Nomura Commodity Assumptions

78 Appendix V: China railway map

79 Appendix VI: China/Mongolia/Russia railways network

80 Appendix VII: Sector valuation I

81 Appendix VII: Sector valuation II


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82 Appendix VII: Sector valuation III

83 China Shenhua Energy

111 China Coal Energy

134 Yanzhou Coal

159 Appendix A-1


4

Executive summary

How we differ from our last report and market consensus

We have become less bullish; we had previously expected coal price to peak at CNY850/t in November We had a bullish view on coal when we published our last anchor coal report "Always room for dessert", 18 Jan 2011 and expected the average spot coal price to rise 8% in 2011. In 2011, spot price rose by 9% to the peak of CNY850/t, from CNY780/t on 3 Jan 2011.

Thus far, the price has declined by 7%; we expect another 10-15% fall from now... Subsequently, in our 18 Nov 2011 report "China coal: Momentum to slow; awaiting a better entry point in 1Q12F, we turned less bullish on coal and expected Qinhuangdao (QHD) spot coal price to peak at CNY850/t (as of 18 Nov, 2011), due to high coal inventories with IPPs (21 days, historically showing a high negative correlation) and higher-than-expected coal production in 2011 (+11.6% y-y in 11M11 vs our estimate of 4.2% for 2011F), and a further fall of 10-15% in spot coal price is likely through Jan/Feb 2012F when IPPs destock and then enter the low demand season. Since then, QHD spot coal price has fallen by 7% to CNY793/t as of 9 Jan, 2012.

Turn Neutral on the sector Now we turn Neutral on the sector. Although the expected “supply deficit” in 2012-13F, albeit at a smaller scale, should prevent coal price from a free fall, it does not provide enough horsepower for it to rise significantly either, in our view. The key risk on coal price is from 2014F when we expect the market to turn to a “supply surplus”, with transportation bottlenecks easing.

Chinese spot coal price forecast cut by 9% and coking coal price forecast by 12% We have cut our Chinese spot coal price forecast by 9% and now expect coal price to fall 9.2% (and be range bound at CNY720/t-CNY830/t) during 2011-15F. A similar 10% cut to our Newcastle coal price forecast is also adopted by our global mining team. We now forecast a Newcastle coal price of US$125/t (+1% y-y), US$130/ton (+4% y-y), US$130/ton (+0% y-y), US$110/ton (-15% y-y) in 2012-15F.

Meanwhile, our global mining team also cut its coking coal price forecasts for 2012-15F by 10-18% and now expects coking coal price to fall 41% during 2011-15F. This is in line with our 12% cut in Chinese coking coal price forecasts for 2012-15F, but more bearish than our expectation of a 6% price decline for Chinese coking coal during 2011-15F.

Fig. 1: Nomura coal price forecasts

Source: sxcoal, Nomura estimates

2009A 2010A 2011A 2012F 2013F 2014F 2015F

China coal price forecast

QHD spot price (CNY/t, 5,500kcal/t) 600 744 820 787 827 827 744

QHD spot price (USD/t, 5,500kcal/t) 88 110 130 128 139 139 125

y-y (%) 24% 10% -4% 5% 0% -10%

Liulin No.4 clean coal (exc. VAT, CNY/t) 1,087 1,267 1,405 1,321 1,321 1,321 1,321

Liulin No.4 clean coal (USD/t) 158 191 222 214 222 222 222

y-y (%) 17% 11% -6% 0% 0% 0%

Australia coal price forecast

Australia thermal coal (USD/t) 70 98 124 125 130 130 110

y-y (%) 40% 26% 1% 4% 0% -15%

Australia coking coal (USD/t) 129 216 274 256 230 190 160

y-y (%) 67% 27% -6% -10% -17% -16%


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Fig. 2: Nomura China coal price forecasts


Fig. 3: Nomura Australia coal price forecasts

Source: Nomura estimates

Cut coal consumption forecast by 2-5% due to more non-coal fired capacity We have revised down our coal consumption forecasts by 2-5% for 2012-15F due to slowing coal demand growth for power generation given that more non-coal-fired capacities (hydo, nuclear and natural gas) are expected to come online during the 12th Five Year Plan (FYP) as a result of the government’s policy to reduce energy and CO2 intensity. Our coal production forecast for 2012-15F is also raised by 1-7% as we factor in the production targets of the six major coal provinces during the 12th FYP.

Cut FY11-13F sector earnings by 4-13% We have cut the FY11-13F earnings for Shenhua by 4-9% and Yanzhou by 13%, and raised China Coal by 8-18%. We downgrade Shenhua to Neutral and Yanzhou to Reduce, while upgrading China Coal to Buy.

Fig. 4: Stock for action

Source: Bloomberg, Nomura estimates Note: Pricing as of 26 Jan 2012

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Price target Price PEG

Company Ticker Rating L. Curr. L. Curr. 11F 12F 13F 11-13F 11F 12F 13F 11F 12F 13F

Shenhua Energy-H 1088 HK Neutral 38.10 35.15 12.5 10.6 8.9 0.6 2.5 2.2 1.8 3.2 3.8 4.5

Chinacoal Energy-H 1898 HK Buy 12.25 10.2 10.4 8.6 6.8 0.3 1.3 1.2 1.0 2.6 3.1 3.9

Yanzhou-H 1171 HK Reduce 17.10 19.28 8.5 8.3 7.7 0.8 1.8 1.4 1.1 3.4 3.6 3.7

P/B (x)P/E (x) Yield (%)


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Fig. 5: China’s spot and contract price (2002-12)

Source: China Coal Transportation and Distribution Association (CCTD), Nomura research

Fig. 6: IPP inventory days

Source: sxcoal, Nomura research

Fig. 7: Spot coal price vs IPP inventory days


Fig. 8: Raw coal production volume and growth (2009-2011)

Source: CCTD, Nomura research

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Spot price refers to Shanxi blend (5,500kcal/kg) at Qinghuangdao port

Peaked at RMB995/t after government announced spot price cap on July 23

Spot price at CNY793/tonne on 9 Jan 2012, down 1.9% w-w

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Monthly production (LHS) y-y growth (RHS)(mnt) (%)


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While the market remains bullish on coal and prices for 2012-15F, we are more cautious

We are more cautious than the market in terms of:

1) Supply/demand outlook for 2012-15F.

– We foresee a balanced market with a slight supply deficit for 2012-13F and a surplus from 2014F vs the market's view of a continued supply deficit for 2012-15F.

– We forecast slower coal demand at a 3.6% CAGR for 2011-15F due to Beijing’s efforts to cap energy and CO2 intensity, vs the market's expectation of a 7-8% CAGR.

– We forecast faster coal production and supply (after factoring in transportation) growth at 5.4% and 7.0% CAGR, respectively for 2011-15F, respectively, vs the market's expectation of a 5% CAGR.

2) Pricing outlook for 2012-15F.

– We expect coal spot price to fall 10-15% in 1H12F and remain range-bound at CNY720-830/t in 2012-15F; we estimate the average coal price to fall by 9.2% in 2012-15F vs the market's expectation of a continued 2-3% p.a. increase in the average spot price.

– We expect key contract price to rise 5% in both 2012F and 2014F, vs the market’s expectation of a 5% p.a. increase for 2012-14F.

3) We expect unit production costs to rise by 5-6% p.a. in 2012-13F and a higher 10-11% p.a. in 2014-15F due to the implementation of a 5% value-based resource tax from 2014F, vs the market's expectation of a 5-6% pa rise in production costs for 2012-15F.

In the near term, consensus now expects a strong rebound in spot coal prices in 2H12F. However, we believe is this is not without risk, and would adopt a wait-and-see approach and keep an eye on production growth, IPP coal inventory days and GDP growth in the following months to confirm the trend.

Fig. 9: QHD Datong premium to Global Coal NEWC (incl. USD11/t freight rate)

Source: Wind, Bloomberg, Nomura research

Fig. 10: QHD price vs Newcastle price (incl. USD11/t freight rate)


Greater risk on seaborne coal price

Although coal imports to China only account for a single digit percentage of China’s total annual consumption, this represents over one-fourth of seaborne coal market imports in Asia (around 500mnt). Therefore, any change in the import pattern of China would materially affect the seaborne market.

Given we forecast a 160mnt import by China for 2012F, vs 165mnt and 183mnt for 2010 and 2011, respectively, seaborne coal prices should remain stable and range-bound at current levels for 2012F, in our view.

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However, the expected reduced supply deficit in 2013F and supply surplus in China from 2014F should cut the requirement for imports to 100mnt, 50mnt and zero for 2013-15F, which would be a very significant reduction to the regional seaborne coal demand and should lead regional seaborne coal prices to fall substantially and faster than Chinese’s spot coal price during the same period, in our view.

Meanwhile, our global mining team is expecting a 15-18% pa price correction for Australian Newcastle prices (also our benchmark for seaborne coal price) starting from 2015F, but we believe the correction may happen earlier and be greater, based on our analysis above.

The last sub-8% GDP growth in end-2008 drove coal prices and share prices to fall 55% and 74-80%, respectively

Our China economist, Zhiwei Zhang, forecasts GDP growth to drop below 8% in 2012F, with the biggest risk in 1Q (7.5%), 2Q (7.6%), 3Q (8.1%) and 4Q (8.4%) due to a slowdown in housing investment. The last period of sub-8% GDP growth was during 4Q08 (7.6%) to 1Q09 (6.6%), which drove the QHD spot coal price to fall by 55% to the low of CNY451/t in December 2008 (source: CCTD), from the peak of CNY995/t in July 2008. During the same period, the share prices of coal companies also fell by 74-80%.

Current share prices already reflect a CNY700/t coal price, but 10-15% downside risk remains

However, the impact this time should not be as severe as that of end-2008, in our view, given: 1) our expected 4.5 percentage points fall in GDP from the peak of 12% in 1Q10 is only 75% of the 6 percentage points decline (in 12 months) from the peak of 13.6% in 4Q07, and 2) IPPs’ coal inventory was 26 days as of end-2008, vs the recent peak of 21 days at in November 2011.

We believe there remains 10-15% share price downside risk in 1H given coal companies’ shares have corrected by only 32-55% since the peak in Jul 2011 and coal prices have fallen by 7% since the peak in Nov 2011; these are approximately 10-15% smaller than 75% of the respective 74-80% and 55% corrections in 2008.

Nevertheless, on our estimates, the current share prices have already factored in a CNY700/t QHD spot coal price for 2012 (based on Shenhua’s model); thus we believe we may not be too far from the bottom.

Fig. 11: GDP growth vs spot coal price

Source: sxcoal, CCTD, Nomura research

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Fig. 12: China: Spot coal price forecast for 2012F

Source: Nomura research

Fig. 13: China: Coal price forecast for 2012-15F


Accumulate further at expected falls in March/April 2012

We recommend that investors take an opportunistic stance (and range trade) on the sector in 2012F, and use the likely falls in March/April 2012F as a way to accumulate further, when poor 1Q12 figures on GDP growth and power demand growth are likely to be unveiled and closely monitor the upcoming monthly trend of IPP coal inventory days, coal production and GDP growth. In addition, the potential bottoming out of the USD and deepening of the European debt crisis do not provide a positive backdrop, in our view.

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CNY/tonne (5,500 kcal/ton) 2009 2010 2011F 2012F 2013F 2014F 2015FKey contract price (FOB)-40% of total contract sales 540 570 570 599 599 628 628

y-y (%) 18 6 0 5 0 5 0

Non key contract price (FOB)-60% of total contract sales

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Blended contract price (FOB) increase (%) 6 3 6.2 0 5 0

Spot price (CNY/t, 5,500kcal/t) 600 744 820 787 827 827 744

y-y (%) -17 24 10 -4 5 0 -10

Spot price (USD/t, 5,500kcal/t) 130 128 139 139 125

CNY/USD 6.33 6.17 5.96 5.96 5.96

Average selling price (50% contract; 50% spot) 570 657 695 696 713 727 686

15% 6% 0% 2% 2% -6%

Price is in between spot and contract price; different on each company; moving with spot coal price trend


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Fig. 14: China: coal industry supply / demand forecast

Source: CEIC, CCTD, Nomura estimates

Key investment themes for 2012

Coal sector earnings and margins were driven by robust ASPs and moderate volume sales growth over the past two years, despite rising unit production costs. However, we expect Chinese spot coal price to remain range-bound at CNY720-830/t and the average price to fall by 9.2% during 2011-15F, while the key contract price should be more resilient and rise by 10% over the same period. As a result, we believe sales volume growth (own production or third-party trade or asset injection or M&A) becomes the only driver from this year, while more existing percentage sales in contract could alleviate the pricing risks. Although coal companies have been moving towards more spot sales, we do not expect any substantial improvement going forward, given their state-owned nature which would require a certain level of “social responsibility”.

For 2012F, given the underlying risks on spot price (the potential rebound in 2H is contingent upon a number of factors), while the key contract price for 2012F has been fixed, we would prefer companies with the following attributes in their order of significance. These should provide higher earnings visibility in 2012F.

1) Robust self coal production growth.

2) Sufficient resources.

3) Higher likelihood of asset injection.

4) Less exposure to spot (more on contract).

5) A power portfolio.

6) Less overseas exposure given the unattractive seaborne prices, a stronger US dollar and an even stronger CNY in 2012F.

As a result, we upgrade China Coal to Buy (from Neutral), and downgrade Yanzhou Coal to Reduce (from Buy) and Shenhua to Neutral (from Buy).

(mnt) 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F 2014F 2015FCoal production (a) 2,350 2,529 2,692 2,802 2,950 3,413 3,789 3,978 4,177 4,407 4,671

% chg 10.7 7.6 6.4 4.1 5.3 15.7 11.0 5.0 5.0 5.5 6.0

Net increase 227 179 163 110 148 463 375 189 199 230 264

Effective supply factor (Transportation) 87% 87% 89% 93% 95% 93% 93% 94% 95% 97% 99%Coal sales (e) 2,044 2,209 2,398 2,606 2,817 3,179 3,529 3,739 3,968 4,275 4,624

% chg 8.1 8.6 8.6 8.1 12.9 11.0 6.0 6.1 7.7 8.2

Net increase 165 189 207 211 362 350 210 229 306 350

Coal consumption (b) 2,319 2,551 2,727 2,811 3,213 3,350 3,692 3,805 3,973 4,117 4,231

% chg 10.0 6.9 3.1 14.3 4.3 10.2 3.1 4.4 3.6 2.8

Net increase 232 177 84 402 137 342 113 167 144 115

Coal supply deficit (275) (342) (329) (205) (396) (171) (163) (66) (5) 158 393

Change in inventory and others* (c) (15) (47) (38) (14) (160) 209 265 315 284 320 420

As % of total production (0.6) (1.9) (1.4) (0.5) (5.4) 6.1 7.0 7.9 6.8 7.3 9.0 As % of total consumption (0.6) (1.9) (1.4) (0.5) (5.0) 6.2 7.2 8.3 7.2 7.8 9.9

Net exports/(imports) (d) 46 25 2 5 (103) (146) (168) (142) (80) (30) 20

of which: net coking coal exports/ (imports) (2) (0) (4) (3) (34) (46) (37) (50) (53) (58) (63) net thermal coal exports/ (imports) 47 25 6 8 (70) (100) (131) (92) (27) 28 83

Total Export 72 63 53 45 22 19 15 18 20 20 20 of which coking coal exports 5 4 3 3 1 1 4 2 2 2 2 thermal coal exports 66 59 51 42 22 18 11 16 18 18 18

Total imports (26) (38) (51) (40) (126) (165) (183) (160) (100) (50) - of which:coking coal imports (7) (5) (6) (7) (34) (47) (42) (52) (55) (60) (65) thermal coal imports (19) (33) (45) (33) (91) (118) (142) (108) (45) 10 65

Total coal inventory in China 150 149 188 172 206 471 786 1,070 1,391 1,811 % chg 1- 26 9- 20 128 67 36 30 30


11

Shenhua (1088 HK, Neutral) – Expensive for its quality

In our view, Shenhua remains the best quality play in the sector, due to its distinctive integrated business model (coal, railways, ports, shipping and power), with a captive logistics network and sufficient reserves (2.4x of China Coal’s and 3.8x Yanzhou’s), which helps control unit production cost, facilitate third-party trade and sustain double-digit sales volume growth and above-average ROE despite slowing self-production growth. Shenhua’s sizeable power portfolio (30% of revenue) should be able to hedge any earnings risk amid the coal price correction, in our view.

In our view, the improvement in Shenhua’s sales mix to the more expensive spot, fast growth in third-party trade with above-peers' margins (~38% vs China Coal’s 2%), whole group listing (asset injection) and TT project acquisition are near-term catalysts for the shares.

The stock currently trades at 10.6x FY12F P/E, a 15% premium to the industry average 9.2x. We believe Shenhua deserves to trade at a premium valuation, given that its: Xinjie project in Inner Mongolia is already worth HKD10/share, captive railway network standouts amid the prevailing transportation bottlenecks in China, power assets provide an effective hedging on profit and ROE is higher than the sector average.

However, although Shenhua remains the best quality play and deserves to trade at a premium to peers, in our view, we downgrade it to Neutral from Buy. This is due to the unfavourable coal price outlook and its less robust self-production growth (7.3-8.4% pa) for 2012-13F. As well, it is difficult to justify a 13x TP P/E for Shenhua based on a 20%-plus upside TP.

We have revised down our TP to HK$38.1 (from HK$44.4). Our TP is based on DCF valuation, with the WACC of 9.9% and terminal growth rate of 2.0%). We cut our 2011F, 2012F and 2013F’s earnings by 4%, 8% and 9%, respectively, to reflect the unfavourable coal price outlook.

Yanzhou (1171 HK, Reduce) – Inexpensive for a reason

We downgrade Yanzhou Coal to Reduce (from Buy) and lower our TP to HK$17.1 (from HK$27.7) as we believe:

1) Yanzhou (75% volume in spot) should be affected by the weakening spot coal price momentum from December 2011 and there is likely to be a 10-15% correction in 1H12F, in our view.

2) Yanzhou’s bigger exposure in the spot market (75% vs. Shenhua at 55% and China Coal at 44%), regional market (19%, vs. Shenhua at 2% and China Coal’s nil) and coking coal market (40%, vs. Shenhua’s nil and China Coal’s 2%) is unfavourable amid a weakening thermal/coking coal price trends domestically and internationally (seaborne)

3) We believe Yanzhou is vulnerable to a likely weakening of AUD/USD, and appreciation of CNY/USD, given that ~30% of its earnings can be attributed to Yancoal Australia. Nomura’s currency strategist, Stephen Roberts, expects the AUD to depreciate by 7% by end-2012F to 1.05 AUD/USD (from 0.98 in 2011) and expects the CNY to appreciate by 2.5% by end-2012F to 6.17 CNY/USD (from 6.33 in 2011).

4) Yanzhou Coal appears to have insufficient resources for growth in China; however, we think its latest acquisitions of Xintai in China, Potash in Canada and Gloucester Coal in Australia are all expensive in terms of P/E valuations or EV/ton of production/reserves. As well, Yanzhou’s parent should not have many meaningful coal assets to inject. This does not appear to bode well for quality and sustainable growth, in our view.

5) The stock currently trades at an undemanding 8.3x 2012F P/E, similar to that of China Coal (8.6x) but cheaper than Shenhua (10.6x), while Shenhua is distinctive for its quality, we would prefer China Coal over Yanzhou for similar valuation.

Our price target of HK$17.1 is based the DCF valuation with a WACC of 8.2% and terminal growth rate of 2.5%. We have also cut our FY12F earnings by 13% to reflect the margin decline due to several ROE-dilutive acquisitions in 2011 and a poorer coal price


12

(thermal and coking) outlook domestically and internationally, although strong volume sales growth is also expected.

China Coal (1898 HK, Buy) – Near-term outperformer

The National Development and Reform Commission’s (NDRC) cap on key contract prices (5% increase, 40% of contract) for 2012F is lower than our original forecast of 7%, as published in our report "Always room for dessert", 18 Jan 2011, but a likely bigger increase in non-key contract price (c.7%, 60% of contract) should alleviate the impact, we estimate.

We upgrade the shares of China Coal to Buy (from Neutral), with a new TP of HK$12.25 (from HK$10.86) given that 56% of its contracted sales volume has been concluded at an weighted average increase of 6.2%, and we expect its production growth (17%) to outperform peers in 2012F.

In addition, give its lower exposure to spot, the potential 10-15% drop in spot price in 1H12F should have the least impact on the company compared with its peers.

In our view, the fast production recovery from the Shanxi accident and the contained increase in unit production costs in 2H11 (as evident by its impressive 2011 results) have shown that China Coal is back on track for quality and defensive growth.

We believe that China Coal’s higher likelihood of coal asset injection from its parent in 2012F, vs its peers, is a plus.

Our PT is based on the DCF with a WACC of 9.3% and a terminal growth rate of 2.5%. We raise our earnings estimates by 8-18% for 2011-13F, so as to reflect the margin improvement and strong production/sales volume growth.

We prefer China Coal over Shenhua and Yanzhou Coal

Shenhua outperformed China Coal and Yanzhou Coal by 34-34.2% in 2011, however, we believe China Coal should have more catalysts this year in accordance with our "key theme for 2012"; China Coal is currently trading at a 19% discount 2012F P/E to Shenhua. We would prefer China Coal over Shenhua, especially over a three- to six-month horizon. Indeed, we believe China Coal and Yanzhou Coal have quietly outperformed Shenhua since 2012, showing investors’ appetite to bottom-fish inexpensive coal names despite lower quality.

Nomura vs consensus

Our 2012F earnings estimates are above consensus estimates by 1% for Shenhua, 10% for China Coal, and below consensus estimates by 2% for Yanzhou Coal. We believe that, our earnings estimates are, in general, driven by our lower ASP, higher cost, and in-line production volume assumptions.

China IPPs: Margins should expand in 2012F; we prefer CPID and Huaneng

On 30 November 2011, the NDRC announced an on-grid tariff hike of CNY0.026/kWh (~6.5%) for coal-fired power plants, together with a coal price cap for both spot and contract. We believe this should provide an opportunity for IPPs to improve their margins in 2012F. In addition, we expect GDP growth in China to slow to 7.5% and 7.6% in 1Q12F and 2Q12F, respectively, before rising again to 8.4% in 4Q12F. With the economic slowdown in China, we expect the spot coal price to correct by 10-15% in 1H12F (-4% in 2012F), and interest rates to drop by 25bps in 1Q12F. Therefore, we expect IPP margins to improve and prefer China “power” over “coal” in 2012F.

This year, the key themes for IPPs are likely to be: 1) tariff reforms due to low inflation (we expect another 5% tariff hike in July), 2) coal price correction and 3) interest rate declines. This is despite utilisation also being lower. IPPs' earnings are more sensitive to


13

tariffs, followed by coal price, then interest rates and the least is utilisation. Therefore, we expect margins to improve on the back of the above parameters.

We expect tariff hikes to become a more sustainable story from now. We believe tariff reform (power pooling) is likely in 2014/15F, with a reference to the operating margins of other similar markets such as Singapore and UK (~30%) indicating that Chinese on-grid tariffs should rise by 27.5% amid a power pooling market. This should comfortably allow on-grid tariff to rise gradually by 5% p.a. over 2012-15F, we estimate.

Across the sector, we like CPID (2380 HK, Buy), given its all-time low valuation (0.6x book) and potential improvement in hydropower generation in 2012F. We also like Huaneng (902 HK, Neutral), given its high leverage to coal price (mainly coal-fired power assets) and interest rate correction, and tariff hikes.

Sensitivity analysis

We have conducted an earnings sensitivity analysis on spot prices, contract prices, unit production costs and sales volumes. Yanzhou Coal has the highest positive leverage to spot coal price upside, while China Coal is most vulnerable to increases in unit production costs.

Fig. 15: Sensitivity analysis to 2012F net profit


Fig. 16: Performance of China coal stocks in 2011

Source: Bloomberg, Nomura research

Fig. 17: Performance of China coal stocks in 2012, YTD


(%) Shenhua China Coal Yanzhou

% chg in net profit on 1% change in contract price 0.84 1.33 0.48

% chg in net profit on 1% change in spot price 1.42 1.47 1.96

% chg in net profit on 1% change in unit cost (1.70) (3.50) (1.89)

% chg in net profit on 1% change in sales volume 2.51 4.47 2.88

-21.3%

1.5%

-32.7% -32.5%

-66.1%

-51.9%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

HSI Shenhua China Coal

Yanzhou Hidili Fushan

0.7%

-3.6%

8.0%

0.8%

14.2%

2.6%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

HSI Shenhua China Coal

Yanzhou Hidili Fushan


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Investment risks

Upside risks • Higher-than-expected coal prices and volume sales: Coal prices are the most sensitive

factor to earnings.

Downside risks • A weaker-than-expected recovery in China’s economy. If the economy becomes worse

than expected, we believe coal demand from the four key sectors of power, steel, cement and chemicals will deteriorate and exert pressure on coal prices.

• Higher unit production costs: Higher cost hikes could be mainly from policy-related cost increases. We have already factored in 5% of the ex-mine coal price resources tax from July 2014F.

• High CPI inflation: High CPI inflation not only increases input costs but also exerts pressure on a likely coal price cap.

• Higher interest rates: We expect interest rates to decline by 25 bps in 2012F and to rise by 75bps in 2013F. However, in our view, this will not be an issue for Shenhua and China Coal, as they are under-geared with net cash, and at 16.1% gearing (net debt-to-equity), respectively, with strong positive free cash flows. That said, this may be a bigger concern for Yanzhou, given its 46.5% gearing level as of 2012F.


15

P/E comparison

Fig. 18: Shenhua forward P/E


Fig. 19: China Coal forward P/E


Fig. 20: Yanzhou Coal forward P/E


5x

10x

15x

20x

25x

0

10

20

30

40

50

60

70

80

90

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12

Price (HKD)

Avg: 13.7 x

1x

5x

10x

15x

20x

25x

30x

0

5

10

15

20

25

30

35


Price (HKD)

Avg: 15.4x

1x

5x

10x

15x

0

5

10

15

20

25

30

35

40


Price (HKD)

Avg: 9x


16

P/B comparison

Fig. 21: Shenhua forward P/B


Fig. 22: China Coal forward P/B


Fig. 23: Yanzhou Coal forward P/B


0.5x

1.5x

2.5x

3.5x

4.5x

0

10

20

30

40

50

60

70

80


Avg: 2.6x

Price (HKD)

0.5x

1.5x

2.5x

3.5x

4.5x

0

5

10

15

20

25

30

35

40


Avg: 1.7x

Price (HKD)

0.5x

1.5x

2.5x

0

5

10

15

20

25

30

35

40


Avg: 1.7x

Price (HKD)


17

Operation metrics comparison

Fig. 24: Operation metrics comparison (1/3)

Source: Company data, Nomura estimates

Production 2009A 2010A 2011F 2012F 2013F

Coal procution volumn (mnt)

China Shenhua (commercial) 210.3 224.8 279.3 302.9 325.0

China Coal (commercial) 79.0 94.4 97.4 114.0 139.8

China Coal (raw) 100.8 122.5 126.5 148.0 181.5

Yanzhou Coal (raw) 36.3 49.4 55.5 70.0 81.2

(y-y %)

China Shenhua (commercial) 6.9 24.2 8.4 7.3

China Coal (commercial) 19.5 3.2 17.0 22.6

China Coal (raw) 21.6 3.2 17.0 22.6

Yanzhou Coal (raw) 36.1 12.2 26.2 16.0

Wash rate (%)

China Shenhua NA NA NA NA NA

China Coal 79 73 77 77 77

Yanzhou Coal 99 92 92 92 92

Sales volume (mnt)

China Shenhua 209.5 220.2 279.3 302.9 325.0

China Coal 78.9 89.8 98.2 114.0 139.8

Yanzhou Coal 36.0 44.3 49.7 61.7 68.9

Coking coal sales volume contribution (%)

China Shenhua 0.0 0.0 0.0 0.0 0.0

China Coal 1.5 0.9 1.4 3.7 5.2

Yanzhou Coal 29.8 34.4 39.6 36.6 34.6

Pricing

ASP of self-producted coal (CNY/t)

China Shenhua 387.9 426.8 443.6 444.9 464.6

China Coal 416.0 456.0 503.9 536.1 563.8

Yanzhou Coal 528.5 653.9 704.8 676.2 682.7

(y-y %)

China Shenhua 10.0 3.9 0.3 4.4

China Coal 9.6 10.5 6.4 5.2

Yanzhou Coal 23.7 7.8 (4.1) 1.0


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Cost 2009A 2010A 2011F 2012F 2013F

Unit production cost (CNY/t)

China Shenhua 101.0 115.5 121.7 128.0 136.0

China Coal 204.7 230.4 244.2 258.8 275.1

Yanzhou Coal 256.4 269.3 303.2 319.6 336.2

(y-y %)

China Shenhua 14.3 5.3 5.2 6.3

China Coal 12.5 6.0 6.0 6.3

Yanzhou Coal 5.0 12.6 5.4 5.2

Effective tax rate (%)

China Shenhua 21.0 20.4 21.0 21.0 21.0

China Coal 23.2 25.9 23.0 24.0 24.0

Yanzhou Coal 27.3 25.4 28% 28% 28%

Effective interest (borrowing) rate(%)

China Shenhua 4.4 5.2 5.2 5.0 5.7

China Coal 3.8 4.8 5.0 4.8 5.5

Yanzhou Coal 0.4 2.7 3.0 2.8 3.5

Profitability

Revenue (CNYmn)

China Shenhua 121,312 152,063 202,732 230,471 261,176

China Coal 53,187 70,303 88,146 105,336 130,967

Yanzhou Coal 20,677 33,944 40,656 47,366 49,944

(y-y %)

China Shenhua 25.3 33.3 13.7 13.3

China Coal 32.2 25.4 19.5 24.3

Yanzhou Coal 64.2 19.8 16.5 5.4

Normalized EPS (CNY)

China Shenhua 1.59 1.92 2.30 2.65 3.08

China Coal 0.56 0.56 0.78 0.95 1.17

Yanzhou Coal 0.84 1.46 1.84 1.87 1.96

(y-y %)

China Shenhua 20.3 19.8 15.4 16.0

China Coal 0.8 39.2 20.7 23.4

Yanzhou Coal 74.6 25.8 1.6 4.7


19



Profitability (Cont') 2009A 2010A 2011F 2012F 2013F

Overall EBITDA margin (%)

China Shenhua 48.1 45.7 39.9 39.7 40.4

China Coal 22.6 20.9 22.3 24.1 24.1

Yanzhou Coal 34.6 37.5 41.5 38.3 39.7

Overall EBIT margin (%)

China Shenhua 38.8 37.1 32.9 32.8 33.7

China Coal 18.4 15.7 17.2 18.5 18.9

Yanzhou Coal 25.7 29.4 32.1 28.3 28.7

Net profit margin (%)

China Shenhua 26.1 25.1 22.5 22.9 23.4

China Coal 13.9 10.6 11.8 11.9 11.8

Yanzhou Coal 19.9 27.3 20.8 19.4 19.3

Key Ratios

ROE (%)

China Shenhua 19.9 20.7 21.5 21.8 22.2

China Coal 11.7 10.5 13.3 14.5 16.0

Yanzhou Coal 14.7 27.9 21.0 18.9 16.3

ROCE (%)

China Shenhua 15.3 17.3 19.0 20.2 21.7

China Coal 9.5 9.9 10.1 10.5 12.0

Yanzhou Coal 9.5 17.3 12.2 11.6 11.5

Net gearing (%)

China Shenhua 6.0 net cash net cash net cash net cash

China Coal net cash net cash 9.9 16.1 10.2

Yanzhou Coal 48.0 43.5 61.1 46.5 29.8

EBITDA interest coverage (%)

China Shenhua 29 30 39 99 94

China Coal n.a 135 44 17 19

Yanzhou Coal 158 21 20 19 15

Current ratio (%)

China Shenhua 1.7 1.8 1.7 1.8 2.0

China Coal 3.3 2.5 2.3 2.3 2.2

Yanzhou Coal 1.9 2.4 2.5 2.6 3.1


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Valuation comparison

Fig. 27: Valuation comparison (1/3)

Note: pricing as of 26 Jan 2012 closing / Bloomberg estimate for not rated stocks.

Source: Company data, Bloomberg, Nomura estimates

Price target Price Market cap

Free float Rept'g Fiscal

Company Ticker Rating L. Curr. L. Curr. (US$mn) (%) curr. Y/E 11F 12F 13F 11F 12F 13F

Coal

AsiaHongkong - Coking coalFushan 639 HK Buy 5.27 3.2 2219.3323 76 HKD Dec 2,508 2,824 3,055 25 13 8 Hidili 1393 HK Neutral 6.11 2.93 779.7582 45 CNY Dec 826 1,112 1,335 23 35 20 Mongolia Mining 975 HK n.a. n.a. 6.48 3094.8537 29 USD Dec 123 296 435 105 140 47 South Gobi 1878 HK n.a. n.a. 51.5 1206.9788 29 USD Dec 10 56 115 n.a. 449 107 Average 1,152 1,411 1,608 51 62 25 Hongkong - Thermal coal

Shenhua Energy-H 1088 HK Neutral 38.10 35.15 90116.588 100 CNY Dec 45,675 52,715 61,168 20 15 16 Chinacoal Energy-H 1898 HK Buy 12.25 10.20 17431.892 93 CNY Dec 10,391 12,541 15,476 39 21 23 Yanzhou-H 1171 HK Reduce 17.10 19.28 12222.935 100 CNY Dec 9,042 9,188 9,621 26 2 5 Average 21,703 24,815 28,755 28 13 15

Hongkong Average 11,428 13,113 15,182 40 38 20

ChinaDatong Coal 601001 CH n.a. n.a. 13.39 3551.4138 37 CNY Dec 1,390 1,502 1,644 8 8 9 Shanxi Xishan Coal & Electricity 000983 CH n.a. n.a. 16.3 8139.667 43 CNY Dec 3,143 3,856 4,551 19 23 18 Pingdingshan Tianan Coal Mining Co 601666 CH n.a. n.a. 11.83 4426.436 37 CNY Dec 2,163 2,455 2,866 17 14 17 Shanxi Guoyang 600348 CH n.a. n.a. 18.65 7107.8299 41 CNY Dec 3,000 3,352 3,822 24 12 14 Shanghai Energy 600642 CH n.a. n.a. 4.63 3469.5459 48 CNY Dec 1,379 1,750 2,128 1 27 22 Hengyang Coal 600971 CH n.a. n.a. 15.83 2508.5677 29 CNY Dec 1,067 1,231 1,314 12 15 7 Lu'an Environmental Energy 601699 CH n.a. n.a. 24.92 9087.0645 33 CNY Dec 3,979 4,560 5,587 16 15 23 SDIC Xinji 601918 CH n.a. n.a. 11.77 3451.2954 26 CNY Dec 1,631 2,026 2,102 21 24 4 China Average 2,219 2,592 3,002 15 17 14

S.E AsiaBanpu BANPU TB n.a. n.a. 584 5075.1759 71 THB Dec 15,348 16,453 17,595 (38) 7 7 Bumi BUMI IJ Buy 3000 2525 5850.8461 71 USD Dec 346 394 645 11 14 64 ITMG ITMG IJ Reduce 37300 37750 4757.9106 35 USD Dec 522 417 559 155 (20) 34 Bukit Asam PTBA IJ Buy 26000 20000 5140.2833 35 IDR Dec 3,090,741 3,376,358 3,823,559 54 9 13 Indika Energy INDY IJ Neutral 2500 2500 1452.0753 37 IDR Dec 1,093,729 1,572,412 2,085,143 51 44 33 Adaro ADRO IJ Buy 2450 1840 6564.8823 40 IDR Dec 4,297,154 4,679,003 5,620,024 81 9 20 S.E Asia Average 1,416,307 1,607,506 1,924,587 52 10 28

Asia Average 429,208 487,222 583,131 34 21 20

AustraliaWhitehaven Coal WHC AU Neutral 6 5.53 2864.8417 53 AUD Jun 10 195 269 (91) 1,856 38 New Hope Corp NHC AU n.a. n.a. 5.67 4416.0885 22 AUD Jul 149 228 237 (21) 53 4 Gloucester Coal GCL AU n.a. n.a. 8.36 1590.9715 35 AUD Jun 54 56 101 24 3 80 Stanmore Coal SMR AU n.a. n.a. 0.775 113.48823 73 AUD Jun (2) (7) (6) n.a. n.a. n.a.Macarthur Coal MCC AU n.a. n.a. 16.01 n.a. n.a. AUD Jun 149 234 279 22 57 19 Australia Average 72 141 176 (17) 492 35

North AmericaArch Coal ACI US n.a. n.a. 14.55 3079.0449 100 USD Dec 189 433 508 19 129 17 Consol Energy Inc. CNX US n.a. n.a. 35.87 8136.0874 100 USD Dec 667 691 784 92 4 13 Peabody Energy Corp. BTU US n.a. n.a. 37.33 10111.738 100 USD Dec 1,017 1,236 939 6 21 (24) N. America Average 624 786 744 39 51 2

Net profit (Local $ m) Net earnings growth (%)


21




PEG

Company 11F 12F 13F 11F 12F 13F 11F 12F 13F 11-13F 11F 12F 13F 11F 12F 13F

Coal

AsiaHongkong - Coking coalFushan 0.47 0.52 0.57 26 13 8 5.8 5.1 5.6 0.3 0.8 0.7 0.7 0.8 0.9 1.0Hidili 0.40 0.53 0.64 23 35 20 5.9 4.2 3.5 0.2 0.6 0.5 0.5 2.8 4.5 7.3Mongolia Mining 0.04 0.08 0.11 88 122 43 23.2 10.4 7.3 0.1 3.6 2.6 2.0 n.a. n.a. 0.4South Gobi 0.01 0.24 0.61 n.a. 2,118 149 603.5 27.2 10.9 n.a 1.8 1.7 1.5 n.a. n.a. n.a.Average 0.30 0.38 0.44 46 56 24 11.6 6.6 5.5 0.2 1.7 1.3 1.0 1.8 2.7 2.9Hongkong - Thermal coalShenhua Energy-H 2.30 2.65 3.08 20 15 16 12.5 10.6 8.9 0.6 2.5 2.2 1.8 3.2 3.8 4.5Chinacoal Energy-H 0.78 0.95 1.17 39 21 23 10.4 8.6 6.8 0.3 1.3 1.2 1.0 2.6 3.1 3.9Yanzhou-H 1.84 1.87 1.96 26 2 5 8.5 8.3 7.7 0.8 1.8 1.4 1.1 3.4 3.6 3.7Average 1.64 1.82 2.07 28 13 15 10.5 9.2 7.8 0.6 1.9 1.6 1.3 3.1 3.5 4.0

Hongkong Average 0.97 1.10 1.25 37 35 19 11.0 7.9 6.6 0.4 1.8 1.4 1.2 2.6 3.2 3.4

ChinaDatong Coal 0.79 0.91 1.01 3 15 12 16.9 14.8 13.2 1.5 2.2 2.0 1.8 1.7 1.8 2.0Shanxi Xishan Coal & Electricity 1.03 1.23 1.29 23 19 5 15.8 13.3 12.6 0.9 3.4 2.8 2.4 2.4 2.6 2.8Pingdingshan Tianan Coal Mining Co 0.93 1.10 1.23 19 18 12 12.7 10.7 9.6 0.7 2.3 1.9 1.6 2.5 2.7 3.2Shanxi Guoyang 1.27 1.44 1.64 27 14 13 14.7 12.9 11.4 0.7 4.0 3.1 2.5 1.2 1.3 1.5Shanghai Energy 0.30 0.36 0.42 (5) 22 17 15.7 12.9 11.0 1.2 n.a. n.a. n.a. n.a. n.a. n.a.Hengyang Coal 1.27 1.45 1.33 22 15 (9) 12.5 10.9 11.9 1.3 n.a. n.a. n.a. n.a. n.a. n.a.Lu'an Environmental Energy 1.73 1.97 2.38 16 14 20 14.4 12.6 10.5 0.8 3.5 3.5 2.9 3.6 4.2 5.2SDIC Xinji 0.87 1.09 1.14 20 24 5 13.5 10.8 10.3 0.7 2.3 1.9 n.a. 2.4 2.9 n.a.China Average 1.02 1.19 1.30 15 18 9 14.5 12.4 11.3 1.0 2.9 2.5 2.2 2.3 2.6 2.9

S.E AsiaBanpu 61.02 60.76 65.51 (33) (0) 8 9.6 9.6 8.9 n.a. 2.0 1.8 1.6 3.3 3.4 3.5Bumi 0.02 0.02 0.03 11 14 64 16.8 14.8 9.0 0.5 3.1 2.6 2.1 1.1 1.2 1.4ITMG 0.46 0.37 0.49 155 (20) 34 9.1 11.4 8.5 0.3 4.5 4.4 3.6 4.2 8.3 6.6Bukit Asam 1,341.39 1,465.35 1,659.44 54 9 13 14.9 13.6 12.1 0.6 5.6 4.6 3.8 2.6 3.4 3.7Indika Energy 210.04 301.97 400.44 51 44 33 11.9 8.3 6.2 0.2 2.0 1.7 1.4 1.0 3.4 4.8Adaro 134.35 146.28 175.70 81 9 20 13.7 12.6 10.5 0.4 2.7 2.3 2.0 1.5 2.3 1.5S.E Asia Average 291.21 329.13 383.60 53 9 29 12.7 11.7 9.2 0.4 3.3 2.9 2.4 2.3 3.6 3.6

Asia Average 88.06 99.55 115.98 33 20 18 12.9 10.8 9.3 0.6 2.7 2.3 1.9 2.4 3.1 3.3

AustraliaWhitehaven Coal 0.02 0.39 0.54 (92) 1,855 37 274.5 14.0 10.2 0.5 2.6 2.3 1.8 1.3 1.1 1.5New Hope Corp 0.18 0.28 0.29 (22) 57 4 31.5 20.1 19.3 2.4 2.0 2.0 1.9 2.9 3.3 3.2Gloucester Coal 0.34 0.27 0.44 (31) (20) 59 24.4 30.5 19.1 n.a. 1.7 1.4 1.4 0.2 0.1 0.7Stanmore Coal (0.02) (0.05) (0.04) n.a. n.a. n.a. n.a. n.a. n.a. n.a 3.2 2.2 1.7 n.a. n.a. n.a.Macarthur Coal 0.52 0.81 0.96 7 55 19 30.7 19.8 16.6 0.8 2.9 2.7 2.5 2.2 2.5 3.0Australia Average 0.21 0.34 0.44 (34) 487 30 90.3 21.1 16.3 1.2 2.5 2.1 1.9 1.7 1.7 2.1

North AmericaArch Coal 1.18 2.16 2.45 20 83 14 12.4 6.7 5.9 0.2 0.8 0.8 0.7 2.9 3.0 3.0Consol Energy Inc. 2.96 3.11 3.42 84 5 10 12.1 11.6 10.5 0.4 2.3 2.1 1.8 1.2 1.3 1.3Peabody Energy Corp. 3.70 4.76 4.17 5 28 (12) 10.1 7.8 9.0 1.4 1.9 1.6 1.8 0.9 0.9 1.0N. America Average 2.61 3.34 3.34 36 39 4 11.5 8.7 8.5 0.6 1.7 1.5 1.5 1.7 1.7 1.8

Yield (%)EPS (Local $) EPS growth (%) P/E (x) P/B (x)


22




Company 11F 12F 13F 11F 12F 13F 11F 12F 13F 11F 12F 13F

Coal

AsiaHongkong - Coking coalFushan net cash net cash net cash 13.0 12.9 12.4 10.7 11.9 12.6 3.0 2.2 1.5Hidili 60.5 58.2 53.4 11.3 13.7 14.7 6.1 7.4 8.0 6.3 5.0 4.4Mongolia Mining 0.1 0.2 0.1 15.9 29.4 31.0 10.0 16.3 18.4 15.7 6.6 4.5South Gobi net cash 0.1 0.2 0.6 4.4 11.2 2.0 3.3 8.1 41.9 9.5 4.9Average 30.3 29.2 26.8 13.4 18.7 19.4 8.9 11.8 13.0 8.4 4.6 3.4Hongkong - Thermal coalShenhua Energy-H net cash net cash net cash 21.5 21.8 22.2 23.3 23.6 25.1 6.8 5.7 4.5Chinacoal Energy-H 9.9 16.1 10.2 13.3 14.5 16.0 13.1 13.7 15.5 5.9 4.9 3.7Yanzhou-H 61.1 46.5 29.8 21.0 18.9 16.3 16.6 17.5 15.0 6.1 5.6 4.7Average 35.5 31.3 20.0 18.6 18.4 18.2 17.7 18.3 18.5 6.3 5.4 4.3

Hongkong Average 32.9 30.2 23.4 16.0 18.6 18.8 13.3 15.1 15.8 7.3 5.0 3.9

ChinaDatong Coal n.a. n.a. n.a. 14.5 14.7 15.9 13.0 12.3 12.5 n.a. n.a. n.a.Shanxi Xishan Coal & Electricity n.a. n.a. n.a. 23.5 23.7 25.3 11.9 13.0 13.8 n.a. n.a. n.a.Pingdingshan Tianan Coal Mining Co n.a. n.a. n.a. 20.3 19.6 19.6 10.7 10.3 10.8 n.a. n.a. n.a.Shanxi Guoyang n.a. n.a. n.a. 29.5 26.7 24.5 13.6 13.9 13.5 n.a. n.a. n.a.Shanghai Energy n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Hengyang Coal n.a. n.a. n.a. 17.4 17.7 16.9 n.a. n.a. n.a. n.a. n.a. n.a.Lu'an Environmental Energy n.a. n.a. n.a. 29.1 27.5 28.3 12.7 13.5 15.5 n.a. n.a. n.a.SDIC Xinji n.a. n.a. n.a. 16.4 17.4 n.a. 8.4 9.0 n.a. n.a. n.a. n.a.China Average n.a. n.a. n.a. 21.5 21.0 21.8 11.7 12.0 13.2 n.a. n.a. n.a.

S.E AsiaBanpu 0.6 0.4 0.2 25.7 19.8 18.6 9.3 7.9 7.8 3.8 3.2 3.0Bumi 169.6 120.7 66.6 19.7 19.1 25.7 4.0 4.4 7.1 4.7 4.1 2.9ITMG net cash net cash net cash 59.2 39.6 46.9 62.0 43.1 53.3 5.3 7.0 5.0Bukit Asam net cash net cash net cash 42.3 36.8 34.3 69.3 58.7 56.8 10.2 9.1 7.8Indika Energy 76.9 57.0 34.9 18.5 22.6 25.2 9.9 12.1 15.7 6.9 5.5 4.4Adaro 49.5 44.9 21.9 21.4 20.0 20.3 11.2 10.7 12.0 5.8 6.0 4.8S.E Asia Average 74.2 55.8 30.9 31.1 26.3 28.5 27.6 22.8 25.5 6.1 5.8 4.6

Asia Average 53.5 43.0 27.1 22.8 21.9 23.0 17.5 16.6 18.4 6.7 5.4 4.3

AustraliaWhitehaven Coal net cash net cash net cash 1.0 17.5 20.2 0.8 15.3 19.6 18.3 8.0 5.6New Hope Corp net cash net cash net cash 7.9 10.2 9.2 7.5 11.2 10.1 28.3 21.5 19.9Gloucester Coal 0.1 0.1 0.1 10.4 4.7 7.4 8.7 4.6 7.3 18.0 10.9 7.7Stanmore Coal net cash net cash 0.0 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Macarthur Coal net cash net cash net cash 10.5 15.5 18.1 10.7 17.1 19.6 22.3 15.0 12.9Australia Average 0.1 0.1 0.0 7.5 12.0 13.7 6.9 12.0 14.2 21.7 13.9 11.5

North AmericaArch Coal 1.0 0.9 0.7 6.2 11.5 13.3 2.1 3.5 6.2 n.a. n.a. n.a.Consol Energy Inc. 0.8 0.6 0.4 19.1 15.2 15.9 5.1 6.3 7.8 3.0 3.0 2.8Peabody Energy Corp. 1.1 0.8 0.8 20.8 19.5 53.3 6.2 8.3 7.7 1.8 1.5 1.6N. America Average 0.9 0.8 0.6 15.4 15.4 27.5 4.5 6.0 7.2 2.4 2.3 2.2

Net debt/equity (%) RoE (%) RoA (%) EV/EBITDA (x)


23

Coal price is losing steam – range-bound at CNY720-830/t in 2012-15F Due to the two price caps imposed by the government in 2008 and the global financial crisis, spot coal price at Qinhuangdao port for 5,500kcal/kg bottomed at CNY451/tonne in December 2008 (source: CCTD). With the economic recovery spurring strong coal demand growth, the spot coal price rebounded.

After the rapid growth in 2010 (up 25% y-y to CNY744/t), spot coal price rose by another 10% in 2011 due to robust coal demand, strong international coal price and persisting transportation bottlenecks.

Fig. 30: QHD FOB spot thermal coal price


We became less bullish and expected coal prices to peak at CNY850/t in November

We had a bullish view on coal when we published our last anchor coal report Always room for dessert dated 18 Jan 2011 and expected average spot coal price to rise 8% in 2011. During 2011, spot price rose by 10% to the peak of CNY850/t, from CNY780/t on 3 Jan 2011.

The price has declined 7% since then; we expect it to fall by another 10-15% from now Subsequently, in our 18 Nov 2011 report China coal: Momentum to slow; awaiting a better entry point in 1Q12F we became less bullish on coal and expected Qinhuangdao (QHD) spot coal price peaking at CNY850/t, due to high coal inventory at IPPs level (21 days, historically showing a high correlation) and a larger-than-expected coal production in 2011 (+11.6% y-y in 11M11 vs our estimate of 4.2% for 2011F), and a further fall of 10-15% is likely through January/February 2012F when IPPs destock and then enter the low demand season. Since then, QHD spot coal price has fallen 7% to CNY793/t as of 9 Jan, 2012.

In any case, we do not expect the spot price to be anywhere close to the CNY900-1,000/t level in the next four years, unless IPP coal inventory day deteriorates significantly to less than 10 days. This compares with an average of 15 days since July 2007 and 10 days on 23 July 2008, when spot coal price peaked at CNY995/tonne.

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24

Fig. 31: China’s spot price and contract price (2002-2012)


Fig. 32: Spot coal price vs QHD inventory


Fig. 33: Spot coal price vs IPP inventory days


Fig. 34: IPP inventory days


Fig. 35: Raw coal production volume and growth (2009-2011)


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25

While the market remains bullish on the coal market and prices for 2012-15, we take a more cautious stance

We take a more cautious stance than the market in terms of:

1) Supply/demand outlook for 2012-15F

– We see a balanced market with a slight supply deficit for 2012-13F and a surplus from 2014F vs the market's view of a continued supply deficit for 2012-15F

– We forecast slower coal demand at a 3.6% CAGR for 2011-15F as a result of Beijing’s policy to cap energy and CO2 intensity, vs the market's expectation of a 7-8% CAGR.

– We forecast faster coal production and supply (after factoring in the transportation) growth of 5.4% and 7% CAGR for 2011-15F, respectively, vs the market's expectation of a 5% CAGR.

2) Pricing outlook for 2012-15F:

– We expect coal spot price to fall 10-15% in 1H12F and remain range-bound at CNY720-830/t for 2012-15F; we estimate the average price to fall 9.2% for 2012-15F vs the market's expectation of a continued 2-3% pa increase in average spot price.

– We expect key contract price to rise 5% in 2012F and 2014F, vs the market’s expectation of 5% pa for 2012-14.

3) We expect unit production cost to rise 5-6% pa for 2012-13F and a higher 10-11% pa for 2014-15F due to the implementation of a 5% value-based resource tax from 2014F, vs the market's expectation of a 5-6% pa rise for 2012-15F.

In the near term, consensus now expects a strong rebound in spot coal price in 2H12. However, this is not without risk, in our opinion; we would adopt a “wait-and-see” approach and keep an eye on production growth, IPP coal inventory days and GDP growth in the following months to confirm the trend.

Supply deficit likely to persist in 2012-13F …

That said, we believe a slight supply deficit (albeit at a smaller scale) will persist in 2012-13F, mainly due to transportation bottlenecks until 2014F. This is despite coal demand growth likely trending south, given slowing power demand (which accounts for 50% of annual coal demand), increasing output from non-coal generations (eg, nuclear, hydro and gas) and reducing demand from housing related and high energy intensive industries (e.g., steel, cement, chemicals, etc, which account for another 50% of the annual coal demand).

…but we believe near-term price risks exist and key pricing risk is from 2014F when market turns to a “surplus”

Although the expected “supply deficit” in 2012-13F, albeit at a smaller scale, should allow spot coal price to remain stable and prevent it from a free fall, it does not provide enough horsepower for it to rise significantly, in our view. Also, near-term price risks include:

1) Likely weakening power demand growth (it was negative for seven months after the 2008 financial crisis).

2) QHD price remains at an 8.3% premium to Newcastle price (including US$11/t freight rate) as of 6 Jan, 2012.

3) A potential recovery of hydropower generation (hydropower output fell 3.5% y-y in 2011 due, to the drought in southern China).

Nevertheless, in our view, the key risk on spot coal price is from 2014F when market turns to a “supply surplus” and transportation bottlenecks ease.


26

A premium to NEWC price post downward pressure

According to Wind, the QHD spot price (5,800 kcal/kg) is trading at 15.4% and 15.0% premiums to the NEWC price and Australia BJI, respectively, (after considering the US$11/t transportation cost from Australia to China) as of 19 Dec 2011. We believe the lower international price will encourage end users to increase imports to perform price arbitrage, which is likely to cause downward pressure for domestic price.

Fig. 36: QHD Datong premium to Global Coal NEWC (incl. USD11/t freight rate)


Fig. 37: QHD price vs Newcastle price (incl. USD11/t freight rate)


The last sub-8% GDP growth in end-2008 drove coal prices and share prices to fall 55% and 74-80%, respectively

Our China economist, Zhiwei Zhang, forecasts GDP growth dropping below 8% in 2012, with the biggest risk in 1Q (7.5%), 2Q (7.6%), 3Q (8.1%) and 4Q (8.4%) due to a slowdown in housing investment. The last period of sub-8% GDP growth was during 4Q08 (7.6%) to 1Q09 (6.6%), which drove QHD spot coal price to fall by 55% to the low of CNY451/t in December 2008, from the peak of CNY995/t in July 2008. During the same period, the share prices of coal companies also contracted by 74-80%.

Fig. 38: GDP growth vs spot coal price


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27

Current share prices already reflect CNY700/t coal price but 10-15% downside risks remains

The impact should not be as severe as that of end-2008, given: 1) our expected 4.5 percentage points fall in GDP from the peak of 12% in 1Q10 is only 75% of the 6 percentage points decline (in 12 months) from the peak of 13.6% in 4Q07, and 2) IPPs coal inventory was 26 days as of end-2008, vs the recent peak of 21 days at in November 11. We believe there remains 10-15% downside risks on share prices in 1H given coal companies’ shares have corrected by only 32-55% since the peak in Jul 2011 and coal prices have fallen by 7% since the peak in Nov 2011, these are approximately 10-15% lower than a 75% of the respective 74-80% and 55% corrections in 2008.

Nevertheless, we believe current share prices have already factored in a CNY700/t QHD spot coal prices for 2012 (based on Shenhua’s model), thus we may not be too far from the bottom, in our view.

We expect spot coal price to drop by an additional 10-15% to a low of CNY720/t in April 2012F …

We continue to believe that QHD spot coal price will decline by an additional 10-15% to a low of CNY720/t in April 2012 (from CNY793/t as of 9 Jan 2012), to rebound from 2Q and to finish at CNY810/t at end-2012F, leaving the average price for 2012F at CNY787/t, down 4% y-y. During the year, seasonal weakness (strength) in February to May (June to August) and September to October (November to January) is also expected, in our view.

According to Xinhua, on 18 January 2012, Geng Zhicheng, a researcher with the Energy Research Institute of NDRC, predicted that the price for 5,500-kilocalorie power coal may bottom at CNY700/tonne in 1H12 and rebound in the 2H. He added that China's coal market has remained sluggish since the end of 2011, and there has been no sign indicating a loosened policy for real estate control and measures for easing tight domestic coal supply. Domestic coal suppliers have lost their influence on coal prices under such sluggish demand. In 2013F, we expect average spot coal price to rise by 5% to CNY827/t and to remain unchanged for 2014F.

Fig. 39: China: Spot coal price forecast for 2012F


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…and to rebound in 2H12, depending on how quickly Beijing releases its stimulus policy and the increase in coal supply in 2012

However, the rebound may be slow and prolonged, depending on how quickly Beijing releases its stimulus policy and the increase in coal supply in 2012. Therefore, in our opinion, key data points to watch for in 2Q12F would be: 1) IPPs coal inventory days (back to normal 10-14 days or remain at high level?); 2) Coal production growth (back to normal 5-6% growth or remain at double digit?); 3) GDP growth (back to 8%-plus growth or remain at sub-8%?).

If any of these disappoint the market, we do not rule out the possibility that Chinese spot coal price would only be range-bound in 2H12F and for 2013F.

We note that coal supply thus far has exceeded our expectations (production rose 11.6% y-y in 11M11 vs our estimate of 4.2% for 2011F) and six major coal production provinces (Shanxi, Inner Mongolia, Shaanxi, Xinjiang, Guizhou and Ningxia, accounting for 65% of total national supply) have already announced plans to increase their production by 57% (9.4% CAGR) over the 12th Five Year Plan (FYP) (2011-2015).

We cut our 2011-15F Chinese coal price forecast by 9.2%

We have cut our Chinese coal price forecast by 9% and now expect coal prices to fall 9.2% during 2011-15F. A similar 10% cut for Newcastle price forecast is also adopted by our global mining team. Now, we forecast Newcastle coal price of US$125/t (+1% y-y), US$130/ton (+4% y-y), US$130/ton (+0% y-y), US$110/ton (-15% y-y) in 2012-15F.

Fig. 40: China: Coal price forecast for 2012-15F


In 2015F, we estimate spot price to decline by 10% or more

In 2015F, given supply deficit is expected to be resolved by 2014F owing to the easing of transportation bottlenecks (increasing effective supply) in our view, production released from the completion of industry consolidation and a persistent 5%-plus production growth, we expect QHD average spot coal price to fall 10% to CNY744/t, which is also our long-term price assumption from 2016F.

A bigger fall could be realised if demand for coal is restricted by Beijing's target: 1) to cap coal demand at 4.1bn tons at 2015 (vs our forecast of 4.23bn tons); 2) to reduce coal to 63% of primary energy, from 70% in 2009; and 3) its administrative measures on reducing energy and CO2 intensity per GDP (by 16% and 17%, respectively, for 12 FYP or 2011-15).

The NDRC has implemented since this year a pilot run of carbon credit trading in Beijing, Tianjin, Shanghai, Chongqing, Shenzhen, Guangdong and Hebei.


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y-y (%) -17 24 10 -4 5 0 -10


CNY/USD 6.33 6.17 5.96 5.96 5.96

Average selling price (50% contract; 50% spot) 570 657 695 696 713 727 686

15% 6% 0% 2% 2% -6%



29

Global mining team also turning less bullish

In the region, having performed strongly in the beginning of 2011 – reaching ~US$130/ton in January 2011 (up 3.3% from ~US$126/ton at the end of 2010) – on the back of the flooding in Australia, the Newcastle thermal coal price closed down 11.7% y-y at ~US$111/ton at the end of 2011.

Now, our global mining team forecasts a Newcastle coal price of US$125/t (+1% y-y), US$130/ton (+4% y-y), US$130/ton (+0% y-y), US$110/ton (-15% y-y) in 2012-15F. The 2012-14F coal price assumptions are ~10% lower than our previous forecasts of US$140/ton, US$150/ton, and US$140/ton, respectively, due to the slowdown in the global economy and changes in global thermal coal supply and demand dynamics, which are not as tight as we estimated previously.

Our thermal coal forecasts reflect the recent lower Newcastle thermal contract for 1Q12 of ~USD115/t and expectations of a weak 1H12 for China’s domestic thermal coal prices. However, strong thermal coal prices are forecast for 2012-13F as India brings on new coal-fired capacity and the marginal cost for thermal coal delivered to southern China increases.

…and becoming very bearish on coking coal price in Australia

Meanwhile, our global mining team also cut its coking coal price forecasts for 2012-15F by 10-18% and now expects coking coal price to fall 41% during 2011-15F. This is in line with our 12% cut in Chinese coking coal price forecasts for 2012-15F, but more bearish than our expectation of a 6% price decline for Chinese coking coal during 2011-15F. This is not a positive backdrop for Yanzhou as Yanzhou has the biggest exposure (34% of sales volume output in 2010) to coking coal compared to Shenhua (nil) and China Coal (1%).

Fig. 41: Nomura China coking coal price forecast


Fig. 42: Nomura Australia coal price forecast


…but we are even more cautious on the seaborne coal price and see key risk from 2013F

Although coal imports to China only account for a single digit percentage of China’s total annual consumption, this represents over one-fourth of seaborne coal market imports in Asia (around 500mnt). Therefore, any change in the import pattern of China should materially affect the seaborne market. Given we forecast a 160mnt import by China for 2012F, vs 165mnt and 183mnt for 2010 and 2011, respectively, seaborne coal prices should remain stable and range-bound at current levels for 2012F.

(CNY/tonne) 2009A 2010A 2011A 2012F 2013F 2014F 2015F

Liulin No.4 clean coal (exc. VAT, CNY/tonne) 1,087 1,267 1,405 1,321 1,321 1,321 1,321

Liulin No.4 clean coal (USD/tonne) 158 191 222 214 222 222 222

y-y (%) 17% 11% -6% 0% 0% 0%

Sichuan Panzhihua (exc. VAT, CNY/tonne) 869 1,139 1,287 1,210 1,210 1,210 1,210

Sichuan Panzhihua (USD/tonne) 127 172 203 196 203 203 203

y-y (%) 31% 13% -6% 0% 0% 0%

(USD/tonne) 2008A 2009A 2010A 2011A 2012F 2013F 2014F 2015F

Thermal coal 125 70 98 124 125 130 130 110

y-y (%) -44 40 26 1 4 0 -15

Coking coal 305 129 216 274 256 230 190 160

y-y (%) -58 67 27 -6 -10 -17 -16


30

However, the expected reduced supply deficit in 2013F and supply surplus in China from 2014F should cut the requirement for import to 100mnt, 50mnt and zero for 2013-15F, which would be a very significant reduction to the regional seaborne coal demand and should cost regional seaborne coal price to fall substantially and faster than Chinese’s spot coal price during the same period, in our view.

Our global mining team is expecting a 15-18% pa price correction for Newcastle coal price (also a benchmark for seaborne coal price) starting from 2015F, but we believe the correction may happen earlier and be greater, based on the analysis above.

Our estimate is based on Australia’s production of 424mnt and exports of 139mnt in 2010, followed by Indonesia (306mnt, 236mnt), Russia (317mnt, 77mnt) and South Africa (254mnt, 67mnt).

Fig. 43: Nomura global coal price assumptions


Our forecast on Australia Newcastle coal price (including USD11/t freight rate) puts the Chinese QHD price continues to trade at a premium of 2-12% for 2012-17F. Although the import only accounts for less than 5% of the annual consumption in China, this should suppress the upward momentum of Chinese coal spot prices to a certain extent, given historically Chinese coal is indeed on average 2% cheaper than the Australian coal (plus USD11/t freight rate) since 2007.

Fig. 44: Nomura QHD / Australia NEWC coal price forecast

Source: Wind, Bloomberg, Nomura estimates

Limited impact of potential value-based resources tax

At the end of 2011, the NDRC issued a consultative document on revising the coal resources tax from being volume-based to value-based (likely 5% of sales price); however, the impact on coal companies should be contained, in our view, given implementation is likely only in 2014-15F (when power pooling is implemented and cost could be effectively passed on to consumers) and the reduction in coal levies should be more or less offset by the increase in the resources tax. In our model, we assume a 5% value-based resources tax to be implemented from July 2014F.

2009A 2010A 2011A 2012F 2013F 2014F 2015F 2016F 2017F LT

Coking Coal (USD/t FOB) 129 216 274 256 230 190 160 160 160 160

Low Vol PCI (USD/t FOB) 106 161 202 190 174 146 124 124 124 124

Semisoft Coal (USD/t FOB) 85 144 163 180 164 136 114 114 114 114

Thermal coal (N'stle, USD, FOB) 70 98 124 125 130 130 110 90 90 90

South African Thermal (USD/t) 64 94 118 120 125 135 105 85 85 85

Freight Aus-China (USD/t) 11 10 9 10 10 10 10 10 10 10

2009 2010 2011F 2012F 2013F 2014F 2015F 2016F 2017F LT

Thermal coal (NEWC 6,000kcal, USD/t, FOB) 70 98 124 125 130 130 110 90 90 90

y-y (%) 40% 27% 1% 4% 0% -15% -18% 0% 0%

Transportation cost to China (USD/t) 11 11 11 11 11 11 11 11 11 11

CIF price (USD/t 6,000kcal) 81 109 135 136 141 141 121 101 101 101

CIF price (CNY/t 6,000kcal) 553 739 855 839 840 840 721 602 602 602

China QHD spot price (CNY/t, 5,500kcal/t) 600 744 820 787 827 827 744 632 569 560

y-y (%) 24% 10% -4% 5% 0% -10% -15% -10% -2%

China QHD spot price (CNY/t, 6,000kcal/t) 654 811 894 858 901 901 811 689 620 610

QHD spot price over NEWC 15.4% 8.9% 4.4% 2.2% 6.7% 6.7% 11.1% 12.7% 3.0% 1.4%


31

Key contract price for 2012 is capped at a 5% increase

On 30 Nov 2011, NDRC announced an increase in on-grid power tariffs for the third time that year by CNY2.6cents/kWh (6.5%) for coal-fired power plants and by an average of CNY2.5cents/kWh for all power plants effective from 1 Dec 2011. This, together with the two-time tariff hikes in April and June 11, saw 2011 on-grid tariff rise by a total of 8.9%.

In December 2011, to avoid a follow-on coal price increase and to protect IPPs’ margins, the NDRC announced capping spot coal price at CNY800/t (QHD 5,500kcal/kg) from January 2012 and the magnitude of key contract coal price increase for 2012 at a maximum of 5%. This was the second price control in two years following the key contract price freeze in 2011.

The NDRC also limited spot prices for coal transported by railway and truck at settlement prices as of April 2011. Coal levies introduced by sub-provincial governments were abolished from this year, while provincial levies were capped at CNY23/t. The price cap only applies to key contract sales to power companies. Key contracts include annual contract quotas allocated to coal companies by the government, which also have secured railway capacity. We estimate key contract volume accounts for 40% of total contract sales in China, taking into account contracts signed at and outside of the annual meeting.

According to the CCTD, Chinese miners have signed “key coal supply contracts” totaling 1.2bn tonnes for 2012, or 32% of the forecast volume sales of 3.7bn tones for 2012F, with buyers from the power and steel industry, 44% ahead of the 835mn tonnes target set by the government. We believe key contract prices should rise by 5% in 2012F, in line with the government's price cap. Unlike 2008, when the cap on spot price proved ineffective, we believe price caps for 2012 should be effective and enforceable, given less tightening of the coal supply in 2012 and the NDRC did, in fact, punish violators seriously last year.

In June 2011, five months after the NDRC introduced a price cap to 2011 key contracts, it conducted an investigation on several coal companies to ensure that they adhered to the price cap and requested that they maintain a high contract fulfillment rate. Any form of price hike (eg, reducing contract fulfillment rates) on key contract coal is forbidden and will result in a fine of up to 5x the revenue related to the price hike. If there has been any, the extra charges must be returned to the IPPs immediately, according to the NDRC.

According to Xinhua’s News, dated 26 December 2011, the NDRC is planning to launch an investigation into price-related violations in the thermal coal sector to curb price fixing and unreasonable charges. In 2012, the NDRC will continue to monitor the movement of market prices and crack down on price-related violations in an effort to maintain sound market order and safeguard the interests of consumers. In our view, this illustrates the government’s determination on price intervention.

Non-key contract price is higher, eg, at a 7% increase, but we expect contract fulfillment rate to rise in 2012F

Despite the key contract price being capped at a 5% increase, the NDRC has not intervened on non-key contracts, although railway capacity is not guaranteed. Given the prevailing 28% spot-contract price spread, we expect a bigger rise in non-key contracts, e.g., at 7%, would happen, especially in some coal-deficit provinces such as Jiangsu, Zhejiang and Shandong. However, we believe the majority of the provinces should be able to honour a higher contract fulfillment rate this year, given the increasing coal supply and falling demand.

In 2014F, we expect contract price to rise by 5%, given the 5% resources tax from July 2014F and the large CNY199/t (24%) price discount to spot vs the 2003-11 average of CNY105/t. In the longer term, from 2016F, we expect (and our long-term assumption) the gap to narrow to a reasonable CNY100-120/t with spot at CNY744/t and contract at CNY628/t.


32

Slowing coal demand growth

Three key downstream drivers: power, steel and cement

According to the CEIC, coal consumption in China increased from 2,319mnt in 2005 to 3,350mnt in 2010, indicating a CAGR of 7.6%. According to the BP Statistical Review of World Energy June 2011, although China only accounts for 13.3% of total coal reserves in the world, China consumed 48.2% of the world’s total coal in 2010 in terms of energy output. The power industry accounted for most coal consumption in 2010 (50%), followed by steel (16%), cement (15%) and chemicals (4%).

Fig. 45: China coal consumption (FY05-10)

Source: CEIC, CCTD, Nomura research

Fig. 46: China coal consumption by industry


We forecast 2011F coal consumption to reach 3.7bn tonnes, up 10.2% y-y, based on a bottom-up approach driven by projected growth in thermal power generation, steel, cement and chemical production. In 2012F and 2013F, we forecast 3.1% and 4.4% growth, respectively, based on a similar approach.

Fig. 47: Coal consumption projection breakdown by downstream industries


2,3192,551

2,727 2,811

3,2133,350

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2005 2006 2007 2008 2009 2010

(mnt)

CAGR (05-10): 7.6%

43% 45% 49% 49% 48% 50%

15% 16% 17% 16% 17% 16%

11% 11% 11% 11% 12% 15% 3%

3% 3% 3% 3% 4% 28% 24% 20% 20% 19% 15%

0

20

40

60

80

100

2005 2006 2007 2008 2009 2010

Power Steel Cement Chemicals Others(%)

(mnt) 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F 2014F 2015F

Power 1,003 1,159 1,326 1,365 1,560 1,678 1,884 1,938 2,037 2,124 2,192 y-y growth (%) 15.5 14.4 3.0 14.3 7.6 12.3 2.9 5.1 4.3 3.2

Steel 340 408 462 461 557 538 598 592 586 581 575 y-y growth (%) 20.0 13.2 (0.2) 20.9 (3.5) 11.2 (1.0) (1.0) (1.0) (1.0)

Cement 246 272 299 319 400 491 541 578 624 657 678 y-y growth (%) 10.7 10.0 6.7 25.3 22.7 10.1 6.9 7.9 5.4 3.2

Chemicals 74 87 92 90 97 140 144 148 153 157 162 y-y growth (%) 16.7 5.7 (2.1) 8.3 43.7 3.0 3.0 3.0 3.0 3.0

Others 655 625 549 575 598 503 525 548 572 597 624 y-y growth (%) (4.6) (12.2) 4.9 3.9 (15.9) 4.4 4.4 4.4 4.4 4.4

Total coal consumption 2,319 2,551 2,727 2,811 3,213 3,350 3,692 3,805 3,973 4,117 4,231 y-y growth (%) 10.0 6.9 3.1 14.3 4.3 10.2 3.1 4.4 3.6 2.8


33

Slowing thermal power output growth due to increasing clean and green power

China heavily relies on coal for its power generation. In 2011, coal-fired power accounted for 80% of total generation, followed by hydro (14%). Coal-fired power generation experienced a 9.8% CAGR during FY06-11. For 2011, coal-fired generation rose 13.4% y-y.

For 2012F and 2013F, we forecast coal power output growth will slow to 3.9% and 6.2% (vs 13.4% in 2011), respectively, on the back of decelerating GDP growth of 7.9% for 2011F and 8.2% for 2012F, as per our China economist, Zhiwei Zhang, and increasing substituted supply from clean and renewable energy (e.g., nuclear, hydro, gas-fired, wind and solar). In particular, we expect hydropower output to grow 23.4% in 2012F vs a 3.5% decline in 2011 due to the drought in southern China. This assumes a power/GDP growth beta of 1.1x and 1.1x for 2012F and 2013F, respectively, down from 1.3x in 2010, mainly due to the government’s effort to reduce energy and CO2 intensity.

To diversify from coal and to reduce potential obligation on CO2 emissions, Beijing aims to reduce carbon intensity by 40-45% in 2020, from 2005 levels. China has introduced targets to reduce energy intensity (per GDP) by 16%, CO2 intensity (per GDP) by 17% and coal to 63% (from currently 70%) of primary energy consumption during 2011-15. This year, Beijing has also piloted carbon credit trading in six locations, including Beijing, Shanghai, Shenzhen, Chongqing, Hebei, etc.

Fig. 48: China: power generation forecast

Source: CEIC, Nomura estimates

(bn kwh) 2009 2010 2011F 2012F 2013F 2014F 2015F 2016F 2017F 2018F 2019F 2020F

Coal 3,012 3,340 3,788 3,937 4,181 4,403 4,590 4,791 5,000 5,142 5,287 5,433

Growth rate (%) 10.9 13.4 3.9 6.2 5.3 4.3 4.4 4.4 2.8 2.8 2.8

Gas 73.7 104.8 140.3 182.1 228.7 282.1 331.0 384.9 438.1 495.5 557.4

Growth rate (%) 42.2 33.9 29.8 25.5 23.4 17.3 16.3 13.8 13.1 12.5

Oil 1.0 1.0 0.9 0.8 0.6 0.4 0.4 0.3 0.3 0.3 0.2

Growth rate (%) 0.0 -9.9 -13.0 -19.3 -40.4 -4.9 -6.2 -9.2 -11.4 -14.3

Hydro 572 686 663 818 923 1,006 1,062 1,102 1,169 1,218 1,270 1,326

Growth rate (%) 20.1 -3.5 23.4 12.8 9.0 5.6 3.8 6.1 4.2 4.3 4.4

Nuclear 70 77 87 109 144 209 299 370 423 479 538 600

Growth rate (%) 9.7 13.8 24.4 32.2 45.7 42.9 23.8 14.3 13.2 12.3 11.5

Others (solar, wind etc) 28 50 78 109 145 185 233 278 329 379 434 493

Growth rate (%) 81.4 54.7 39.3 33.3 27.9 25.7 19.7 18.2 15.3 14.4 13.6

Total 3,681 4,228 4,722 5,113 5,575 6,032 6,466 6,873 7,306 7,657 8,025 8,410

Growth rate (%) 14.9 11.7 8.3 9.0 8.2 7.2 6.3 6.3 4.8 4.8 4.8

Contribution (%)

Coal 81.8 79.0 80.2 77.0 75.0 73.0 71.0 69.7 68.4 67.2 65.9 64.6

Gas 1.7 2.2 2.7 3.3 3.8 4.4 4.8 5.3 5.7 6.2 6.6

Oil 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Hydro 15.5 16.2 14.0 16.0 16.6 16.7 16.4 16.0 16.0 15.9 15.8 15.8

Nuclear 1.9 1.8 1.9 2.1 2.6 3.5 4.6 5.4 5.8 6.3 6.7 7.1

Others (solar, wind etc) 0.8 1.2 1.7 2.1 2.6 3.1 3.6 4.0 4.5 5.0 5.4 5.9

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0


34

Fig. 49: Thermal power output forecast (2008-13F)


Fig. 50: Power and industrial output growth

Source: CEIC, Nomura research

Consistent with the government’s target of reducing energy intensity and improving efficiency, small and inefficient power plants have been replaced by bigger-sized units (critical and super critical with 600MW or above). Coupled with technology advancement, unit coal consumption for power generation has been reduced by 2-3 gram/kwh (1%) pa (source: China Power Statistics Year Book). Thus, we estimate coal consumption by coal-fired power generation will increase by a slower 2.9% and 5.1% in FY12F and FY13F, respectively.

2,790 3,012

3,340

3,788 3,937 4,181

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

2008 2009 2010 2011F 2012F 2013F

(bn kwh)

(2)

(1)

0

1

2

3

(15)

(10)

(5)

0

5

10

15

20

25

30

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

GDP growth (LHS)Power output growth - 3 month running (LHS)Industrial output growth - 3 month average (LHS)Beta - "power output growth/GDP growth" (RHS)

(%) (x)


35

Fig. 51: China power generation forecast


2009 2010 2011 2012F 2013F 2014F 2015F 2016F 2017F 2018F 2019F 2020F

Supply

Installed capacity (GW) 874 966 1,056 1,141 1,237 1,337 1,437 1,529 1,621 1,709 1,797 1,885

Capacity launched (GW) 81 92 90 85 96 100 100 92 92 88 88 88

Capacity growth 10.2% 10.5% 9.3% 8.1% 8.4% 8.1% 7.5% 6.4% 6.0% 5.4% 5.1% 4.9%

Capacity breakdown

Thermal 74.4% 72.9% 71.9% 70.3% 69.1% 67.9% 66.8% 65.7% 64.7% 63.6% 62.6% 61.5%

Hydro 22.5% 22.4% 21.8% 21.9% 21.8% 21.7% 21.6% 21.3% 21.0% 20.7% 20.4% 20.2%

Nuclear 1.0% 1.1% 1.2% 1.3% 1.7% 2.4% 3.0% 3.3% 3.5% 3.8% 4.0% 4.2%

Winds 1.8% 3.1% 4.3% 5.3% 5.9% 6.4% 6.8% 7.6% 8.3% 9.1% 9.9% 10.6%

Solar 0.0% 0.0% 0.2% 0.5% 0.7% 0.9% 1.0% 1.4% 1.7% 2.0% 2.3% 2.7%

Biomass 0.0% 0.6% 0.6% 0.6% 0.7% 0.7% 0.7% 0.7% 0.7% 0.8% 0.8% 0.8%

Others 0.2% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Demand

Electricity generation (bn KWh) 3,681 4,228 4,722 5,113 5,575 6,032 6,466 6,873 7,306 7,657 8,025 8,410

Generation growth 6.2% 14.6% 11.7% 8.3% 9.0% 8.2% 7.2% 6.3% 6.3% 4.8% 4.8% 4.8%

Real GDP growth 8.5% 10.3% 9.2% 7.9% 8.2% 8.2% 8.0% 7.0% 7.0% 6.0% 6.0% 6.0%

Demand growth/ Real GDP growth (i.e. beta) 0.7 1.4 1.3 1.1 1.1 1.0 0.9 0.9 0.9 0.8 0.8 0.8

Utilisation

Plant utilisation

National average 51.9% 53.1% 54.0% 54.3% 54.8% 54.7% 54.3% 53.9% 53.8% 53.3% 53.0% 52.9%

Thermal 55.5% 57.4% 60.4% 60.6% 61.2% 61.0% 60.5% 60.3% 60.6% 60.3% 60.3% 60.4%

Hydro 38.0% 38.9% 34.6% 37.9% 39.6% 40.1% 40.4% 39.6% 40.1% 40.0% 40.2% 40.5%

Nuclear Power 89.2% 89.5% 88.7% 88.8% 88.9% 89.0% 89.9% 90.0% 90.0% 90.1% 90.1% 90.2%

Winds 20.4% 23.4% 21.7% 20.2% 20.5% 21.5% 22.5% 22.9% 22.9% 22.8% 22.7% 22.6%

Solar 11.4% 12.6% 12.6% 12.6% 12.6% 12.6% 12.6% 12.6% 12.6% 12.6% 12.6% 12.6%

Biomass 29.7% 29.7% 31.8% 34.0% 36.2% 38.4% 40.5% 42.7% 44.9% 47.0% 49.2% 51.4%

Equivalent utilisation hours

National average 4,546 4,650 4,731 4,759 4,798 4,792 4,759 4,717 4,717 4,669 4,644 4,631

Thermal 4,865 5,030 5,294 5,308 5,365 5,345 5,301 5,283 5,308 5,280 5,278 5,291

Hydro 3,328 3,404 3,028 3,322 3,469 3,516 3,540 3,468 3,510 3,506 3,521 3,549

Nuclear Power 7,814 7,840 7,772 7,779 7,787 7,794 7,877 7,881 7,886 7,890 7,894 7,898

Winds 1,791 2,047 1,903 1,765 1,795 1,884 1,974 2,007 2,010 1,994 1,985 1,982

Solar 1,000 1,100 1,100 1,100 1,100 1,100 1,100 1,100 1,100 1,100 1,100 1,100

Biomass 2,600 2,600 2,790 2,980 3,170 3,360 3,550 3,740 3,930 4,120 4,310 4,500

Others

Peak demand (GW) 828 949 1,060 1,148 1,252 1,354 1,452 1,543 1,640 1,719 1,802 1,888

Shortage (pent-up demand, GW) 46 17 (4) (7) (15) (17) (15) (14) (20) (10) (5) (3)

Reserve margins (%) = (installed capacity - peak demand)/ Installed capacity

5% 2% 0% -1% -1% -1% -1% -1% -1% -1% 0% 0%

Market equilibrium Balance Balance Balance Balance Balance Balance Balance Balance Balance Balance Balance Balance


36

Growth unlikely in steel production for 2012-15F

Now that preliminary steel production data for Dec-11 have been released (51.3mt, down 0.4% y-y), we estimate that China’s total steel production for 2011 was c.680mt and apparent consumption was 625mt. Our steel analyst, Matthew Cross, expects steel production/consumption to remain unchanged at 680mt/625mt for 2012-15F, which implies no growth over 2011 levels. We retain our view that China’s steel production “peaked” in 2011, with the real risk of production likely falling y-y in 2012F. By applying a 1% decrease in unit coal consumption, we expect coal demand from the steel industry to fall by 1% pa for 2012-15F.

Catalyst: Why would 2011 be the peak for China’s steel production?

In our view, there are three key reasons why we believe China’s steel consumption peaked in 2011:

• Steel-intensive stimulus packages launched in 2008 brought forward too much demand, too quickly, and this demand is non-recurring. The 2008 stimulus packages are now more than three years old and are reaching completion. We believe new stimulus measures will be needed to replace the old ones and to prevent a fall in demand in 2012 and 2013.

• Change in annual production appears to be incorrect as a way to measure steel production growth, as it ignores previous consumption: 70% of China’s steel demand is directly or indirectly related to property/infrastructure construction and capital goods with useful lives of >one year. Once last year’s building is completed, steel production capacity is freed up for new buildings. We believe China can create incremental growth (more buildings and roads) with the same level of steel production (or even with lower production). Perpetual annual production growth is not needed, in our opinion.

• The profitability crisis, which is striking Chinese steel mills, appears to be a function of too much steel production relative to available low-cost iron ore and coking coal. In our view, further steel production growth should exacerbate the shortage of raw material and result in higher commodity prices, not higher profit for steel mills. With no financial incentives to raise production, we anticipate a ceiling on steel production growth.

We expect moderate cement output growth

According to our cement analyst, Yang Luo, demand for cement products in China is expected to slow down in 2012F, but still moderate to 8.0% y-y growth, amounting to 2,260mn tonnes, implying a net increment of 167mn tonnes. This is primarily attributable to the downward trend of economic development, tightening monetary policy and severe macro controls on the property market. The cement sector in China is still in a rapid growth stage which is likely to last for another five years or so, based on the historical development trajectory of foreign developed markets, including the US, Japan, Korea, Taiwan and Japan, in our view. Along with the economy regaining momentum, Yang Luo forecasts cement demand in China to further accelerate to 9.0% y-y in 2013F. This is set to continue to boost coal demand over the next several years. By assuming unit coal consumption per tonne clinker production decreases 1% y-y, the cement industry should use 7% more raw coal in 2012F and 8% for 2013F.


37

Fig. 52: China: Cement industry production forecast

Source: NBS, Nomura estimates

Fig. 53: Steel output forecast (08-13F)


Fig. 54: China cement: Clinker output forecast (08-13F)


The CAGR for coal consumption by the chemical industry and others were 3% and 4.4% (between 2007 and 2009), respectively. For FY11F-13F, we assume the same growth rates for projecting their respective coal demand.

… thus coal demand could rise by 3.1% in 2012F and 4.4% in 2013F

Thus, based on our analysis, we expect coal demand to rise to 3.8bn tonnes in 2012F, up 3.1% y-y and to 3.9bn tonnes in 2013F (up 4.4% y-y), backed by demand from power, steel and cement sectors. This is significantly lower than the 10.2% recorded in 2011, and the 5-6% pa consensus estimates.

The significant drop in hydropower generation in 2011 is only a seasonal issue; we expect a rebound in 2012F

With the severe drought in 2011 (the most serious in the past 20 years), despite the 14GW new hydropower generation capacity (6.7% of 2010’s total hydropower capacity) installed during 2011, hydropower generation actually recorded a drop of 3.5%y-y to 663bn kWh. This resulted in a significant decline in the utilisation hours of hydropower by 11% y-y, from 3,404 hrs in 2010 to 3,028 hrs in 2011.

The shortfall of hydropower generation in 2011, therefore, led to extra demand for thermal (coal, oil and gas) power generation. During 2011, thermal power generation increased 13.4% y-y to 3.8bn kWh, larger than the 11.7% national growth rate.

mn tonnes except for % 2005 2006 2007 2008 2009 2010 2011 2012F 2013F 2014F 2015F

Total production 1,069 1,237 1,361 1,424 1,644 1,882 2,093 2,260 2,463 2,621 2,733

y-y % 10.60% 15.70% 10.10% 4.60% 15.50% 14.50% 11.20% 8.00% 9.00% 6.40% 4.30%

Clinker production for cement 822.2 951.4 1,047.1 1,095.0 1,264.6 1,447.6 1,610.0 1,738.2 1,894.4 2,016.5 2,102.4

y-y % 10.60% 15.70% 10.10% 4.60% 15.50% 14.50% 11.20% 8.00% 9.00% 6.40% 4.30%

Clinker to cement ratio 1.3 1.3 1.3 1.3 1.3 1.3 1.3 1.3 1.3 1.3 1.3

Clinker production as inventory 41.1 47.6 52.4 54.8 63.2 72.4 80.5 86.9 94.7 100.8 105.1

as % of clinker for cement 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%

Total clinker needs to be produced 863.3 998.9 1,099.4 1,149.8 1,327.8 1,520.0 1,690.5 1,825.1 1,989.1 2,117.3 2,207.5

y-y % 10.60% 15.70% 10.10% 4.60% 15.50% 14.50% 11.20% 8.00% 9.00% 6.40% 4.30%

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574627

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38

Overall, we foresee the drop in hydropower generation as a seasonal issue and expect hydropower generation to recover in 2012F. We expect 19GW of new capacity to be installed in 2012F and utilisation hours to rebound to 3,322hrs; thus we estimate hydropower generation to increase 23.4% y-y in 2012F to 818bn kWh.

Fig. 55: Hydropower generation and utilisation hours (FY10-12F)

Source: CEC, Nomura estimates

Fig. 56: Thermal power generation and utilisation hours (FY10-12F)

Source: CEC, Nomura estimates

Fig. 57: China: Coal industry supply / demand forecast


687 663 818

3,404

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(hrs)(mn MWh) Power generation (LHS)

Utilization hours (RHS)

(mnt) 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F 2014F 2015FCoal production (a) 2,350 2,529 2,692 2,802 2,950 3,413 3,789 3,978 4,177 4,407 4,671 % chg 10.7 7.6 6.4 4.1 5.3 15.7 11.0 5.0 5.0 5.5 6.0Net increase 227 179 163 110 148 463 375 189 199 230 264

Effective supply factor (Transportation) 87% 87% 89% 93% 95% 93% 93% 94% 95% 97% 99%Coal sales (e) 2,044 2,209 2,398 2,606 2,817 3,179 3,529 3,739 3,968 4,275 4,624 % chg 8.1 8.6 8.6 8.1 12.9 11.0 6.0 6.1 7.7 8.2 Net increase 165 189 207 211 362 350 210 229 306 350

Coal consumption (b) 2,319 2,551 2,727 2,811 3,213 3,350 3,692 3,805 3,973 4,117 4,231 % chg 10.0 6.9 3.1 14.3 4.3 10.2 3.1 4.4 3.6 2.8Net increase 232 177 84 402 137 342 113 167 144 115

Coal supply deficit (275) (342) (329) (205) (396) (171) (163) (66) (5) 158 393

Change in inventory and others* (c) (15) (47) (38) (14) (160) 209 265 315 284 320 420 As % of total production (0.6) (1.9) (1.4) (0.5) (5.4) 6.1 7.0 7.9 6.8 7.3 9.0 As % of total consumption (0.6) (1.9) (1.4) (0.5) (5.0) 6.2 7.2 8.3 7.2 7.8 9.9

Net exports/(imports) (d) 46 25 2 5 (103) (146) (168) (142) (80) (30) 20 of which: net coking coal exports/ (imports) (2) (0) (4) (3) (34) (46) (37) (50) (53) (58) (63) net thermal coal exports/ (imports) 47 25 6 8 (70) (100) (131) (92) (27) 28 83

Total Export 72 63 53 45 22 19 15 18 20 20 20 of which coking coal exports 5 4 3 3 1 1 4 2 2 2 2 thermal coal exports 66 59 51 42 22 18 11 16 18 18 18

Total imports (26) (38) (51) (40) (126) (165) (183) (160) (100) (50) -

of which:coking coal imports (7) (5) (6) (7) (34) (47) (42) (52) (55) (60) (65) thermal coal imports (19) (33) (45) (33) (91) (118) (142) (108) (45) 10 65

Total coal inventory in China 150 149 188 172 206 471 786 1,070 1,391 1,811 % chg 1- 26 9- 20 128 67 36 30 30


39

12th FYP: Coal drops to 63% of total energy consumption

In 2010, coal represented 68% of China’s primary energy consumption, significantly higher than the world average of 30% and the OECD average of 20% (source: BP Statistical Review of World Energy June 2011). China’s reliance on coal is much higher than the second most coal-dependent country, India (53% of primary energy comes from coal) (source BP Statistical Review of World Energy June 2011). In 2010, China accounted for 48% of the world’s total coal consumption, 3x more than the second-largest coal consumer, the US.

In order to realize a low carbon economy, China has two goals for energy and the environment during the 12FYP (2011-15). They are to reduce energy intensity (per GDP) by 16% and CO2 intensity (per GDP) by 17% by 2015. In addition, China aims to increase the use of non-fossil energy to 15% of primary energy consumption in 2020 and to reduce coal from 70% of primary energy used in 2009 to 63% by 2015.

In the five years to 2010, China achieved a 19.1% decrease in energy consumption per unit of GDP, close to its target of 20%. However, we believe more administrative measures introduced in the latter part of the current 5-year plan, i.e., 2014-15, are likely to curb coal and energy consumption. To recap: power rationing was introduced to 19 high energy intensive and restricted industries in 2H11, the last six months of the 11th FYP, to cut energy consumption.

Other than policies to reduce energy consumption and CO2 generation, we believe new energy will be highlighted in the 12th FYP and emphasis will be on, sequentially, nuclear, natural gas, small hydro, wind, solar and biomass energy. According to local news in Xinhua (4 March 2011), The Energy Research Institute (ERI) of the NDRC forecasts non-fossil fuel to represent 11.4% of overall primary energy consumption in 2015 (from ~8% currently). The ERI expects the 2020 target for nuclear is likely to increase to 70-80GW, from 40GW. Other issues we expect to be discussed in the plan should include tariff reform (power pooling), smart-grids and imbalanced power supply between regions.

Fig. 58: China: primary energy consumption (FY05-10)


Fig. 59: World, OECD and India primary energy consumption(FY2010)

World, OECD and India primary energy consumption

71% 71% 71% 70% 70% 68%

20% 19% 19% 18% 18% 19%

3% 3% 3% 4% 4% 4%7% 7% 7% 8% 8% 9%

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Coal Crude Oil Natural Gas Hydro, Nuclear and others

30%38% 34%

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5% 6% 6%1% 2% 1%

0%

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India OECD Total world

Oil Natural gas Coal Nuclear Hydro Renewable


40

… which implies 2012F and 2013F coal demand to grow at 2.8% and 3.1%, respectively, in line with our bottom-up approach

On a top-down approach, assuming China is able to achieve the following goals: 1) a reduction on reliance on coal of the primary energy consumption to 63% by 2015F and 2) energy intensity to fall by 16% from the 2010 level by 2015, coal demand growth would be 2.8% and 3.1% for 2012F and 2013F, based on our GDP forecast of 7.9% and 8.2% for 2012F and 2013F, respectively.

This is in line with our bottom-up approach of a 3.1% and 4.4% coal demand growth for 2012 and 2013F, respectively.

Fig. 60: Top-down coal consumption projections


… despite slowing demand, it is difficult to replace coal in the near term

We believe coal will continue to account for the majority of China’s energy consumption, at least for the next two decades. In our view, coal cannot be easily replaced by another type of energy in the near term, given the "structural issues" that exist, including:

• Abundant coal reserves in China, while it is only sufficient on gas and is short of oil (source: BP Statistical Review of World Energy June 2011). China has the third-largest coal reserves in the world, with 114.5bn tons of coal reserves (source: BP Statistical Review of World Energy 1H11), after Russia and the US. This is equal to 35 years of production based on the 2010 run rate, compared with oil at 9.9 years and gas at 29 years.

• Regulated power tariff without fuel cost pass through and coal remains the cheapest source of energy, in our view. Thus, the majority of power generation is likely to continue to rely on coal in the next 5-10 years, by our estimates. Compared with other major energy sources (eg, gas, LPG and diesel, which appear to be more closely correlated with crude oil prices), coal enjoys a 100-340% cost advantage. Even though we forecast coal prices to increase, coal should still maintain its pricing competitiveness in China over other major energy sources, in our view.

• It takes more time to build other base-load and low cost fuel type power plants, eg, nuclear.

• Renewable energies (wind, solar, biomass) are not base-load power. They are less scalable and affordable in China, in our view.

• Nevertheless, we expect non-coal power generation will increase faster (19% CAGR for 2011-15F) from this year and pace should further pick up from 2014-15F, vs coal fired generation of 5% CAGR, when China implements the power pooling, which allows a power company to effectively pass on the fuel cost.

2010 2011 2012 2013 2014 2015

GDP growth 9.2% 7.9% 8.2% 8.2% 8.0%

Energy Intensity reduction -3% -3% -3% -3%

Total energy consumption (Index to 100 for base year)

100.0 104.7 109.8 115.3 120.8

Coal as primary energy consumption 69% 68% 66% 65% 64% 63%

CAGR -1.7%

Coal consumption (Index to 67.0 for the base year: 2011)

67.6 69.5 71.7 73.9 76.1

Projected Growth 2.8% 3.1% 3.1% 2.9%

Assuming a 16% energy intensity reduction target by 2015 from 2010 level, representing ~3% CAGR

Assuming China reduces coal reliance from 70% (2009) to 63% (2015), representing a ~1.7% CAGR reduction in reliance per year


41

Fig. 61: China: fossil fuel lifetime

Note: Lifetime defined as reserves / production

Source: BP Statistical Review of World Energy 2011, Nomura research

Fig. 62: China: Energy price comparison (May 2011)


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137 158

17 61

74 91


42

Turn from coal supply deficit to surplus from 2014F In the last 10 years, China witnessed rapid growth in coal output, with a CAGR of 9%. In 2010, total production in China reached 3.41bn tonnes, more than double production in 2000. According to the BP statistical review of world energy June 2011, China produced nearly 44.5% of total world coal output. In the next two years, although coal production and supply growth is expected to outpace the demand growth, the persisting transportation bottlenecks should decrease the effective volume supply, causing a slight supply deficit, in our view. However, the deficit should be significantly alleviated compared with previous years, due to gradual improvement in transportation, slowing demand and rising coal production.

Fig. 63: China: coal supply forecasts

Source: CEIC, CCTD, Nomura estimate

Effective coal supply to grow 6.0% and 6.1% for 2012-13F

For 2011F, we project coal production to rise to 3,789mn tonnes, +11% y-y, based on 11M11’s actual output of 3,462mn tonnes (source: CCTD). We forecast production growth to slow to 5.0% y-y for both 2012F and 2013F, yielding 3,978mn and 4,177mn tonnes of coal output in the respective year and the effective supply to increase 6.0%/6.1% y-y to 3,739mnt and 3,968mnt for 2012-13F, respectively, based on our industry checks and analysis of the current market environment:

• Less effective supply caused by transportation bottlenecks.

• Government intervention on capacity expansion.

• Geographically imbalanced supply;

• Depletion of eastern coal mines.

• Small mines consolidation.

Fig. 64: Comparison between coal sales and production

Source: CCTD, CEIC, Nomura research

Fig. 65: Comparison between coal sales and consumption

Source: CCTD, CEIC, Nomura research

(mnt) 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F 2014F 2015F

Coal production 2,350 2,529 2,692 2,802 2,950 3,413 3,789 3,978 4,177 4,407 4,671

% chg 7.6 6.4 4.1 5.3 15.7 11.0 5.0 5.0 5.5 6.0

Net increase 179 163 110 148 463 375 189 199 230 264

Effective supply factor (Transportation) 87% 87% 89% 93% 95% 93% 93% 94% 95% 97% 99%

Coal sales 2,044 2,209 2,398 2,606 2,817 3,179 3,529 3,739 3,968 4,275 4,624

% chg 8.1 8.6 8.6 8.1 12.9 11.0 6.0 6.1 7.7 8.2

Net increase 165 189 207 211 362 350 210 229 306 350

2,802 2,950

3,413 3,789

3,978 4,177

2,606 2,817

3,179 3,529

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43

Due to the lack of sufficient transportation capacity, effective coal supply to market only accounted for 87% to 95% of coal production from 2005 to 2010. With the construction of new lines and expansion of existing lines, we believe the factor will be improved gradually. We expect the effective supply factor to be 93% in 2011F (the same as in 2010) and ameliorate 1pct y-y in 2012/13F, respectively, resulting in the effective supply to stand at 3,529mnt (+11%), 3,739mnt (+6.0%) and 3,968mnt (+6.1%) in 2011-13F separately. A 99% effective supply factor is expected for 2015F as the majority of new railway lines should have been completed and transportation bottleneck should be resolved by then.

However, the risk to supply appears to be on the upside, as we only factor in the 1,258mnt production increase from the six coal provinces (Shanxi, Inner Mongolia, Shaanxi, Xinjiang, Guizhou and Ningxia) for 2011-15F, in accordance to their 12th FYP, which accounts of only 68% of total coal supply in China.

We note that coal supply announced thus far for 2011 has exceeded our expectations (production rose 11.6% y-y in 11M11 vs our estimate of 11%/5.0% for 2011F/2012F).

Fig. 66: Production plan of major coal output provinces

Source: CCTD, Gov website, Nomura research

Current coal inventory at high levels

According to CCTD, most of China’s coal inventory can be found in ports, power plant and coal mines, etc. As an important port to transport coal in China, QHD coal inventory stood at 6.95mnt (+7.3% w-w) on 9 Jan, 2012, (avg: 5.30mnt since 2002), representing 12% higher than average volume from 2002. National coal inventory was 294.19mnt in Oct-11 (+39.7% y-y and +8.0% m-m). Currently, we see overall coal inventory in China at high levels, exerting pressure on coal prices for 2012F.

Fig. 67: QHD weekly coal inventory


Fig. 68: National coal inventory


Province2010 production

volume (mnt) % of total 10M11 production

volume (mnt) % of total2015 production target

volume (mnt)Increase volume

(mnt) Increase % CAGR %

Inner Mongolia 787 23.1% 814 26.1% 1,000 213 27% 4.9%

Shanxi 741 21.7% 710 22.8% 1,000 259 35% 6.2%

Shaanxi 355 10.4% 312 10.0% 600 245 69% 11.1%

Xinjiang 101 3.0% 91 2.9% 500 399 395% 37.7%

Guizhou 160 4.7% 128 4.1% 250 90 56% 9.3%

Ningxia 68 2.0% 67 2.2% 120 52 76% 12.0%

Total of Top 6 2,212 64.9% 2,122 68.1% 3,470 1,258 57% 9.4%

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44

IPP inventory up coupling with coal consumption drop

Power accounted for around 50% of coal consumption in China in recent years. We observe that IPP coal consumption and IPP coal inventory days are practically moving in the opposite directions. These two indicators are self explanatory in our view. The declining coal consumption from IPP in recent months should also exert pressure on spot coal price in 2012F, in our view.

Fig. 69: IPP coal consumption vs IPP days of coal inventory


Government restriction on capacity expansion

According to Reuters’ King coal report in January 2011, China accounted for 46% of the world’s total coal supply but is responsible for about 80% of global mining fatalities. Therefore, in light of the government’s efforts to reduce energy consumption per unit of GDP in 12th FYP and reducing coalmining casualties, Beijing has introduced more rigorous requirements for workers’ safety and approval of new coal capacity.

We believe production growth disruption should not be a major concern for leading coal players such as Shenhua and China Coal. Their output growth should run faster than the national growth of 6.5% CAGR, given their existing sufficient reserves, recent acquisitions of resources, potential pipelines from asset injections and being beneficiaries of small mines’ consolidation. In particular, Shenhua’s captive logistics network could facilitate third-party trade, which supports double-digit volume sales growth over our forecast horizon. However, in our view, the said restriction, coupled with depleting coal resources in Shandong, has prompted Yanzhou Coal to move away from its hometown, like investing in Australia more aggressively.

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45

Geographically imbalanced supply

China is rich in coal resources, however, most of its resources are located in the Northwest part of the country, and the top 10 coal production provinces are all in the North, Northwest or Southeast parts (source: sxcoal).

Fig. 70: China: Top 10 provinces by raw coal production


Growing reliance on Inner Mongolia and Shanxi

Shanxi and Inner Mongolia are critical to domestic coal supply. Contributions from the two provinces have grown from 34.5% (FY05) to 45.0% (FY10) and are likely to further increase to 49% (10M11). Prior to 2009, Shanxi was the biggest producing province, with a CAGR of 5% in FY05-08. Although supply in Shanxi dropped to 615mn tonnes in 2009 (down 6.4% y-y) due to the closure of small mines policy, FY10 raw coal output rebounded strongly to 741mn tones (increase 20.5% y-y), according to sxcoal, CCTD.

Inner Mongolia has the largest thermal coal resources in China, according to Wood Mackenzie. In the last few years, due to the upgrade of railway regional lines, which feed into the Daqin or Shenhuang lines (see our “transportation” sector for details), production grew rapidly and overtook Shanxi in 2009 as the largest coal producing province. According to the Inner Mongolia Economic and Information Technology Commission (source: hncost.com), Inner Mongolia’s coal output may reach 900mn tonnes in FY11; while Shanxi’s coal output is expected at 800mn tonnes (source: CCTD and Shanxi Coal Industry Office). We expect the contributions from these two provinces to increase, due to their rich coal resources and slowing growth (or decline) at other production bases due to depleting resources. Henan had a production decline (source: cctd), while Shandong saw slow growth (source: steelinfo) in 2010.

According to the 10M11 statistics, Shanxi and Inner Mongolia’s raw coal output totaled 1,524mnt, accounting for 49% of total coal output in China. Assuming a similar run rate and proportion, we project Shanxi and Inner Mongolia’s total raw coal production volume at 1,829mnt with total coal output in China is expected to reach 3.7bnt in FY11F, largely in line with our production estimation.

According to the 12th FYP, Inner Mongolia and Shanxi target 1bn tons production each by 2015, which should continue to maintain their top two production bases for 2012-15. However, Xinjiang and Shaanxi are expected by the 12th FYP to grow production faster by 395% and 69% to 500mn tons and 600mnt, respectively, by 2015 and become the fourth- and third-biggest production bases, respectively.

787741

361

179 160 149 131 102 101 98 97

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100200300400500600700800900

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2010 2009(mnt)


46

Fig. 71: Shanxi vs Inner Mongolia production


Fig. 72: Shanxi / IM’s total % of China Production


Industry consolidation continues; some capacity has been gradually released to market

Compared with the overseas market, China’s coal market remains fragmented. In 2010, the large stated-owned mines accounted for 50% of China’s total coal output; local SOE produced 15%, while the township mines produced the remaining 35% (source: sxcoal).

Fig. 73: Production breakdown by miners


Consolidation finished in Shanxi …

Under the 11th FYP and 12th FYP, China’s central government is pushing to shut small coal mines and aiming to create giant coal firms with working capital to install and run safety equipment and to enhance more efficient use of resources (to improve production yield). Since 2005, over 15,300 small mines have been closed by July 2011. By 2015, the government plans to close an additional 7,000-plus mines, resulting in only 4,000 mines remaining (see policy development section for details). Shanxi, Henan and Inner Mongolia lead the country’s small coal mines consolidation in the campaign. Since 2008, the government has introduced policies to shutter small coal mines (below 300,000 tonnes of capacity) in these provinces. According to sxcoal, by end-2008, Shanxi had 2,600 coal mines with an average capacity of 330,000 tons p.a. and 70% of them were smaller than 300,000 tons p.a. After three years of industry consolidation, by May 2011, the number of coal mines and companies reduced to 1,053 (from 2,600) and 130 (from 2,200), respectively, with average capacity rose to 1,200,000 tons p.a. (source: Shanxi Coal Bureau).

565 581640 657

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47

After one year, coal production decreased in 2009 (615 mn t, a 6.4% decrease y-y), due to the closure of small mines for consolidation and safety checks. Coal production volume rebounded to 741 mn t in 2010 (a 20.5% increase y-y), and 710 mn t in 10M2011 (c.56% output from key SOE). Those were even higher than that of 2008 (657mnt, the pre-consolidation level), thanks to the higher production efficiency post consolidation, according to sxcoal.

In our view, we see the coal industry’s consolidation and restructuring as indeed increasing the output, although a short-term production constraint could occur during the consolidation.

… speeding up consolidation in other provinces …

According to the NDRC and State Administration of Energy (SAE), China will speed up consolidation for the coal industry across the rest of the country, such as Inner Mongolia, Shaanxi, etc.

According to wnnews, Shaanxi province will press for consolidation aggressively in 2011, and aim to have only 120 coal companies by end-2011, from 550 in February 2011, and only remain 450 coal mines within the province.

Inner Mongolia announced in 2011 that it plans to have average coal mine output capacity reach to 1,200,000 tons per year after consolidation in 12th FYP, and only remain 100 coal companies by same time (source: sxcoal).

… coal production boost in major coal output provinces …

Inner Mongolia, Shanxi, Shaanxi, Xinjiang, Guizhou and Ningxia, the six major coal production provinces, contributed 68% of coal output in China for 10M11, increasing from 65% in 2010. According to the 12th FYP, these six provinces aim to increase their production by 57% (1,258mn tons, 9.4% CAGR) during 2011-15F, with the fastest growth likely to come from Xinjiang, followed by Ningxia and Shaanxi.

Fig. 74: Production plan of major coal output provinces

Source: CCTD, Gov website, Nomura research

… is a further benefit to big players

Starting from 2005 onwards, more than 15,000 small mines had been closed by July 2011 during the mines’ consolidation. By 2015, the government plans to shut down an additional 7,000-plus small mines, resulting in only 4,000 mines remaining (see policy development section for details). In the meantime, the government will attempt to limit annual total coal production to under 4bn tons by 2015F and push to form large scale coal enterprises to control most of the production capacity (source: sxcoal).

According to Zhang Ping’s (NDRC chairman) speech at the national coal conference in November 2010, China aims to form 10 super large-scale coal enterprises of 100mn tonnes annual capacity, and another 10 large coal companies with annual capacity of 50mn tons by 2015.

Province2010 production

volume (mnt) % of total 10M11 production

volume (mnt) % of total2015 production target

volume (mnt)Increase volume

(mnt) Increase % CAGR %

Inner Mongolia 787 23.1% 814 26.1% 1,000 213 27% 4.9%

Shanxi 741 21.7% 710 22.8% 1,000 259 35% 6.2%

Shaanxi 355 10.4% 312 10.0% 600 245 69% 11.1%

Xinjiang 101 3.0% 91 2.9% 500 399 395% 37.7%

Guizhou 160 4.7% 128 4.1% 250 90 56% 9.3%

Ningxia 68 2.0% 67 2.2% 120 52 76% 12.0%

Total of Top 6 2,212 64.9% 2,122 68.1% 3,470 1,258 57% 9.4%


48

The12th FYP will increase annual production criteria for coal mines to: 1) at least 300,000 tonnes in all parts of China; 2) at least 0.6mn tonnes in national key planned mining areas; and 3) over 1.2mn tonnes in major coal-producing provinces, including Shanxi, Inner Mongolia, Shaanxi, Xinjiang and Ningxia.

Although consolidation is causing short-term tightness, the subsequent large scale enterprises formation favours big SOE players, eg, Shenhua and China Coal. In our view: 1) they are better-positioned in getting reserves across the nation, especially in those six major coal production provinces, than non-SOE coal players. Shenhua has been focusing its investments on the biggest coal production base in China - Inner Mongolia, while China Coal is in the second - Shanxi; 2) the policies bode well for enhancing market share for large scale miners and, thereby, would result in stronger pricing power for leading producers. Thus, we expect the key companies to enjoy a double-digit production CAGR during FY10-13F, almost double that of China’s coal industry production growth average.

Fig. 75: Market share projections

Note: measured by raw coal production


Fig. 76: Production CAGR growth (10-13F)

Note: Yanzhou figure includes Australia production


6.6%

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49

What’s new from the NDRC’s energy conference

The NDRC targets 6.4trn kWh and 4.1bn tons of coal consumption in 2015

During the National Energy Working Conference on 10 January 2012, consumption targets during the 12-5 year plan were set by the committee. Total energy consumption was targeted at 4.1bn tons of coal, while electricity consumption was targeted at 6.4trn kWh. Most provinces actually expected a total consumption target of at least 5bn tons of coal.

Discourage coal consumption

To diversify from coal and reduce potential obligation on CO2 emissions, China has introduced targets to reduce energy intensity (per GDP) by 16%, CO2 intensity (per GDP) by 17% and coal to 63% (from currently 70%) of primary energy consumption during 2011-15.

The target of 6.4trn kWh is in line with our forecast, but 4.1bn tons of coal is 3% lower than our expectation of 4.23bn tons of coal consumption in 2015F. However, actual coal consumption in 2010 came in at 3.25bn tons, which was 8% higher than the original 11-5 year plan target of 3.0bn tons. Thus, we believe our forecasts for both electricity and coal consumption are reasonable.

However, even though based on our higher estimate of 4.23bn tons of coal consumption in 2015F, this implies a CAGR of 5% for 2010-15F, significantly lower than the supply CAGR of 8% during the same period. The case is even more distinct as we only factor in the production increase from the six coal provinces (Shanxi, Inner Mongolia, Shaanxi, Xinjiang, Guizhou and Ningxia), which accounts for only 68% of total coal supply in China.

Nuclear, wind, hydro, natural gas and coal-chemical likely to benefit; electricity tariff poised to rise

We believe the NDRC’s conservative 4.1bn tons of coal consumption goal in 2015 is part of Beijing’s target to reduce energy and CO2 intensity, which should:

• Impose more restrictions on coal consumption by high-energy-intensive industries, such as steel, cement and aluminum smelters.

• Expedite an electricity tariff hike and reform to properly reflect generation cost and to discourage power consumption, eg, speed up generation-grid segregation and power pooling, introduce peak-trough and progressive tariff schemes.

• Encourage the development of scalable and affordable clean energy, such as hydropower, nuclear, wind and natural gas (and some solar) and

• More supportive policy on coal-chemical, clean coal technology and nonconventional gas sources, like coal-bed-methane, coal-to-gas, coal-to-oil and shale gas.

According to cnctock.com, NDRC published guidance on 28 December 2011 which requested national key energy users to save 250 mnt standard coal in 12th FYP by 2015. Key energy users included 17,000 companies, with annual consumption of more than 10,000 tonnes of standard coal each, or above 5,000 tonnes for certain stipulated companies, which accounted for more than 60% of total energy consumption in 2010.


50

Transportation bottlenecks likely to persist until 2014F In our view, the geographical disparity in supply and demand regions, with most suppliers in the northwest and consumers in coastal areas, indicates that coal transportation is a key element of China’s coal industry. This is intensified by the depleting resources in the old and eastern coal bases. Coal is transported by rail or truck from the “Three West” regions to the main ports and then to downstream customers in the Yangtze River Delta and Pearl River Delta.

According to the National Bureau of Statistics (NBS) and Ministry of Railway (MoR), coal accounted for 60% of total freight goods carried by railway in 11M11 in tonnage terms.

Fig. 77: Major production and consumption provinces


The problem is likely to remain until the end of 12th FYP

With railway capacity growth lagging production growth, transportation bottlenecks have become a major roadblock for China’s coal industry in the past few years. We believe this problem will persist for some years, given: 1) limited railway capacity expansion in the two backbone railway lines (Daqin and Shenhuang lines), 2) regional lines cannot solve the bottleneck issue, 3) trucking is too expensive and inefficient and 4) new major railway lines, dedicated to coal transportation, will not be completed until 2014-15F.

We expect railway capacity to increase 67% during 2011-15F; however, the majority of the new capacity are back-end loaded in 2014-15. Thus, transportation remains a constraint for the coal sector for 2012-13 (we estimate railway capacity to grow by a mere 1.7% and 7.7% for 2012-13F), which should continue to affect the effective coal supplying to the market, in our view. Thus, we continue to expect a supply deficit for 2012-13F, mainly due to only 94-95% of coal produced actually being supplied into the market due to transportation bottleneck.

Shaanxi+201mnt Jiangsu

-186mnt

Shanxi+316mnt

Hebei-180mnt

Inner Mongolia

Zhejiang-133mnt

Shandong-204mnt

Liaoning-94mnt

Guangdong-136mntMajor exporter (production>consumption)

Major importer (production<consumption)

Hubei-100mnt


51

Fig. 78: Railway capacity of key lines for coal transportation

Source: MOR, Shanghai Securities, Baidu Baike, Nomura research

Railway lines From To Strength (km) 2010 2011F 2012F 2013F 2014F 2015F

North Corridor (mnt) (mnt) (mnt) (mnt) (mnt) (mnt)

Daqin Datong, Shanxi Qinghuangdao, Hebei 653 405 440 450 460 470 480

Shuohuang Shenchi, Shanxi Huanghuagang, Hebei 600 160 170 180 200 230 250

Fengshada Fengtai, Beijing Shacheng, Hebei 105 65 65 65 65 65 65

Jitong Jining, Inner Mongolia Tongliao, Inner Mongolia 995 15 15 15 20 25 35

Jingyuan Shijingshan, Beijing Yuanping, Shanxi 418 15 15 15 16 17 19

Zhangtang Zhangjiakou, Heibei Tangshan, Hebei 528 60

Baoxi Baotou, Innter Mongo Xi'an, Shaanxi 935 55 55 55 55 55 55

Subtotal (mnt) 715 760 780 816 862 964

Net Increase (mnt) 45 20 36 46 102

% chg (%) 6.3% 2.6% 4.6% 5.6% 11.8%

Central Corridor (mnt) (mnt) (mnt) (mnt) (mnt) (mnt)

Shitai Shijiazhuang, Hebei Taiyuan, Shanxi 243 70 70 72 74 76 78

Hanchang Handan, Hebei Changzhi, Shanxi 212 15 15 15 20 40 62

Taizhongyin Taiyuan, Shanxi Yinchuan, Ningxia 892 60 60 60 60 60

Shanxi Central South Lvliang, Shanxi Rizhao, Shandong 1,000 50 100

Subtotal 85 145 147 154 226 300


% chg (%) 70.6% 1.4% 4.8% 46.8% 32.7%

South Corridor (mnt) (mnt) (mnt) (mnt) (mnt) (mnt)

Houyue Houma, Shanxi Yueshan, Henan 252 130 130 130 135 140 159

Taijiao Taiyuan, Shanxi Jiaozuo, Henan 398 62 62 62 62 65 70

Longhai Lanzhou, Gansu Lianyungang, Jiangsu 1,759 40 40 40 40 45 50

Ningxi Xi'an, Shaanxi Nanjing, Jiangxu 1,030 25 25 25 25 25 25

Xikang Xi'an, Shaanxi Ankang, Shaanxi 267 20 20 20 20 20 20

Subtotal 277 277 277 282 295 324


% chg (%) 0.0% 0.0% 1.8% 4.6% 9.8%

East Inner Mongolia (mnt) (mnt) (mnt) (mnt) (mnt) (mnt)

Chisui Chifeng, Inner Mongo Huludao, Liaoning 357 20 60 80

Chijin Chifeng, Inner Mongo Jinzhou, Liaoning 282 40 60

Subtotal 0 0 0 20 100 140


% chg (%) NA NA NA 400% 40%

Xinjiang area (mnt) (mnt) (mnt) (mnt) (mnt) (mnt)

Lanxin Lanzhou, Gansu Urumqi, Xinjiang 1,903 50 50 50 50 50 50

Lanxin Line No.2 Lanzhou, Gansu Urumqi, Xinjiang 1,903 50

Hace Line Hami, Xinjiang Ceke, Inner Mongolia 650 25

Lince Line Linhe, Inner Mongolia Ceke, Inner Mongolia 750 18 18 18 18 25 30

Hami - Lop Nor Railwa Hami Luobupo 360 30 30 30

Subtotal 68 68 68 98 105 185


% chg (%) 0.0% 0.0% 44.1% 7.1% 76.2%

Total 1,145 1,250 1,272 1,370 1,588 1,913

Net Increase (mnt) 105 22 98 218 325

% chg (%) 9.2% 1.8% 7.7% 15.9% 20.5%


52

Limited capacity expansion from the two backbone lines

The Daqin and Shenhuang lines are the two backbones of the West-to-East railway system in China, connecting key coal production provinces to the two main coal loading ports (Qinhuangdao and Huanghua ports). We expect limited expansion from these two lines in the short- to medium term.

• Daqin line (Line 1 in chart below): Stretching 653km, linking Datong of Shanxi province and Qinhuangdao port, Daqin line is the most important railway line dedicated to coal transportation. Daqin’s freight volume more than tripled from 100mn tonnes in 2002 to 405mn tonnes in 2010 (source sxcoal). After freight volume growth in 2011F to 440mn tonnes due to growing demand for coal transportation, future growth should be limited. Subject to the Ministry of Railway’s approval, we expect freight volume to increase by 10mn tonnes pa in 2012-15F and to reach full capacity of 480mnt in 2015F.

• Shenhuang line (Line 2 in chart below): Stretching 815km, Shenhuang line is the second largest line in terms of coal freight volume. The Shenhuang (Shenshuo-Shuohuang lines) line, which runs from Shenmu of Shaanxi through Shuozhou to Huanghua port, is owned by China Shenhua Energy. It was primarily designed to carry coal produced by Shenhua, and will only serve third-party coal players when it has spare capacity.

According to our cross-check with Daqin Railway, Shenhuang’s transportation volume reached 170mn tonnes in 2011F and its capacity should expand to 250mn tonnes in 2015F. We expect transportation volume to increase steadily to the level in 2015F.

However, extra capacity could be absorbed by Shenhua’s own output growth and third-party trade, as we expect Shenhua’s self-production to rise by 130mn tonnes and third-party trade to increase by 80mn tonnes from 2011 to 2015F.

Fig. 79: Key existing lines capacity expansion


Trucks too expensive and less efficient in transporting coal

Trucking is another way to transport coal. However, it is unlikely to replace railway, as it is too expensive and less efficient. As well, in an effort to reduce dust, coal trucks have been barred from travelling within 1km of the city’s boundaries and overloading is penalised. The higher charges are due to the lack of scale and toll road charges, according to our industry check with CCTD, truck cost is c.3x of the railway cost; around CNY 0.4-0.45/t per km.

In addition, trucking is much slower compared to railway transportation, and the efficiency quite depends on the road traffic condition. In addition, extreme weather such as snow, ice, rain, fog, etc, may block roads and negatively impact coal truck transportation, the situation is likely to become worse if inclement weather occurs during the winter/summer coal peak demand season. The local press reported that coal trucks were stuck on the Tibet-Beijing highway for more than two weeks in September and pointed to coal trucks being slowed down due to severe a traffic jam last summer from Shanxi to other provinces.

(mn tonnes) 2009 2010 2011F 2012F 2013F 2014F 2015F

Daqin lines 330 405 440 450 460 470 480

Shuohuang lines 140 160 170 180 200 230 250

Total capacity 470 565 610 630 660 700 730

Net Increase 95 45 20 30 40 30

% chg (%) 20% 8% 3% 5% 6% 4%


53

Regional lines link Inner Mongolia to backbone lines but cannot solve the problem

Coal from Inner Mongolia is mainly transported through regional lines that feed into the two backbone lines:

• Dazhun line (Line 3 in chart below): Stretching 264km, linking Inner Mongolia to the Daqin line, the Dazhun line is owned by China Shenhua Energy and carried 60mn tonnes in 2009.

• Dabao line (Line 4 in chart below): Stretching 452km, from Baotou to Datong, the Dabao line is another linkage between Inner Mongolia and the Daqin line. The line upgraded its capacity to 120mn tonnes in 2009.

• Baoshen line (Line 5 in chart below): Stretching 170km, from Baotou to Shenmu of Shanxi, the Baoshen line is also owned by Shenhua Energy and connects coal from Inner Mongolia to the Shenhuang line. Freight volume exceeds 22mn tonnes.

These regional lines cannot solve the bottleneck issue as they still feed into the Daqin and Shenhuang lines, increasing their burden. With the completion of new major lines pending, transportation bottlenecks may continue to be a serious constraint for Inner Mongolia coal producers as it is land-locked and trucking distance to major ports (QHD port and Huanghua port) is even longer than Shanxi.

New railways to ease the bottleneck in 2014F/ 2015F

According to the 12th FYP, Inner Mongolia and Shanxi target 1bn tons production each by 2015, which should continue to maintain their top two production bases for 2012-15. However, Xinjiang and Shaanxi are expected by the 12th FYP to grow their production faster by 395% and 69% to 500mn tons and 600mnt, respectively, by 2015, and become the fourth- and third-biggest production bases, respectively. Therefore, to construct a proper railway lines to link such two provinces is vitally important to the sustainable development of coal industry.

To ease the transportation bottleneck, we understand that the MoR is working on several major lines, adding 485mn tonnes of railway transportation capacity by the end of 12th FYP from Inner Mongolia/Shanxi to the ports, and also linking Xinjiang coal to the market.

Excluding the Taizhongyin Line, which was completed in January 2011, the other seven lines are scheduled to be completed in the back-end of the 12th FYP, in 2014-15F. Thus, during 2012-13, railway capacity growth is likely to mainly depend on the expansion of the existing lines, which seems quite limited, in our view.

• The Third line for West-to-East system (Zhangtang Line, Line 6 in chart below): from Ordos to Caofeidian port, would add additional capacity of 200mn tonnes when it is completed. China would invest CNY40bn into Phase 1 (120mn tonnes), the Zhangtang line, 542km, from Zhangjiakou of the Hebei province to Caofeidian. Phase 1 commenced in November 2010, and estimated construction time is 4.5 years. The construction work for Phase 2, from Zhunge’er to Zhangjiakou, has not been officially started. Due to the long construction time, we expect it will be finished by the end of 2014 and will contribute 60mn tonnes capacity in 2015, and reach 120mn tonnes capacity by 2016F.

• Central-southern line (Line 7 in chart below): running from Lvliang (Watang town) of the Shanxi province to Rizhao port in the Shandong province, is designed for capacity of 200mn tonnes per year. The more than 1000km line is estimated by the government to be completed in late 2013. We expect it to be operational in 2014F, with initial capacity of 50mn tonnes, and to reach 200mn tonnes of capacity by 2016F.

• Chisui line (Line 8 in chart below): stretching 357km and with designed capacity of 114mn tonnes, will build a link between Chifeng of Inner Mongolia and Suizhong port near Hulu Island. Construction commenced in October 2010 and should be finished in September 2013. We expect the line to come into full operation in 2016F/2017F.


54

• Chijin Line (Line 9 in chart below): stretching 282km and with designed capacity of 90mn tone, will serve as a link between Chifeng of East Inner Mongolia and Jinzhou Port. Construction commenced in November 2010 and is due to be finished by the end of 2013. We expect that the Chijin Line will contribute 40mn tonnes when it starts operation in 2014 and will reach full capacity in 2016F/2017F.

• Taizhongyin Line (Line 10 in chart below): stretching 892km and with designed capacity of 60mn tonnes. After the four-year construction, the railway line was put into operation in January 2011. It links Yinchuan, Ningxia and Taiyuan, Shanxi, serving as a shortcut between China’s west and east. After the operation of Taizhongyin Line, the transportation distance between Northwest China and major cities in North China was shortened by 100km to 500km.

• Lanxin No.2 Line (Line 11 in chart below): linking Lanzhou, Gansu and Urumqi, Xinjiang, stretching 1,903km with designed capacity of 200mn tonnes and commenced construction in November 2009. We believe the Lanxin No.2 Line will contribute 50mn tonnes capacity in its first year operation in 2015F. Meanwhile, the current Lanxin No.1 Line has reached full capacity of 50mn tonnes, and we expect no upgrade during the 12th FYP.

• Hace Line (Line 12 in chart below): part of the Halin Line, linking Hami, Xinjiang and Linhe, Inner Mongolia, with designed capacity of 25mn tonnes. It is scheduled to be finished at the end of 12th FYP, supplying 25mn tonnes in full capacity.

• Hami - Lop Nor Railway (Line 13 in chart below): stretching 360km, linking Hami and Lop Nor, with designed capacity of 30mn tones. It commenced construction in later 2010 and is scheduled for completion by end 2012 and projected to contribute 30mn tones in 2013F.


55

Fig. 80: Major railway lines to transport coal

Note: Route is estimated basing on the information from Ministry of Railway

Source: Ministry of Railway, ditu.baidu.com


56

Imports to remain at high levels to fill the supply deficit in 2012-13F

China: A net coal importer since 2009

China is rich in coal resources. According to BP statistical review of world energy, in June 2011, China ranked third in proven coal reserves as of end-2010, having 13.3% of the world’s total proven reserves, following the US with 27.6% and the Russian Federation at 18.2%. The reserves-to-production ratio of China is 35 years. However, in recent years, China’s coal supply growth has lagged its soaring coal demand and the country has become a net coal importer since 2009, with imports of 126mn tonnes and exports of 22mn tonnes for the year, according to sxcoal.

Fig. 81: China’s total coal imports and exports


Fig. 82: China’s net imports of coal


Supply deficit to be filled by imports in 2011F-13F

Rapid economic growth, depleting resources, transportation bottleneck and restricted supply (Beijing, Guangzhou, Jiangsu and Shanghai have shut down their own mines according to Reuters King coal report in January 2011) have forced the developed east and southern coasts to rely more on coal imports.

This was even obvious as effective supply was as low as 87% in 2005, though it has gradually improved to 93% in 2010, mainly due to the transportation bottleneck. Even though this factor is likely to improve by c.1pct pa from 2011F, along with the new railway capacity launch, 2012-13F should continue to experience a supply deficit (before turning to a surplus in 2014F), although the deficit should not be as worse as in previous years.

As a result, we expect China to remain a net importer of coal in 2011-13F. Based on 10M11 net imports of 126mn tonnes (up 6.8% y-y), we project 2011F net imports at 183mn tonnes. We expect a smaller 160mn tonnes and 100mnt tonnes net imports for 2012-13F due to less severe supply deficit during the period compared to previous years.

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Fig. 83: Net imports/export forecasts

Source: CEIC, CCTD, sxcoal, Nomura estimates

Indonesia and Australia as main suppliers

In 10M11, the four biggest coal exporters to China were Indonesia, Australia, Russia and South Africa. (Source: sxcoal).

According to Australian Mineral Economics (AME), China ranked No. 2 in seaborne thermal coal imports in Asia in 2010. With growing requirements of coal imports to fill the supply gap, China’s seaborne thermal coal imports also ranked second (106mn tonnes) in Asia in 2011F, between Japan (115.2mn tonnes) and South Korea (90.3mn tonnes).

Although coal imports to China only account for a single digit percentage of China’s total annual consumption, this represents over one-fourth of seaborne coal market imports in Asia (around 500mnt). Therefore, any change in the import pattern of China should materially affect the seaborne market.

Given we forecast a 160mnt import by China for 2012F, vs 165mnt and 183mnt for 2010 and 2011, respectively, seaborne coal prices should remain stable and range-bound at current levels for 2012F, in our view.

Significant reduction for seaborne imported coal to China may happen from 2013F

However, the expected reduced supply deficit in 2013F and supply surplus in China from 2014F should cut the requirement for import to 100mnt, 50mnt and zero for 2013-15F, which we believe would translate into a very significant reduction in regional seaborne coal demand and cause regional seaborne coal price to fall substantially and faster than Chinese’s spot coal price during the same period, in our view.

Our global mining team is expecting a 15-18% pa price correction for Newcastle coal price (also a benchmark for seaborne coal price) starting from 2015F, but we believe the correction may happen earlier and be greater according to our analysis above.

Our estimate is based on Australia’s production of 424mnt and exports of 139mnt in 2010, followed by Indonesia (306mnt, 236mnt), Russia (317mnt, 77mnt) and South Africa (254mnt, 67mnt).

(mn tonnes) 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F 2014F 2015F

Consumption 2,319 2,551 2,727 2,811 3,213 3,350 3,692 3,805 3,973 4,117 4,231

y-y chg (%) 10 7 3 14 4 10 3 4 4 3

Production 2,350 2,529 2,692 2,802 2,950 3,413 3,789 3,978 4,177 4,407 4,671

y-y chg (%) 8 6 4 5 16 11 5 5 5 6

Effective supply (coal sales) 2,044 2,209 2,398 2,606 2,817 3,179 3,529 3,739 3,968 4,275 4,624

y-y chg (%) 8 9 9 8 13 11 6 6 8 8

Coal surplus/(deficit) (275) (342) (329) (205) (396) (171) (163) (66) (5) 158 393

Change in inventory and others (15) (47) (38) (14) (160) 209 265 315 284 320 420

Net Import / (export) 46 25 2 5 (103) (146) (168) (142) (80) (30) 20

Total Export 72 63 53 45 22 19 15 18 20 20 20

Total imports (26) (38) (51) (40) (126) (165) (183) (160) (100) (50) -


58

Fig. 84: China thermal coal imports (10M11)


Fig. 85: China thermal coal imports (FY10)


Fig. 86: Coal production and imports of major countries

Note: Production account for solid fuels (incl. bituminous coal and anthracite (hard coal), and lignite and brown (sub-bituminous) coal

Source: AME, BP Statistical Review of World Energy 2011

Indonesia, 38%

Australia, 33%

Russia, 9%

South Afirica, 13%

Others, 6%

Indonesia, 39%

Australia, 26%

Russia, 11%

South Afirica, 11%

Others, 13%

mn tonne 2007 2008 2009 2010

Australia 393 399 413 424

Export (seaborne thermal coal) 115 124 142 139

Indonesia 217 240 256 306


Russia 314 329 301 317


South Africa 248 253 251 254



59

Rising costs ahead The cost of coal production mainly includes: 1) the production cost and washes cost of miners (including tax, levies and depreciation); 2) profit of miners (considering the mine acquisition price); 3) coal wash cost; 4) transportation cost; 5) harbor dues; 6) freight cost and 7) other fees (eg, wagon fee). We believe coal producers will be faced with cost pressures in the following years due to:

• Staff and material cost hikes: We believe inflation will be an indicator for the staff and material cost increases of the coal miners. Our economist, Zhiwei Zhang, expects inflation at 4.0% in 2012, lower than 5.6% in 2011.

• Government fees and levies: Including coal price adjustment fund and coal sustainable development fund.

• Rising transportation cost: The unsolved transportation bottleneck should push up the transportation cost for the coal miners. In addition, inflation pressure is likely to be another driver for transportation cost rise.

Production costs

According to our industry check with sxcoal, production costs includes material cost, staff cost, power cost, depreciation and other fees and levies. As production costs depend on the geological features of the mines, it varies in different provinces. Taking Shanxi, Inner Mongolia and Xinjiang for example, Inner Mongolia enjoys the lowest unit production cost of CNY115-125/t owing to its favourable geological features and high mechanization. Xinjiang’s unit production cost is a bit higher, CNY120-140/t, as its mechanization ratio is lower than that of Inner Mongolia’s. Shanxi has the highest unit production cost among the three. Excluding fees and levies, unit production cost in Shanxi is currently c.CNY300/t, in line with CNY228/t to CNY333/t range since April 2010. Considering the unit fee and levies of CNY50-70/t, confirmed by the industry experts at CCTD, total unit production cost in Shanxi is c.CNY350-370/t.

Fig. 87: Average production cost in Shanxi


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Wash cost

Coal wash is the process of removing impurities in raw coal. The average washing cost is about CNY15-20/t regardless of the coal quality. We assume the average to be CNY20/t on the conservative basis.

Fees and levies edging up production costs

The major fees and levies of the coal miners include coal price adjustment fund and coal sustainable development fund. Although the resource tax remains to be volume-based, we believe revenue-based resource tax is the direction of resource tax reform. If implemented, it will be another cost pressure for coal producers, in our view.

Coal price adjustment fund Major coal production provinces such as Inner Mongolia, Shaanxi, Henan, Hunan, Guizhou, Sichuan and Ningxia have introduced a coal price adjustment fund (“CPAF”). For raw coal, excluding Guizhou, the CPAD ranges from CNY8/tonne to CNY40/tonne, while the charge is between CNY25/tonne and CNY60/tonne for clean coal.

In 2011, Henan started to levy the CPAF, while Guizhou and Hunan have implemented an adjustment to their CPAF policies.

• Henan commenced to levy CNY20/t, CNY30/t and CNY35/t on raw coal, clean coal and coke respectively, which was effective in July 2011.

• Guizhou changed its CPAF from volume based to value based in October 2011.

– Raw coal: The local government will levy a value-based CPAF of 10% of the selling price (including VAT). The tax should be no less than CNY50/t.

– Clean coal: 10% CPAF will be imposed on the amount of raw coal washed. The taxable price should refer to the average price of like raw coal products selling in the same areas. The tax should not be less than CNY50/t.

– Coal sold outside Guizhou: outgoing raw coal and washed mixed coal are subject to second levy, ie, an additional CNY200/ton.

– The NDRC guided on November 30 that coal levies introduced by sub-provincial governments will be abolished from 2012 and the provincial levies will be capped at CNY23/t. As the current CPAF in Guizhou is higher than the NDRC’s guidance, it is possible that the local government will cancel or cut the CPAF in 2012.

• Hunan cut its CPAF from CNY30/t to CNY10/t for non-thermal coal and the thermal coal for power generation is exempted from CPAF effective from 1 October, 2011.

Coal sustainable development fund Although Shanxi is not charging the CPAD, it started to charge a levy in March 2007, after passing the proposal in 2006 and the ordinance in 2007; the proceeds flow to a sustainable development fund (“SDF”).

As of 2010, an CNY13-20/ tonne SDF charge is applied to a regular coal mine and CNY40/tonne for unqualified coal mines. In March 2011, the SDF was capped at CNY18/t for thermal coal, CNY23/t for anthracite coal and CNY23/t for coking coal.

In 2009, Inner Mongolia received approval from the State Council for SDF, which might be introduced soon. The CPAF and SFD charges for “Three West” areas add up CNY8-25/tonne to production cost.


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Fig. 88: China: Coal price adjustment fund (current)

* CNY8/ tonne in Inner Mongolia apply to Lignite and CNY15/tonne apply to other type of raw coal.

Source: local government, coalcoke, fjcoal, Nomura research

Resources tax for thermal, coking coal is unlikely before 2014

The NDRC issued a consultation document in January 2012 and expressed its plans to change the tax structure for fossil fuels (eg, thermal and coking coal) to price-based from volume-based, similar to what was implemented for natural gas and oil from November 2011.

China has already introduced a value-based tax on oil and natural gas sales from 1 November, 2011 to help conserve energy use and boost local government revenues. The tax is 5-10% of sales. For the coal sector, tax remains on a volume basis; China levies a tax of CNY8-20/ton of coking coal sold and CNY0.3-5/ton for other coal grades (including thermal) starting from 1 November, 2011.

• For thermal coal, this (CNY0.3-5/ton) is actually no change from the previous scheme of CNY3-5/t (Shenhua is paying on average CNY3.5/t).

• However, for coking coal, the resources tax was raised from CNY3-5/t to CNY8-20/t. Nevertheless, the incremental resources tax only represents 0.3-1% of the prevailing coking coal price (Shanxi Liulin No.4 FOB was CNY1,670/t as of 10 October 2011), thus the impact to producers should be insignificant, in our view.

We believe the decision of having resources tax for coal unchanged during last November was the outcome of the coal seller's market and high inflation and the low profitability of IPPs.

We are not surprised that the NDRC proposed a change in the tax structure for fossil fuels to price-based from volume-based, similar to the move on natural gas and oil, but the time frame is likely to be in 2014-15F, in our view.

This is because although inflation is subsiding, spot coal price is falling and electricity tariff was raised a couple of times last year; the IPPs’ profitability remains fragile and unable to accept further coal price rise without a follow-on tariff hike. This is likely unless the NDRC becomes more receptive on “fuel cost pass through and tariff hike” and thereby the increasing cost to coal miners can be effectively passed on to end-users, leaving both IPP and coal companies’ margins unchanged.

Thus, we believe a value-based resources tax for coal will be implemented eventually in 2014-15F when:

• China's coal market has a surplus - a buyer's market (from 2014F onwards when the transportation bottleneck is resolved, in our view), such that resources tax would be absorbed internally, or

• Power pooling is established, likely in 2014-15F, such that incremental cost could be passed on to power grids or end-users effectively.

Province Effective Date Raw Coal (RMB/t) Clean Coal (RMB/t) Coke (RMB/t)

Henan July 2011 20 30 35Guizhou Oct 2011

Hunan Oct 2011

Inner Mongolia Dec 2009 8 or 15* 20 n/aShaanxi Aug 2005 15 25 25Sichuan Aug 2008 40 60 70Chongqing Sep 2008 40 60 70Ningxia Jan 2006 30 n/a n/a

Non thermal coal: RMB10/tThermal coal for power plant is exempt from coal price adjustment fund

Raw coal: 10% of the selling price (including VAT) on the raw coal sales. The tax should not be less than RMB50/t.Clean coal: 10% CPAF will be imposed on the amount of raw coal washed. The tax should not be less than RMB50/t.Coal sold outside Guizhou: outgoing raw coal and washed mixed coal are subject to second levy, ie, an additional RMB200/ton.


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Impact may be less if NDRC decides to reduce or eliminate the local coal price adjustment fund

Major coal production provinces, such as Inner Mongolia, Shaanxi, Shanxi, Hunan, Guizhou and Sichuan, have already introduced a coal price adjustment fund (CPAD). For raw coal, the CPAD ranges from CNY8/tonne to CNY40/tonne, while the charge is between CNY25/ton and CNY60/ton for coking (clean) coal.

These CPAD and levies are indeed a form of resources tax pre-collected by local governments and are similar to the potential 5% resources tax rate (CNY13-39/ton for raw and CNY85/t for coking, based on the current spot prices). Therefore, these CPAD may be eliminated or reduced by NDRC after the official lifting of resources taxes to value-based, which can alleviate part and even all of the impact to coal producers.

Transportation costs to be a big part

As discussed above, due to the demand-supply disparity, coal needs to be transported from the inland regions (northwest) to the coastal areas (southeast China). The lack of the efficient transportation infrastructure has aggravated the unbalanced structure. Given the current situation, transportation cost is a major cost head for coal producers:

• Railway cost: Railway cost from Shanxi to Qinghuangdao port is c.CNY85-98/tonne (applying CNY0.13-0.15 per ton per km for the Daqin line of 653km). Railway cost from Inner Mongolia is even higher due to longer distance of around 300-500km to Datong. However, the higher transportation cost in Inner Mongolia is offset by lower production costs. The coals produced in Xinjiang are mostly for local consumption and for Gansu. They will not be transported to coastal ports owing to the economic inefficiency. Xinjiang is more than 3,600km away from the coastal ports. The transportation cost would be as high as CNY468-540/t without considering the wagon fee.

• Truck cost: Truck transportation is more expensive than railway. According to our industry check with CCTD, truck cost is around 3x that of railway cost, around 0.4-0.45/tonne per km.

• Harbour dues: CNY30/t, which including loading fee and port handling fee, according to our industry check with CCTD.

• Shipping cost: In 2011, it varied from CNY39.5/ton to CNY73/ton with the average freight of CNY56/t from Qinghuangdao to Guangzhou and from CNY30/t to CNY50/t with the average freight of CNY44/t from Qinghuangdao to Shanghai. The freight was peaked in the end of March and end of Sep due to the pre-stock demand.

• Other fees: According to our industry check with CCTD, coal producers (especially small miners) need to pay wagon fees to obtain railway capacity at the major coal producing provinces. Wagon fees fluctuate on the basis of the tightness of the coal market. It is about CNY60-70/t during the slack season and will surge to CNY150-160/t during the peak season. Due the seasonality, we assume a wagon fee of CNY110/t on average. Due to the captive transportation network, Shenhua does not need to pay a wagon fee.

Fig. 89: Nomura's estimate of total unit cost

Note: The cost estimates are based on 5,500 Kcal/ tonne thermal coal and FOB spot sales. Cost for ex-mines sales and key contract sales would be lower.


Cost Item Inner Mongolia (CNY/t) Shanxi (CNY/t)

Production cost (including tax, fees & depreciation) 120 360

Wash cost 20 20

Railway cost 161 91

Harbour dues 30 30

Shipping 44-55 44-55

Others (wagon fees etc) 110 110

Total cost 485-496 655-666


63

Overview of seaborne coal market

2011 coal price performance review

Having performed strongly in the beginning of 2011 - reaching ~US$130/ton in January 2011 (up 3.3% from ~US$126/ton at the end of 2010) - on the back of the flood situation in Australia, the Newcastle coal price closed down 11.7% y-y at ~US$111/ton at the end of 2011.

Fig. 90: Coal price down 11.0% in 2011


We attribute a couple of factors to the poor performance of the international coal price in 2011:

Japanese earthquake The earthquake in Japan in the middle of March 2011 was the first negative event to hit the coal market, as it destroyed not only coal-fired power plants but also the infrastructure needed to import coal. Although, theoretically speaking, Japan’s coal demand of coal is likely to increase post the closure of the Fukushima nuclear power plant, this might only happen over the next two to three years at the earliest. A couple of reasons for this, in our opinion:

• Utilization rate in Japan’s coal-fired power plants has been high, reaching 80-85% higher than those of gas-fired (50%) and oil-fired (60%) ones.

• It is likely to take ~three years to build new coal-fired power plants.

That being stated, we estimate that coal demand from Japan in 2011 was down by ~10mn tons due to the power plant and infrastructure situations post the quake. As highlighted below, right after the quake the coal price declined ~US$10/ton from ~US$130/ton to US$120/ton and remained at that level until mid-October 2011.

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Fig. 91: Coal price down ~7.7% (US$10/ton) post the Japan quake in March 2011


China situation Another factor contributing to the weakening of coal prices in 2011 was the inventory level in China’s power sector, which climbed as high as ~20 days in 3Q11, higher than the historical average of 15.7 days. In our view, the high inventory days were due to China’s higher-than-expected production level. The figure below suggests that coal price didn’t move up much when the inventory level was high. Our estimate suggests that the coefficient correlation (ρ) between China’s coal inventory and Newcastle coal price was quite strong at -0.62226.

Fig. 92: Higher-than-average coal inventory days in 2011


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Fig. 93: Weakening coal price when coal inventory was high


Where are coal prices headed in 2012F?

Nomura’s assumptions Nomura global mining team forecasts 2012F, 2013F, 2014F and 2015F thermal coal prices of US$125/ton, US$130/ton, US$130/ton, US$110/ton, respectively. The 2012F, 2013F and 2014F coal price assumptions are lower than previous forecasts of US$140/ton, US$150/ton, and US$140/ton, respectively, due to the slowdown in the global economy and changes in global thermal coal supply and demand dynamics, which are not as tight as we estimated previously. The team expects the coal price to rebound in 2H12F on the back of the expected demand recovery in China and other coal-importing countries.

Fig. 94: Nomura coal price assumptions


ASP purposes For our modeling purposes, we take a more conservative approach in deriving ASP assumptions of Indonesian thermal coal companies by taking larger discounts to the benchmark prices. That being said, our financial modeling exercises implies coal prices of US$115-120/ton in 2012-13F.

Our 2012F coal price assumption US$115/ton is 8.7% lower than 2011’s ~US$121/ton mainly on the back of global economic slowdown, and is based on a couple of indicators, such as:

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• Japanese price settlement in January

Japan and Australia had already both agreed on the US$115/ton price for the January 2012 contract. We understand that the January volume only takes into account 5% of the annual volume, and as such, one might believe that the January price is not a good indicator for the April price, which carries higher volume (70% of total). Nevertheless, in our view, despite relatively low volume, the January price is still a good indicator as we don’t see any reason for coal prices to increase significantly in 1Q12, which could in turn push up the April price. Instead, we see a downside risk that coal prices might decline before the Chinese New Year due to low demand and high inventory level in China.

Fig. 95: Coal prices for 2011/12 Japanese fiscal year

Source: Platts

• Forward price

The Platts forward coal price curve (as of 13 January, 2012) suggests that the Newcastle coal price for will remain in the range US$110-115/ton in 2012F. Starting in 2013F, coal price is expected to rise and reach almost US$120/ton in 2015F.

Fig. 96: Coal price of US$110-115/ton in 2012F

Source: Platts (as of Jan 12) and Nomura estimates

Coal market vs equity market

Even though, as mentioned previously, the coal physical market suggests coal price at ~US$115/ton, consensus, in our view, has a more aggressive coal price assumption of US$130.4/ton on our estimates (range US$117.6-135.1/ton).

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Fig. 97: Consensus more aggressive in 2012F coal price assumption

*Nahakam Sumber Jaya (MSJ) only

Source: Bloomberg (as of January 11), Nomura research

Coal price vs oil price

Are they still correlated? Based on 12-year data, oil and coal prices have a strong statistical correlation with ρ of 0.91711 on our estimates. Nevertheless, in the last year the correlation between these two commodity prices had broken down. In 2011, the statistical correlation had even turned negative to -0.16858.

Fig. 98: Coal price vs oil price (2000-2011)


Fig. 99: Coal price vs oil price (2011)


Fig. 100: Coefficient correlation (ρ) of coal and oil prices in different periods


Coal prices under different scenarios Our regression analysis suggests that, based on 12-year data, coal price movements are affected by oil price movements. The mathematical relationship between these two variables is described as: coal price (y) = -2.33137 + 1.119849*oil price (x). The equation has an adjusted R2 of 0.84084 which suggests a strong explanatory power. The table below highlights coal prices under different oil price scenarios.

Coal sales (USDmn)

Volume (mn tons)

Implied ASP (USD/ton)

ADRO 3,991 50.8 78.6 71.0 10.7% 41.3% 134.0

BUMI 7,534 75.0 100.5 90.7 10.8% 25.6% 135.1

HRUM* 1,038 10.5 98.9 92.5 6.9% 24.1% 130.3

ITMG 2,637 26.5 99.5 97.0 2.6% 15.4% 117.6

PTBA 1,516 16.5 92.1 82.6 11.5% 31.7% 135.0

Average 130.4

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price (USD/ton)Company

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Fig. 101: Regression between coal and oil price


Fig. 102: Coal price under different oil price scenarios based on regression relationship


Coal vs oil: statistic or fundamental?

In our view, the strong statistical correlation between coal and oil prices exists because coal is perceived as a substitute for oil as a source of energy. In spite of the strong statistical correlation, we believe that coal price movements are affected more by fundamental factors of the coal industry because:

• It will take some time to convert the energy source from oil to coal

• Conversion from oil to coal is likely to face several technical issues as not all oil-fired power plants can be automatically converted to consume coal.

• Supply and demand dynamics of the coal business play a dominant role in determining coal price movements.

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Nomura Expert Series: China coal market 2012 outlook The following section is written by Mr David Fang, President of CoalWorld.net and Director of China Coal Transport and Distribution (CCTD).

David Fang is the president of CoalWorld.net, the official coal portal of China Coal Transport and Distribution Association (CCTD), China's official coal market watchdog. Mr Fang also holds other responsibilities in the association. Since joining the information center of CCTD in 2005, Mr Fang has systematically kept track of the Chinese coal industry and coal market, consulting on the coal market for leading international investment banks and hedging funds, speaking at numerous coal conferences. Prior, he worked as a vice president of a consulting firm based in Beijing. He started his career as a public servant in the central government 20 years ago. Mr Fang holds a MBA from Cardiff Business School, University of Wales, UK, and a master’s degree in economics from Renmin University of China.

General Outlook for China coal market

The NDRC said it will allow the contract prices of thermal coal to float by no more than 5% in 2012. In our view, it is likely to see a considerable slowdown in coal demand growth in China in 2012.

For the near term in 2012, a lack of demand from both coal users and coal traders, coupled with high coal inventories at major power plants, has been putting downward pressure on thermal coal prices. Coal demand may hardly improve during the Chinese Lunar New Year holiday, which starts in the week of 22 January, 2012, when industrial activities will be mostly suspended, factories and construction projects in the nation may halt operations during the festival. We think thermal coal prices may drop slightly in the coming weeks, but they are unlikely to see a large decline from the current levels, the benchmark price should be well supported at the levels of 750-780 CNY/ton (5500 kcal/kg).

We believe China’s coal imports may continue to rise in 2012F due to cost arbitrage opportunities, putting some pressure on domestic coal prices in the coming year.

…a more detailed opinion from Mr. Fang be available on 15 February as part of Nomura Dialogue Series

As part of the Nomura Dialogue Series, we are pleased to have Mr David Fang share insights on the topic “China Coal Market Outlook 2012”, on 15 February 2012.

Main topics will be:

• Pricing Trend, Supply and Demand, Production Cost Curve

• Latest Government Regulations

• Industry Consolidation, Coal Transportation Bottleneck

Date & Time

Wednesday, 15 February 2012

12:15pm-1:30pm

Nomura International (Hong Kong) Limited.

Board Room, 30/F, Two International Finance Centre

8 Finance Street, Central, Hong Kong


70

Appendix I: Policy development on coal

Development on coal price intervention policy

Fig. 103: Price intervention policy and news flow


Coal and energy consumption reduction initiatives

Fig. 104: Recent news flow on coal/energy reduction initiative

Source: NDRC, Xinhua, Reuters, Nomura research

2008 price intervention

Timeframe Particulars

19 Jun, 2008 China announced a cap on thermal coal prices through the end of the year at the 19 June 2008 level (RMB830/tonne for 5,500Kcal/kg),while hiking diesel, gasoline and jet fuel prices immediately and raising retail electricity tariffs beginning 1 July 2008. However, thepolicy did not have an immediate impact on the spot price and coal price kept rising to RMB995/tonne as of 21 July 2008.

24 Jul, 2008 NDRC issued another price cap policy. It required that the 5,500Kcal/kg thermal coal FOB price in QHD port and Tianjin port should notexceed RMB860/tonne and RMB840/tonne from the policy date to 31 Dec 2008. The spot price started to come down after the policyannouncement. However, only until 27 Oct 2008, three months after this second price cap, did the QHD price come down toRMB860/tonne.

Mid-2010 price intervention


25 Jun, 2010 In view of the large spread between contract and spot prices, some coal companies increased the contract price by RMB40-50/tonne inearly 2010. In June, NDRC issued a document that required coal companies to honour the contract signed at the beginning of 2010without increasing the price. Coal companies that raised prices, needed to return the extra amount back to customers.

End 2010 key contract price intervention


Mid-Nov The Bureau of Economic Operations Adjustment of NDRC urged coal producing provinces and enterprises to help stabilise the supplychain this winter and self-regulate coal prices. In order to contain the impact of a spot price increase on downstream industries, it alsourged coal enterprises to honour coal contracts.

1 Dec, 2010 According to news on Xinhua, Cao Changhing, head of the Department of Price of NDRC, said during an internal conference that 2011thermal contract price of key contract sales should be unchanged from the 2010 levels and any form of price increase is not allowed.

6 Dec, 2010 NDRC issued the “2011 National coal production – transportation-demand” notice, reiterating its effort and intent to control prices of keycoal contracts. As coal transportation bottlenecks are yet to be resolved in China, NDRC uses “railway transportation capacityallocation” as a tool to ensure that coal companies fulfil their key contracts. In the notice, NDRC said it would favour those corporationswhich have mid-long term contracts for 2011 and those which possess a history of high contract fulfilment rate when allocating railwaytransportation capacity. For FY11F, NDRC projects railway transportation capacity of 932mn tons, of which, 769 mn tons of capacityhas been allocated for thermal coal transportation to IPPs, 94.53mn tons for non-ferrous metal production, 34.84mn tons for thechemical industry (fertilizers) and 33.63mn tons for residential use. The notice further mentioned that all key coal contracts above300,000 tons in 2010 should be carried forward into 2011. (Source: CCTD)

End 2011 price intervention


30 Nov, 2011 NDRC capped the spot price at RMB800/t for the coal with the heat value of 5,500kcal/kg at the northern port in China from Jan 2012 and guided the magnitude of contract price increase for 2012 by a max of 5%

Development on coal resources taxTimeframe ParticularsMid-2010

3 Nov, 2010

7 Jan, 2011

Dec.28.2011

5 Jan, 2012 According to Xinhua, citing government sources. It said proposals for a new environmental taxation system had already been submitted for review to the Ministry of Finance and were expected to be implemented before the end of the 2011-2015 five-year plan. The tax would begin at a rate of 10 yuan ($1.59) per tonne of carbon dioxide, and gradually increase depending on a company's emission levels, the report said. It did not elaborate on when the higher tax bands would kick in.

According to Reuters, Chinese government has called on the country's biggest energy users to save 250 million tonnes of standard coal in the five years ending 2015, the National Development and Reform Commission said in a release published on De.28. The 17,000 companies, which annually consume more than 10,000 tonnes of standard coal each, or above 5,000 tonnes for certain stipulated companies, accounted for more than 60 percent of total energy consumption in 2010, the commission said.

According to Xinhua news, during its 12th FYP, the government is determined to drive its low-carbon development strategy and NDRCmay target to reduce coal consumption from 70% of primary energy used now to 63% in 2015.

According to Xinhua news, China’s coal association officials estimate China's coal demand to reach 3.8bn tons in 2015F. Thisrepresents an increase of 800mn tonnes from 2009, which translates into a CAGR of 3.9% for the 2009-15 period. Such a forecast isnot only the unofficial view, but also too conservative and unlikely to be implemented, according to our industry checks.

According to Xinhua, Zhang Ping, director of the National Development and Reform Commission (NDRC), said that China could meetits goal of reducing energy consumption per unit of gross domestic product (GDP) by around 20 percent from the 2005 levels by the endof 2010.


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Development on resources tax and other surcharges

Fig. 105: Resource tax, coal price adjustment fund and sustainable development fund

Source: xinhuanet, ccoalnew, fert.cn, Chongqing government web-site, Shaanxi government web-site, gov.cn, Nomura research


27 Oct, 2010

10 Oct, 2011

26 Dec, 2011

Year effective Province Raw coal (RMB/tonne) Clean coal (RMB/tonne) Coke (RMB/tonne)

2011 Henan 20 30 35

2011 Hunan

2011 Guizhou

2009 Inner Mongolia 8 or 15 * 20 n/a

2008 Sichuan 40 60 70

2008 Chongqing 40 60 70

2008 Hunan 35

2005 Shaanxi 15 25 25

2004 Guizhou 20*

Timeframe

2006

2007

2009

As at 2010

March 2011

Development on coal resources tax

Coal price adjustment fund (historical)

* RMB8/ tonne in Inner Mongolia apply to Lignite and RMB15/tonne apply to other type of raw coal. Guizhou reduced CPAD from RMB50/tonne to RMB20/tonne in 2008

Sustainable development fund in Shanxi and Inner Mongolia

RMB13-20/ tonne SDF applied to regular coal mines and RMB40/tonne for unqualified coal mines in Shanxi.

Shanxi's SDF was capped at RMB18/23/23 per tonne for thermal coal, anthracite and coking coal respectively.

According to Xinhua news, the 12-FYP proposal published by the CPC Central Committee, quoted Chinese Premier Wen Jiabao saying that China should strengthen its reforms on resources and factor pricing, as well as undertake full-scale reforms on the resources tax on key commodities, such as coal. Currently, local governments charges RMB2-5/tonne as resources tax, representing less than 1% of the spot price.

Particulars

Proposal for charging sustainable development fund (“SDF”) in the province of Shanxi passed.

The local government ordinance for SDF in Shanxi passed; charging of SDF became effective on 7 Mar, 2007

Inner Mongolia received approval from the State Council for SDF.

According to the recent resource tax reform, the Chinese government will extend a value-based tax on oil and natural gas sales to the entire nation starting next month to help conserve energy use in the world’s fastest-growing major economy and boost local government revenues. The tax will be 5% to 10% of sales. China will apply a value-based tax on other commodities when the time is right. Based on the announcement, the resource tax for coal sector remains to be volume based and the tax rate is RMB8-20/ton of coking coal sold and RMB0.3-5/ton for other coal grades. We believe a value-based resources tax for coal will implement eventually when: 1) China's coal market has a surplus - a buyer's market (from 2014 onward when the transportation bottleneck is resolved, in our view), such that resources tax would be absorbed internally and 2) Power pooling is established, likely in 2014-15, such that incremental cost could be passed on to power grids or end-users effectively.

Non thermal coal: RMB10/tThermal coal for power plant is exempt from coal price adjustment fund

According to Mr. Xie Xuren, Minister of MoF, China will actively accelerate the resource tax reform in 2012 and extend the value based resource tax to promote resource conservation and environment protection.

Raw coal: 10% of the selling price (including VAT) on the raw coal sales. The tax should not be less than RMB50/t.Clean coal: 10% CPAF will be imposed on the amount of raw coal washed. The tax should not be less than RMB50/t.Coal sold outside Guizhou: outgoing raw coal and washed mixed coal are subject to second levy, ie, an additional

NDRC guided on Nov 30 that Coal levies introduced by sub-provincial governments will be abolished since 2012, while provincial levies will be capped at RMB23/t. We believe the local government will be likely to cancel or cut the CPAF if it is currently higher than the NDRC's guidance.


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Small mine consolidation

Fig. 106: Policy and news flow on small mines consolidation

Source: Cnstock, China.com.cn, Gov.cn, Chinasafety.gov.cn, CCTD, sxcoal, Nomura research

Policies and development in the Eleventh Five-Year Plan

Mining rights are only granted to coal mining projects of above 300,000 tons per annum.

Phase out all mine shafts with less than 30,000 tons per annum by 2007.

Phase out mine shafts of low capacity after 2007 through consolidation and technology upgrade with the following threshold:

- Shanxi, Inner Mongolia, Shaanxi: 300,000 tons p.a.

- Xinjiang, Gansu, Qinghai, Ningxia, Beijing, Hebei, N.E. and Easter regions: 150,000 tons p.a.

- S.E. and Southern regions: 90,000 tons p.a.

Reduce the number of small coal mines to 10,000 by the year 2010 by consolidating and closing down small coal mines under the threshold capacity of

300,000 tons per annum

Close down coal mines that are deemed unsafe

Reduce the total production of small coal mines to below 27% of national production from the 45% level in 2005.

After a few high profile accidents in early 2009. Shanxi has imposed a stricter consolidation policy than the national requirement, in which the minimum

production threshold to obtain a new license was 900,000 tons per annum. Moreover, the increased intensity of small mine crackdowns has led to a sharp

decline in the number of small mines by 60% to 1,053 from 2,598.

Potential policies/targets in the Twelfth Five-Year Plan

According to CCTD, further industry consolidation is a likely direction for China’s coal industry and the number of coal mines may be reduced to 4,000 by

the end of the Twelfth Five-Year Plan period.

The Twelfth Five-Year Plan is likely to specify that the designed annual production capacity of coal mines should not be less than 300,000 tonnes/ year in

all parts of China, and 600,000 tonnes/ year in national key planned mining areas, and 1.2mn tonnes/ year in major coal-producing provinces, including

Shanxi, Inner Mongolia, Shaanxi, Xinjiang and Ningxia.

The Twelfth Five-Year Plan policy can extend to the formation of big coal companies.

The National Coal Conference, conducted in early November with Zhang Ping (Chairman of NDRC), has concluded the formation of ten super large scale

coal enterprises, with annual capacity of 100mn tons and above, followed by another 10 large scale coal enterprises with annual capacity of 50mn tons by

2015 to be the strategic choice for China.


73

Appendix II: Industry knowhow

Fig. 107: Coal classification in China

Source: Coalprice.cn, Nomura research

Type Symbol Vdaf PM

Anthracite (无烟煤) WY <10.0%

Bituminous (烟煤) YM >10.0%

Lignite (褐煤) HM >37.0% <50%

Sub-Type of Anthracite (无烟煤) Symbol Vdaf Hdaf

Anthracite no.1 (无烟煤一号) WY1 0 - 3.5% 0 - 2.0%

Anthracite no.2 (无烟煤二号) WY2 >3.5% - 6.5% >2.0% - 3.0%

Anthracite no.3 (无烟煤三号) WY3 >6.5% - 10.0% >3.0%

Sub-Type of Bituminous (烟煤) Symbol Vdaf G Y b

Meager coal (贫煤) PM >10.0% - 20.0% =<5

Meager lean coal (贫瘦煤) PS >10.0% - 20.0% >5 - 20

Lean coal (瘦煤) SM >10.0% - 20.0% >20 - 50

>10.0% - 20.0% >50 - 65

Coking coal (焦煤) JM >10.0% - 20.0% >65 <25.0mm <150%

>20.0% - 28.0% >50 - 65

>20.0% - 28.0% >65 <25.0mm <150%

Fat coal (肥煤) FM >0.0 - 20.0% >85 >25.0mm >150%

>20.0% - 28.0% >85 >25.0mm >150%

>28.0% - 37.0% >85 >25.0mm >220%

1/3 Coking coal (1/3焦煤) 1/3JM >28.0% - 37.0% >65 <25.0mm <220%

Gas-fat coal (气肥煤) QF >37.0% >85 >25.0mm >220%

Gas coal (气煤) QM >28.0% - 37.0% >50 - 60

>37.0% >35 - 50

>37.0% >50 - 65

>37.0% >65 <25.0mm <220%

1/2 Weakly caking coal (1/2中粘煤) 1/2ZN >20.0% - 28.0% >30 - 50

>28.0% - 37.0% >30 - 50

Weakly caking coal (弱粘煤) RN >20.0% - 28.0% >5 - 30

>28.0% - 37.0% >5 - 30

Non-caking coal (不粘煤) BN <30.0% - 28.0% <5

>28.0% - 37.0% <5

Long flame coal (长焰煤) CY >37.0% <5

>37.0% <5 - 35

Sub-Type of Lignite (褐煤) Symbol PM Q-A.GN

Lignite no. 1 (褐煤一号) HM1 0 - 30 -

Lignite no. 2 (褐煤二号) HM2 >30 - 50 <24MJ/kg

Specifications

Specifications

Specifications

Specifications


74

Fig. 108: Coal classification

Source: cwestc, world coal institute, sxcoal, Nomura

Fig. 109: Price type


Type Sub-type Major use Heat content Price

Anthracite (无烟煤) Domestic/industrial

Coking Coal (焦煤) Manufacture of iron and steel

Thermal Coal (动力煤) Power generation, industrial use

Lignite (褐煤） Largely power generation/domestic

Bituminous (烟煤)

High High

Low Low

Ex-mine (坑口价)

Price at the mine mouth

Include: Tax and surcharges from the government

Exclude: Any transportation nor misc. fee

Ex-wash (出厂价)

Price after processing (such as washing)

Include: Ex-mine price, plus processing (washing) fee

F.O.B. (Railway) (车板价)

Price when coal is on freight train

Include: Ex-mine or ex-wash price plus loading/transportation costs (mine to railway) and misc. cost charged by railway station

Exclude: Railway transportation fee

F.O.B. (Ship) (车板价)

Referred as port price

Include: F.O.B. (Railway) plus railway & vehicle transportation fee, port handling and ship loading fee

Exclude: Shipment fee

Coal Mine

User


75

Appendix III: Nomura 2012 China Economic Outlook Zhiwei Zhang, 5 December, 2011, China Economic Outlook

Sub-8% growth in 2012

Growth is set to slow quickly in 1H12 as housing investment and exports weaken. Policy will be loosened, but only gradually and moderately, with a lagged effect on 2H.

Activity: We expect economic momentum to weaken quickly in 4Q11 and 1H012. Private housing investment has reached a tipping point and is set to slow at a faster pace as house prices have finally started to soften and transaction volumes contract. New starts in public housing are likely to decline substantially through 1Q12 as the government has already hit its 10mn unit target for 2011. Leading indicators show exports are set to slow as external demand weakens. Growth should pick up in 2H12, supported by policy loosening and resumed investment in public housing. We expect GDP growth for full-year 2012 of 7.9%, picking up to 8.2% in 2013 as the government starts new investment initiatives after a changing of the guard in March 2013.

Inflation: CPI inflation is likely to trend lower in 1H as food prices drop, growth momentum slows and commodity prices weaken. However, we expect CPI inflation to pick up anew in 2H and average 4% for the full year, due to energy and utility price reforms in the pipeline and structural factors such as higher wage inflation. We estimate CPI inflation to rise to 4.2% in 2013 as growth momentum picks up.

Policy: We believe housing policy will remain tight and monetary policy will be loosened in 2012, but only gradually and moderately (for more, see Box: China economic and policy outlook). The reserve requirement cut on 30 November 2011 indicates the beginning of the loosening process, in our view. We expect the PBoC to cut policy rates by 25bp in 1Q12, cut the bank reserve requirement ratio by 200bp mostly in 1H and set a new 2012 loan supply at CNY8tn. This should help support growth in 2H as policy transmission takes time. We expect fiscal policy to be moderately expansionary through further investments in public housing, tax reforms on targeted industries such as logistics, and financial support to the seven strategic industries identified in the 12th five-year plan. Interest rates are likely to rise in 2013 as inflation picks up again and financial reforms are pushed forward once the new government takes office. Fiscal policy may become more expansionary as new leaders feel pressure to boost growth through investment.

Risks: We see three main risks for China in 2012. First, external demand could weaken more than we expect if the crisis in Europe worsens. Second, the property market could weaken faster than we project. Third, the PBoC may loosen policy more aggressively and quickly than we anticipate, which would help to boost growth in the short term but raise macro risks in the long term. Beyond 2012, we see the main challenge as how fast structural reforms are pushed forward, as China urgently needs new reforms, such as a more market-based monetary policy framework and less preferential treatment to the state-owned enterprises, to reduce macro risks.


76

Fig. 110: Details of the forecast: 2012 China Economic

Notes: Numbers in bold are actual values; other forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data as of 5 December 2011.

Source: CEIC, Nomura Global Economics

% y-y growth unless otherwise stated 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 2011 2012 2013

Real GDP 9.1 8.6 7.5 7.6 8.1 8.4 8.4 8.2 9.2 7.9 8.2

Consumer prices 6.3 5.4 3.9 3.6 3.9 4.5 4.1 3.9 5.6 4.0 4.2

Core CPI (excl. food & energy) 2.4 2.2 2.0 1.9 2.0 2.1 2.2 2.0 2.0 2.0 2.2

Retail sales (nominal) 17.3 16.8 15.2 15.7 16.3 16.8 16.2 15.9 16.9 16.0 16.5

Urban Fixed-asset investment (Nominal, YTD) 24.9 23.8 18.0 18.5 18.8 19.0 21.0 20.6 23.8 19.0 21.0

Industrial production (real) 13.8 13.3 11.5 11.8 12.0 12.4 12.3 12.0 13.9 12.1 12.3

Exports (value) 20.6 8.0 8.0 10.0 13.0 15.0 13.0 12.0 18.6 11.7 11.0

Imports (value) 24.9 15.0 15.0 15.0 17.0 17.0 18.0 18.0 23.4 16.0 16.0

Trade surplus (USDbn) 63.8 41.5 -28.8 30.0 53.9 39.0 -55.6 4.1 151.3 94.1 4.7

Current account (% of GDP) 2.8 1.7 1.0

Fiscal balance (% of GDP) -1.7 -1.7 -1.5

Net increase in CNY loans (CNYtrn) 7.3 8.0 9.0

1-yr bank lending rate (%) 6.56 6.56 6.31 6.31 6.31 6.31 6.56 6.56 6.56 6.31 7.06

1-yr bank deposit rate (%) 3.50 3.50 3.25 3.25 3.25 3.25 3.50 3.50 3.50 3.25 4.00

Reserve requirement ratio (%) 21.50 21.00 20.00 19.50 19.00 19.00 19.00 19.00 21.00 19.00 19.00

Exchange rate (CNY/USD) 6.40 6.33 6.32 6.25 6.23 6.17 6.12 6.07 6.33 6.17 5.96


77

Appendix IV: Nomura Commodity Assumptions

Fig. 111: Nomura commodity assumptions


2009 2010 2011F 2012F 2013F 2014F 2015F 2016F 2017F LT

Precious MetalsGold (US$/oz) 974 1,225 1,571 1,788 2,063 1,775 1,500 1,300 1,300 1,200Silver (US$/oz) 14.69 20.17 35.51 42.00 49.00 35.00 25.00 20.00 20.00 20.00Platinum (US$/oz) 1,209 1,612 1,725 1,325 1,250 1,500 1,550 1,750 1,750 1,750Palladium (US$/oz) 265 527 734 500 525 700 650 550 550 550Rhodium (US$/oz) 1,589 2,454 2,034 1,500 2,000 2,500 2,500 2,500 2,500 2,500

Base MetalsAluminium (USc/lb) 0.76 0.99 1.09 1.00 1.07 1.10 1.10 1.10 1.10 1.10Aluminium (US$/t) 1,670 2,172 2,408 2,200 2,350 2,424 2,424 2,424 2,424 2,424Copper (USc/lb) 2.34 3.42 4.01 4.00 3.60 3.25 3.00 2.75 2.75 2.75Copper (US$/t) 5,163 7,540 8,839 8,816 7,934 7,163 6,612 6,061 6,061 6,061Lead (USc/lb) 0.76 0.97 1.09 0.97 1.02 1.04 1.05 0.98 0.98 0.98Lead (US$/t) 1,670 2,147 2,403 2,138 2,248 2,292 2,314 2,160 2,160 2,160Nickel (USc/lb) 6.65 9.90 10.46 9.00 9.38 9.00 9.00 9.00 9.00 9.00Nickel (US$/t) 14,651 21,816 23,049 19,836 20,663 19,836 19,836 19,836 19,836 19,836Zinc (USc/lb) 0.75 0.98 1.00 0.91 0.95 1.00 1.02 0.95 0.95 0.95Zinc (US$/t) 1,659 2,159 2,197 2,006 2,094 2,204 2,248 2,094 2,094 2,094Cobalt (USc/lb) 17.35 20.56 17.64 12.00 10.00 10.00 10.00 10.00 10.00 10.00Cobalt (US$/t) 38,239 45,314 38,879 26,448 22,040 22,040 22,040 22,040 22,040 22,040Moly (USc/lb) 11.40 15.86 15.59 22.00 20.00 18.00 16.00 15.00 15.00 15.00Moly (US$/t) 25,126 34,961 34,364 48,488 44,080 39,672 35,264 33,060 33,060 33,060Copper TC (US$/t) 75 40 60 64 50 50 50 50 50 50Copper RC (US$/lb) 0.08 0.04 0.06 0.06 0.05 0.05 0.05 0.05 0.05 0.05

Bulks & EnergyAlumina (US$/t) 220 286 359 330 353 364 364 364 364 364Coking Coal (US$/t FOB) 129 216 274 256 230 190 160 160 160 160Low Vol PCI (US$/t FOB) 106 161 202 190 174 146 124 124 124 124Semisoft Coal (US$/t FOB) 85 144 163 180 164 136 114 114 114 114Thermal coal (N'stle, US$, FOB) 70 98 124 125 130 130 110 90 90 90South African Thermal (US$/t) 64 94 118 120 125 135 105 85 85 85Ferrochrome (US$/lb) 0.85 1.25 1.26 1.40 1.30 1.20 1.20 1.20 1.20 1.20Iron Ore (China Spot 62%, Dry, CIF) 159 154 155 150 120 100 95 90 90Freight Aus-China (US$/t) 11 10 9 10 10 10 10 10 10 10Freight Brazil-China (US$/t) 28 26 22 22 22 22 22 22 22 22Freight Brazil-Europe (US$/t) 15 14 11 12 12 12 12 12 12 12Australian Lump (FOB, US$/t, Dry, 64%) 86 150 175 170 165 134 113 108 103 103Australian Lump (FOB, USc/%Fe) 134 235 273 266 258 209 177 169 161 161Australian Fines (FOB, US$/t, Dry, 62%) 68 136 145 145 140 110 90 85 80 80Australian Fines (FOB, USc/%Fe) 109 213 226 227 219 172 141 133 125 125Pellets CVRD-Europe (FOB, US$/t, Dry, 66%) 75 173 201 195 189 162 132 122 115 114Pellets CVRD-Europe (FOB, USc/%Fe) 114 269 325 302 293 243 194 186 178 178Manganese (US$/%Mn, FOB Europe) 10.40 7.72 6.05 9.00 8.00 7.50 7.00 7.00 7.00 7.00Oil (WTI, US$/bbl) 62 79 96 83 85 85 85 85 85 85Oil (Brent US$/bbl) 62 80 111 100 95 95 95 95 95 95LNG (US$/boe) 49 63 87 78 74 74 74 74 74 74Australian Domestic Gas (A$/mmcf) 3.42 3.48 4.82 4.88 5.00 5.00 5.00 5.00 5.00 5.00Henry Hub Gas (US$/mmcf) 3.92 4.37 3.98 4.50 5.00 5.50 5.50 5.50 5.50 5.50Uranium (US$/lb) 49 46 56 50 50 50 49 49 48 47Uranium (US$/t) 107,478 101,129 124,182 110,200 110,200 110,200 107,996 107,996 105,792 103,588

CurrenciesAUD/USD 0.79 0.92 1.03 1.02 1.05 1.05 0.81 0.81 0.81 0.81Rand 8.42 7.32 7.25 7.05 7.25 7.25 7.15 7.15 7.15 7.15Euro/USD 1.39 1.33 1.39 1.33 1.35 1.35 1.25 1.25 1.25 1.25GBP/USD 1.57 1.55 1.61 1.61 1.65 1.65 1.65 1.65 1.65 1.65CAD/USD 0.89 0.98 0.99 0.96 0.96 0.96 0.96 0.96 0.96 0.96USD/BRL 2.00 1.76 1.67 1.72 1.75 1.75 1.75 1.75 1.75 1.75


78

Appendix V: China railway map

Fig. 112: China railways map

Source: Winsway, Nomura research


79

Appendix VI: China/Mongolia/Russia railways network

Fig. 113: China/Mongolia/Russia railways network

Source: Winsway, Nomura research


80

Appendix VII: Sector valuation I

Fig. 114: Asia ex-Japan utilities stocks valuation summary (1/3)

Note: Ratings and Price Targets are as of the date of the most recently published report (http://www.Nomura.com) rather than the date of this document. Priced on 26-Jan-12, as of last market close. *Annualised.

Source: Bloomberg, Nomura estimates

Reporting Share Free Price target Price Market cap

Company Type Ticker currency o/s float Rating Local ($) Local ($) (US$mn) 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F

Power Assets Holdings Ltd Integrated 6 HK HKD 2,134.00 53.09 Buy 57.30 53.45 14,702.64 3.42 4.00 4.16 2.11 2.20 2.29 7,306.68 8,540.58 8,880.81

CLP Holdings Integrated 2 HK HKD 2,408.25 80.24 Neutral 65.20 62.45 19,366.62 4.19 4.01 4.32 2.45 2.48 2.59 10,083.15 9,647.96 10,383.62

Hong Kong & China Gas Gas 3 HK HKD 7,182.32 52.11 Reduce 16.50 18.30 18,634.10 0.67 0.74 0.80 0.40 0.45 0.49 4,838.54 5,294.60 5,733.50

CKI Integrated 1038 HK HKD 2,254.21 15.42 Neutral 38.60 42.75 12,885.83 2.24 3.31 3.45 1.23 1.66 1.72 5,060.37 7,466.26 7,775.79

HK utilities average 16,397.30 2.63 3.02 3.18 1.55 1.70 1.77 6,822.18 7,737.35 8,193.43

Datang Intl IPP 991 HK CNY 13,310.04 36.20 Neutral 3.04 2.55 9,343.75 0.21 0.22 0.28 0.07 0.07 0.09 2,569.73 2,830.16 3,729.66

Huaneng Power Intl IPP 902 HK CNY 14,055.38 35.00 Neutral 4.75 4.53 11,113.60 0.28 0.28 0.36 0.20 0.15 0.20 3,347.99 3,869.92 5,034.48

Huadian Power Intl IPP 1071 HK CNY 6,771.08 41.00 Neutral 1.68 1.74 3,088.93 0.03 0.03 0.14 - 0.01 0.04 169.90 172.37 927.73

China Power Intl IPP 2380 HK CNY 5,107.06 31.00 Buy 2.25 2.00 1,316.44 0.13 0.17 0.24 0.05 0.06 0.08 666.89 859.44 1,227.17

China Resources Power IPP 836 HK HKD 4,735.97 31.00 Neutral 16.37 14.70 8,990.04 1.05 1.34 1.86 0.33 0.45 0.62 4,903.65 6,350.38 8,794.18

China power average 6,770.55 0.34 0.41 0.57 0.13 0.15 0.21 2,331.63 2,816.45 3,942.64

China Shenhua Energy Coal 1088 HK CNY 19,890.00 27.00 Buy 44.40 35.15 87,231.03 1.92 2.39 2.88 0.75 0.96 1.15 38,132.01 47,585.83 57,189.23

China Coal Energy Coal 1898 HK CNY 13,258.66 44.00 Neutral 10.86 10.20 19,412.68 0.56 0.66 0.87 0.15 0.18 0.23 7,466.36 8,793.67 11,572.22

Yanzhou Coal Mining Coal 1171 HK CNY 4,918.40 40.00 Buy 27.70 19.28 16,413.47 1.46 1.69 2.14 0.25 0.53 0.67 7,188.41 8,329.21 10,540.69

Hidili Industry Coal 1393 HK CNY 2,060.00 - Neutral 6.11 2.93 780.05 0.32 0.40 0.53 0.10 0.07 0.10 669.51 825.71 1,111.82

Shougang Fushan Coal 639 HK HKD 5,380.56 58.00 Buy 5.27 3.20 2,217.80 0.37 0.47 0.52 0.02 0.03 0.03 2,004.69 2,508.17 2,824.17

China coal average 25,211.01 0.93 1.12 1.39 0.25 0.35 0.44 11,092.19 13,608.52 16,647.63

Suntech Solar STP US USD 179.05 70.50 Neutral 2.20 3.24 583.73 0.51 (0.78) (1.03) - - - 90.76 (139.95) (183.96)

Canadian Solar Solar CSIQ US USD 42.84 70.10 Neutral 3.40 3.59 156.28 2.28 (0.52) (0.72) - - - 97.83 (22.42) (30.84)

Trina Solar Solar TSL US USD 68.05 70.00 Neutral 7.00 8.08 642.27 5.16 0.46 (0.55) - - - 351.16 31.45 (37.16)

Yingli Green Solar YGE US USD 155.66 67.10 Neutral 3.40 4.22 665.24 9.15 3.45 (5.61) - - - 1,386.78 536.79 (884.68)

LDK Solar Solar LDK US USD 148.10 45.70 Reduce 2.60 4.65 674.08 2.19 (0.07) (0.78) - - - 290.80 (10.06) (115.39)

JA Solar Solar JASO US CNY 179.64 63.20 Neutral 2.00 1.75 297.46 1.63 0.19 (0.18) - - - 265.96 34.60 (34.62)

Solargiga Solar 757 HK CNY 1,705.00 - Reduce 1.10 0.86 248.52 0.16 0.19 - - - - 278.11 314.58 -

GCL Poly Solar 3800 HK HKD 15,472.20 47.50 Neutral 2.50 2.49 4,964.97 0.26 0.31 0.15 0.05 0.05 0.05 4,023.58 4,804.76 2,261.48

China solar average 1,029.07 2.67 0.40 (1.09) 0.01 0.01 0.01 848.12 693.72 121.85

China Everbright Intl Water 257 HK HKD 3,652.46 51.40 Buy 3.90 3.44 1,629.56 0.17 0.20 0.24 0.02 0.03 0.04 613.42 746.00 894.83

Guangdong Investment Water 270 HK HKD 6,253.10 38.90 Neutral 5.30 4.46 3,582.88 0.35 0.41 0.44 0.15 0.16 0.18 2,196.39 2,557.53 2,758.18

China Water Affairs Water 855 HK HKD 1,529.35 59.50 Neutral 2.40 2.29 440.62 0.11 0.11 0.16 0.05 0.05 0.05 141.02 146.38 236.51

Beijing Enterprises Water Water 371 HK HKD 6,850.13 46.10 Buy 3.00 2.23 1,985.78 0.13 0.11 0.14 - - - 512.51 676.52 1,023.88

Hyflux Limited Water HYF SP SGD 857.93 - Reduce 1.00 1.38 937.22 0.09 0.05 0.10 0.04 0.01 0.03 79.33 38.87 85.05

Sound Global Ltd Water 967 HK CNY 1,290.00 45.60 Buy 4.40 3.55 590.23 0.28 0.32 0.37 0.05 0.07 0.08 365.86 419.21 494.36

Tianjin Capital Water 1065 HK CNY 1,427.23 46.90 Reduce 1.80 2.01 1,041.13 0.19 0.18 0.15 0.11 0.10 0.09 271.16 253.25 214.41

China water average 1,458.20 0.19 0.20 0.23 0.06 0.06 0.07 597.10 691.11 815.32

ENN Energy Gas 2688 HK CNY 1,050.15 65.00 Buy 29.05 23.15 3,136.28 0.96 1.28 1.64 0.29 0.32 0.49 1,013.09 1,345.13 1,723.10

Towngas China Gas 1083 HK HKD 2,460.35 25.54 Neutral 4.16 4.41 1,398.41 0.20 0.22 0.28 0.03 0.04 0.05 435.80 542.95 683.59

China Resources Gas Gas 1193 HK HKD 1,831.10 31.90 Buy 14.46 11.00 2,860.56 0.51 0.61 0.70 0.08 0.12 0.14 733.68 1,116.15 1,280.18

China Gas Gas 384 HK HKD 4,383.05 70.00 Neutral 3.32 3.58 2,022.37 0.26 0.16 0.24 0.01 0.02 0.03 875.64 625.90 1,042.24

Beijing Enterprises Gas 392 HK HKD 1,137.57 40.70 Buy 58.60 44.20 6,480.38 2.32 2.62 3.08 0.70 0.79 0.93 2,639.28 2,980.10 3,505.66

China gas average 3,179.60 0.85 0.98 1.19 0.22 0.26 0.33 1,139.50 1,322.05 1,646.95

China High Speed Wind 658 HK CNY 1,362.69 78.00 Neutral 4.69 4.41 774.56 0.99 0.60 0.55 0.28 0.14 0.14 1,272.32 818.19 749.07

China Longyuan Wind 916 HK CNY 7,464.29 36.30 Buy 7.40 6.00 5,772.18 0.24 0.36 0.46 0.05 0.05 0.07 1,804.69 2,698.49 3,439.63

Xinjiang Goldwind Wind 2208 HK CNY 2,694.59 65.80 Reduce 3.50 4.80 3,161.80 0.98 0.33 0.27 0.40 0.13 0.11 2,278.78 876.18 723.27

China wind average 3,236.18 0.74 0.43 0.43 0.24 0.11 0.11 1,785.26 1,464.29 1,637.32

Shanghai Electric Equipment 2727 HK CNY 12,823.63 36.90 Buy 4.70 4.20 10,353.56 0.22 0.25 0.28 0.07 0.08 0.09 2,783.61 3,269.06 3,639.25

Dongfang Electric Equipment 1072 HK CNY 2,003.86 49.10 Buy 30.50 25.30 7,401.71 1.31 1.58 1.67 0.13 0.16 0.17 2,617.41 3,174.33 3,340.80

Harbin Power Equipment 1133 HK CNY 1,376.81 49.00 Neutral 9.40 7.78 1,380.55 0.74 0.74 0.76 0.14 0.14 0.14 1,024.50 1,015.17 1,047.44

China equipment average 6,378.61 0.76 0.86 0.90 0.11 0.12 0.13 2,141.84 2,486.19 2,675.83

Korea Electric Power Integrated 015760 KS KRW 641.57 40.93 Buy 35,000.00 27,200.00 15,400.98 (112.47) (957.68) 52.00 - - 36.38 (72.16) (614.42) 33.36

Korea Gas Gas 036460 KS KRW 72.61 32.00 Buy 52,000.00 42,800.00 2,952.80 2,810.06 3,870.08 5,923.07 843.02 1,161.02 1,776.92 204.03 281.00 430.07

Korea utilities average 9,176.89 1,348.79 1,456.20 2,987.53 421.51 580.51 906.65 65.94 (166.71) 231.71

E-Ton Solar Tech Solar 3452 TT TWD 204.65 52.20 Reduce 37.00 12.90 207.14 (1.98) 2.11 2.91 - - - (404.70) 432.54 595.77

Motech Industries Solar 6244 TT TWD 346.30 61.00 Reduce 39.00 60.30 883.35 12.30 (0.95) (5.30) 7.00 5.50 2.50 4,259.47 (329.05) (1,837.08)

Taiwan solar average 545.25 5.16 0.58 (1.20) 3.50 2.75 1.25 1,927.39 51.74 (620.65)

Indonesia

Perusahaan Gas Negara Gas PGAS IJ IDR 24,241.51 43.10 Buy 3,900.00 3,450.00 9,338.23 283.69 244.14 252.24 154.43 167.64 155.08 6,876.59 5,918.26 6,114.78

Glow IPP GLOW TB THB 1,462.87 30.90 Neutral 62.00 54.50 2,544.72 3.09 3.12 5.18 1.86 1.95 2.23 4,514.00 4,568.61 7,581.05

Electricity Generating IPP EGCO TB THB 526.47 52.17 Buy 110.00 92.00 1,545.96 13.27 12.63 11.82 5.05 5.10 5.15 6,984.84 6,651.61 6,221.82

Ratchaburi Generating IPP RATCH TB THB 1,450.00 - Buy 41.00 44.00 2,036.39 3.97 4.02 3.97 2.28 2.32 2.35 5,758.57 5,824.68 5,762.61

Thai power average 2,042.35 6.77 6.59 6.99 3.06 3.12 3.25 5,752.47 5,681.63 6,521.83

Tenaga Nasional Integrated TNB MK MYR 5,440.88 40.10 Neutral 6.60 6.14 10,978.46 0.47 0.08 0.47 0.16 (0.01) 0.13 2,545.90 440.71 2,541.06

YTLP Integrated YTLP MK MYR 6,753.12 34.39 Neutral 2.28 1.84 4,415.76 0.18 0.19 0.18 0.11 0.12 0.12 1,126.40 1,264.11 1,242.02

Malaysia utilities average 7,697.11 0.32 0.13 0.33 0.14 0.05 0.12 1,836.15 852.41 1,891.54

Energy Development Corp Power EDC PM PHP 18,750.00 50.00 Buy 7.20 6.20 2,712.38 0.39 0.35 0.53 0.13 0.11 0.16 7,237.80 6,632.55 9,849.43

Meralco Power MER PM PHP 1,127.71 38.99 Reduce 134.10 263.00 6,916.59 13.33 16.58 16.85 4.00 5.80 6.32 15,028.18 18,693.52 18,997.42

Philippines utilities average 4,814.49 6.86 8.47 8.69 2.07 2.95 3.24 11,132.99 12,663.03 14,423.42

Suzlon WTG SUEL IN INR 1,556.72 42.00 Rating Suspended 88.80 27.25 966.59 1.33 5.70 10.18 - - - 2,025.30 8,868.10 15,849.57

NTPC* IPP NTPC IN INR 8,245.46 15.50 Buy 206.00 174.75 28,756.07 9.67 10.73 11.02 4.44 4.43 4.65 79,767.47 88,463.88 90,891.55

JSW Energy Integrated JSW IN INR 1,640.05 23.30 Reduce 65.00 53.95 1,765.82 4.55 5.14 8.58 0.87 - - 7,454.90 8,435.89 14,072.25

Adani Power Integrated ADANI IN INR 2,180.04 26.50 Neutral 115.00 88.30 3,841.68 0.78 2.85 10.02 - - - 1,701.07 6,214.96 21,852.02

Power Grid* Grid PWGR IN INR 4,629.73 30.50 Buy 120.00 100.85 9,318.12 5.08 5.83 6.48 1.75 2.04 2.45 21,372.10 25,365.08 30,001.65

Reliance Power* Integrated RPWR IN INR 2,805.08 15.20 Reduce 136.00 97.40 5,452.66 2.85 3.03 3.45 - - - 6,838.95 7,752.07 9,671.44

Lanco Infratech* Integrated LANCI IN INR 2,407.80 32.10 Buy 30.00 14.90 715.99 2.12 1.28 0.48 - - - 4,741.58 3,072.15 1,143.92

India utilities average 7,259.56 3.77 4.94 7.17 1.01 0.92 1.01 17,700.19 21,167.45 26,211.77

Coal India Coal COAL IN INR 6,316.36 10.00 Buy 433.00 342.90 43,224.69 15.56 17.30 20.32 3.50 3.90 5.00 98,302.16 109,276.35 128,332.54

India coal average 43,224.69 15.56 17.30 20.32 3.50 3.90 5.00 98,302.16 109,276.35 128,332.54

Australia

AGL ENERGY LTD Integrated AGK AU AUD 461.31 100.00 Buy 17.50 14.56 6,282.51 0.96 0.94 1.05 0.59 0.60 0.63 428.90 431.07 482.11

EPS (local $) DPS (local $) Net profit (local $ m)


81

Appendix VII: Sector valuation II




Company 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F

Power Assets Holdings Ltd 9.10 16.89 3.98 - 4.32 3.98 9.10 16.89 3.98 32.09 24.25 18.17 NA NA NA 15.61 13.36 12.85 3.95 4.12 4.28

CLP Holdings 23.03 (4.32) 7.63 (1.15) 1.41 4.15 23.03 (4.32) 7.63 40.77 58.65 53.98 NA NA NA 14.92 15.59 14.48 3.92 3.98 4.14

Hong Kong & China Gas (14.37) 9.43 8.29 14.28 12.50 8.89 (6.50) 9.43 8.29 22.45 22.94 23.57 NA NA NA 27.16 24.82 22.92 2.19 2.46 2.68

CKI (9.12) 47.54 4.15 2.82 34.13 4.15 (9.12) 47.54 4.15 9.35 9.96 10.73 NA NA NA 19.04 12.91 12.39 2.89 3.87 4.03

HK utilities average 2.16 17.39 6.01 3.99 13.09 5.29 4.13 17.39 6.01 26.16 28.95 26.61 NA NA NA 19.18 16.67 15.66 3.24 3.61 3.78

Datang Intl 60.04 5.84 26.83 (4.31) 1.86 31.78 67.24 10.13 31.78 474.15 393.44 404.96 7.05 6.47 6.32 10.43 9.26 6.93 3.21 3.48 4.84

Huaneng Power Intl (32.38) (0.43) 30.09 (4.76) (24.28) 30.09 (32.08) 15.59 30.09 246.31 253.82 253.63 3.92 3.47 3.22 13.99 13.20 9.63 5.17 4.17 5.71

Huadian Power Intl (86.94) 1.45 438.21 (100.00) NA 438.21 (85.32) 1.45 438.21 549.24 595.53 605.54 4.35 4.24 4.04 59.23 54.86 9.67 na 0.55 3.10

China Power Intl (7.73) 28.87 42.79 - 28.87 42.79 28.49 28.87 42.79 304.73 320.64 327.64 3.90 3.67 3.62 13.08 10.59 7.03 2.63 3.61 5.44

China Resources Power (11.84) 27.65 38.24 (13.15) 35.98 38.48 (7.78) 29.50 38.48 161.53 174.05 175.46 7.01 6.71 6.45 12.11 8.79 6.02 2.63 3.81 5.56

China power average (15.77) 12.68 115.23 (24.44) 10.61 116.27 (5.89) 17.11 116.27 347.19 347.49 353.44 5.25 4.91 4.73 21.77 19.34 7.86 3.41 3.12 4.93

China Shenhua Energy 20.27 24.79 20.18 41.51 27.60 20.18 20.27 24.79 20.18 net cash net cash net cash NA NA NA 15.60 11.75 9.27 2.51 3.41 4.31

China Coal Energy 0.77 17.78 31.60 (2.78) 17.78 31.60 0.77 17.78 31.60 net cash 11.12 24.74 NA NA NA 15.41 12.30 8.86 1.73 2.16 3.00

Yanzhou Coal Mining 74.60 15.87 26.55 (37.50) 111.79 26.55 74.61 15.87 26.55 43.51 45.46 31.46 NA NA NA 11.22 9.10 6.82 1.52 3.43 4.58

Hidili Industry 65.07 23.33 34.65 NA (35.00) 54.17 65.92 23.33 34.65 60.62 60.53 58.17 NA NA NA 7.76 5.93 4.18 4.01 2.76 4.49

Shougang Fushan 47.16 25.54 12.60 (80.19) 39.13 12.60 62.54 25.12 12.60 net cash net cash net cash NA NA NA 8.78 6.89 6.10 0.58 0.80 0.90

China coal average 41.57 21.46 25.12 (19.74) 32.26 29.02 44.82 21.38 25.12 52.07 39.03 38.12 NA NA NA 11.75 9.19 7.05 2.07 2.51 3.46

Suntech (5.81) (254.20) NA NA NA NA (5.81) (254.20) NA 66.54 115.27 129.27 NA NA NA 6.33 na na na na na

Canadian Solar 345.81 (122.91) NA NA NA NA 361.87 (122.91) NA 60.31 131.07 116.38 NA NA NA 1.42 na na na na na

Trina Solar 146.55 (91.04) (218.16) NA NA NA 207.96 (91.04) (218.16) net cash 27.76 28.46 NA NA NA 1.73 19.31 na na na na

Yingli Green NA (62.32) (262.74) NA NA NA NA (61.29) (264.81) 43.00 68.87 84.53 NA NA NA 3.10 7.95 na na na na

LDK Solar NA (103.11) NA NA NA NA NA (103.46) NA 224.97 181.36 193.71 NA NA NA 2.05 na na na na na

JA Solar NA (88.20) (192.00) NA NA NA NA (86.99) (200.05) 6.90 33.72 25.79 NA NA NA 1.04 8.51 na na na na

Solargiga NA 18.49 NA NA NA NA NA 13.11 NA net cash 13.98 net cash NA NA NA 4.39 3.70 NA na na -

GCL Poly NA 19.42 (52.93) NA - - NA 19.42 (52.93) 45.10 61.82 51.16 NA NA NA 9.59 8.03 17.07 2.05 2.05 2.05

China solar average 162.19 (85.48) (181.46) NA NA NA 188.01 (85.92) (183.99) 74.47 79.23 89.90 NA NA NA 3.71 9.50 17.07 2.05 2.05 1.02

China Everbright Intl 49.78 21.28 19.95 20.89 21.02 19.95 67.12 21.61 19.95 46.98 55.67 54.64 NA NA NA 20.72 17.09 14.25 0.73 0.88 1.05

Guangdong Investment 4.63 16.07 7.48 36.24 9.17 7.49 5.21 16.44 7.85 10.85 3.05 net cash NA NA NA 12.80 10.99 10.20 3.36 3.67 3.94

China Water Affairs 441.80 (3.05) 50.40 67.04 (0.84) (4.85) 461.26 3.80 61.58 71.55 54.69 18.88 NA NA NA 21.56 25.37 16.30 2.19 2.17 2.06

Beijing Enterprises Water 108.36 (13.83) 29.07 NA NA NA 165.95 32.00 51.34 168.66 60.19 52.99 NA NA NA 17.51 20.32 15.75 na na na

Hyflux Limited (5.85) (51.93) 118.79 24.96 (67.37) 118.79 0.40 (51.00) 118.79 75.05 20.78 73.19 NA NA NA 15.00 30.61 13.99 3.03 0.99 2.16

Sound Global Ltd 29.73 14.58 12.99 NA 45.00 12.99 29.73 14.58 17.93 net cash net cash net cash NA NA NA 10.65 8.78 7.39 1.70 2.60 3.09

Tianjin Capital 11.60 (6.60) (15.34) 37.50 (6.60) (15.34) 11.60 (6.60) (15.34) 105.42 89.05 54.17 NA NA NA 9.00 9.10 10.23 6.43 6.36 5.66

China water average 91.43 (3.35) 31.91 37.32 0.06 23.17 105.90 4.40 37.44 79.75 47.24 50.77 NA NA NA 15.32 17.47 12.59 2.91 2.78 3.00

ENN Energy 24.08 32.78 28.10 51.84 10.65 53.72 26.18 32.78 28.10 56.56 37.80 21.00 NA NA NA 21.05 15.28 11.26 1.44 1.67 2.72

Towngas China 47.21 10.97 25.90 50.00 24.00 26.50 64.40 24.59 25.90 26.42 27.48 26.89 NA NA NA 22.13 19.94 15.84 0.68 0.84 1.07

China Resources Gas 48.11 20.07 14.70 28.08 52.13 14.70 59.64 52.13 14.70 net cash net cash net cash NA NA NA 21.67 18.05 15.74 0.72 1.09 1.25

China Gas 741.87 (38.27) 47.11 15.75 58.42 20.00 744.56 (28.52) 66.52 229.05 70.73 53.74 NA NA NA 17.61 29.75 17.86 0.39 0.61 0.74

Beijing Enterprises 10.02 12.87 17.64 7.69 12.89 17.64 10.02 12.91 17.64 net cash net cash 0.92 NA NA NA 19.89 17.61 14.97 1.58 1.79 2.10

China gas average 174.26 7.68 26.69 30.67 31.62 26.51 180.96 18.78 30.57 104.01 45.34 25.64 NA NA NA 20.47 20.13 15.13 0.96 1.20 1.58

China High Speed 11.76 (39.53) (8.45) 6.06 (50.38) 2.58 15.02 (35.69) (8.45) 31.76 37.38 28.44 NA NA NA 4.49 5.89 6.43 7.49 3.95 4.05

China Longyuan 41.47 49.53 27.46 NA 0.42 27.46 105.10 49.53 27.46 142.15 183.67 202.86 NA NA NA 21.33 13.79 10.39 1.05 1.09 1.44

Xinjiang Goldwind 27.81 (66.96) (17.45) 532.99 (67.11) (17.45) 32.14 (61.55) (17.45) net cash net cash net cash NA NA NA 4.14 11.77 14.26 9.71 3.40 2.81

China wind average 27.01 (18.99) 0.52 269.52 (39.02) 4.20 50.75 (15.91) 0.52 86.96 110.52 115.65 NA NA NA 9.99 10.48 10.36 6.08 2.81 2.77

Shanghai Electric 11.66 16.39 11.32 10.71 17.44 11.32 13.46 17.44 11.32 65.74 67.64 62.44 NA NA NA 16.27 13.14 11.80 1.83 2.28 2.54

Dongfang Electric 55.32 21.28 5.24 62.50 21.85 5.24 73.66 21.28 5.24 263.74 211.59 168.21 NA NA NA 16.44 12.74 12.10 0.61 0.79 0.83

Harbin Power 69.00 (0.91) 3.18 105.88 (0.91) 3.18 69.00 (0.91) 3.18 35.02 30.86 28.95 NA NA NA 8.87 8.41 8.15 2.12 2.24 2.31

China equipment average 45.33 12.25 6.58 59.70 12.79 6.58 52.04 12.60 6.58 121.50 103.36 86.53 NA NA NA 13.86 11.43 10.69 1.52 1.77 1.89

Korea Electric Power (131.11) NA NA NA NA NA (131.11) NA NA 90.22 93.99 97.43 NA NA NA na na 535.88 na na 0.13

Korea Gas (14.27) 37.72 53.05 (14.27) 37.72 53.05 (14.27) 37.72 53.05 510.39 543.02 496.84 NA NA NA 15.23 11.06 7.23 1.97 2.71 4.15

Korea utilities average (72.69) 37.72 53.05 (14.27) 37.72 53.05 (72.69) 37.72 53.05 300.30 318.50 297.13 NA NA NA 15.23 11.06 271.55 1.97 2.71 2.14

E-Ton Solar Tech NA NA 37.74 NA NA NA NA NA 37.74 82.79 82.20 78.99 NA NA NA na 6.10 4.43 na na na

Motech Industries 2,975.00 (107.73) NA 250.00 (21.43) (54.55) 12,735.15 (107.73) NA net cash 17.63 25.41 NA NA NA 4.95 na na 11.61 9.12 4.15

Taiwan solar average 2,975.00 (107.73) 37.74 250.00 (21.43) (54.55) 12,735.15 (107.73) 37.74 82.79 49.92 52.20 NA NA NA 4.95 6.10 4.43 11.61 9.12 4.15

Indonesia

Perusahaan Gas Negara 22.62 (13.94) 3.32 0.16 8.55 (7.49) 24.98 (13.94) 3.32 12.42 net cash net cash NA NA NA 12.16 14.13 13.68 4.48 4.86 4.50

Glow 19.23 1.21 65.94 1.20 4.99 14.47 19.23 1.21 65.94 162.00 191.01 168.46 NA NA NA 17.66 17.45 10.52 3.41 3.58 4.10

Electricity Generating (6.95) (4.77) (6.46) 1.00 1.00 1.00 (6.95) (4.77) (6.46) 1.41 net cash net cash NA NA NA 6.93 7.28 7.78 5.49 5.54 5.60

Ratchaburi Generating (14.46) 1.15 (1.07) 1.50 1.50 1.50 (14.46) 1.15 (1.07) 25.65 17.95 12.09 NA NA NA 11.08 10.95 11.07 5.19 5.27 5.35

Thai power average (0.73) (0.80) 19.47 1.23 2.50 5.66 (0.73) (0.80) 19.47 63.02 104.48 90.27 NA NA NA 11.89 11.90 9.79 4.70 4.80 5.01

Tenaga Nasional 17.82 (82.73) 476.58 46.90 (107.60) NA 18.02 (82.69) 476.58 54.98 54.32 41.94 NA NA NA 13.12 75.80 13.15 2.55 (0.19) 2.14

YTLP 56.71 5.22 (1.75) (11.17) 1.50 1.50 74.21 12.23 (1.75) 206.23 202.96 203.52 NA NA NA 12.80 11.59 11.79 6.25 6.34 6.43

Malaysia utilities average 37.26 (38.75) 237.42 17.87 (53.05) 1.50 46.12 (35.23) 237.42 130.61 128.64 122.73 NA NA NA 12.96 43.70 12.47 4.40 3.07 4.29

Energy Development Corp (0.53) (8.36) 48.50 33.54 (20.29) 48.50 (0.53) (8.36) 48.50 114.85 102.27 78.67 NA NA NA 16.14 17.61 11.86 2.14 1.70 2.53

Meralco 549.92 24.39 1.63 59.87 45.12 8.88 561.45 24.39 1.63 53.40 30.34 15.00 NA NA NA 19.89 15.99 15.73 1.51 2.19 2.38

Philippines utilities average 274.70 8.01 25.06 46.71 12.41 28.69 280.46 8.01 25.06 84.12 66.31 46.83 NA NA NA 18.01 16.80 13.80 1.82 1.95 2.46

Suzlon (82.71) 329.60 78.73 NA NA NA (82.12) 337.87 78.73 105.38 112.95 98.08 NA NA NA 21.69 4.95 2.77 na na na

NTPC* 29.60 10.90 2.74 5.50 (0.28) 5.07 29.60 10.90 2.74 34.23 39.61 54.73 NA NA NA 18.06 16.29 15.85 2.54 2.53 2.66

JSW Energy (10.21) 13.16 66.81 NA (100.00) NA 169.43 13.16 66.81 126.27 132.62 126.36 NA NA NA 11.87 10.49 6.29 1.62 na na

Adani Power NA 265.36 251.60 NA NA NA NA 265.36 251.60 162.77 327.39 325.11 NA NA NA 113.16 30.97 8.81 na na na

Power Grid* 21.37 14.87 11.09 24.72 16.54 20.00 21.37 18.68 18.28 195.37 174.13 196.65 NA NA NA 19.86 17.29 15.56 1.74 2.02 2.43

Reliance Power* 179.70 6.35 13.62 NA NA NA 179.70 13.35 24.76 net cash 16.42 87.74 NA NA NA 34.14 32.10 28.25 na na na

Lanco Infratech* 67.75 (39.68) (62.76) NA NA NA 69.12 (35.21) (62.76) 197.92 305.16 598.44 NA NA NA 7.04 11.68 31.36 na na na

India utilities average 34.25 85.80 51.69 15.11 (27.91) 12.53 64.52 89.16 54.31 136.99 158.32 212.44 NA NA NA 32.26 17.68 15.56 1.97 2.28 2.55

Coal India 141.92 11.16 17.44 29.59 11.47 28.21 141.92 11.16 17.44 net cash net cash net cash NA NA NA 22.03 19.82 16.88 1.02 1.14 1.46

India coal average 141.92 11.16 17.44 29.59 11.47 28.21 141.92 11.16 17.44 net cash net cash net cash NA NA NA 22.03 19.82 16.88 1.02 1.14 1.46

Australia

AGL ENERGY LTD 12.47 (1.19) 10.67 9.26 1.69 5.00 13.23 0.51 11.84 7.25 6.59 15.94 NA NA NA 15.26 15.43 13.94 4.05 4.12 4.33

Net Gearing (%) EV/MW (local $) P/E (x) Yield (%)EPS growth (%) DPS growth (%) Net earnings growth (%)


82

Appendix VII: Sector valuation III




Company 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F 2010 2011F 2012F

Power Assets Holdings Ltd 61.64 55.01 55.01 25.75 27.55 29.42 2.08 1.94 1.82 13.98 11.64 11.06 70.41 69.56 69.58 9.68 11.46 11.86 13.65 15.02 14.61 9.55 10.23 10.53

CLP Holdings 58.45 61.95 59.95 31.11 32.65 34.41 2.01 1.91 1.81 10.02 9.29 8.73 28.47 27.59 26.91 9.53 7.81 8.10 13.85 12.57 12.86 6.69 5.86 5.76

Hong Kong & China Gas 59.38 61.04 61.38 4.92 5.27 5.64 3.72 3.47 3.25 17.89 16.80 15.72 38.36 37.17 36.24 10.46 10.86 11.17 14.19 14.46 14.64 8.78 8.92 9.03

CKI 55.00 50.00 50.00 23.13 24.56 26.06 1.85 1.74 1.64 19.76 13.50 13.18 22.62 26.93 27.60 9.50 12.48 12.32 10.73 13.89 13.63 9.99 12.29 12.01

HK utilities average 58.62 57.00 56.58 21.23 22.51 23.88 2.41 2.27 2.13 15.41 12.81 12.17 39.97 40.31 40.08 9.79 10.65 10.86 13.10 13.98 13.93 8.75 9.32 9.33

Datang Intl 33.53 32.27 33.53 2.51 2.96 3.15 0.87 0.69 0.62 10.18 9.11 8.02 27.20 27.14 28.19 1.78 1.73 2.08 9.02 8.06 9.18 1.31 1.29 1.56

Huaneng Power Intl 72.33 55.00 55.00 3.83 3.95 4.11 1.01 0.92 0.84 9.42 8.43 7.17 18.46 17.79 18.21 2.64 2.79 3.47 6.98 7.08 8.88 1.63 1.70 2.08

Huadian Power Intl - 30.00 30.00 2.39 2.41 2.50 0.62 0.58 0.53 14.66 10.74 8.55 14.20 17.37 19.47 0.22 0.20 0.98 0.79 0.76 3.75 0.15 0.13 0.65

China Power Intl 34.46 34.46 34.46 2.40 2.51 2.66 0.71 0.64 0.57 10.81 9.26 7.81 28.84 28.45 27.73 1.51 1.69 2.15 4.48 5.23 6.30 1.23 1.44 1.83

China Resources Power 31.38 33.43 33.49 8.93 9.80 11.03 1.41 1.20 1.01 10.01 7.61 5.97 24.58 25.58 27.22 5.21 5.63 6.80 12.30 14.34 17.83 3.94 4.31 5.19

China power average 34.34 37.03 37.30 4.01 4.32 4.69 0.92 0.81 0.71 11.02 9.03 7.50 22.66 23.26 24.17 2.27 2.41 3.10 6.71 7.09 9.19 1.65 1.77 2.26

China Shenhua Energy 39.12 40.00 40.00 9.97 11.41 13.13 3.00 2.46 2.03 8.43 6.40 4.99 45.73 42.73 44.67 16.35 17.88 18.87 20.67 22.38 23.44 14.86 16.67 17.97

China Coal Energy 26.61 26.61 26.61 5.58 6.07 6.71 1.55 1.34 1.15 7.09 6.53 5.07 20.86 21.36 24.49 9.10 8.25 9.46 10.47 11.38 13.65 7.52 7.63 8.07

Yanzhou Coal Mining 17.11 31.27 31.27 7.59 8.75 10.23 2.16 1.76 1.43 7.60 6.07 4.51 37.53 38.07 39.28 16.68 12.37 14.64 27.92 20.72 22.58 15.48 11.69 13.38

Hidili Industry 31.11 16.40 18.77 3.38 3.72 4.16 0.74 0.63 0.54 7.99 6.31 5.02 48.15 52.42 49.85 5.66 6.17 7.57 10.11 11.28 13.70 5.77 6.05 7.35

Shougang Fushan 4.96 5.50 5.50 3.37 3.81 4.31 0.95 0.84 0.74 4.53 3.02 2.17 62.07 65.70 65.78 10.08 12.16 12.01 10.61 12.97 12.92 8.23 10.70 11.88

China coal average 23.78 23.95 24.43 5.98 6.75 7.71 1.68 1.41 1.18 7.13 5.67 4.35 42.87 44.06 44.82 11.57 11.36 12.51 15.96 15.75 17.26 10.37 10.55 11.73

Suntech - - - 10.43 8.05 7.01 0.30 0.39 0.45 4.68 11.78 55.52 12.46 6.08 1.66 9.68 (18.91) (8.92) 13.67 (27.08) (13.65) 6.32 (10.21) (4.28)

Canadian Solar - - - 12.47 11.90 11.18 0.25 0.27 0.28 2.94 9.78 11.38 10.43 4.87 4.61 8.88 (3.78) (5.46) 10.13 (4.29) (6.24) 5.03 (1.70) (2.18)

Trina Solar - - - 17.25 17.31 16.76 0.46 0.46 0.47 0.92 6.54 9.47 25.38 7.44 5.28 25.42 (0.17) (2.30) 33.66 (0.26) (3.21) 25.83 (0.18) (1.80)

Yingli Green - - - 55.11 57.24 50.91 0.49 0.47 0.53 2.35 4.20 10.17 26.40 15.92 10.47 12.51 3.99 (6.18) 18.51 6.22 (10.45) 8.85 2.67 (4.13)

LDK Solar - - - 7.67 9.55 8.77 0.59 0.47 0.51 4.96 8.28 11.87 23.66 16.58 13.86 18.25 (0.39) (4.13) 30.49 (0.83) (8.51) 6.25 (0.18) (1.98)

JA Solar - - - 6.21 5.82 5.18 0.26 0.28 0.31 0.97 4.29 6.20 19.71 9.57 10.48 20.98 0.48 (4.31) 31.24 0.67 (6.06) 23.99 0.45 (4.11)

Solargiga - - - 0.98 1.22 - 0.71 0.57 - 0.74 2.75 NA 19.27 18.66 NA 17.38 16.59 - 18.22 17.25 N/A 17.24 15.08 -

GCL Poly 19.61 16.42 34.89 1.04 1.36 1.52 2.39 1.83 1.64 6.62 5.25 7.97 37.42 37.05 24.62 18.92 15.24 6.43 28.98 25.81 10.16 14.71 11.82 4.70

China solar average 2.45 2.05 4.36 13.89 14.06 12.66 0.68 0.59 0.53 3.02 6.61 16.08 21.84 14.52 10.14 16.50 1.63 (3.11) 23.11 2.19 (5.42) 13.53 2.22 (1.72)

China Everbright Intl 14.83 14.80 14.80 1.46 1.64 1.84 2.35 2.10 1.87 14.28 12.21 10.00 35.95 35.47 39.59 7.55 7.65 7.47 12.44 13.19 14.08 7.67 7.19 7.37

Guangdong Investment 42.46 39.93 39.93 3.07 3.31 3.57 1.45 1.35 1.25 6.48 5.70 5.25 68.88 72.21 73.05 10.58 10.68 10.96 13.39 12.85 12.79 8.80 9.01 9.37

China Water Affairs 45.03 46.06 29.14 1.92 2.07 2.34 1.19 1.11 0.98 11.18 8.50 5.03 31.12 32.22 39.07 8.04 9.32 4.82 13.63 15.58 7.34 4.97 5.76 3.11

Beijing Enterprises Water - - - 0.85 1.17 1.38 2.62 1.91 1.61 24.13 21.96 14.73 14.34 24.71 22.51 7.90 8.05 7.96 15.73 12.16 11.05 4.70 4.76 6.04

Hyflux Limited 44.19 30.00 30.00 0.59 1.08 1.15 2.35 1.27 1.19 10.42 10.24 9.52 26.61 28.44 24.95 9.57 2.33 4.70 21.03 7.59 15.31 8.66 3.13 4.99

Sound Global Ltd 18.06 22.86 22.86 1.50 1.77 2.19 2.02 1.61 1.24 6.19 5.09 3.91 27.52 23.88 23.28 11.40 14.51 16.10 16.51 19.91 18.47 17.62 17.77 15.95

Tianjin Capital 57.90 57.90 57.90 2.42 2.49 2.56 0.71 0.65 0.60 8.35 8.70 7.53 52.08 41.58 37.95 4.17 3.94 3.40 8.04 7.23 5.95 3.75 3.27 3.04

China water average 31.78 30.22 27.80 1.69 1.93 2.15 1.81 1.43 1.25 11.58 10.34 8.00 36.64 36.93 37.20 8.46 8.07 7.92 14.40 12.64 12.14 8.02 7.27 7.12

ENN Energy 30.00 25.00 30.00 5.74 6.70 7.85 3.44 2.77 2.24 9.61 6.55 5.30 20.27 21.16 20.23 9.32 8.44 9.69 14.51 16.20 17.24 6.60 7.51 8.58

Towngas China 15.05 16.82 16.90 3.50 3.66 3.91 1.26 1.20 1.13 14.93 11.55 9.70 19.41 18.31 17.08 4.89 4.68 5.62 5.44 5.78 6.85 3.66 3.91 4.63

China Resources Gas 15.55 19.70 19.70 3.10 3.59 4.16 3.54 3.06 2.65 11.64 7.47 6.32 19.66 21.17 20.35 7.99 9.30 9.23 18.09 18.20 18.04 7.09 8.19 8.19

China Gas 5.30 13.61 11.10 1.23 1.80 2.01 2.92 1.99 1.78 15.37 9.04 6.82 17.13 14.72 15.17 7.49 5.47 7.29 23.84 10.44 12.50 4.99 3.16 4.92

Beijing Enterprises 30.16 30.17 30.17 30.13 32.01 34.25 1.47 1.38 1.29 8.59 8.07 7.36 15.31 14.60 14.20 6.19 6.36 6.87 8.05 8.43 9.30 5.16 5.45 5.95

China gas average 19.21 21.06 21.57 8.74 9.55 10.44 2.53 2.08 1.82 12.03 8.54 7.10 18.36 17.99 17.40 7.17 6.85 7.74 13.99 11.81 12.79 5.50 5.64 6.45

China High Speed 28.20 23.14 25.93 5.77 5.70 6.11 0.65 0.62 0.58 3.92 4.80 4.34 25.30 21.99 21.59 17.40 7.70 7.46 23.42 9.64 9.31 12.26 5.61 5.63

China Longyuan 22.33 15.00 15.00 3.12 3.43 3.83 1.64 1.42 1.23 12.96 11.47 10.11 37.51 44.02 48.71 4.74 4.62 4.68 8.94 11.05 12.70 3.31 3.43 3.66

Xinjiang Goldwind 40.20 40.02 40.02 5.74 4.92 5.06 0.71 0.78 0.76 1.53 4.09 5.82 17.50 11.41 11.03 21.37 6.12 4.99 24.76 6.60 5.38 15.44 5.00 4.05

China wind average 30.25 26.05 26.98 4.88 4.68 5.00 1.00 0.94 0.85 6.13 6.79 6.76 26.77 25.81 27.11 14.51 6.14 5.71 19.04 9.10 9.13 10.34 4.68 4.45

Shanghai Electric 29.72 29.99 29.99 2.11 2.30 2.50 1.69 1.46 1.34 11.98 9.34 8.38 7.12 8.40 8.69 10.43 10.77 11.02 11.28 11.58 11.83 3.49 3.77 3.87

Dongfang Electric 9.95 10.00 10.00 5.51 7.10 8.76 3.90 2.84 2.30 19.28 13.82 12.75 9.59 11.16 11.19 25.43 24.54 20.60 26.15 25.14 21.03 4.06 4.31 4.11

Harbin Power 18.81 18.81 18.81 7.00 7.60 8.22 0.94 0.82 0.75 7.02 6.12 5.81 6.07 6.39 6.27 8.73 8.00 7.67 11.21 10.10 9.62 2.53 2.59 2.54

China equipment average 19.50 19.60 19.60 4.87 5.66 6.49 2.18 1.71 1.47 12.76 9.76 8.98 7.59 8.65 8.72 14.86 14.44 13.10 16.21 15.61 14.16 3.36 3.55 3.51

Korea Electric Power - - 69.96 64,302.12 66,793.42 72,377.03 0.42 0.41 0.38 6.94 8.72 7.59 19.78 14.89 16.55 (0.10) (0.78) 0.04 (0.18) (1.46) 0.07 (0.08) (0.61) 0.03

Korea Gas 30.00 30.00 30.00 60,105.82 63,132.88 67,894.92 0.71 0.68 0.63 13.80 12.57 11.74 6.66 7.16 6.71 1.10 1.29 2.05 4.75 6.28 9.04 0.78 0.92 1.34

Korea utilities average 15.00 15.00 49.98 62,203.97 64,963.15 70,135.98 0.57 0.54 0.50 10.37 10.64 9.67 13.22 11.03 11.63 0.50 0.26 1.04 2.29 2.41 4.56 0.35 0.15 0.68

E-Ton Solar Tech - - - 41.64 43.75 46.67 0.31 0.29 0.28 21.03 7.55 5.77 8.82 7.99 9.42 (13.80) 2.58 3.44 (26.56) 4.95 6.44 (12.26) 2.25 2.89

Motech Industries 56.91 (578.82) (47.13) 67.11 59.11 47.77 0.90 1.02 1.26 3.62 14.23 62.55 17.63 7.34 2.94 19.49 (1.19) (7.54) 23.65 (1.51) (9.93) 17.85 (1.15) (6.53)

Taiwan solar average 28.46 (289.41) (23.56) 54.38 51.43 47.22 0.60 0.66 0.77 12.32 10.89 34.16 13.23 7.67 6.18 2.84 0.69 (2.05) (1.45) 1.72 (1.74) 2.80 0.55 (1.82)

Indonesia

Perusahaan Gas Negara 54.44 68.66 61.48 572.10 697.06 787.89 6.03 4.95 4.38 7.97 8.31 7.59 54.21 51.57 51.16 26.50 29.08 25.33 48.74 44.03 34.81 28.95 32.31 29.96

Glow 60.21 62.46 43.09 23.09 24.85 28.04 2.36 2.19 1.94 14.98 15.46 9.32 25.17 24.92 28.99 6.21 4.40 7.06 17.66 13.19 20.13 6.50 4.27 6.39

Electricity Generating 38.06 40.37 43.59 104.28 111.81 118.48 0.88 0.82 0.78 4.72 4.63 4.61 55.32 51.25 47.23 11.23 10.12 9.04 13.25 11.69 10.26 12.20 11.58 10.83

Ratchaburi Generating 57.50 57.70 59.20 32.39 34.09 35.71 1.36 1.29 1.23 7.50 6.76 6.56 19.66 19.82 18.86 9.86 10.27 10.04 12.59 12.08 11.39 8.71 8.74 8.65

Thai power average 51.93 53.51 48.63 53.26 56.92 60.74 1.53 1.44 1.32 9.07 8.95 6.83 33.38 32.00 31.70 9.10 8.26 8.71 14.50 12.32 13.93 9.13 8.20 8.62

Tenaga Nasional 33.34 (14.67) 28.10 5.29 5.41 6.00 1.16 1.13 1.02 6.30 10.02 6.02 25.56 15.53 22.57 6.62 2.73 6.82 11.69 4.51 10.66 4.89 1.97 4.86

YTLP 64.60 62.31 64.37 1.13 1.20 1.26 1.63 1.54 1.46 9.37 9.03 9.31 20.64 20.63 21.12 4.46 5.59 4.68 16.44 16.11 14.95 3.85 4.15 3.89

Malaysia utilities average 48.97 23.82 46.24 3.21 3.31 3.63 1.40 1.34 1.24 7.83 9.53 7.67 23.10 18.08 21.85 5.54 4.16 5.75 14.06 10.31 12.80 4.37 3.06 4.37

Energy Development Corp 34.49 30.00 30.00 1.64 1.89 2.26 3.81 3.30 2.76 11.06 10.24 8.25 55.21 58.64 56.43 5.92 8.27 11.62 13.86 20.39 25.40 5.53 8.65 11.89

Meralco 30.00 35.00 37.50 57.33 68.10 78.63 4.62 3.89 3.37 11.51 9.34 8.96 12.68 14.44 14.18 14.87 17.10 16.24 24.63 26.43 22.96 9.53 11.51 11.45

Philippines utilities average 32.25 32.50 33.75 29.48 35.00 40.45 4.22 3.59 3.06 11.28 9.79 8.61 33.94 36.54 35.31 10.40 12.69 13.93 19.25 23.41 24.18 7.53 10.08 11.67

Suzlon - - - 57.39 63.09 73.27 0.47 0.43 0.37 6.88 5.86 4.68 9.29 10.74 11.04 0.88 3.64 7.17 2.31 9.46 14.93 0.65 2.97 4.69

NTPC* 45.89 41.27 42.20 75.72 82.34 89.12 2.31 2.12 1.96 14.27 13.30 13.33 25.07 23.63 22.11 8.94 8.40 7.53 14.57 13.97 13.34 9.49 8.88 7.95

JSW Energy 19.24 - - 29.15 34.29 42.87 1.85 1.57 1.26 12.26 10.49 6.08 51.54 36.84 41.22 6.78 5.96 8.09 23.82 16.22 22.24 6.79 6.02 8.28

Adani Power - - - 26.50 29.36 39.38 3.33 3.01 2.24 117.53 35.32 10.42 56.07 56.97 61.58 1.17 2.14 5.58 4.22 10.21 29.17 1.41 2.62 6.01

Power Grid* 34.48 34.98 37.79 37.87 46.15 50.18 2.66 2.19 2.01 13.26 12.26 10.63 82.35 83.66 83.71 4.11 4.53 4.15 13.36 14.46 13.45 3.64 4.08 3.84

Reliance Power* - - - 60.34 61.26 64.71 1.61 1.59 1.51 na 86.55 37.54 (517.87) 26.82 31.69 4.18 2.73 2.24 4.84 4.90 5.47 9.42 4.96 3.25

Lanco Infratech* - - - 13.89 19.20 19.68 1.07 0.78 0.76 6.67 9.79 12.29 18.88 23.48 21.91 4.14 2.29 0.34 16.85 11.20 2.44 3.71 2.12 0.31

India utilities average 14.23 10.89 11.43 42.98 47.95 54.17 1.90 1.67 1.44 28.48 24.79 13.57 (39.24) 37.45 39.04 4.31 4.24 5.02 11.42 11.49 14.44 5.02 4.52 4.91

Coal India 22.48 22.54 24.61 40.92 52.74 66.31 8.38 6.50 5.17 16.74 12.78 10.24 22.99 26.83 25.13 39.25 34.90 32.91 42.90 36.74 34.13 30.82 33.22 34.89

India coal average 22.48 22.54 24.61 40.92 52.74 66.31 8.38 6.50 5.17 16.74 12.78 10.24 22.99 26.83 25.13 39.25 34.90 32.91 42.90 36.74 34.13 30.82 33.22 34.89

Australia

AGL ENERGY LTD 61.74 63.54 60.28 12.89 13.75 14.16 1.13 1.06 1.03 8.83 8.67 8.27 11.93 11.38 11.47 5.30 8.79 6.55 6.12 9.20 7.49 4.28 6.51 5.12

P/B (x) EV/EBIDTA (x) EBIDTA Margin (%) RoIC (%) RoE (%) RoA (%)Dividend payout (%) BV/share (local $)

Key company data: See page 2 for company data and detailed price/index chart.

China Shenhua Energy 1088.HK 1088 HK .

METALS & MINING

EQUITY RESEARCH

Downgrade to Neutral with TP of HKD38.10

Quality play with sustainable resources and integrated business model

February 1, 2012

Rating Down from Buy

Neutral

Target price Reduced from 44.40

HKD 38.10

Closing price January 26, 2012

HKD 35.15

Potential upside +8.4%

Action: Downgrade to Neutral with a HKD38.10 TP (from HKD44.40) Shenhua remains the best quality play and deserves a premium over its peers, in our view, given its distinctive integrated business model (hedge against coal price correction), with a captive logistics network, and sufficient reserve at low cost (Xinjie is already worth HKD10/share) help facilitate third-party trade and sustain double-digit growth and above-average ROE, despite slowing self-production growth. However, the unfavourable coal price outlook, its less robust self-production growth (7.3-8.4% for 2012-13F vs peers’ 19-21%) and the difficulty in justifying a 13x TP P/E based on a 20%-plus TP lead us to downgrade our rating to Neutral, from Buy.

We cut 2011-13F earnings by 4-9% to reflect: A 5-9% cut in ASP along with our expectation of a less robust coal

market on the back of slowing GDP growth and Beijing’s efforts to reduce energy and CO2 intensity.

A 9-16% sales volume increase, mainly driven by third-party trade, despite the output from Xinjie and Watermark is delayed to 2014F.

An 8.9% rise in on-grid electricity tariff announced last year.

Catalysts and valuation: Asset injection is a near-term catalyst A spot price rebound, asset injection (coal-to-oil project and Wuhai coking coal mine), ramp-up of greenfield projects and whole group listing are potential catalysts. Shenhua trades at a FY12F P/E of 10.6x, a 15% premium to the industry average of 9.2x and a 23% discount to its historical average. Our TP implies an 11.5x FY12F P/E and a 20% premium to prevailing industry average, which is justified, in our view, given Shenhua’s distinctive quality.

31 Dec FY10 FY11F FY12F FY13F

Currency (CNY) Actual Old New Old New Old New

Revenue (mn) 152,063 196,545 202,732 220,053 230,471 239,764 261,176

Reported net profit (mn) 38,132 47,586 45,675 57,189 52,715 67,267 61,168

Normalised net profit (mn) 38,132 47,586 45,675 57,189 52,715 67,267 61,168

Normalised EPS 1.92 2.39 2.30 2.88 2.65 3.38 3.08

Norm. EPS growth (%) 20.3 24.8 19.8 20.2 15.4 17.6 16.0

Norm. P/E (x) 15.6 N/A 12.5 N/A 10.6 N/A 8.9

EV/EBITDA (x) 8.4 6.7 6.8 5.3 5.7 4.3 4.5

Price/book (x) 3.0 N/A 2.5 N/A 2.2 N/A 1.8

Dividend yield (%) 2.5 N/A 3.2 N/A 3.8 N/A 4.5

ROE (%) 20.7 22.4 21.5 23.4 21.8 23.9 22.2

Net debt/equity (%) net cash net cash net cash net cash net cash net cash net cash


Anchor themes

China will remain in coal deficit in 12-13F due to transportation, not production constraints. We see the coal price falling by 10-15% in 1H12F and rebounding in 2H due to slowing GDP growth and Beijing’s effort to cap CO2/Energy intensity.

Nomura vs consensus

Our 12F earnings is 1% above consensus, but TP is 10% below, owing to our bullish view on third-party trade volume, sustainable margins and lower LT coal price.

Research analysts




Nomura | China Shenhua Energy February 1, 2012

84

Key data on China Shenhua Energy Income statement (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FRevenue 121,312 152,063 202,732 230,471 261,176Cost of goods sold -65,492 -86,838 -120,977 -137,742 -156,486Gross profit 55,820 65,225 81,755 92,728 104,689SG&A -8,712 -8,774 -15,032 -17,089 -16,754Employee share expense

Operating profit 47,108 56,451 66,723 75,639 87,935

EBITDA 58,360 69,544 80,934 91,435 105,475Depreciation -11,252 -13,093 -14,211 -15,796 -17,539Amortisation

EBIT 47,108 56,451 66,723 75,639 87,935Net interest expense -2,038 -2,313 -2,062 -922 -1,125Associates & JCEs

Other income 742 615 677 744 819Earnings before tax 45,812 54,753 65,338 75,462 87,629Income tax -9,626 -11,184 -13,721 -15,847 -18,402Net profit after tax 36,186 43,569 51,617 59,615 69,227Minority interests -4,480 -5,437 -5,941 -6,899 -8,059Other items

Preferred dividends

Normalised NPAT 31,706 38,132 45,675 52,715 61,168Extraordinary items

Reported NPAT 31,706 38,132 45,675 52,715 61,168Dividends -10,541 -14,917 -18,270 -21,086 -24,467Transfer to reserves 21,165 23,215 27,405 31,629 36,701

Valuation and ratio analysis

FD normalised P/E (x) 19.5 15.6 12.5 10.6 8.9FD normalised P/E at price target (x) 21.1 16.9 13.5 11.5 9.6Reported P/E (x) 19.5 15.6 12.5 10.6 8.9Dividend yield (%) 1.7 2.5 3.2 3.8 4.5Price/cashflow (x) 11.6 10.4 7.9 7.1 6.0Price/book (x) 3.6 3.0 2.5 2.2 1.8EV/EBITDA (x) 10.7 8.4 6.8 5.7 4.5EV/EBIT (x) 13.3 10.4 8.2 6.9 5.4Gross margin (%) 46.0 42.9 40.3 40.2 40.1EBITDA margin (%) 48.1 45.7 39.9 39.7 40.4EBIT margin (%) 38.8 37.1 32.9 32.8 33.7Net margin (%) 26.1 25.1 22.5 22.9 23.4Effective tax rate (%) 21.0 20.4 21.0 21.0 21.0Dividend payout (%) 33.2 39.1 40.0 40.0 40.0Capex to sales (%) 25.6 17.8 17.9 17.3 16.8Capex to depreciation (x) 2.8 2.1 2.5 2.5 2.5ROE (%) 19.9 20.7 21.5 21.8 22.2ROA (pretax %) 20.4 22.0 23.3 23.6 25.1

Growth (%)

Revenue 13.2 25.3 33.3 13.7 13.3EBITDA 18.1 19.2 16.4 13.0 15.4EBIT 18.7 19.8 18.2 13.4 16.3Normalised EPS 19.0 20.3 19.8 15.4 16.0Normalised FDEPS 19.0 20.3 19.8 15.4 16.0

Per share

Reported EPS (CNY) 1.59 1.92 2.30 2.65 3.08Norm EPS (CNY) 1.59 1.92 2.30 2.65 3.08Fully diluted norm EPS (CNY) 1.59 1.92 2.30 2.65 3.08Book value per share (CNY) 8.58 9.97 11.35 12.94 14.78DPS (CNY) 0.53 0.75 0.92 1.06 1.23Source: Company data, Nomura estimates

Relative performance chart (one year)

Source: ThomsonReuters, Nomura research

(%) 1M 3M 12M

Absolute (HKD) 1.6 -0.3 10.0

Absolute (USD) 1.9 -0.1 10.4

Relative to index -8.0 -9.1 22.1

Market cap (USDmn) 90,116.6

Estimated free float (%) 27.0

52-week range (HKD) 40.2/27.1

3-mth avg daily turnover (USDmn)

60.44

Major shareholders (%)

China Shenhua Group 73.0

Source: Thomson Reuters, Nomura research

Notes

Revenue growth through volume expansion in spite of the unfavourable price trend


85

Cashflow (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FEBITDA 58,360 69,544 80,934 91,435 105,475Change in working capital 1,326 5,435 6,915 4,463 5,129Other operating cashflow -6,341 -17,770 -15,783 -16,768 -19,527Cashflow from operations 53,345 57,209 72,067 79,129 91,077Capital expenditure -31,040 -27,096 -36,200 -39,820 -43,802Free cashflow 22,305 30,113 35,867 39,309 47,275Reduction in investments 0 0 0 0 0Net acquisitions -78 126 -5,633 0 0Reduction in other LT assets -2,239 -3,487 0 0 0Addition in other LT liabilities -452 -202 0 0 0Adjustments -4,457 6,230 677 744 819Cashflow after investing acts 15,079 32,780 30,910 40,053 48,094Cash dividends -9,149 -10,541 -18,270 -21,086 -24,467Equity issue 0 0 0 0 0Debt issue 2,115 -12,459 6,463 7,109 7,820Convertible debt issue

Others -1,155 -2,379 0 0 0Cashflow from financial acts -8,189 -25,379 -11,807 -13,977 -16,647Net cashflow 6,890 7,401 19,103 26,076 31,446Beginning cash 59,054 65,944 73,345 92,448 118,524Ending cash 65,944 73,345 92,448 118,524 149,971Ending net debt 10,239 -8,717 -21,357 -40,324 -63,951Source: Company data, Nomura estimates

Balance sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash & equivalents 65,944 73,345 92,448 118,524 149,971Marketable securities 0 0 0 0 0Accounts receivable 8,781 10,645 14,192 16,134 18,283Inventories 7,727 11,167 15,557 17,713 20,123Other current assets 10,007 8,838 11,109 12,353 13,730Total current assets 92,459 103,995 133,306 164,724 202,107LT investments 4,308 4,235 9,868 9,868 9,868Fixed assets 196,690 210,623 232,612 256,636 282,898Goodwill

Other intangible assets 2,928 3,228 3,228 3,228 3,228Other LT assets 15,292 18,779 18,779 18,779 18,779Total assets 311,677 340,860 397,793 453,235 516,880Short-term debt 22,252 15,898 17,488 19,237 21,160Accounts payable 13,890 18,264 25,444 28,970 32,913Other current liabilities 19,542 24,738 34,682 40,959 48,083Total current liabilities 55,684 58,900 77,614 89,166 102,156Long-term debt 53,931 48,730 53,603 58,963 64,860Convertible debt

Other LT liabilities 4,644 4,442 4,442 4,442 4,442Total liabilities 114,259 112,072 135,659 152,572 171,457Minority interest 26,757 30,463 36,404 43,304 51,363Preferred stock 0 0 0 0 0Common stock 19,890 19,890 19,890 19,890 19,890Retained earnings 150,771 178,435 205,840 237,469 274,170Proposed dividends

Other equity and reserves

Total shareholders' equity 170,661 198,325 225,730 257,359 294,060Total equity & liabilities 311,677 340,860 397,793 453,235 516,880

Liquidity (x)

Current ratio 1.66 1.77 1.72 1.85 1.98Interest cover 23.1 24.4 32.4 82.1 78.2

Leverage

Net debt/EBITDA (x) 0.18 net cash net cash net cash net cashNet debt/equity (%) 6.0 net cash net cash net cash net cash

Activity (days)

Days receivable 25.6 23.3 22.4 24.1 24.0Days inventory 43.4 39.7 40.3 44.2 44.1Days payable 65.6 67.6 65.9 72.3 72.2Cash cycle 3.4 -4.6 -3.3 -4.0 -4.0Source: Company data, Nomura estimates

Notes

Sufficient cash inflow to fuel capex needs

Notes

Healthy balance sheet with net cash


86

Downgrade to Neutral with new TP of HKD38.10 We downgrade Shenhua to Neutral (from Buy) with a revised target price of HKD38.10 (from HKD44.40) and cut our 2011F, 2012F and 2013F’s earnings estimates by 4%, 8% and 9% to CNY45,675mn, CNY52,715mn and CNY61,168mn, respectively, to factor in the following changes of assumption:

• We increase our 2011F-15F commercial coal production estimates by 3-13%: We revise up our FY11F commercial coal output estimate by 9% to 279mnt to reflect the better-than-expected 1H11 operational results (140mnt vs our previous FY11 output volume forecast of 256mnt), mainly driven by the three injected projects (Shenbao, Chaijiagou and Baotou) in December 2010. However, Xinjie and Watermark were behind our previous expectation. In our new model, the output contribution of Xinjie and Watermark will be delayed to 2014F from 2013F. We cut Xinjie’s output to 10mnt/30mnt (from 20mnt/30mnt) in 2014/15F and Watermark’s output to 1mnt/6mnt (from 7mnt/12mnt) in 2014/15F. We believe the delay of the two projects should be offset by the ramp-up of the existing mines. Thus, we have revised upwards our 2011-15 output estimates by 9%, 6%, 5% and 3% and 13% to 279mnt, 303mnt, 325mnt, 361mnt and 409mnt, respectively.

• We increase our total 2011F-15F coal sales volume estimates by 9-30%, driven by self-production and third-party trade: We are bullish on Shenhua’s third-party trade due to its captive transportation network and revise upwards our 2011-15F third-party trade volume estimates to 100mnt, 120mnt, 140mnt, 160mnt and 180mnt, from 100mnt, 100mnt, 100mnt, 100mnt and 100mnt, respectively. Thus, together with the increase in our 2011-15F coal production estimates, we have increased our total sales volume estimates by 9%, 12%, 16%, 18% and 30% to 373mnt, 417mnt, 458mnt, 514mnt and 582mnt, respectively.

• Improvement in sales mix: Based on the 1H11 results, we cut our contract sales estimates to 45% (from 50%) in 2011F and to 45% (from 55%) in 2012F and beyond.

• Overall ASP cut by 5-16% for 2011F-15F: Taking into account 1H11 results and our new coal price forecasts in our industry outlook, we revise downwards our key contract and spot ASP estimates but raise our 2011-15F export ASP estimates; therefore, overall ASP has been adjusted downwards by 5-16% for the same period. This is also due to the production ramp-up from the Shenbao injected coal mines at end-2010, which are 70% lignite coal, with a lower ASP and margins.

• We lift our 2011F-15F power tariff estimates by 4-13%: On the back of the 8.9% on-grid electricity tariff hike announced in 2011, we revise upwards our power tariff estimate by 4% to CNY348/MWh (from CNY336/MWh) and 11% to CNY371/MWh (from CNY336/MWh) in 2011F and 2012F, respectively. In addition, we expect the power tariff to remain unchanged at CNY381/MWh (from CNY336/MWh) in 2013F and beyond.

• We cut unit production cost in our 2011-13 forecasts by 4-6%: We cut our 2011, 2012 and 2013 unit production cost estimates by 4%, 4% and 6% to CNY122/t, CNY128/t and CNY136/t, to factor in the better-than-expected 9M11 cost performance and the easing CPI in the coming two years. However, we maintain our 2014F unit production cost estimate at CNY151/t and increase our 2015F unit production cost forecast to CNY169/t (from CNY159/t) to price in the likely (in our view) value-based resource tax of 5% to be implemented in July 2014. Due to the captive transportation network and ramp up of output, we also cut unit transportation cost to CNY91/t (fromCNY91/t -CNY99/t) in 2011-15F. As a result, we revise down our total unit cost for 2011-15F by 8-12% to CNY213/t, CNY219/t, CNY227/t, CNY234/t and CNY241/t.

• A lower effective interest rate: We cut our effective interest cost estimate for 2011 to 5.2% (from 5.8%), based on 9M11 results. Our economist Zhiwei Zhang expects the interest rate will be cut by 25bps in 2012F and raised by 75bps in 2013F. As a result, we cut our interest rate assumption to 4.95% (from 5.8%) in 2012F and 5.7% (from 5.8%) in 2013F and beyond.


87

• A higher tax rate: We increase the effective tax rate by 1ppt to 21% for 2011-15F.

As a result of the above changes in assumptions, we revise down our EBITDA margin forecasts to 39-40% (from 42-47%), lift our sales volume estimates by 9-16%% and cut our blended ASP forecasts by 5-9%, resulting in earnings estimates cuts of 4-9% for 2011-13F.

Fig. 117: Changes in assumptions (1/2)


2011F 2012F 2013F 2014F 2015F

Coal production volume

Total commercial coal production

New model (mnt) 279 303 325 361 409

Old model (mnt) 256 285 310 349 363

Change (%) 9% 6% 5% 3% 13%

Sales volume

Contract sales

New model (mnt) 170 188 206 231 262

Old model (mnt) 172 204 217 238 247

Change (%) -1% -8% -5% -3% 6%

Spot sales

New model (mnt) 204 229 252 283 320

Old model (mnt) 172 167 178 195 202

Change (%) 19% 37% 42% 45% 59%

Total

New model (mnt) 373 417 458 514 582

Old model (mnt) 343 372 395 434 448

Change (%) 9% 12% 16% 18% 30%

Contract sales as a % of domestic sales

New model (%) 45 45 45 45 45

Old model (%) 50 55 55 55 55

Change (pcts) -5 -10 -10 -10 -10

Third party trade volume

New model (mnt) 100 120 140 160 180

Old model (mnt) 100 100 100 100 100

Change (%) 0% 20% 40% 60% 80%

Export sales volume

New model (mnt) 6 6 7 7 7

Old model (mnt) 13 13 15 15 15

Change (%) -54% -54% -53% -53% -53%


88

Fig. 118: Changes of assumptions (2/2)


Priced for quality

Our new target price of HKD38.10 (from HKD44.40), which offers 8% upside potential from current levels, is based on DCF valuation. Our target price, with a WACC of 9.9% and terminal growth rate of 2.0%, implies a FY12F P/E of 11.5x, a 20% premium to the prevailing industry average.

The stock is now trading at 10.6x FY12F P/E, a 23% discount to the historical average of 13.7x P/E and a discount to its Australian, China-listed and Southeast Asia peers, but at a 20% premium to China Coal, Yanzhou Coal and its US counterparts. We think the premium is justified, given Shenhua’s distinctive integrated business model, sustainable coal resources, above-industry-average ROE, undergeared balance sheet (net cash in FY11F) and position as China’s largest coal company.

2011F 2012F 2013F 2014F 2015F

Price

Contract price

New model (CNY/t) 336 365 377 408 408

Old model (CNY/t) 397 429 446 465 484

Change (%) -15% -15% -16% -12% -16%

Spot price

New model (CNY/t) 525 504 530 530 477

Old model (CNY/t) 522 548 559 570 581

Change (%) 1% -8% -5% -7% -18%

Export ASP

New model (CNY/t) 702 674 708 708 637

Old model (CNY/t) 623 629 642 655 668

Change (%) 13% 7% 10% 8% -5%

Overall ASP

New model (CNY/t) 444 445 465 478 448

Old model (CNY/t) 465 487 502 517 532

Change (%) -5% -9% -7% -7% -16%

Power Tariff

New model (CNY/ MWh) 348 371 381 381 381

Old model (CNY/ MWh) 336 336 336 336 336

Change (%) 4% 11% 13% 13% 13%

Cost

Unit production cost - self produced

New model (CNY/t) 122 128 136 151 169

Old model (CNY/t) 127 133 144 151 159

Change (%) -4% -4% -6% 0% 6%

Total unit cost of self produced coal

New model (CNY/t) 213 219 227 0 0

Old model (CNY/t) 230 240 254 264 275

Change (%) -8% -9% -10% -100% -100%

Unit cost for third party trade

New model (CNY/t) 435 418 438 438 395

Old model (CNY/t) 366 366 373 381 388

Change (%) 19% 14% 17% 15% 2%

Interest rate

New model (%) 5.2 4.95 5.7 5.7 5.7

Old model (%) 5.8 5.8 5.8 5.8 5.8

Change (pcts) -0.6 -0.8 -0.1 -0.1 -0.1

Tax rate

New model (%) 21 21 21 21 21

Old model (%) 20 20 20 20 20

Change (pcts) 1 1 1 1 1


89

Shenhua is the best quality play in the sector, despite its likely underperformance to China Coal in 2012

Shenhua had outperformed China Coal and Yanzhou Coal by 34-34.2% during 2011. We continue to rate Shenhua as the best quality play in the sector, given its seemingly solid quality of assets and management, its status of being China largest coal company (no. 2 in the world, according to Hexun.com). We believe its valuation premium could persist despite our expectations that Shenhua will underperform China Coal during 2012, given China Coal’s discounted valuation, strong production growth for 2012F and limited impact from the potential spot coal price correction in 1H12.

Shenhua’s other merits include:

• Its distinctive integrated business model, which allows growth through third-party trade at a decent gross margin (32.4% vs China Coal’s 1.9% and Yanzhou’s 1.0% in 2012F);

• It appears to be less vulnerable to potential spot price correction, while leveraging on potential non-key contract price upward revisions later in the year.

• Its solid leading position in China’s coal industry with a visible growth profile underpinned by sufficient reserves and potential asset injections (whole group listing);

• Quality margins, driven by better sales mix and low production costs;

• Its power segment has above-industry profitability, while power sector profitability should continue to improve amid power tariff hike (tariff reform likely in 2014/15F), falling interest cost and a more controllable coal price ahead.

Fig. 119: Valuation and sensitivity table


WACC 9.9%Terminal growth rate 2.00%

NPV $593,658.28 --- Terminal Growth Rate ---Cash 94,469 38.13 1.25% 1.50% 1.75% 2.00% 2.25% 2.50% 2.75%Debt (71,091) 9.1% 40.22 40.99 41.80 42.67 43.61 44.62 45.71

617,036.33 9.3% 39.16 39.87 40.63 41.44 42.31 43.25 44.25 No of share 19,890 9.5% 38.14 38.81 39.52 40.28 41.09 41.95 42.89 RMB per share 31.02 9.7% 37.18 37.80 38.47 39.17 39.93 40.74 41.60 HK$ per share 38.1 9.9% 36.26 36.85 37.47 38.13 38.83 39.59 40.39

10.1% 35.39 35.94 36.52 37.14 37.80 38.50 39.25 Risk free rate 2.50% 10.3% 34.55 35.07 35.62 36.20 36.81 37.47 38.17 Market risk premium 7.50% 10.5% 33.76 34.24 34.76 35.30 35.88 36.49 37.15 Beta 1.189 10.7% 32.99 33.45 33.94 34.45 34.99 35.57 36.18 Tax rate 21%Cost of debt 5%Cost of equity 11.4%WACC 9.9%

D/(D+E) 21%

---W

AC

C--

-


90

Fig. 120: Valuation comparison

Note: pricing as of 26 Jan 2011 closing. Bloomberg estimates for not rated stocks


Price target PriceMarket

cap Fiscal PEG

Company Ticker Rating L. Curr. L. Curr. (US$mn) Y/E 11F 12F 13F 11-13F 11F 12F 13F 11F 12F 13F 11F 12F 13F 11F 12F 13F

Coal

AsiaHongkong - Coking coalFushan 639 HK Buy 5.27 3.2 2219.33 Dec 5.8 5.1 5.6 0.3 0.8 0.7 0.7 0.8 0.9 1.0 net cash net cash net cash 13.0 12.9 12.4Hidili 1393 HK Neutral 6.11 2.93 779.758 Dec 5.9 4.2 3.5 0.2 0.6 0.5 0.5 2.8 4.5 7.3 60.5 58.2 53.4 11.3 13.7 14.7Mongolia Mining 975 HK n.a. n.a. 6.48 3094.85 Dec 23.2 10.4 7.3 0.1 3.6 2.6 2.0 n.a. n.a. 0.4 0.1 0.2 0.1 15.9 29.4 31.0South Gobi 1878 HK n.a. n.a. 51.5 1206.98 Dec 603.5 27.2 10.9 n.a 1.8 1.7 1.5 n.a. n.a. n.a. net cash 0.1 0.2 0.6 4.4 11.2Average 11.6 6.6 5.5 0.2 1.7 1.3 1.0 1.8 2.7 2.9 30.3 29.2 26.8 13.4 18.7 19.4Hongkong - Thermal coalShenhua Energy-H 1088 HK Neutral 38.10 35.15 90116.6 Dec 12.5 10.6 8.9 0.6 2.5 2.2 1.8 3.2 3.8 4.5 net cash net cash net cash 21.5 21.8 22.2Chinacoal Energy-H 1898 HK Buy 12.25 10.2 17431.9 Dec 10.4 8.6 6.8 0.3 1.3 1.2 1.0 2.6 3.1 3.9 9.9 16.1 10.2 13.3 14.5 16.0Yanzhou-H 1171 HK Reduce 17.10 19.28 12222.9 Dec 8.5 8.3 7.7 0.8 1.8 1.4 1.1 3.4 3.6 3.7 61.1 46.5 29.8 21.0 18.9 16.3Average 10.5 9.2 7.8 0.6 1.9 1.6 1.3 3.1 3.5 4.0 35.5 31.3 20.0 18.6 18.4 18.2

Hongkong Average 11.0 7.9 6.6 0.4 1.8 1.4 1.2 2.6 3.2 3.4 32.9 30.2 23.4 16.0 18.6 18.8

ChinaDatong Coal 601001 CH n.a. n.a. 13.39 3551.41 Dec 16.9 14.8 13.2 1.5 2.2 2.0 1.8 1.7 1.8 2.0 n.a. n.a. n.a. 14.5 14.7 15.9Shanxi Xishan Coal & Electricity 000983 CH n.a. n.a. 16.3 8139.67 Dec 15.8 13.3 12.6 0.9 3.4 2.8 2.4 2.4 2.6 2.8 n.a. n.a. n.a. 23.5 23.7 25.3Pingdingshan Tianan Coal Mining Co 601666 CH n.a. n.a. 11.83 4426.44 Dec 12.7 10.7 9.6 0.7 2.3 1.9 1.6 2.5 2.7 3.2 n.a. n.a. n.a. 20.3 19.6 19.6Shanxi Guoyang 600348 CH n.a. n.a. 18.65 7107.83 Dec 14.7 12.9 11.4 0.7 4.0 3.1 2.5 1.2 1.3 1.5 n.a. n.a. n.a. 29.5 26.7 24.5Shanghai Energy 600642 CH n.a. n.a. 4.63 3469.55 Dec 15.7 12.9 11.0 1.2 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Hengyang Coal 600971 CH n.a. n.a. 15.83 2508.57 Dec 12.5 10.9 11.9 1.3 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 17.4 17.7 16.9Lu'an Environmental Energy 601699 CH n.a. n.a. 24.92 9087.06 Dec 14.4 12.6 10.5 0.8 3.5 3.5 2.9 3.6 4.2 5.2 n.a. n.a. n.a. 29.1 27.5 28.3SDIC Xinji 601918 CH n.a. n.a. 11.77 3451.3 Dec 13.5 10.8 10.3 0.7 2.3 1.9 n.a. 2.4 2.9 n.a. n.a. n.a. n.a. 16.4 17.4 n.a.China Average 14.5 12.4 11.3 1.0 2.9 2.5 2.2 2.3 2.6 2.9 n.a. n.a. n.a. 21.5 21.0 21.8

S.E AsiaBanpu BANPU TB n.a. n.a. 584 5075.18 Dec 9.6 9.6 8.9 n.a. 2.0 1.8 1.6 3.3 3.4 3.5 0.6 0.4 0.2 25.7 19.8 18.6Bumi BUMI IJ Buy 3000 2525 5850.85 Dec 16.8 14.8 9.0 0.5 3.1 2.6 2.1 1.1 1.2 1.4 169.6 120.7 66.6 19.7 19.1 25.7ITMG ITMG IJ Reduce 37300 37750 4757.91 Dec 9.1 11.4 8.5 0.3 4.5 4.4 3.6 4.2 8.3 6.6 net cash net cash net cash 59.2 39.6 46.9Bukit Asam PTBA IJ Buy 26000 20000 5140.28 Dec 14.9 13.6 12.1 0.6 5.6 4.6 3.8 2.6 3.4 3.7 net cash net cash net cash 42.3 36.8 34.3Indika Energy INDY IJ Neutral 2500 2500 1452.08 Dec 11.9 8.3 6.2 0.2 2.0 1.7 1.4 1.0 3.4 4.8 76.9 57.0 34.9 18.5 22.6 25.2Adaro ADRO IJ Buy 2450 1840 6564.88 Dec 13.7 12.6 10.5 0.4 2.7 2.3 2.0 1.5 2.3 1.5 49.5 44.9 21.9 21.4 20.0 20.3S.E Asia Average 12.7 11.7 9.2 0.4 3.3 2.9 2.4 2.3 3.6 3.6 74.2 55.8 30.9 31.1 26.3 28.5

Asia Average

AustraliaWhitehaven Coal WHC AU Neutral 6 5.53 2864.84 Jun 274.5 14.0 10.2 0.5 2.6 2.3 1.8 1.3 1.1 1.5 net cash net cash net cash 1.0 17.5 20.2New Hope Corp NHC AU n.a. n.a. 5.67 4416.09 Jul 31.5 20.1 19.3 2.4 2.0 2.0 1.9 2.9 3.3 3.2 net cash net cash net cash 7.9 10.2 9.2Gloucester Coal GCL AU n.a. n.a. 8.36 1590.97 Jun 24.4 30.5 19.1 n.a. 1.7 1.4 1.4 0.2 0.1 0.7 0.1 0.1 0.1 10.4 4.7 7.4Stanmore Coal SMR AU n.a. n.a. 0.775 113.488 Jun n.a. n.a. n.a. n.a 3.2 2.2 1.7 n.a. n.a. n.a. net cash net cash 0.0 n.a. n.a. n.a.Macarthur Coal MCC AU n.a. n.a. 16.01 n.a. Jun 30.7 19.8 16.6 0.8 2.9 2.7 2.5 2.2 2.5 3.0 net cash net cash net cash 10.5 15.5 18.1Australia Average 90.3 21.1 16.3 1.2 2.5 2.1 1.9 1.7 1.7 2.1 0.1 0.1 0.0 7.5 12.0 13.7

North AmericaArch Coal ACI US n.a. n.a. 14.55 3079.04 Dec 12.4 6.7 5.9 0.2 0.8 0.8 0.7 2.9 3.0 3.0 1.0 0.9 0.7 6.2 11.5 13.3Consol Energy Inc. CNX US n.a. n.a. 35.87 8136.09 Dec 12.1 11.6 10.5 0.4 2.3 2.1 1.8 1.2 1.3 1.3 0.8 0.6 0.4 19.1 15.2 15.9Peabody Energy Corp. BTU US n.a. n.a. 37.33 10111.7 Dec 10.1 7.8 9.0 1.4 1.9 1.6 1.8 0.9 0.9 1.0 1.1 0.8 0.8 20.8 19.5 53.3N. America Average 11.5 8.7 8.5 0.6 1.7 1.5 1.5 1.7 1.7 1.8 0.9 0.8 0.6 15.4 15.4 27.5

P/B (x)P/E (x) Yield (%) Net debt/equity (%) RoE (%)


91

An integrated model allows growth through third-party sales In our view, Shenhua’s vertically integrated business model, with exposure to coal, downstream power and its own railway and ports, forms a distinct advantage over its peers.

Internal hedging between coal and power business. Covering the complete value chain in coal, power and its own transportation, Shenhua has not only built an internal hedge against risk to coal sales, but also has provided its power business with stable and quality coal supply on the back of its captive railway and port networks.

Captive networks allow sales-mix enhancement with higher margin: The interconnected railways and ports not only alleviate transportation bottleneck problems, but also provide the company with flexibility to adjust transportation methods and coal sales to get more market share within the higher-margin coastal market. In FY10, Shenhua sold 57% of its domestic coal through the seaborne market.

Transportation networks secure third-party trade at good margins: Leveraging the strong coastal demand and its logistic (railways and ports) arms, we believe Shenhua has the ability to enhance third-party trade volume when supply is affected by policy. As well, given its captive network, Shenhua could be able to buy low/sell high along the railway line and achieve a 32.4% gross margin on its third-party trade, vs China Coal’s 1.9% and Yanzhou’s 1.0% in 2012F.

Captive networks secure third-party trade

Railways: Shenhua runs five interconnected self-owned railways, with turnover of 150.3bn tonne km in 2010 (up 8.8% y-y). The Shenhuo-Shuohuang line is one of two backbone lines dedicated to west-to-east coal transportation in China. In 2010 and 1H11, coal transported through self-owned railways accounted for 78% and 77% of the total turnover of the company’s.

In addition, the other three railway lines, Ganquan Line, Bazhun Line and Zhunchi Line, are currently under construction. After the construction in 2013F, Shenhua will own eight railway lines to secure the transportation of self-produced coals and third-party trade.

Bazhun Line: Stretching 134.69km, linking the Shenbao Line and the Dazhun Line. Commencing construction in May 2010, the Bazhun Line, with the capacity of 200mnt, is expected to finish the construction by mid 2013.

Zhunchi Line: Stretching 179.86km, linking the Dazhun Line and the Shuohuang Line, approved by the NDRC on 15 December, 2010. With the designed capacity of 200mnt, it is scheduled for operation by mid-2013 with the initial freight volume of 50mnt and should reach to 200mnt capacity by 2016F.

Ganquan Line: Stretching 367km, linking Wanshuiquan, one station of the Shenbao Line and Ganqimaodu, situated at the frontier of China and Mongolia. Starting in April 2011, the Ganquan Line (capacity of 30mnt), served as the ancillary facility of TT project, is expected to finish the construction by the end of 2012.

Ports: Shenhua operates Huanghua Port, the second-largest port for seaborne coal, and Shenhua Tianjin Coal Dock. In 2010 and 1H11, coal transported through self-owned ports accounted for 65% and 59% of the total coal transported through domestic ports.


92

Per our industry outlook, we estimate the transportation bottleneck will persist until 2014F, which could cause tight supply in certain periods. Thanks to its captive network, Shenhua, in our view, should be better positioned than its peers to weather these developments, given:

1. Captive networks provide Shenhua flexibility to adjust transportation methods and coal sales to get more market share within the higher-margin coastal market.

2. Shenhua has changed its strategy from solely relying on production growth to increasing sales volume from both third-party trade and own output, with a long-term target of becoming a full-fledged coal-trading company.

3. In light of the development strategy shift and the compatible transportation network, we estimate third-party trade will become an increasingly visible portion of Shenhua’s sales mix from 72.4mn tonnes in FY10 to 140mn tonnes in FY13F and 180mn tonnes in FY15F.

Fig. 121: Shenhua's major operations

Source: Company data, Nomura research


93

Aims to double its size by 2015F, underpinned by sufficient reserve, globalization, third-party trade and asset injection As China’s biggest coal producer, Shenhua had a 7.4% market share in terms of raw coal production in 2011F, more than double that of China Coal (3.3%) and Yanzhou Coal (1.5%).

Shenhua aims to double (15-20% CAGR) its production (to 409mnt), sales volume (to 582mnt) and profit (to CNY66,216mn ) from 2009 level by 2015F through:

• Organic growth

• Asset injection

• Industry consolidation (M&A),

• Third-party trade and

• Globalization

Fig. 122: Management guidance vs Nomura’s forecasts


Shenhua management expects the company to increase its market share to 20-25% by 2015, from 12% currently. By then, management hopes to gain pricing power in the coastal market in China and to become a global and Fortune 100 company (from 356 in 2010.

Over the longer term, Shenhua expects the spot sales portion will increase to 60-65% (from 43.7% in 2010) and third-party trade to account for 50% of total sales (from 24.7% in 2010). Shenhua aims to become a full-fledged global coal production and trading company, with 20-30% market share in China, like a “Wal-Mart” of the coal industry.

We are optimistic about Shenhua’s volume expansion story in 12th FYP. Based on its current projects and announced/completed asset injection, we expect Shenhua’s production volume and sales volume to reach 400mnt and 580mnt, with CAGR of 10% and 12%, respectively, during 2011-2015F.

Previous Mgt.guidance Nov. 2010 Mgt. guidance Apr. 2011 Our forecast Our rationale

Production Vol. Target to output 320-340mnt by 2014

management guided that the Xinjie mine would start production in 2014F, with initial production of 20mn tonnes in 2014. Target to have total output 357 mnt in 2014F

361 mnt commercial coal production by 2014F

We revised up FY11F’s commercial coal output by 9% to 279mnt to reflect the better-than-expected 1H11 operational results (140mnt vs. our previous FY11F’s output volume of 256mnt), mainly driven by the three injected projects (Shenbao, Chaijiagou and Baotou) in Dec 2010. We revised up 2011-15F’s output by 9%/ 6%/ 5%/ 3% and 13% to 279mnt/ 303mnt/ 325mnt/ 361mnt and 409mnt respectively.

Spot sales (%) 10F: Spot sales to contribute 42% of sales11-15F: A few more percentage point increase but spot sales should not exceed 45%

Spot coal sales to contribute 53% in 2011

Spot coal sales to contribute 55% as domestic sales in 2011-15F

Based on the 1H11 results, we raise the spot sales to 55% in 2011-15F (from 50% for 2011 and 45% for 2012F and beyond)


94

Fig. 123: Shenhua market share by raw coal production


Fig. 124: Shenhua: commercial coal production projection


Fig. 125: Shenhua: raw coal production projection


6.6%7.4% 7.6% 7.8%

8.2%8.8%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

2010 2011F 2012F 2013F 2014F 2015F

(mnt)

225 279 303 325

361 409

0

50

100

150

200

250

300

350

400

450

2010 2011F 2012F 2013F 2014F 2015F

(mnt)

(mn tonne) Location 2009 2010 2011F 2012F 2013F 2014F

Shendong Shaanxi and Inner Mongolia

Shendong Coal Group 149.9 151.4 159.6 167.6 174.6 178.6

Jinjie Energy 12.7 14.5 16.3 17.3 17.3 17.3

Zhunge'er Inner Mongolia

Heidaigou 23.1 25.3 29.0 32.0 35.0 37.9

Ha'erwusu 14.1 19.3 24.0 28.0 33.0 38.0

Shengli Inner Mongolia

Beidian Shengli 10.5 14.3 22.0 26.0 30.0 33.6

Baorixile Inner Mongolia

Shenbao Mine 25.0 27.0 29.0 29.0

Baotou Inner Mongolia

Baotou Mine 2.6 4.0 5.1 6.4

Tongchuan Shaanxi

Chanjiagou Mine 0.8 1.0 1.0 1.0

Greenfield

Xinjie Inner Mongolia 10.0

Yushen Shaanxi 8.0

Watermark Australia 1.0

Total 210.3 224.8 279.3 302.9 325.0 360.8


95

Organic growth: sufficient reserves and greenfield project to sustain organic growth

By 1H11, Shenhua owned marketable coal reserves of 9,489mn tonnes under the JORC standard, translating into 34 years of reserve life based on 1H11 output of 140.4mnt. Given these mines are all in traditionally coal resource-rich areas, we are optimistic about potential resource upgrades by geological exploration.

Fig. 126: Shenhua: coal mine snapshot


Following a strong push to close smaller, more dangerous and less efficient coal mines in the 11th FYP; China will continue promoting mine consolidation in the current 12th FYP. Shenhua, as a state-owned enterprise and the largest domestic coal player, should be better positioned to gain access to reserves across the nation, thus, in our view, making it the most likely beneficiary of the consolidation process.

In our view, Shenhua’s sufficient reserves should sustain organic output growth:

• Current operating mines should contribute 80mnt output growth (vs management guidance of 85-100mnt; excluding the mine injected at the end of 2010) during 2009-2014F. In light of the government’s policy in supply restriction and the more rigorous safety requirements, our projected production output growth from 225mnt in 2010 to 361mnt in 2014F is at the low end of management’s guidance.

• Greenfield projects should contribute 19mnt to output growth by 2014F (vs management’s guidance of 20-30mnt). Factoring in the more rigorous safety requirements and slower government approvals, we assume a slower pace of greenfield project completion, with 10mn tonnes annual production from Xinjie, 8mn tonnes from Yushen and 1mn tonnes from Watermark by 2014F.

• The Xinjie project, in Inner Mongolia, has 13bn tons of high-quality coal reserve with annual designed production capacity of over 100mnt (>100 years of production). It will become a major growth driver for Shenhua. Currently, the company is working on mining license and permit applications and expects initial production in 2012 (to grow to 30-40mt in 2015F). Shenhua paid CNY2bn for the resource (CNY1.7/t). Xinjie, which may be worth more than CNY200bn now based on valuation similar to that of the adjacent coalfield (Zhuanlongwan mine, 548mnt resources and 5mnt production capacity) bought by Yanzhou Coal for CNY7.8bn (CNY14.3/t) in January 2011.

However, despite Shenhua continuing to grow its production, management understands that it will be difficult to attain its targets without relying on inorganic growth such as globalization, coal trading and M&A.

Coal mines Shendong Zhunge'er Shengli Baorixile Baotou (including Lijiahao) Tongchuan Total

Coal type Thermal Coal Thermal Coal Thermal Coal

Lignite Coking coal, Weak caking, Non-caking coal, Long-flame coal

Long-Flame

Location Shaanxi and Inner Mongolia

Inner Mongolia Inner Mongolia

Inner Mongolia

Inner Mongolia Shaanxi

Shenhua's stake (%) 100 57.76 62.68 56.61 100.00 95

Recoverable Coal reserve (mnt) (PRC standard)

8,368 3,499 1,461 1,350 684 6 15,368

% of total 54 23 10 9 4 0

Marketable reserve (mnt) (JORC standard) 4,739 2,211 816 1,406 314 3 9,489

% of total 50 23 9 15 3 0

Output (1H11) (mn tonnes) 88 27 11 13 1 1 140

% of total 63 19 8 9 1 0


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Globalization

During the 12th five-year plan (2011-15), China’s government aims to create four to five international companies, including Shenhua. Thus, the company has been working on four international coal/power projects (Russia – Far East, Mongolia – Tavan Tolgoi, Indonesia – Sumatra and Australia – Watermark).

Russia Far East region (confirmed, JV with Russia): 1bn coal reserve and 20mnt production capacity; initial output in 2015 (20mnt); supply to China through dedicated state railway lines. As the project is at the very initial stage, we do not factor it into our forecast.

Mongolia Tavan Tolgoi (pending): Tavan Tolgoi's Western Tsankhi site, an open-pit mine with the designed capacity of 15mnt, has 1.2bnt of coking coal reserves, situated 270km away from Mongolia-China border. The Tavan Tolgoi is expected to contribute initial output by 2015. Railway transportation in China’s part is Shenhua’s 80%-owned Ganquan railway line. The railway line, with the total length of 367km and the designed capacity of 30mnt, is expected to be completed by 2013F. The first phase of the Ganquan industrial park has already been completed.

On 5 July 2011, Shenhua led Peabody and a Russian-Mongolia group winning the TT bid. Shenhua was supposed to receive a 40% stake, with the other two getting stakes of 24% and 36%, respectively. But in mid-September 2011, Mongolia’s National Security Council rejected the previous agreement made in early July 2011 due to complaints from Japanese and Korean investors. Shenhua appears to be confident that is will win such a project again, given it has advantages over the other bidders in terms of railway transportation and market. Guanquan railway and a dedicated 180km line from Tsankhi to border of Mongolia will be built by Shenhua if it wins the project. In addition, China remains as the major consumer of Mongolia’s coking coal, and Shenhua will build a coking coal-to-coke plant at Guanquan industrial park and sell coke to steel producers in the region. Even though the company is not able to get such, it will be able to buy coking coal at the border at a slight premium given its strong bargaining power, according to Shenhu management. As the bidding for TT has not concluded with and no decisions have been made, we have not factored it into our model.

Indonesia Sumatra project (confirmed, 70% owned by Shenhua): low-quality coal (4,000- 4,500kcal/kg); production (1.5mnt in 2011for its own 2x150MW power plant; 3mnt by 2015 for exporting to China). The two power plants completed pilot operation in June and November 2011, respectively.

Australia Watermark project (confirmed, 100% owned by Shenhua): high-quality coal (6,000kcal/g); over 1bn tons coal reserve, with annual production capacity of 10mnt, all exporting to China; and the NSW government committed to build the port and railway for this project. Shenhua invested in Watermark mines in Australia in late 2008 as its first overseas investment.

According to Dow Jones on 24 November, 2011, Shenhua hoped to submit an environmental impact statement for the project by the middle of 2012 and the construction of the open-cut mine is expected to commence in later 2013. Considering the construction period of 9-12 month, we conservatively expect Watermark to contribute 1mnt and 6mnt in 2014F and 2015F, respectively, ramping up to 12mnt in the 13th FYP.

Third-party trade – In our view, only Shenhua has the ability to grow the third-party trade business at a good margin

Shenhua rebutted the market misconception that its third-party trade carries a low margin and reiterated that the gross margin (38% in 2010 and 31% in 1H11) was similar to that of its self-produce coal (43% in 2010), but higher than China Coal’s 1.9% and Yanzhou Coal’s 1%.


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This is due to the fact that all coal purchased from third parties, albeit at higher cost, is sold in the spot seaborne market, while the majority of its self-produced coal is sold in contracts. Indeed, in our view, only Shenhua has the advantage of conducting third-party trade at a high margin (and high ROE), given its captive logistic network. The company expects this business to account for 50% of total sales (24% in 2010) in the long run.

Due to its captive transportation network (two ports, five operational railway lines and three railway lines in construction), we believe Shenhua will outperform its peers in the third-party coal transaction and the third-party volume should reach 180mnt in 2015F, 31% of the sales volume.

Potential asset injection from the parent company

On 20 December 2010, Shenhua announced that it would: 1) pay CNY5.6bn to its parent company for equity interests in nine coal, power and other supporting companies; and 2) pay CNY3.1bn to Baotou Mining for three mines in Inner Mongolia.

The deal was completed at end-February 2011. This will contribute 1.8bnt reserve (JORC standard) and 25mnt of annual production output from 2011. The injected mines (Shenbao, Chanjiagou and Baotou mines) contributed 14.1mnt, 10% of the total self-produced coal in 1H11. Due to the ramp-up of the mines, we believe the output will reach 36.4mnt in 2014F.

Currently, its parent, China Shenhua Group, has 50bnt of coal reserve (in China standard) with annual production of 100mt, coal-to-oil project and coal-to-olefins project, with majority of coal assets in Inner Mongolia (Wuhai, 19mnt pa), Ningxia (Shenning, 60mnt pa) and Xinjiang (Shenxin, 30mnt pa). Shenhua plans to acquire all these assets in five years and is eyeing to buy the Wuhai 20mnt coking coal mine (in 2012) and the coal-to-oil/coal-to-olefins project (in 2012) as the first step. The CNY15bn coal-to-oil project is currently producing 1.08mnt oil product and is expected to ramp up to 3mnt in three years. It is very profitable, considering the current WTI crude oil price of USD101.56/barrel as of 6 January, 2012 and the break-even oil price point of USD45/barrel. Shenhua emphasizes that the hurdle rate for asset injection or M&A should be at least 12% equity IRR, and will likely acquire all these projects at book value.

In 2010, one-third of the 3.3bnt of coal production came from small and township coal mines, which will be gradually eliminated in 10 years (100mnt pa). We believe this provides an opportunity for Shenhua to acquire the resources at 1.0-1.5x book value. In 2010, Shenhua Group bought 20 mines at Ha’erwusu at only CNY1.5-2/ton.

Unlike China Coal, whose management has already guided to inject the parent’s coal assets by the end of 2015, Shenhua has not provided the specific timeline of the asset injection. Therefore, we do not factor any potential asset injection into our forecasts.

Fig. 127: Parent’s coal related assets

Note: * Shenning’s capacity is expected to ramp up to 100mnt by 2015 and 130mnt by 2020

** Shenxin’s capacity is expected to ramp up to 150mnt by 2020

Source: Company, Nomura research

Assets LocationStake owned by

Shenhua (%)Coal resource

(mnt)Coal type

Capacity (mnt)

Completion year

Coal chemicals

Coal-to-oil project Ordos, Inner Mongolia 100 NA NA 3.2 2008

Coal-to-olefins project Baotou, Inner Mongolia 100 NA NA 0.6 2011

Key coal assets

Wuhai Inner Mongolia 100 1,630 Cooking coal 18.3~19.8 NA

Shenning Ningxia 51 29,508 Thermal coal 60* NA

Shenxin Xinjiang 100 7,000 Thermal coal 30** NA


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Coal-to-oil and coal-to-olefins projects

Fig. 128: SWOT analysis for Shenhua’s CTL and CTO projects

Source: company data, Nomura research

Shenhua coal-to-oil (CTL) project (Ordos, Inner Mongolia) The Shenhua Ordos CTL project employs two technologies – direct coal liquefaction and indirect coal liquefaction, and the first phase has pilot run since end-2008. So far, Shenhau Group has invested over CNY15bn into the project. The main products involve diesel oil, liquefied gas, naphtha, etc. The direct coal liquefaction project (using Shenhua’s own technology) aims at a final annual oil throughput of 5mn tons and is divided into two phases, of which the first phase consists of three production lines, including 14 processing plants for coal liquefaction, coal hydrogen making, etc. Currently, the first phase produces 3.2mn tons pa of various oil products, including 2.15mn tons diesel oil and 310,000 tons liquefied gas, which requires annual coal consumption of 9.7mn tons.

During 1Q11, the Shenhua Ordos CTL plant produced 216,000 tonnes of refined oil products, which brought in more than CNY100mn (USD15.38mn) in profits, translating into an ROI of 3% and an ROE of 12% (assuming 25% in equity), according to Zhang Yuzhuo, general manager of Shenhua Group. The plant operated for a total of 5,000 hours and produced 450,000 tonnes of oil products in 2010. Shenhua Group was considering injecting this project to the listing company. Although we believe the chance of this happening is high given the superior return and the wish to have a whole group listing in five years, we do not currently factor this project into our model.

Fig. 129: Shenhua Ordos CTL project

Source: Company report, Nomura research

Fig. 130: Shenhua Ordos CTL project

Source: Company report, Nomura research

Shenhua coal-to-olefins (CTO) project (Baotou, Inner Mongolia) The Shenhua Baotou coal-to-olefins (CTO) project is the first coal-to-olefins project in the world using coal as raw material. The Baotou CTO project commenced production in August 2010. The plant produces 300,000 tonnes/year of ethylene and 300,000

Strengths Weaknesses

1. Rich of Coal resources 1. Lack of industrial experiences for large scale projects

2. Rich of capitals from Stock Market and government support 2. The distribution channels of oil products are controlled by

3. Self-owned CTL technology. Leading position in China Sinopec and PetroChina.

CTL/CTO

4. Self-owned railway, ports and with logistic advantages

Opportunities Threats

1. Coal based chemicals are more competitive in the 1. The fluctuation of oil price

high oil price situation 2. Take part in several projects at the same period with

2. The increasing demand of China oil and chemicals investment risks

3. The refined oil pricing is regulated by government


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tonnes/year of propylene, which are used as feedstocks for the company’s polyethylene (PE) and polypropylene (PP) plants in Baotou, each with 300,000 tonne/year capacity. Total investment is estimated at CNY17bn.

The Baotou CTO project requires coal gasification (for methanol production), methanol conversion (for olefins production) and olefins polymerization to produce PE and PP. The final PE/PP products can be widely used in the production of high-value products such as film, fiber, pipe and plate.

The Shenhua Baotou CTO plant entered into commercial operation on 1 January, 2011. The company targeted to produce 450,000 tons of polyolefin products, and make revenue of CNY4.3bn in 2011. Up to mid-September 2011, the cumulative production polyolefin products and revenue had reached 315kt and CNY3.99bn, respectively, and sales of PE/PP products were 310,000 tons, and other by-products were 82,000 tons. Shenhua Group was considering injecting this project to the listing company. For the same reason, we have not factored this project into our model at this moment.

Other coal assets in Shenhua Group (Wuhai, Shenning, Shenxin) On 26 August, 2011, Shenhua announced it had already conducted the pre-acquisition work of the certain subsidiaries of Shenhua Group relevant to sales and production of coal and electricity. According to the company, the total asset of the target companies will be less than 5% of Shenhua’s as of 30 June, 2011. Also, the net assets and the 1H11 net profit of the target companies will be less than 1.5% of that of Shenhua. Despite the fact that pre-acquisition work has been ongoing and the chance of asset injection this year is high, we conservatively do not factor it into our forecasts.

Shenhua Wuhai Shenhua Wuhai company was founded in 2008, with 1,630mn tonnes of resources (China standard), currently has 11 coal mines, with the designed production capacity is 18.3~19.8mn tonnes per year. Two-thirds of the products are coking coal and one-third are coke and fat coals. Key coal mines include: Huangbai Ci coal mine, Luotuo Shan coal mine, Wuhu Shan coal mine, Pinggou coal mine and Limin coal mine. Besides the coal mines, Shenhua Wuhai also has 13 coal-washing plants with total design capacity of 16mn tonnes per year and 5 coking plants with production capacity 3mn tonnes per year. In addition, Shenhua Wuhai has 500 MW of power capacity.

Shenning (Shenhua Ningxia) Shenhua Group cooperated with the Ningxia government to establish Shenhua Ningxia Coal Industry Group (Shenning) in January 2006, with registration capital of CNY10.1bn, of which 51% was from Shenhua, and 49% from the Ningxia government. Shenning operates business in coal mining and washing (including 15 coal mines and 3 coal-washing plants), coal deep processing, coal chemical (currently a CTO project and plans for CTL in the future), electric power, etc. According to Wang Jian, Chairman of the Board, Shenning’s 2011 coal output is expected to stand at 70mn tonnes, representing 16.7% y-y growth. Shenning’s CTO project with a designed capacity of 520kt PP per year is located in Shendong’s coal chemical base. Construction commenced in 2007 and was completed in 2010. After trial operation of one year, the project started commercial operation in May 2011.

Shenxin (Shenhua Xinjiang) Shenhua Xinjiang Energy (Shenxin) is Shenhua Group’s share-holding subsidiary, and an important enterprise of Xinjiang Uyghur Autonomous Region, which was founded in 2005. Shenxin’s key business is coal production and sales, with seven major coal mines, including the Weihu Liang coal mine, the Jiangou coal mine, the Xiaohong Gou coal mine, the Dahong Gou coal mine, the Tiechang Gou coal mine, the Tunbao coal mine and the Kuangou coal mine, Shenxin had 30mn tonnes of coal production capacity per year by 2010, and targets to have 150mn tonnes coal production capacity per year by 2020. The majority of Shenxin coal is thermal coal with low ash, low sulphur and high heat value characteristics; resources are around 7,000mn tonnes of China standard.

Shenxin enjoys railway transportation benefits because the Lanxin line passes through the company’s coal mines. Shenxin also plans to build CTL and CTO projects in Xinjiang, and aims for total capacity for CTL/CTO projects to reach 6mn tonnes per year by 2020.


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Better margins driven by improved sales mix and low production cost Historically, Shenhua has delivered the highest net margin among its peers. Despite the NDRC’s guidance of a key contract price growth rate within 5% for 2012F and a spot price cap of CNY800/t for coal with the heat value of 5,500kcal/kg at China’s major northern ports, we maintain Shenhua as our top pick in the sector for its impressive net profit margin of 22.9% and 23.4% in FY12-13F respectively, given:

• The improved and most defensive sales mix (balanced spot and contract exposure), which should offset the negative effect of weak spot price caused by the decelerating economic growth, in our view.

• Faster GDP growth in 2013F, which is likely to support a spot price rebound and a contract price standing at 2012’s level. Shenhua is more than likely to benefit from the situation, in our opinion.

• Shenhua enjoys the lowest unit production cost among peers, partly due to a good safety track record.

Defensive sales mix offset a weak spot price performance

On 30 November, the NDRC announced it would raise on-grid tariffs by CNY2.6cents/kWh (6.5%) for coal-fired power plants and by an average of CNY2.5cents/kWh for all power plants from 2012. To protect IPPs’ margins, the NDRC also announced plans to cap the spot coal price at CNY800/t (QHD 5,500kcal/kg) from January 2012 and the magnitude of contract coal price increases for 2012 at a max of 5%. The NDRC also capped spot prices for coal transported by railway and truck at settlement prices as of April 2011.

As a result, as we noted in our sector outlook, we believe key contract prices will increase at the highest rate guided by the NDRC (eg, 5% y-y) in 2012F. In addition, the non-key contract price, not regulated by NDRC and negotiated between sellers and buyers, is likely to rise by a larger 7% y-y over the same period, in our view, which leads to a blended contract price to hike 6.2%, according to our estimates.

We are less positive on the spot price due to economic slowdown and Beijing’s efforts to cap CO2 emissions. We expect the spot coal price to drop 10-15% in 1H12 to a low of CNY720/t in April (from CNY790/t currently), and rebound in 2H and finish at CNY810/t in December 2012F, translating to an average 4% y-y decline in 2012F.

Shenhua has shifted its focus to spot sales since 2010, with spot sales accounting for 45% in FY10, compared to 29% in FY09. Based on the 9M11 spot sales portion of 54.5% and the wide spread between the spot and contract price, we expect the 2011 spot portion to be consistent with 9M11 at 55%.

Management expects spot sales to increase by a few percentage points over the next few years; however, given Shenhua as a major state-owned enterprise and the largest contract coal supplier, it will likely be under policy pressure to stabilise coal supply and its contract price. Therefore, we believe Shenhua will maintain its spot portion at 55% in FY12F and onwards, so as to secure long-term customer relationships and government support (such as for asset acquisitions) in the future.

As well, there is lower pricing visibility on spot price than contract price, as the contract price for 2012 has been fixed at a 5% rise and the prevailing 30% discount to spot would suggest lower pricing risk going forward for contract compared to spot. We prefer companies with balanced spot/contract exposure with the potential to improve sales mix to feature more spot sales, like Shenhua and China Coal. In our view, Shenhua’s 45%/55% contract/spot exposure will help it to minimize the negative effect of the potential weak spot price performance going forward. Similar industry price trends on contract and spot are applied to our Shenhua model; this, together with the assumed unchanged sales mix in 2012-14F, translates into blended ASP increases of 0.3%, 4.4% and 2.9% to CNY445/t, CNY465/t and CNY478/t for 2012F, 2013F and 2014F, respectively, compared to 3.9% increase and CNY444/t in 2011F.


101

Fig. 131: Domestic sales mix (2009-15F)


Fig. 132: Contract and spot price (2009-15F)


Lowest unit costs among peers

In FY10, Shenhua’s production costs were CNY115/tonne and CNY154/tonne lower than that of China Coal and Yanzhou Coal, respectively, reflecting Shenhua’s: 1) lower unit staffing costs due to its large production scale; 2) shallower mines than China Coal; and 3) lower blending costs due to lower sulphur/ash content and lower calorific values. The low production costs likely offset its marginally higher unit transportation costs related to its longer distance to customers.

Shenhua is a leading coal producer, with 70% of its coal production already in full automation. The fatality rate per million tonnes of raw coal production was 0.0123 in 2010 (vs China’s average at 0.289). The full automation and low fatality rate could substantially reduce production costs.

Leveraging its production scale, favourable mining conditions and captive transportation networks, we expect Shenhua’s unit cost discount to China Coal to grow to 37%, 38% and 39% in FY11F, FY12F and FY13F, respectively, on our estimates, while the gap between Shenhua and Yanzhou Coal will be 34-37% during the same period.

Fig. 133: Unit production cost (self-produced coal)

Source: Company data, Nomura estimate

Fig. 134: Total unit cost (self-produced coal)


71 55

45 45 45 45 45

29 45

55 55 55 55 55

0

20

40

60

80

100

2009 2010 2011F 2012F 2013F 2014F 2015F

Contract sales Spot sales(%)

362 385336 365 377 408 408

421466

525504

530 530

477

388 427 444 445 465 478 448

0

100

200

300

400

500

600

2009 2010 2011F 2012F 2013F 2014F 2015F

Contract price Spot price Blend ASP(CNY/t)

101115 122 128 136

205230

244259

275256 269

303320

336

0

50

100

150

200

250

300

350

400

2009 2010 2011F 2012F 2013F

Shenhua China Coal Yanzhou(CNY/t)

207 216 213 219 227

289320

336354

373

267293

328347

366

0

50

100

150

200

250

300

350

400

2009 2010 2011F 2012F 2013F



102

Resources tax

China announced resource tax reform on 11 October, 2011. According to the new regulation, the government will introduce a value-based tax on oil and gas (say, 5-10% of sales). For coal miners, the tax will remain volume based and the government will levy a tax of CNY8-20/tonne on coking coal and CNY0.3-5/tonne for other coal grades. In our view, this is good news for thermal coal producers, especially for Shenhua. Shenhua, as the typical thermal producer, almost has no exposure to coking coal. According to our cross checks, Shenhua has already been paying tax of CNY3.5/tonne on average, within the new range.

However, Beijing aims to accelerate the transition of resource tax reforms for fossil fuels from being volume based to value based. According to our industry outlook, the reforms will likely be introduced in mid-2014 (but not in the next two years) and taxed at 5% of the selling price, when we expect the coal market to change to a surplus from the current deficit, and power pooling is established. Therefore, based on 5% of the estimated ex-mine price of CNY400/t in 2014F and implementation in July 2014, the additional resource tax on top of the current CNY3.5/t will be around CNY17-19/t from 2014F, which has been factored into our model. Currently, we assume no price pass-through to users given an expected surplus market in 2014F; however, we do not rule out a pass-through if power pooling is successfully implemented and Shenhua continues to be a low-cost producer.


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Power segment has above-industry profitability As at 30 June 2011, Shenhua operated 15 coal-fired power plants and two other power plants, with an installed gross capacity of 29.86GW and equity installed capacity of over 20,162GW. The power segment recorded EBIT of CNY8,353mn and CNY5,048 for 2010 and 1H11, implying EBIT margins of 18.5% and 18.3%, respectively – higher than the average EBIT margin of 11% for the five Hong Kong-listed IPPs in 1H11. The above-industry profitability, in our view, is due to:

• higher utilisation hours;

• lower unit fuel cost; and

• strategic capacity layout.

Fig. 135: 2010/1H11 EBIT margin comparison vs IPPs


Fig. 136: Utilisation hours (Shenhua vs IPPs)


Higher utilisation hours

Thanks to its effective capacity layout in higher power demand areas, Shenhua’s utilisation hours are higher than the industry average. Shenhua registered average utilisation hours of 5,566 hours in FY10 and 2,957 hours in 1H11, compared with the industry average of 5,031 hours and 2,592 hours, respectively.

Lower unit fuel cost on synergies with upstream coal

On the back of over 90% of coal supplied by its own coal business, Shenhua enjoys a lower unit fuel cost than the average of the five Hong Kong-listed IPPs. Although the price of Shenhua’s internal coal sales to its power business is the same as that offered to external clients, subject to coal quality and transportation distances, self-produced coal enables the firm to secure steady coal supply and shorten delivery times, which helps to stabilise its power business operations, especially during peak demand periods in winter.

Strategic power plant layout

Based on the company’s principle of “proximity to market, customers and production”, Shenhua’s power plants are located either: 1) close to its coal mines or rail lines, so as to secure coal supply and save transportation costs; or 2) in high power demand areas such as east China (including Zhejiang and Guangdong) and north China (including Beijing, Tianjin and Hebei), which are the most developed areas in China and thus have stronger power demand and higher power tariffs.

15%

8%4%

16% 17% 18%

13%

8%

5%

15%17%

18%

0%

5%

10%

15%

20%

25%

30%

Datang Huaneng Huadian CR Power

CPI Shenhua

FY10 1H11

6,3025,995

5,615 5,465 5,566

2,957

5,633 5,316 4,911 4,839 5,031

2,592

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

2006 2007 2008 2009 2010 1H11

(Hours) Shenhua Coal-fire power plant industry average


104

Beneficiary of tariff hikes

On Nov 30 2011, the NDRC announce an on-grid tariff hike of CNY2.6cents/kWh (6.5%) for coal-fired power plants and an average of CNY2.5 cents/kWh for all plants. Together with the announced on-grid tariff hikes in April (1.9%) and June (0.4%) 2011, total on-grid tariff was raised by 8.9%. Also, another 5% tariff hike is expected in July 2012, in our view. By June 2011, coal-fired capacities accounted for 97% of the total installed capacities of Shenhua.

As a result, we factor in 4.3%, 6.6%, 2.7% tariff hikes for Shenhua in 2011-13F respectively, which we estimate will increase the power gross profit from CNY9,538mn in 2010 to CNY12,148mn in 2011F, CNY17,094mn in 2012F and CNY20,271mn in 2013F.

Internal hedging between coal and power segment

Demand from the power segment makes up about 50% of total coal demand in China, according to our industry outlook. Based on generation of 170bn kwh in 2011F and 300g/kwh unit coal consumption, Shenhua is expected to consume ~51mn tonnes pa internally for power generation or 18-20% of its annual self production. We believe coal demand will not be as strong as before in the coming years due to the economic slowdown and the government’s efforts to reduce CO2/energy intensity. The power segment has provided stable demand for self coal production and a hedge to its earnings despite falling coal prices. On the other hand, the captive logistics network and self-produced coal should in turn secure coal supply, especially in structural tight supply periods, e.g. the pre-stocking periods before summer and winter.


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Earnings outlook

Coal as key profit contributor

We forecast Shenhua’s revenue growth will be 33.3% in FY11F and slow to 13.7% and 13.3% in 2012F/13F respectively, driven by less robust coal price expectations and an unchanged sales mix in the coming years, despite a continued improvement in self production and third-party trade. The primary source of earnings at present is coal mining, accounting for around 73% of the company’s PBT in 1H11, with power growing rapidly as the second-largest contributor. Thanks to Shenhua’s low unit production cost, the coal business should maintain its high gross margin of 45-47% from FY11F to FY13F, while the power segment offers an above industry gross margin of 22-28% during the same period, based on our estimates.

Fig. 137: Shenhua: revenue breakdown (FY12F)


Fig. 138: Shenhua: gross margin trend (09-13F)


Key profit drivers and sensitivity

We expect Shenhua’s normalised net profit to increase by 19.8% y-y to CNY45.7bn in FY11F. We forecast FY12F earnings growth to be 15.4% to CNY52.7bn with 12.4% coal sales volume growth as the biggest driver. The increase of coal sales ASP (mainly driven by contract price growth) is likely to contribute another 1.1% of the net profit growth. However, the increase of unit cost is expected to drag down net profit by 4.1%. On a consolidated basis, we forecast the coal business to contribute 8.7% of the net profit growth in FY12F, while power and other businesses contribute the remaining 6.7%.

Fig. 139: Shenhua: 2012F net profit growth driver


Fig. 140: Shenhua: EPS growth (2009-13F)


Coal revenue,

69.0%

Power revenue,

28.5%

Rail and Ports, 1.5%

Others, 1.0%

4643

40 40 40

53 5247 46 45

2521 22

26 28

0

10

20

30

40

50

60

2009 2010 2011F 2012F 2013F

Group Coal Power(%)

12.4%1.1% -4.1%

8.7%

6.7% 15.4%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Increase in sales volume

Increase in coal ASP

Increase of unit cost

Coal business

Power and

others

Group

19 20 20 15 164 1

39

21 23

-37

75

26

2 5

(60)

(40)

(20)

0

20

40

60

80

100

2009 2010 2011F 2012F 2013F

Shenhua China Coal Yanzhou(%)


106

From the sensitivity table below, we note that Shenhua is the least sensitive to unit cost change relative to its peers.



Among its different earnings drivers, Shenhua is more sensitive to spot price and unit cost changes. Given that contract represents a smaller portion of its sales mix, Shenhua is less sensitive to contract price changes in comparison to China Coal.

Balance sheet and cashflow

To achieve its output growth target and maintain its integrated advantages, Shenhua is aggressively expanding its coal output, rail and port facilities and power generation.

Management guided that it will spend CNY36.2bn in capex in 2011F (excluding M&A): 43% in coal (CNY15.5bn), 35% in railway (CNY12.7bn), 4% in ports (CNY1.6bn), 4% in shipping (CNY1.6bn) and 13% in power (CNY4.6bn), CNY11.9bn (33%) of which has been spent in 1H11. The remaining CNY24.3bn is expected to be utilized in 2H, in line with the historical record.

Similar annual capex will be spent over the next five years, with an emphasis on railway and coal, while investment in power is expected to fall. Currently, three railway lines – Bazhun, Zhunchi (CNY11bn) and Ganquan (CNY4.3bn) – are under construction, these will enhance its railway tonnage capacity to 350mnt pa from 2012 (vs currently 192mnt).

In order to achieve the growth target of 325mn tones in coal output and 6000MW in power capacity during 2011-13, we estimate that Shenhua will increase its capex by 10% yoy in 2012F with another 10% growth in 2013F.

Shenhua was net cash in 2010 and due to the strong cash generating operating activities, we expect Shenhua to maintain a strong in cash position (net cash) from 2011F. In spite of the significant capex needs in the following year, we believe there is no need for Shenhua to perform equity financing given its under-geared balanced sheet (net cash), ample cash position (CNY92,448mn in 2011F), rich operating cash flow and strong credit pipeline from banks.

The company lifted its dividend payout to 40% in 2010, from 33% in 2009. Shenhua management believes this policy will be maintained given strong cashflow and a healthy balance sheet despite capex remaining high at CNY35-40bn pa over the next five years.

In our view, Shenhua does not require an equity issue in the near term given its positive free cash flow (after capex) in 2011-12F and low gearing (net cash). This view is reinforced by its decision to raise the dividend payout ratio to 40% from this year.




% chg in net profit on 1% change in unit cost -1.70 -3.50 -1.89



107

1H11 results recap Shenhua’s 1H11 came in at CNY22,726mn (EPS CNY1.14), up 16.5% yoy, 2Q profit was CNY11,675mn (+5.8% qoq). Revenue and EBIT increase 40.5% yoy and 22.4% yoy to CNY100,692mn and CNY36,172mn respectively. However, these were erased by the higher-than-expected effective tax rate hike in 1H11 (25%, +4.3ppts yoy). EBIT margin was 35.9% (41.2% in 1H10), driven by cost pressure in all segments (coal: EBIT margin 30.2%, -2.8ppt yoy; power: 18.2%, - 2.4ppt; railway: 44.2%, -6.1ppt; ports: 27.6%, - 0.5ppt; shipping: 12.4%, vs nil).

Fig. 142: 1H results details


Profit & Loss (CNYmn) 2010 H1 2011 H1 y-y change

RevenueCoal 48,063 68,774 43.1%Power 21,372 27,293 27.7%Self owned railway carriage (bnt km) 1,279 2,881 125.3%Others 954 1,744 82.8%

71,668 100,692 40.5%

Cost of sales (37,880) (59,013) 55.8%

Gross profit 33,788 41,679 23.4%

SG&A (4,095) (5,001) 22.1%

Other operating expenses (income) (131) (506) 286.3%

Profit from operations 29,562 36,172 22.4%

Finance costs, net (1,231) (888) -27.9%Investment income 9 - -100.0%Investment income from associates 280 126 -55.0%

Profit before income tax 28,620 35,410 23.7%Income tax expense (6,026) (8,990) 49.2%

Profit for the year 22,594 26,420 16.9%

Profit attributable to:Equity holders of the Company 19,509 22,726 16.5%Minority interests 3,085 3,694 19.7%

22,594 26,420 16.9%

Basic and diluted EPS (CNY) 0.98 1.14 16.5%

EBITDA 36,185 43,648 20.6%

Key ratios: 2010 H1 2011 H1change in

ppts

Gross Profit Margin 47.1% 41.4% -5.8 pptNet Profit Margin 31.5% 26.2% -5.3 pptEBITDA Margin 50.5% 43.3% -7.1 pptEBIT Margin 41.2% 35.9% -5.3 pptEffective tax rate 21% 25% 4.3 ppt


108

Our view

• Blended ASP was CNY429/t in 1H11, +5.5% yoy, due to an unexpected 8% yoy decline in long-term key contract ASP, while spot ASP rose 9.5%. This was despite the spot sales volume portion having increased to 52.6% (1H10 39.3%). We believe this is attributable to increasing output from the coal mines injected by its parent in 1Q11, in which 70% of the reserve was lignite coal with lower heat content and ASP.

• 1H11 commercial coal production volume was 140mnt (+18.4% yoy). Assuming the same run rate as 2010 (1H accounted for 48.6% of FY10 output), FY11 output volume should be 288mnt. The newly injected mines are expected to ramp up production in 2H11, providing further potential upside. Coal sales volume was 191mnt, +31% yoy, driven by a 48mnt third party trade (+63% yoy).

• Unit production cost was CNY106/t (+9% yoy) mainly due to increase of staff cost (+12% yoy) and other expenses (+21% yoy, attributable to the increasing environment protection expenditures and mining engineering expenses). However, total unit cost remained flat at CNY196/t, owning to a 10% decline in transportation cost (to CNY89/t in 1H11, due to the increase in mine mouth/direct arrival and third party trade).

• Effective tax rate was 25% in 1H11, -4.3pct yoy, which is attributed to the expiration of tax holiday of Shenhua’s subsidiaries and branches.


109

3Q results recap Shenhua’s 3Q net profit arrived at CNY12,835mn (+9.7% qoq) due to the lower effective tax rate (21.3% in 9M11 vs 25.4% in 1H11). The 9M11 net profit attributed to shareholders of CNY35,561mn and EPS of CNY1.788/sh under IAS GAAP, +19% yoy. Gross margin stood at 40.1% for 9M11. The net profit margin hit 23.1% for 9M11, 0.2pcts higher than consensus estimate of 22.9%.

Fig. 143: 3Q result details


Our view

• The 3Q production and sales volume reached 69.5mnt and 95.2mnt, -0.7% qoq and -2.7% qoq respectively, mainly driven by the relatively weak operational performance in Aug. However, the 9M production and sales volume increased 16.4% yoy and 26.7% yoy to 209.9mnt and 286.4mnt respectively.

• The 9M11 ASP at the group level rose 6.2% yoy to CNY435.6/t. The lower-than-expected ASP is mainly caused by the relatively low quality coal injected in Dec 2010, which partially offset the strong sales volume growth in 9M11. Therefore, the 9M11 revenue reached CNY153,631, accounting for 78.2% of our FY11 estimate of CNY196,545.

Profit & Loss (CNYmn)Jan to

Sep 10Jan to

Sep 11 y-y changeJuly to Sep 11 q-q change

RevenueCoal 75,543 103,172 36.6% 34,398 -4.5%Power 33,709 43,258 28.3% 15,965 8.8%Others 3,988 7,201 80.6% 2,576 -1.9%

113,240 153,631 35.7% 52,939 -0.7%

Cost of sales (60,719) (91,950) 51.4% (32,937) 5.6%

Gross profit 52,521 61,681 17.4% 20,002 -9.5%

SG&A (7,599) (7,764) 2.2% (2,763) 6.4%Other operating expenses (income) (56) (517) 823.2% (11) -97.9%

Profit from operations 44,866 53,400 19.0% 17,228 -9.3%

Finance costs, net (1,711) (1,607) -6.1% (719) 89.7%Investment income 9 - -100.0% - -100.0%Investment income from associates 381 196 -48.6% 70 2.9%

Profit before income tax 43,545 51,989 19.4% 16,579 -11.3%Income tax expense (9,197) (11,056) 20.2% (2,066) -59.2%

Profit for the year 34,348 40,933 19.2% 14,513 6.6%

Profit attributable to:Equity holders of the Company 29,886 35,561 19.0% 12,835 9.7%Minority interests 4,462 5,372 20.4% 1,678 -12.6%Profit for the period 34,348 40,933 19.2% 14,513 6.6%

Basic and diluted EPS (CNY) 1.503 1.788 19.0% 0.645 9.7%

Key ratios:Jan to

Sep 10Jan to

Sep 11

changein pcts

(yoy)July to Sep 11

changein pcts

(qoq)

Gross Profit Margin 46.4% 40.1% -6.2 pct 37.8% -3.7 pctEBIT Margin 39.6% 34.8% -4.9 pct 32.5% -3.1 pctNet Profit Margin 26.4% 23.1% -3.2 pct 24.2% 2.3 pct


110

• The contract price declined 8.3% to CNY336.8/t for 9M11 mainly due to the high quality coal to be sold in the spot market to grasp higher profit. The ASP for spot sales surged 11.7% yoy to CNY510.2/t.

• The contract sales accounted for only 45.5% of the total domestic sales for 9M11, (vs 58.2% for 9M10). Compared with 55.7% of China Coal, Shenhua’s 45.5% contract sales portion remains competitive. The decrease of contract sales volume should provide potential for the company’s future GP margin improvement, in our view.

• Unit production cost was recorded at CNY110.6/t for 9M11 (+8.2% yoy), within management guidance of 10% yoy growth. However, Shenhua’s unit production cost is relatively low compared with its competitors, at a 52% discount to China Coal’s CNY230.1/t.

• The effective tax rate slumped to 21.3% in 9M11 from 25.4% in 1H11, transferring the extremely low 3Q effective tax rate of 12.5%. According to the tax regulation, the already expired tax holiday for the western area development can be prolonged to 2020, which was announced on July 27, after the 1H report cutoff date. As a result, Shenhua may reverse the over accrued 1H tax expense in 3Q, which is attributable to the extremely low effective tax rate in 3Q.


China Coal Energy 1898.HK 1898 HK .

METALS & MINING

EQUITY RESEARCH

Upgrade to BUY with TP of HK$12.25

Strongest production growth with lowest pricing risk. A near-term outperformer: BUY

February 1, 2012

Rating Up from Neutral

Buy

Target price Increased from 10.86

HKD 12.25


HKD 10.20

Potential upside +20.1%

Action: 2011-13F earnings revised up by 8-18%; Upgrade to BUY with TP of HKD12.25 Low pricing risk: 53% of its 2012F sales volume has been contracted at

a price increase of 5%+; Given its lower exposure to spot, the potential 10-15% drop in spot price in 1H12F and 9.2% correction in 2011-15F should have the least impact on the company compared with its peers. Meanwhile, the prevailing 30% discount to spot should allow contract price to rise 10% during 2011-15F. This, together with the improvement in sales mix (contract sales: 53% in 2012F, vs 69% in 2010) and more coking sales (5% in 2012F, vs 1% in 2010) should benefit ASP.

Visible/strong production growth: Its production growth (17% and 23%) is set to outperform peers in 2012-13F driven by two greenfield projects (Pingshuo East and Wanjialing), 4 new mines acquired by the A-share proceeds and potential asset injection. Upside is likely to come from the production ramp-up from 10bn tonnes of resources acquired in 2010.

Fast production recovery from the Shanxi accident, contained increase in unit production costs in 2H2011 (evident by its impressive 2H11 results) and significant improvement in wash rate (77% for 2012F, vs 73% in 1H11) show that China Coal is back on track for quality growth.

Catalyst and valuation: An outperformer in 2012 A bigger non-key contract price increase, rebound of spot price, faster ramp-up of production, potential asset injection are catalysts. We have upgraded China Coal’s earnings by 8-18% for 2011-13F. Trading at 8.6x FY12F P/E (vs industry average of 9.2x), we believe it is attractive owing to 20%+ pa earnings growth and improved ROEs in 2012/13F.



Revenue (mn) 70,303 83,917 88,146 100,259 105,336 120,335 130,967



Normalised EPS 56.31c 66.32c 78.37c 87.28c 94.59c 1.08 1.17

Norm. EPS growth (%) 0.8 17.8 39.2 31.6 20.7 23.8 23.4

Norm. P/E (x) 15.4 N/A 10.4 N/A 8.6 N/A 6.8

EV/EBITDA (x) 7.1 6.8 5.9 5.2 4.9 4.4 3.7



ROE (%) 10.5 11.4 13.3 13.7 14.5 15.2 16.0

Net debt/equity (%) net cash 11.1 9.9 24.7 16.1 31.1 10.2


Anchor themes

China remains in coal deficit in 2012-13F, due to transportation constraints but not production. Coal price set to fall by 10-15% in 1H12F and rebound in 2H due to slowing GDP growth and Beijing’s effort to cap CO2/energy intensity.

Nomura vs consensus

Our 2012F EPS and TP are 10% and 9% above consensus, respectively, due to our more bullish view on production volume and margins.

Research analysts




Nomura | China Coal Energy February 1, 2012

112

Key data on China Coal Energy Income statement (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FRevenue 53,187 70,303 88,146 105,336 130,967Cost of goods sold -41,156 -55,825 -69,119 -81,247 -100,365Gross profit 12,031 14,478 19,027 24,090 30,602SG&A -2,258 -3,416 -3,849 -4,598 -5,830Employee share expense


EBITDA 12,029 14,668 19,694 25,358 31,567Depreciation -2,198 -3,121 -4,278 -5,569 -6,457Amortisation -59 -486 -238 -298 -339EBIT 9,773 11,062 15,178 19,492 24,771Net interest expense 452 -109 -447 -1,477 -1,695Associates & JCEs 91 46 0 0 0Other income 0 0 0 0 0Earnings before tax 10,316 10,999 14,732 18,015 23,076Income tax -2,395 -2,848 -3,388 -4,324 -5,538Net profit after tax 7,920 8,151 11,343 13,691 17,538Minority interests -511 -685 -953 -1,150 -2,062Other items

Preferred dividends

Normalised NPAT 7,409 7,466 10,391 12,541 15,476Extraordinary items

Reported NPAT 7,409 7,466 10,391 12,541 15,476Dividends -2,044 -1,987 -2,765 -3,337 -4,118Transfer to reserves 5,366 5,480 7,626 9,204 11,358


FD normalised P/E (x) 16.1 15.4 10.4 8.6 6.8FD normalised P/E at price target (x) 19.3 18.5 12.5 10.4 8.2Reported P/E (x) 16.1 15.4 10.4 8.6 6.8Dividend yield (%) 1.7 1.7 2.6 3.1 3.9Price/cashflow (x) 10.2 10.8 7.3 5.9 4.6Price/book (x) 1.7 1.6 1.3 1.2 1.0EV/EBITDA (x) 9.8 7.1 5.9 4.9 3.7EV/EBIT (x) 12.1 9.4 7.7 6.3 4.7Gross margin (%) 22.6 20.6 21.6 22.9 23.4EBITDA margin (%) 22.6 20.9 22.3 24.1 24.1EBIT margin (%) 18.4 15.7 17.2 18.5 18.9Net margin (%) 13.9 10.6 11.8 11.9 11.8Effective tax rate (%) 23.2 25.9 23.0 24.0 24.0Dividend payout (%) 27.6 26.6 26.6 26.6 26.6Capex to sales (%) 29.8 37.5 38.8 22.8 12.3Capex to depreciation (x) 7.2 8.5 8.0 4.3 2.5ROE (%) 11.7 10.5 13.3 14.5 16.0ROA (pretax %) 11.0 11.2 13.1 13.7 15.5

Growth (%)

Revenue 2.8 32.2 25.4 19.5 24.3EBITDA -7.8 21.9 34.3 28.8 24.5EBIT -14.3 13.2 37.2 28.4 27.1Normalised EPS 3.9 0.8 39.2 20.7 23.4Normalised FDEPS 3.9 0.8 39.2 20.7 23.4

Per share

Reported EPS (CNY) 55.88c 56.31c 78.37c 94.59c 1.17Norm EPS (CNY) 55.88c 56.31c 78.37c 94.59c 1.17Fully diluted norm EPS (CNY) 55.88c 56.31c 78.37c 94.59c 1.17Book value per share (CNY) 5.17 5.58 6.16 6.85 7.71DPS (CNY) 0.15 0.15 0.21 0.25 0.31Source: Company data, Nomura estimates



(%) 1M 3M 12M

Absolute (HKD) 17.6 9.3 -11.5

Absolute (USD) 18.0 9.5 -11.2

Relative to index 10.2 2.6 2.3



52-week range (HKD) 11.9/6.59


27.72


China National Coal Group 56.0


Notes

20%+ earnings growth due to the resolution of output constraints


113

Cashflow (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FEBITDA 12,029 14,668 19,694 25,358 31,567Change in working capital 7,476 15,906 -1,063 -1,040 -1,455Other operating cashflow -7,817 -19,892 -3,850 -5,816 -7,249Cashflow from operations 11,688 10,683 14,781 18,502 22,863Capital expenditure -15,858 -26,378 -34,237 -24,020 -16,071Free cashflow -4,170 -15,695 -19,456 -5,518 6,792Reduction in investments 0 0 0 0 0Net acquisitions -1,915 -3,131 0 0 0Reduction in other LT assets -13,246 -3,734 -2,884 -1,953 -1,229Addition in other LT liabilities 3,600 393 0 0 0Adjustments 20,889 34,316 6,323 4,370 2,851Cashflow after investing acts 5,158 12,149 -16,017 -3,101 8,414Cash dividends -2,044 -1,987 -2,765 -3,337 -4,118Equity issue 0 0 0 0 0Debt issue 1,227 -723 21,090 8,884 528Convertible debt issue

Others 398 855 -87 -87 -87Cashflow from financial acts -418 -1,855 18,238 5,460 -3,677Net cashflow 4,740 10,294 2,222 2,360 4,737Beginning cash 7,888 12,628 22,922 25,144 27,503Ending cash 12,629 22,922 25,144 27,503 32,241Ending net debt -352 -10,784 8,084 14,609 10,399Source: Company data, Nomura estimates

Balance sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash & equivalents 12,628 22,922 25,144 27,503 32,241Marketable securities

Accounts receivable 4,964 7,006 8,784 10,497 13,051Inventories 4,978 6,215 7,695 9,045 11,174Other current assets 28,303 12,557 14,571 16,510 19,403Total current assets 50,873 48,700 56,193 63,556 75,868LT investments 2,474 4,453 4,453 4,453 4,453Fixed assets 38,121 46,418 69,530 83,177 89,577Goodwill

Other intangible assets 43 43 344 495 534Other LT assets 19,589 23,323 26,207 28,160 29,389Total assets 111,100 122,936 156,727 179,841 199,821Short-term debt 990 1,422 1,761 2,070 2,557Accounts payable 13,887 16,251 20,121 23,652 29,217Other current liabilities 643 1,717 2,056 2,488 3,042Total current liabilities 15,519 19,391 23,938 28,210 34,816Long-term debt 11,287 10,716 31,467 40,042 40,083Convertible debt

Other LT liabilities 6,098 6,491 6,491 6,491 6,491Total liabilities 32,904 36,598 61,896 74,743 81,390Minority interest 9,600 12,290 13,156 14,219 16,194Preferred stock 0 0 0 0 0Common stock 13,259 13,259 13,259 13,259 13,259Retained earnings 42,193 42,818 68,416 77,620 88,978Proposed dividends 1,987 2,073 0 0 0Other equity and reserves 11,157 15,900 0 0 0Total shareholders' equity 68,595 74,049 81,674 90,879 102,237Total equity & liabilities 111,100 122,936 156,726 179,841 199,821

Liquidity (x)

Current ratio 3.28 2.51 2.35 2.25 2.18Interest cover na 101.5 34.0 13.2 14.6

Leverage

Net debt/EBITDA (x) net cash net cash 0.41 0.58 0.33Net debt/equity (%) net cash net cash 9.9 16.1 10.2

Activity (days)

Days receivable 36.4 31.1 32.7 33.5 32.8Days inventory 40.9 36.6 36.7 37.7 36.8Days payable 109.4 98.5 96.0 98.6 96.1Cash cycle -32.1 -30.9 -26.6 -27.4 -26.6Source: Company data, Nomura estimates

Notes

Sufficient cash inflow due to growth of revenue

Notes

Healthy balance sheet due to less need for capex in the coming years


114

Upgrade to BUY with TP of HK$12.25 We upgrade China Coal to BUY (from Neutral) with a revised PT of HK$12.25 (from HK$10.86), implying a potential upside of 20.1%. We have also revised up 2011-13F’s earnings forecast by 18%/ 8%/ 8% to CNY10,391mn/ CNY12,541mn/ CNY15,476mn respectively to reflect the following changes of assumptions:

• Raise 2011F-15F commercial coal production by 4-9%: The likely asset injection is expected to add raw coal production by 5mnt, 15mnt, 20mnt and 25mnt for 2012-15F. Therefore, we have revised up 2011-15F’s total commercial coal production by 4.4%, 6.7%, 8.1%, 9.4% and 9.2% to 97mnt, 114mnt, 140mnt, 151mnt and 154mnt, respectively.

• Upgraded wash rate by 2ppts: According to management and the preliminary FY11 results, the company’s coal quality is expected to improve in the coming years. Therefore, we have raised the wash rate to 77% (from 75%) for 2011F-15F.

• Revised up 2011F-15F total coal sales volume by 6-22%, driven by higher self-produced thermal coal volume and proprietary coal trading volume: Along with the increased output and improved wash rate, sales volume increases accordingly. Therefore, we have revised upwards the total sales volume by 6.1%, 10.7%, 15.1%, 19.4% and 22.0% to 133mnt, 153mnt, 183mnt, 199mnt and 208mnt respectively in 2011-15F.

• Increased sales mix to spot by 2-4 ppts: According to the 9M2011 results, the contracted sales (volume basis) accounted for 56% of the total domestic sales, vs 69% in 2010. Therefore, to reflect the sales mix improvement, we cut 2011-12F’s contract sales portion to 56% (from 60%) and to 53% (from 55%), respectively. Given China Coal does not have a captive transportation network, the contract sales portion is expected to remain at 53% for 2013-15F, higher than our previous assumption of 50%.

• Cut thermal coal ASPs by 3-15% for 2012F-15F: According to the new coal price forecasts in our industry outlook, we have revised down our key contract and spot coal prices by 3-18% in 2012-15F; therefore, the blended thermal coal ASPs have been adjusted down by 3-15% to CNY495/t, CNY508/t, CNY520/t and CNY492/t, respectively.

• Cut unit production cost by 2-4% for 2011-13F: We have cut our unit production cost assumptions by 1.9%, 3.7% and 2.5% to CNY244/t, CNY259/t and CNY275/t for 2011-13F according to the 9M2011 results and the likely easing in CPI in the coming two years. However, we have raised the unit production cost to by 1.9% to CNY302/t and 6.4% to CNY331/t in 2014-15F to price in the likely value-based resources tax of 5% to be implemented in July 2014.

• A lower effective interest rate: We have lifted 2011F’s effective interest rate to 5% (from 3%) according to the 9M2011 results. Our economist, Zhiwei Zhang, expects interest rates to be cut by 25bps in 2012F and for it rebound by 75bps in 2013F. As a result, we cut our effective interest rate to 4.75% (from 5%) in 2012F and revise it up to 5.5% (from 5%) for 2013F and beyond.

• A lower tax rate: We cut our 2011 effective tax rate to 23% (from 26%) according to the preliminary FY11 results and cut the effective tax rate to 24% (from 26%) for 2012F and beyond.

As a result of the above changes in assumptions, EBITDA margins are revised down to 22-24% (from 21-26%), sales volume is lifted by 6-15% and blended ASP is cut by 1-2% for 2011-13F. This results in our earnings estimates rising by 8-18% for 2011-13F.


115

Fig. 144: Change of assumptions (1/2)

Source: Nomura estimate

2011F 2012F 2013F 2014F 2015F

Coal production Volume

Total raw-coal production

New model (mnt) 127 148 182 196 201

Old model (mnt) 125 143 173 184 189

Change (%) 1.6 3.9 5.2 6.5 6.4

Total commercial coal production

New model (mnt) 97 114 140 151 154

Old model (mnt) 93 107 129 138 141

Change (%) 4.4 6.7 8.1 9.4 9.2

Wash rate

New model (%) 77 77 77 77 77

Old model (%) 75 75 75 75 75


Coal sales Volume

Self-produced thermal

New model (mnt) 96 108 130 140 144

Old model (mnt) 90 99 117 122 126

Change (%) 7.2 9.6 11.0 14.1 13.8

Self-produced coking

New model (mnt) 2 6 10 11 11

Old model (mnt) 2 5 8 11 11

Change (%) 0.0 5.6 14.3 0.0 0.0

Proprietary coal trading

New model (mnt) 31 35 40 45 50

Old model (mnt) 30 30 30 30 30

Change (%) 3.7 16.7 33.3 50.0 66.7

Import and export agency

New model (mnt) 4 4 4 4 4

Old model (mnt) 4 4 4 4 4

Change (%) 0.0 0.0 0.0 0.0 0.0

Total

New model (mnt) 133 153 183 199 208

Old model (mnt) 125 138 159 167 171

Change (%) 6.1 10.7 15.1 19.4 22.0

Contract sales as a % of domestic sales

New model (%) 56 53 53 53 53

Old model (%) 60 55 50 50 50

Change (pcts) -4 -2 3 3 3


116

Fig. 145: Change of assumptions (2/2)


Valuation methodology: Our target price is based on discounted cashflow (DCF) analysis with a WACC of 9.3% and a terminal growth rate of 2.5%. As of Jan 26 2012, the stock is trading at 8.6x FY12F P/E, a 44% discount to historical average of 15.4x P/E and a 4% premium to Yanzhou Coal and a 19% discount to Shenhua. Our target price implies a FY12F P/E of 10.4x, an 10% discount to Shenhua’s target multiple of 11.5x.

Risks: Upside risks include: 1) Greater-than-expected output growth and 2) a better-than-expected wash rate. Downside risks include: 1) lower-than-expected spot price increase; 2) weaker coal demand due to weaker-than-expected economic growth in China; 3) higher-than-expected cost hike due to resource tax and inflation; and 4) worse-than-expected sales mix.

2011F 2012F 2013F 2014F 2015F

Price

Domestic contract price (Thermal)

New model (CNY/t) 412 438 438 460 460

Old model (CNY/t) 418 452 470 489 508

Change (%) -1.5 -3.1 -6.8 -5.9 -9.6

Domestic spot price (Thermal)

New model (CNY/t) 583 559 587 587 529

Old model (CNY/t) 563 585 609 627 646

Change (%) 3.5 -4.4 -3.5 -6.3 -18.1

Export ASP (Thermal)

New model (CNY/t) 796 764 802 802 722

Old model (CNY/t) 715 729 744 744 744

Change (%) 11.3 4.8 7.9 7.9 -2.9

Thermal coal ASP

New model (CNY/t) 487 495 508 520 492

Old model (CNY/t) 476 512 539 558 577

Change (%) 2.3 -3.4 -5.8 -6.8 -14.7

Coking coal ASP

New model (CNY/t) 1,405 1,321 1,321 1,321 1,321

Old model (CNY/t) 1,500 1,200 1,100 1,200 1,200

Change (%) -6.3 10.1 20.1 10.1 10.1

ASP Self-Produced coal

New model (CNY/t) 504 536 564 577 550

Old model (CNY/t) 496 548 577 610 626

Change (%) 1.6 -2.2 -2.2 -5.4 -12.2

Cost

Unit production cost - self produced

New model (CNY/t) 244 259 275 302 331

Old model (CNY/t) 249 269 282 296 311

Change (%) -1.9 -3.7 -2.5 1.9 6.4

Total unit cost of self produced coal

New model (CNY/t) 336 354 373 402 435

Old model (CNY/t) 341 365 383 402 422

Change (%) -1.4 -3.0 -2.6 0.1 3.0

Unit cost for coal trading

New model (CNY/t) 682 658 691 691 622

Old model (CNY/t) 647 673 699 720 742

Change (%) 5.5 -2.1 -1.2 -4.1 -16.2

Interest rate

New model (%) 5.00 4.75 5.50 5.50 5.50

Old model (%) 3.00 5.00 5.00 5.00 5.00

Change (pct) 2.00 -0.25 0.50 0.50 0.50

Tax rate

New model (%) 23 24 24 24 24

Old model (%) 26 26 26 26 26

Change (pct) -3 -2 -2 -2 -2


117

Fig. 146: Valuation and sensitivity


Fig. 147: Valuation comparison

Note: Pricing as of 26 Jan 2012 closing, Bloomberg consensus data for the not rated stocks



NPV $129,146.39Cash 32,896 --- Terminal Growth Rate ---Debt (33,228) 12.25 1.75% 2.00% 2.25% 2.50% 2.75% 3.00% 3.25%

128,813.97 8.5% 13.07 13.47 13.89 14.35 14.84 15.39 15.98 No of share 13,259 8.7% 12.59 12.96 13.35 13.77 14.23 14.72 15.27 RMB per share 9.72 8.9% 12.14 12.48 12.84 13.23 13.65 14.11 14.61 HK$ per share 12.25 9.1% 11.71 12.03 12.36 12.72 13.11 13.54 13.99

9.3% 11.31 11.60 11.92 12.25 12.61 13.00 13.42 Risk free rate 2.50% 9.5% 10.93 11.20 11.49 11.81 12.14 12.50 12.89 Market risk premium 7.50% 9.7% 10.57 10.83 11.10 11.39 11.70 12.03 12.39 Beta 1.379 9.9% 10.23 10.47 10.72 10.99 11.28 11.59 11.92 Tax rate 24% 10.1% 9.91 10.13 10.37 10.62 10.89 11.18 11.49 Cost of debt 5%Cost of equity 12.8%WACC 9.3%

D/(D+E) 35% 26%

---

WA

CC

--


cap Fiscal PEG


Coal



ChinaDatong Coal 601001 CH n.a. n.a. 13.39 3551.41 Dec 16.9 14.8 13.2 1.5 2.2 2.0 1.8 1.7 1.8 2.0 n.a. n.a. n.a. 14.5 14.7 15.9Shanxi Xishan Coal & Electricity 000983 CH n.a. n.a. 16.3 8139.67 Dec 15.8 13.3 12.6 0.9 3.4 2.8 2.4 2.4 2.6 2.8 n.a. n.a. n.a. 23.5 23.7 25.3Pingdingshan Tianan Coal Mining Co 601666 CH n.a. n.a. 11.83 4426.44 Dec 12.7 10.7 9.6 0.7 2.3 1.9 1.6 2.5 2.7 3.2 n.a. n.a. n.a. 20.3 19.6 19.6Shanxi Guoyang 600348 CH n.a. n.a. 18.65 7107.83 Dec 14.7 12.9 11.4 0.7 4.0 3.1 2.5 1.2 1.3 1.5 n.a. n.a. n.a. 29.5 26.7 24.5Shanghai Energy 600642 CH n.a. n.a. 4.63 3469.55 Dec 15.7 12.9 11.0 1.2 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Hengyang Coal 600971 CH n.a. n.a. 15.83 2508.57 Dec 12.5 10.9 11.9 1.3 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 17.4 17.7 16.9Lu'an Environmental Energy 601699 CH n.a. n.a. 24.92 9087.06 Dec 14.4 12.6 10.5 0.8 3.5 3.5 2.9 3.6 4.2 5.2 n.a. n.a. n.a. 29.1 27.5 28.3SDIC Xinji 601918 CH n.a. n.a. 11.77 3451.3 Dec 13.5 10.8 10.3 0.7 2.3 1.9 n.a. 2.4 2.9 n.a. n.a. n.a. n.a. 16.4 17.4 n.a.China Average 14.5 12.4 11.3 1.0 2.9 2.5 2.2 2.3 2.6 2.9 n.a. n.a. n.a. 21.5 21.0 21.8

S.E AsiaBanpu BANPU TB n.a. n.a. 584 5075.18 Dec 9.6 9.6 8.9 n.a. 2.0 1.8 1.6 3.3 3.4 3.5 0.6 0.4 0.2 25.7 19.8 18.6Bumi BUMI IJ Buy 3000 2525 5850.85 Dec 16.8 14.8 9.0 0.5 3.1 2.6 2.1 1.1 1.2 1.4 169.6 120.7 66.6 19.7 19.1 25.7ITMG ITMG IJ Reduce 37300 37750 4757.91 Dec 9.1 11.4 8.5 0.3 4.5 4.4 3.6 4.2 8.3 6.6 net cash net cash net cash 59.2 39.6 46.9Bukit Asam PTBA IJ Buy 26000 20000 5140.28 Dec 14.9 13.6 12.1 0.6 5.6 4.6 3.8 2.6 3.4 3.7 net cash net cash net cash 42.3 36.8 34.3Indika Energy INDY IJ Neutral 2500 2500 1452.08 Dec 11.9 8.3 6.2 0.2 2.0 1.7 1.4 1.0 3.4 4.8 76.9 57.0 34.9 18.5 22.6 25.2Adaro ADRO IJ Buy 2450 1840 6564.88 Dec 13.7 12.6 10.5 0.4 2.7 2.3 2.0 1.5 2.3 1.5 49.5 44.9 21.9 21.4 20.0 20.3S.E Asia Average 12.7 11.7 9.2 0.4 3.3 2.9 2.4 2.3 3.6 3.6 74.2 55.8 30.9 31.1 26.3 28.5

Asia Average



Yield (%) Net debt/equity (%) RoE (%)P/E (x) P/B (x)


118

Production growth to resume after the constraints in 2011 As China’s second-largest coal provider, China Coal had a 3.6% market share, in terms of raw coal production volume in FY10 (vs Shenhua’s 6.6% and Yanzhou Coal’s 1.4%). Management has set a target to double its FY09 raw coal output volume (101mn tonnes) by 2014. After the output constraints in 2011, China Coal is now on track to expand its output. We are optimistic on its production target and believe China Coal’s raw coal output will double to 196mn tonnes in 2014 through: 1) its sufficient coal resources (10bn tonnes of resources acquired in 2011in Xinjiang, Inner Mongolia, Shanxi and Shaanxi, and another 2bn tonnes added at the parent level); 2) production contribution from greenfield project (Pingshuo East and Wangjialing); 3) acquired mines with the utilisation of A-share IPO proceeds (the four new coal mines Nalin River No.2, Muduchaideng, Xiaohuigou and Hecaogou) and 4) potential asset injection from parent companies, as per our view.

Enjoys fastest self-production growth for 2012-13F

We expect China Coal to achieve a commercial coal production growth rate of 17% and 23% in 2012F and 2013F. This compares favourably with Yanzhou of 24% and 12%, and Shenhua’s 8% and 7%, respectively.

Fig. 148: Commercial coal production


Fig. 149: Commercial coal production growth


Sufficient coal resources to fuel production expansion

Four coal mines with A-share proceeds China Coal was active in acquiring coal resources in 2010. In 1H10, the company announced changes in the use of A-share proceeds to develop four new coal mines (Nalin River No.2, Muduchaideng, Xiaohuigou and Hecaogou), Yulin Energy Chemical and Zhangjiadou CME industrial park. The transaction boosted China Coal’s recoverable reserves by 1.98bn tonnes, with 1bn tonnes equitable to China Coal. The new mines bring an additional 20mn tonnes pa production capacity to the company. They are expected to contribute 2mn tonnes pa output from this year and gradually grow to full capacity in 2014F.

10bn tonnes resources acquired in 2010 providing upside to its output from 2014F In addition, in 2010, the company acquired over 10bn tonnes of coal resources in Xinjiang, Inner Mongolia, Shanxi and Shaanxi (as of 2009-end; 6.7bn tonnes of the resources were from Xinjiang). Another 2bn tonnes of resources were added to the group level, which might be injected into the listed company at the appropriate time, according to China Coal.

225

279 303

325 361

409

94 97114

140 151 154

46 50 62 69 79 89

0

50

100

150

200

250

300

350

400

450

2010 2011F 2012F 2013F 2014F 2015F

(mnt)Shenhua China Coal Yanzhou Coal

24%

8%7%

3%

17%

23%

9%

24%

12%

0%

5%

10%

15%

20%

25%

30%

2011F 2012F 2013F

Shenhua China Coal Yanzhou Coal


119

Fig. 150: China Coal: Key mines and coal resources of mines


The acquisitions in 2010 boosted the company’s resources by 12bnt. By the end of 2010, the company had total resources of 18.5bnt, which should fuel China’s Coal output growth in the long term.

However, of the 10bn tonnes of new resources added, two-thirds is from Xinjiang province. Transportation infrastructure in Xinjiang is less developed than in China Coal’s other mine bases; therefore, we do not factor in any production from these mines in our forecasts. However, the planned commissioning of Lanxin No 2 railway line (50mnt throughput pa) by 2015, Hace Line (25mnt) by 2015 and Hami line (30mnt) by end-2012, which run from Xinjiang to the east should allow China Coal to boost its production in Xinjiang, providing potential upside to its output from 2014F.

Despite the limited short-term output growth, we view the acquisitions as a strategic long-term move, providing the company with a sustainable growth profile, at a time when the government has stated its intention to slow down approvals for mining resources.

Fig. 151: China Coal: Key mines and coal resources of mines


Tianjin

Beijing

Shanghai

Chongqing

Heilongjiang

Jilin

Liaoning

HebeiShanxi

Shandong

Anhui

Zhejiang

Fujian

Jiangxi

Hubei

Hunan

GuangdongGuangxi

Hainan

Yunnan

Guizhou

Sichuan

Shaanxi

Ningxia

Gansu

Qinghai

Tibet

Xinjiang Inner Mongolia

Henan Jiangsu

Inner Mongolia & Shaanxi Base

2.555 bn tonnesNalinhe No. 2: 1.231 bn tonnes

Muduchaideng: 0.971 bn tonnes

Hecaogou: 0.353 bn tonnesThermal and Coking

Xinjiang Base6.657 bn tonnes

Zhundong: 3.3 bn tonnesHami: 2.7 bn tonnes

Weizigou: 0.447 bn tonnes106: 0.21 bn tonnes

Thermal Coal

Shanxi Base617 mn tonnes

Xiaohuigou: 573 mn tonnesMinzhu: 44 mn tonnes

Coking Coal

Heilongjiang Base183 mn tonnes

Yilan: 183 mn tonnesThermal Coal

New resources acquisitionby China Coal

announced in 1H10

Existing mines in production

Shanxi BasePingshuo Mining Area

Liliu Mining AreaDongpo Coal

Jiangsu BaseDatun Mining Area

Shaanxi BaseNanliang Coal

Denotes usage of proceeds from A-Shares issue

New resources acquisition bythe mother company announced in 1H10

Shanxi Base2.042 bn tonnes

Jinhaiyang: 1.281 bn tonnesIm & Ex Ltd: 0.66 bn tonnes

Gasification: 0.101 bn tonnesThermal and Coking

Mining areaEquity

stake (%)Coal type

Resource(mnt)

Resource attributable to China Coal (mnt)

Calorific valuerange

Calorific value (Kcal/kg, Per cal.) Weight

Calorific value (Kcal/kg, Weighted Avg.)

Pingshuo Mining Area 100 thermal 5,590 5,590 5000-5100KCal/Kg 5,050 56% 2,832

Datun Mining Area 62.43 thermal 1,190 743 5800-6000KCal/Kg 5,900 7% 440

Dongpo Cal 100 thermal 250 250 5000-5500KCal/Kg 5,250 3% 132

Nanliang Coal 55 thermal 40 22 5000-5800KCal/Kg 5,400 0% 12

Zhongtian Coal 38.75 thermal 5,270 2,042 5800KCal/Kg 5,800 20% 1,188

Nalin River No.2 coal mine 51 thermal 1,230 627 5800KCal/Kg 5,800 6% 365

Mudochaideng coal 51 thermal 970 495 5800KCal/Kg 5,800 5% 288

Weizigou 49.94 thermal 400 200 >5,000KCal/Kg 5,000 2% 100

Liliu Mining Area-Shaqu 49 coking 2,233 1,094

Liliu Mining Area-Wangjialing 51 coking 1,327 677

Total 18,500 11,740 100% 5,356


120

Pingshuo East and Wangjialing – two output growth pillars

China Coal’s existing projects – Pingshuo, Datun, Liliu, Dongpo and Nanliang – are all running at nearly full capacity. With the expection of Liliu (coking coal) which is set to add 2mnt pa output from 2012, we do not expect the other fours to add any production from this year. Therefore, the majority of production growth will rely on greenfield projects, the four acquired mines with the utilisation of A-share IPO proceeds and potential asset injections (5-25mnt pa from 2012F).

Due to existing projects running at full capacity, the delay of greenfield projects and production suspension in Shanxi, we see limited output growth in 2011F, say 3%. However, with two greenfield projects, Pingshuo East and Wangjialing, beginning operations, the output bottleneck should be resolved in the coming years. According to our estimates, the two projects will account for 11.5mnt (14.5mnt) of the total 21mnt (34mnt) production growth in 2012F (2013F).

• Pingshuo East: Designed raw coal capacity of 20mnt; trial operation began in 2011. Currently, Pingshuo East’s output is carried by truck, and management is liaising with the Ministry of Railways to increase its loading quota from the Daqin line. According to our estimates, it will contribute 2mnt of engineering coal (not recorded in raw coal production, but deducting the value of fixed asset when transferring to fixed asset from “Construction in Progress”). As per our conversation with management, Pingshuo East is likely to transfer to be a fixed asset by mid-2012. Therefore, we believe it will contribute 10mnt of raw coal output in 2012F and 20mnt in 2013F.

• Wangjialing: 6mnt designed capacity of coking coal. Following the Wangjialing accident in 2010, production plans at Wangjialing have been delayed. Management announced that Wangjialing had already passed the government’s safety checks on Oct 19 2011 and would commence mine construction immediately. Considering the construction period of 8-10 months, we expect Wangjialing to contribute 1.5mnt output in 2012F and 6mnt output in 2013F.

Four mines acquired in 1H10 – providing long-term potential

China Coal announced changes in the use of A-share IPO proceeds in 1H10 to develop four new coal mines (Nalin River No.2, Muduchaideng, Xiaohuigou and Hecaogou). The four mines would add 20mnt of coal production capacity (14 mnt thermal and 6mnt coking coal) and 3.035bn tonnes of coal resources.

• Hecaogou: 3mnt of designed capacity of coking coal and coal resources of 353mnt. Hecaogou commenced trial operation at end 2011. We believe Hecaogou will contribute 2mnt of raw coal output in 2012F and reach full capacity (3mnt) in 2013F and beyond.

• Xiaohuigou: 3mnt of designed capacity of coking coal and coal resources of 479mnt. China Coal will perform technical reforms for the mine in 2012. Usually technical reforms last 1-2 years and after the reforms, the mine will be able to reach 50-60% of the designed capacity. In that case, we believe Xiaohuigou will contribute 1mnt output in 2013 and 3mnt in 2014 and beyond.

• Nalin River No.2 and Muduchaideng: 8mnt and 6mnt designed capacity of thermal coal and coal resources of 1,231mnt and 972mnt. To date, the company hasn’t received NDRC approval for the two mines. After approval of the NDRC, China Coal will also need to perform technical reforms for the two mines, which would likely last 1-2 years. Assuming China Coal gets approval in 2012 and taking the technical reform period into consideration, we believe Nalin River No.2 and Muduchaideng will contribute 4mnt and 3mnt in 2013F, and 8mnt and 6mnt in 2014F and beyond.


121

Potential injection from parent

Following the government’s significant efforts in closing smaller, more dangerous and less efficient coal mines in the 11th Five-Year Plan (FYP), we believe China will continue to promote consolidation in the upcoming 12th FYP.

As a major SOE coal company, China National Coal Group (the parent company of China Coal) is better positioned than non-SOEs to obtain coal resources through industry consolidation, in our view. During 2008-10, the parent company obtained around 20 small mines with production capacity of 20mnt pa. These small mines, after production upgrades, could reach 40mn tonnes of output, according to management. These coal mines could be eventually injected to the listed company, in our view.

Other than these 20 small mines, the coal assets of China National Coal Group outside the listed company are mainly from Jinhaiyang company and Import and Export Company.

• Import and Export Company: 8 underground mines based in Shuozhou and Datong, Shanxi Province with total capacity of 9.9mnt and resource reserves of 6,300mnt.

• Jinhaiyang: 8 underground mines based in Shanyin County, Shanxi Province with current capacity of 10.2mnt and resource reserves of 17,720mnt.

According to management, the production capacity of the two entities can be upgraded and doubled to 40mnt in aggregate (20mnt each), from 20.1mnt currently.

Fig. 152: Potential injected coal assets from parents


Management promised to inject the two companies illustrated above into the listed company during the period from 2012 to 2015. Unlike Shenhua which has no specific timeline for asset injections, China Coal has provided guidance for the deadline, and pre-asset injection preparation work has been carried out.

Although management hasn’t provided detailed timelines, we believe that the asset injection is likely to be finished during the 12th FYP, and we regard Import and Export Company as the first target. In order to reflect this, we factor in 5mnt/15mnt/20mnt/25mnt of output contribution from the parent’s asset injection in 2012-15F respectively.

China National Coal Group also has a 51% stake in an Australian JV in Queensland, with resources of more than 650mn tonnes. However, as there has been no clear guidance from China Coal, we do not factor in this potential asset injection to the listed company at this time.

Entity Location Coal Mine Mine typeEquity stake owned

by China Coal Coal typeReserve resource

(mnt)Designed capacity

(mnt)

Import and Export Company Shuozhou Yangjian Underground 100% Thermal 3.0

Import and Export Company Shuozhou Danshuigou Underground 100% Thermal 0.9

Import and Export Company Shuozhou Xishahe Underground 100% Thermal 0.9

Import and Export Company Datong Tangshangou Underground over 51% Thermal 1.2

Import and Export Company Datong Ganzhuang Underground over 51% Thermal 1.2

Import and Export Company Datong Xiaolianggou Underground over 51% Thermal 0.9

Import and Export Company Datong Shangshenjian Underground over 51% Thermal 0.9

Import and Export Company Datong Beixinyao Underground over 51% Thermal 0.9

Import and Export Company subtoal 630 9.9

Jinhaiyang Shanyin County Wujiagou Underground 100% Thermal 3.0

Jinhaiyang Shanyin County Yuanbaowan Underground 100% Thermal 0.9

Jinhaiyang Shanyin County Taidongshan Underground 100% Thermal 1.2

Jinhaiyang Shanyin County Nanyangpo Underground 100% Thermal 0.9

Jinhaiyang Shanyin County Shuiquan Underground 100% Thermal 0.9

Jinhaiyang Shanyin County Maying Underground 100% Thermal 0.9

Jinhaiyang Shanyin County Yuquanshan Underground 100% Thermal 1.2

Jinhaiyang Shanyin County Nanquanwan Underground 100% Thermal 1.2

Jinhaiyang subtotal 1,772 10.2

Total 2,402 20.1


122

Production suspension in Shanxi – limited impact

Following coal mine flooding on Sep 16 2011, all underground mines under China National Coal Group in Shanxi suspended production for safety checks by Shanxi government. The five underground mines of China Coal were affected. However, the recovery was faster than expectation and China Coal announced the last resumption of Antaibao and Jingdong on Nov 15 2011. We estimate the production suspension would cause a 5.36mnt raw coal production loss for China Coal in 2011F, or 4.35% of 2010’s output.

Fig. 153: Effect of production suspension


Fig. 154: Production projection


output in 2010 (mnt)

% of total output

Resumption date

Suspension period

Estimated output loss (mnt)

Anjialing #1 15.52 13% Oct-1 0.5months 0.65

Anjialing #2 16.82 14% Oct-1 0.5months 0.70

Dongpo 5.10 4% Oct-19 1 month 0.43

Antaibao 8.50 7% Nov-15 2 months 1.42

Jingdong 13.00 11% Nov-15 2 months 2.17

Total 58.94 48% 5.36

Equity stake (%)

Coaltype Location

2009(mnt)

2010(mnt)

2011F(mnt)

2012F(mnt)

2013F(mnt)

2014F(mnt)

2015F(mnt)

Existing projects

Pingshuo Mining Area 100 thermal Shanxi 87.0 103.9 106.0 106.0 106.0 106.0 106.0

Antaibao Open Pit Mine 100 thermal Shanxi 22.7 27.0

Anjialing Open Pit Mine 100 thermal Shanxi 20.3 23.0

Anjialing No.1 Underground Mine 100 thermal Shanxi 16.0 15.5

Anjialing No.2 Underground Mine 100 thermal Shanxi 15.5 16.8

Antaibao undergroup Mine 100 thermal Shanxi 6.7 8.5

Jingdong Mine 100 thermal Shanxi 5.7 13.0

Datun Mining Area 62.43 thermal Jiangsu 8.6 9.1 10.0 10.0 10.0 10.0 10.0

Yaoqiao Mine 62.43 thermal Jiangsu 4.1 4.5

Kongzhuang Mine 62.43 thermal Jiangsu 1.4 1.5

Xuzhuang mine 62.43 thermal Jiangsu 1.8 1.8

Long Dong Mine 62.43 thermal Jiangsu 1.3 1.3

Liliu Mining Area 49 coking Shanxi 1.7 2.6 3.0 6.0 6.0 6.0 6.0

Shaqu mine 49 coking Shanxi 1.7 2.6 3.0 6.0 6.0 6.0 6.0

Dongpo Coal 100 thermal Shanxi 1.9 5.1 5.5 5.5 5.5 5.5 5.5

Nanliang Coal 55 thermal Shanxi 1.7 1.9 2.0 2.0 2.0 2.0 2.0

Greenfield projects

Pingshuo East 100 thermal Shanxi 0.0 10.0 20.0 20.0 20.0

Wangjialing - Liliu 51 coking Shanxi 0.0 1.5 6.0 6.0 6.0

Use of A shares proceeds

Nalin River No.2 coal mine 51 thermal Inner Mongolia 4.0 8.0 8.0

Mudochaideng coal 51 thermal Inner Mongolia 3.0 6.0 6.0

Xiaohuigou coal mine 55 coking Shaanxi 1.0 3.0 3.0

Hecaogou coal mine 50 coking Shaanxi 2.0 3.0 3.0 3.0

Others

5.0 15.0 20.0 25.0

Total 100.8 122.5 126.5 148.0 181.5 195.5 200.5

y-y (%) 22 3 17 23 8 3


123

In-line FY11 operational results

China coal announced FY11 operational results in Jan 2012 with commercial coal output of 102.79mnt (+8.9% yoy, vs our estimate of 97.44mnt) and sales volume of 133mnt (+13.8% yoy, vs our estimate of 133mnt). The sales volume is largely in line with our estimate, while the commercial coal output seems to be ahead of our estimate by 5.5%. This is mainly because the output volume includes the inter-company transaction volume, which should be eliminated at the consolidated level. According to the 1H 11 interim results, we projected the FY11 inter-company transaction volume to be 4.8mnt (vs 2.4mnt in 1H11). After the deduction, the commercial coal output would be 98mnt, in line with our estimate.


124

The less robust price trend remains favorable to China Coal Given Nomura’s economics team forecast of 7.9% real GDP growth in 2012F, we believe coal demand will not as strong as that in 2011, which is likely to drag down the average spot coal price by 4% (down 10-15% in 1H12 and rebound in 2H12), according to our industry outlook. After the flat contract price in 2011, we believe China’s key contract price (40% of contracted volume) will rise 5% in 2012, in line with NDRC guidance announced on Nov 30 2011. However, non-key contract (60% of the contracted volume) should rise by a bigger 7%, according to CCTD, during the year given the price control was only applied to key contracts. We expect the price trend will have less of an impact on China Coal, vs Shenhua and Yanzhou, given: 1) The falling spot price should affect revenue from spot sales on a given sales volume, however the increase in percentage sales mix to a higher price spot (vs contract) should alleviate the impact, and 2) the highest contract sales exposure should allow China Coal to benefit mostly from the 5% contract price increase in 2012, vs Shenhua and Yanzhou.

Unfavourable spot price trend in 2012

Our economist, Zhiwei Zhang, expects GDP growth will slow from 9.2% in 2011F to 7.9% in 2012F, which should ease coal demand. Due to this, in addition to the prevailing high coal inventory at IPPs (19 days, according to CCTD), a premium to Newcastle price and increasing supply, we expect spot price to fall to a low of CNY720/t in April, from currently CNY800/t, and to rebound in 2H depending on how fast Beijing puts out its stimulus policy and market coal supply. In addition, the NDRC has capped the spot price at CNY800/t for coal with a heat value of 5,500kcal/kg at the northern port in China (including Qinghuangdao).

Although we believe the market is cautious on the effectiveness and duration of the policy, there is no doubt that such price intervention will have a negative impact on the spot price, in our view. Also, unlike 2008, when the cap on spot price proved ineffective, we believe price caps for 2012 should be effective and enforceable, given less tightening of coal supply in 2012 and the NDRC did, in fact, punish violators seriously last year. Therefore, after the 24% and 10% yoy growth in 2010/11, we expect the spot price will correct 4% yoy in 2012, which would be bad news for all coal producers.

Fig. 155: Nomura coal price forecast

Source: SXCOAL, CCTD, Nomura estimate


y-y (%) 18 6 0 5 0 5 0


y-y (%) 6 5 7 0 5 0

Blended contract price (FOB) increase (%) 6 3 6 0 5 0


y-y (%) -17 24 10 -4 5 0 -10


CNY/USD 6.33 6.17 5.96 5.96 5.96



125

Contract price increase to offset unfavorable spot price

The NDRC guided on Nov 30 that the growth rate of key contract price should be less than 5%. Given the stronger bargain power of coal miners, we believe the key contract and non-key contract price are likely to rise by 5% and 7% in 2012. Owing to the high contract sales exposure (53% in 2012F), the increase of contract price will offset the negative impact from the spot price decline. According to our estimates, coal segment’s revenue rose 21% in 2012F, among which 2.1pcts are contributed by contract price growth, almost offsetting the -2.4pct from the spot price decline.

Fig. 156: Coal revenue growth drivers


Optimizing sales and product mix fuels ASP improvement

In spite of the 4% yoy decrease in spot price and a 5% rise in contract price in 2012, the ASP of spot sales (CNY787/t) remains CNY188/t higher than that of the contract sales (CNY599/t). Therefore, the improvement of sales volume mix towards more spot should also improve ASP.

Based on management guidance, we assume 80-90% of new output will be sold in the spot market in 2012-14F. This, together with the production ramp up from the greenfield projects from 2012, results in a lower proportion of contract sales, from 69% in 2010 to 56% in 2011F, 53% in 2012F and beyond.

Generally, coking coal enjoys a higher ASP and margins than thermal coal owing to its scarcity. Historically, China Coal has relied heavily on thermal coal sales, which accounted for 98% of its coal production in 2009. With the ramp up of Wangjialing, Shaqu, Hecaogou and Xiaohuigou mines in the following years, the coking coal portion of the total self-produced coal sales volume will grow from 1.2% in 2010 to 6.9% in 2013F, according to our estimates.

Given the wide price spread between coking coal and thermal coal, the increase in the proportion of coking coal is the biggest driver for China Coal’s rising ASP.

With the joint effect of the two factors above, we estimate the overall ASP of self produced coal will be improved by 6% and 5% for 2012-2013F, respectively.

17.2%

2.1% -2.4% 3.7%

19.5%

0%

5%

10%

15%

20%

25%

Self-produced volume increase

Contract pirce growth

Spot price decrease

Others Coal revenue growth


126

Fig. 157: China Coal: contract sales proportion comparison (2010-14F)

Source: Company data, Nomura estimates Note: We only include self-produced coal domestic sales. Yanzhou Coal excludes Yancoal Australia’s sales

Fig. 158: Improving sales mix and product mix


Fig. 159: ASP Self produced coal


Fig. 160: Thermal coal vs. coking coal production


Fig. 161: Coal ASP trend


58%

45% 45% 45% 45%

69%

56%53% 53% 53%

25% 25% 25% 25% 25%

0%

10%

20%

30%

40%

50%

60%

70%

80%

2010 2011F 2012F 2013F 2014F

Shenhua China Coal Yanzhou Coal

1.2% 1.8%5.0% 6.9% 6.7% 7.0%

69%

56%53% 53% 53% 53%

0%

10%

20%

30%

40%

50%

60%

70%

80%

2010A 2011F 2012F 2013F 2014F 2015F

Coking coal % of total salesContract % of domestic sales

456504

536564 577

550

-6

-4

-2

0

2

4

6

8

10

12

0

100

200

300

400

500

600

700

2010A 2011F 2012F 2013F 2014F 2015F

ASP (LHS)y-y growth (RHS)

(CNY/t) (%)

119.9 123.5138.5

165.5177.5 182.5

2.6 3.0 9.5 16.0 18.0 18.0

0

20

40

60

80

100

120

140

160

180

200

2010A 2011F 2012F 2013F 2014F 2015F

Thermal coal Coking coal(mnt)

446 487 495 508 520 492

1,267

1,405 1,321 1,321 1,321 1,321

0

200

400

600

800

1,000

1,200

1,400

1,600

2010A 2011F 2012F 2013F 2014F 2015F

Thermal Coking(CNY/t)


127

Margins improved on higher ASP and more stringent cost control

Highest unit cost lowers profit

Compared with Shenhua, China Coal enjoys a lower transportation cost, benefiting from the shorter distance between its mines and the ports. We believe China Coal has better access to railway capacity since it is a shareholder in the Daqin rail line, one of the backbones for coal transportation in China.

However, its much higher unit production cost than Shenhua counteracts its marginally better unit transportation cost. China Coal’s production cost is much higher given: 1) its average mine depth is nearly double that of Shenhua, 2) it has a higher blending cost since its raw coal has higher sulphur and ash content but lower calorific values than Shenhua, and 3) the majority of its coal production is in Shanxi, which charges one of the highest levies in China, with “sustainable development fund” charges of CNY13-20/t for regular coal mines and CNY40/t for unqualified coal mines, and a resources tax of CNY0.3-5/tonne.

Given its highest unit cost among peers, China Coal’s gross profit margin is around half that of Shenhua and Yanzhou. However, the falling CPI, significant increase in production scale, the improvement in coal quality (wash rate) and gradual diversification from Shanxi to other areas should allow China Coal’s cost inflation to rise more slowly than its peers over the next couple years.

The Pingshuo mines quality problem (high ash due to geological structure change) led China Coal’s wash rate to fall from 83% in 2007 to 79% in 2009 and to 73% in 2010 and further to a low of 69% in 4Q10. However, the gradual improvement in wash rate during 2011 (71% in 1H11, 75% in 2H11) and management target to achieve a 74-75% wash rate in 2012-13 have prompted us to upgrade our wash rate assumption for 2012-15F to 77%, from 75%. This is due to: 1) the commissioning of Pingshuo East mines from 2012, 2) the strengthening operation management and 3) the improving geological conditions at the Pingshuo areas. The improvement in wash rate should be able to offset part of the upward cost pressure, in our view.

Given the rapid growth in output scale, we believe maintenance cost and mining costs, etc., should be well under control. Cost pressure on materials, staff costs and government charges should be alleviated due to a falling CPI, in our view. Currently, we have factored in a 5% value-based resources tax from July 2014F, without any pass through. The potential elimination of coal price adjustment fund, as per CCTD, should more than offset the said resources tax, on our estimates.

The better-than-expected 2H11 results were driven mainly by better-than-expected cost control. All in all, we forecast a 6% and 6% increase in unit production cost, and a 3% and 3% rise in unit transportation cost for 2012-13F, respectively, translating into a 5% and 5% rise in total unit cost for the same period. As a result, EBITDA margins are expected to rise to 24% and 24% for 2012-13F, from 22% in 2011.


128

Fig. 162: China Coal: Unit cost breakdown


Fig. 163: Total unit cost (self produced coal)


Resource tax – impact from July 2014F

China announced the resource tax reform on Oct 11 2011. According to the new regulation, the government will introduce a value-base tax on oil and gas (say 5-10% of sales) effective from Nov 1 2011. For coal miners, the tax remains volume based. The government levies a tax of CNY8-20/tonne on coking coal and CNY0.3-5/tonne for other coal grades. As a Shanxi-based coal producer relying heavily on thermal coal, China Coal has already paid a resources tax of CNY3.2/tonne for thermal coal in Shanxi, within the range of the said CNY0.3-5/tonne. Therefore, the new regulation should not have any impact to China Coal.

However, Beijing aims to accelerate the resource tax reforms for the fossil fuels from being volume based to value based. According to our industry checks, a 5% value-based resources tax will likely be introduced in mid-2014 when the coal market changes to a surplus (buyer’s market) and power pooling is established. According to our price forecasts, the extra resources tax will be CNY22-24/t from 2014F (on top of the current CNY3.2/t resources tax), which we have factored into our model.

Currently, we assume no price pass-through to users given an expected surplus market in 2014F; however, we do not rule out a pass through if power pooling is successfully implemented.

Also, major coal production provinces, such as Inner Mongolia, Shaanxi, Shanxi, Hunan, Guizhou and Sichuan, have already introduced a coal price adjustment fund (CPAD). For raw coal, the CPAD ranges from CNY8/tonne to CNY40/tonne, while the charge is between CNY25/ton and CNY60/ton for coking (clean) coal.

These CPAD and levies are indeed a form of resources tax pre-collected by local governments and are similar to the potential 5% resources tax rate. Therefore, these CPAD may be eliminated or reduced by the NDRC after the official lifting of resources taxes to value-based, which can alleviate part or even all of the impact to China Coal.

81 99 73 73 78 82 87

1924

28 31 33 35 371313

24 32 34 36 385968 80

94 99 105 1128688 84

8992

9598

0

50

100

150

200

250

300

350

400

2007 2008 2009 2010 2011F 2012F 2013F

Materials Staff cost Depn.

Others Transportation

(CNY/t)

207 216 213 219 227

289320

336354

373

267293

328347

366

0

50

100

150

200

250

300

350

400

2009 2010 2011F 2012F 2013F



129

Financial outlook

Gross margin slightly improved

Thanks to the growth in contract price, the negative effect of weak spot price in 2012F is likely to be neutralized. In spite of the expected weak performance in 2012, spot price will still have a 30% premium to the contract price, according to our industry outlook. The optimization of sales mix (contract sales to decrease from 69% in 2010 to 53% in 2012F) and a contained total unit cost rise will contribute to the improvement of gross margin. We expected the gross margin to stand at 22.9% in 2012F, 1.3pcts improved from 21.6% in 2011F.

With higher gross margin than the non-coal business, the coal segment remains the key earnings driver, generating 80% of the total revenue in FY12F and FY13F, on our estimates.

Fig. 164: China Coal: Gross margin by segment


Fig. 165: EPS growth comparison


Key diver and sensitivity analysis

We expect China Coal’s net profit to grow 20.7% to CNY12,541mn in FY12F, largely driven by ASP growth (10.8%). We expect the coal business to contribute 18.5% to net profit growth and non-coal business to contribute the remaining 2.2% on a consolidated basis. Compared with its peers, the 21% yoy earnings growth ranked first among the three thermal coal giants, followed by Shenhua’s 15%.

22.6%20.6%

21.6%22.9% 23.4%

26.8%

22.5%24.2%

25.6% 25.9%

8.8%

13.3%11.0% 11.7% 12.0%

0%

5%

10%

15%

20%

25%

30%

2009 2010 2011F 2012F 2013F

Group Coal business Non coal business

19 20 20 15 164 1

39

21 23

-37

75

26

2 5

-60

-40

-20

0

20

40

60

80

100

2009 2010 2011F 2012F 2013F

Shenhua China Coal Yanzhou(%)


130

Fig. 166: Net profit growth driver (2012F)


From the sensitivity table below, we conclude that China Coal is most sensitive to the contract price change with its highest exposure to contract sales among peers, due to the proportion of contract sales in its sales mix.



Balance sheet and cash flow

China Coal’s balance sheet was healthy with a sufficient cash balance of CNY39bn (net cash) as of Sep 2011. Management guided CNY34.2bn of capex in 2011, 25% of which was accomplished in 1H11, in line with the historical record. Moreover, management guided that capex in 2012 and 2013 would be at least at the level of that in 2011. In order to reach the output growth targeted by management, we expect total capex will reach CNY24bn (-30% yoy) in 2012F and CNY16bn (-33% yoy) in 2013F, respectively. In spite of the significant capex needs, we believe China Coal has no need for additional equity financing with the rich operating cash inflow, ample cash position and strong credit pipelines from banks.

11.2%

10.8%

3.6%-8.1%

18.5%

2.2%

20.7%

0%

5%

10%

15%

20%

25%

30%

Sales volume increase

ASP increase

Purchase cost

decrease

Production cost

increase

Coal business

Non coal business

Group




% chg in net profit on 1% change in unit cost -1.70 -3.50 -1.89



131

Results recap

1H result recap

China Coal recorded 1H profit attributable to shareholders of CNY5,598mn (up 8% yoy) and 1H11 EPS of CNY0.42. No dividend was declared for the interim. Revenue increased 19% yoy to CNY41,767mn, 81% from coal business. GP margin and net profit margin were 24% (-2.6pct yoy) and 13.4% (-1.4pct yoy), respectively.

Fig. 168: 1H2011 result details


Our view • Coal sales volume 65mnt (up 9.8% yoy) in 1H11. In addition, the sales mix improved in

1H. Contract sales accounted of 56% of domestic sales (-13pct yoy). China Coal wants to maintain a similar ratio in 2H.

• According to management, all the additional volume production will be sold in the spot market, implying the contract sales portion will drop continuously, especially in 2012 when production ramps up.

• Overall ASP was CNY494/tonne (up 6.7% yoy). The decreasing contract price (down 3.8% yoy) is mainly due to the shift of higher quality coal to spot sales. The spot sales price rose by 12.1% yoy to CNY575/tonne, largely caused by solid demand from downstream industries.

Profit & Loss (CNY mn) 2010 H1 2011 H1 Y-Y change

RevenueCoal 27,880 33,893 22%Coke and coal-chemical product 2,516 2,753 9%Machinery 3,042 3,289 8%Others 1,652 1,832 11%

35,090 41,767 19%

Cost of sales (26,073) (31,741) 22%

Gross profit 9,017 10,026 11%

SG&A (1,637) (2,016) 23%

Other operating expenses (income) 290 56 -81%

Profit from operations 7,669 8,065 5%

Finance costs/ Income, net (1) (11) 636%Share of profits of associates & JCE 16 35 122%

Profit before income tax 7,684 8,090 5%Income tax expense (1,972) (1,989) 1%

Profit for the period 5,712 6,101 7%

Profit attributable to:Equity holders of the Company 5,195 5,598 8%Minority interests 517 503 -3%

5,712 6,101 7%

Basic and diluted EPS (CNY) 0.39 0.42 8%

Key ratios: 2010 H1 2011 H1 change in pts

Gross Profit Margin, of which: 26.6% 24.0% -2.6 ptEBITDA Margin 27.5% 23.6% -3.9 ptNet Profit Margin 14.8% 13.4% -1.4 pt


132

• The unit cost of self-produced coal was CNY288/tonne (+8% yoy). The strong cost performance was mainly due to superior cost control of the company, especially in unit staff cost (+3% yoy), unit sales taxes (-6% yoy) and unit transportation cost (-1% yoy).

3Q results recap

China Coal reported 3Q net profit of CNY2,657mn (-1% qoq) and 9M11 net profit attributed to shareholders of CNY7,646mn (EPS CNY0.58) under PRC GAAP, +26% yoy, driven by: 1) strong unit cost performance and 2) sales volume growth in spite of the production suspension in later Sept in Shanxi. Gross profit margin and net profit margin reached 33% and 12%, respectively.

Fig. 169: 3Q2011 results details


Our view • The contract price slumped 1% yoy to CNY408/t for the first three quarters mainly due

to the high quality sold in the spot market to grasp high profit. The ASP for spot sales was CNY574/t, up 10% yoy, and the overall ASP stood at CNY494/t,

• The contract sales proportion decreased to 55.7% for 9M11, -17pcts yoy. The contract sales portion was below 60% for three consecutive quarters in 2011, at 58.4%/54.3%/54.5% in the respective period. Compared with the peers, China Coal still has the highest contract sales exposure.

• China Coal executed stringent cost control which led to the 9M11 unit cost of increase only 3% compared with that of FY2010. Compared with that of FY2010, the unit staff cost and depreciation cost declined 1% and 6% respectively, especially in the inflation cycle. In addition, from the previous year’s record, repair expense and other cost increased significantly in the fourth quarter, which caused the FY10’s unit cost to surge

Profit & Loss (CNY mn)Jan to

Sep 10Jan to

Sep 11Y-Y

ChangeJuly to Sep 11

Q-QChange

Revenue 52,564 66,294 26% 23,852 11%

Cost of sales (34,689) (44,475) 28% (16,320) 17%

Gross profit 17,875 21,819 22% 7,531 -1%SG&A (9,142) (10,866) 19% (3,788) 5%Other operating expenses (income) 175 (23) -113% 14 -132%

Profit from operations 8,908 10,930 23% 3,758 -4%

Finance costs/ Income, net (34) (90) 163% (80) -4710%Share of profits of associates & JCE 14 55 292% 20 -33%

Profit before income tax 8,888 10,895 23% 3,698 -6%Income tax expense (2,285) (2,613) 14% (846) -14%

Profit for the period 6,603 8,282 25% 2,852 -4%

Profit attributable to:Equity holders of the Company 6,065 7,646 26% 2,657 -1%Minority interests 538 636 18% 195 -27%Profit for the period 6,603 8,282 25% 2,852 -4%

Basic and diluted EPS (CNY) 0.46 0.58 26% 0.20 -5%

Key ratios:Jan to

Sep 10Jan to

Sep 11

changein pts

(y-y)July to Sep 11

changein pts(q-q)

Gross Profit Margin 34% 33% -1pcts 32% -4pctsNet Profit Margin 13% 12% 0pcts 12% -2pcts


133

9% from that of 9M11 in 2010 under PRC GAAP. Considering the track record, we are cautious about China Coal’s cost performance in 4Q11.

• Due to the flooding accident in Shanxi Jinhaiyang Yuanbaowan Coal mine, all underground mines of China National Coal Group, parent company of China Coal, were required to be closed for safety inspection, including 5 underground mines of China Coal. Compared with the FY11F raw coal production volume of 125mnt, we do not expect to see a significant effect on the total production due to the suspension.

2011 PRC GAAP preliminary results

China Coal announced its preliminary 2011 results under PRC GAAP, with revenue of CNY88,718mn (+24% y-y) and net profit of CNY10,303mn (+36% y-y). According to 9M11 results, net profit under IFRS is 8% higher than that under PRC GAAP. As a result, we project net profit under IFRS would stand at CNY11,118mn, beating our and consensus estimate of CNY8,794mn and CNY9,904mn by 26% and 12%, respectively.

Fig. 170: FY2011 preliminary results


Our view • Revenue came in at CNY88,718mn, +24% y-y, ahead of our estimate of CNY83,917mn

by 5.7% and consensus of CNY84,457mn by 5%, indicating a better-than-expected ASP and volume sales recorded during the year. According to 11M operational results, commercial coal production volume and sales volume totaled 94.36mnt and 120.99mnt, respectively, for 11M11. Assuming the same run rate, commercial coal production and sales volume should have reached 103mnt and 132mnt, better than our expectations of 93mnt and 125mnt. We believe the better-than-expected production and volume sales should be attributable to the fast recovery of the suspension in Shanxi.

• Other than potential higher realised selling prices on contract and spot in 2011, volume sales mix improvement is likely to be another reason for the better-than-expected ASP. According to 9M11 results, contracted volume sales only accounted for 56% of total domestic sales, better than our estimate of 60%.

• Net profit margin stood at 11.6% (+1pct y-y), compared with our estimate of 10.5% and consensus 11.5%, mainly due to a lower than expected effective tax rate. We believe the severe cost control may serve as another major attribution. During 9M11, China Coal recorded a unit cost under PRC GAAP at CNY230.09/t, 2.9% higher than 2010’s FY unit cost of CNY223.7/t. This is lower than our FY11 assumption of CNY249/t (+8% y-y) under IFRS GAAP. Effective tax rate was 23.24% better than our est of 25.9%.

• NDRC’s cap on key contract (5% increase, 40% of contract) for 2012 is lower than our forecast of 7%, but a likely bigger increase in non-key contract (say 7%, 60% of contract) should alleviate the impact. We turn more positive on China Coal in 2012F given 60% of its sales volume in contract which has been concluded at an weighted average increase of 5%+ while the production growth is expected to outperform its peers in 2012. Given its smaller exposure to spot, the potential 10-15% drop in spot price in 1H12 should have the least impact to the company compared to its peers. In our view, the fast production recovery from Shanxi accident and the contained increase in unit production cost in 2011 have shown that China Coal is back on track.

CNY mn2011 (PRC

GAAP)

2010 (PRC

GAAP)y-y

growth

2011 Projected figures (IFRS

GAAP)Nomura estimate

(IFRS GAAP)

Revenuess 88,718 71,268 24% 88,718 83,917

Operating profit 13,352 9,850 36% 13,408

Profit before taxation 13,423 10,222 31% 15,034 12,954

Net profit 10,303 7,571 36% 11,117 8,794

Net profit margin 11.6% 10.6% 1% 10.5%

Effective tax rate 23.2% 25.9% -2.7% 25.9%


Yanzhou Coal 1171.HK 1171 HK .

METALS & MINING

EQUITY RESEARCH

Downgrade to Reduce with TP of HK$17.1

Diminishing return = expensive acquisition + weakening coal price + AUD/CNY appreciation

February 1, 2012

Rating Down from Buy

Reduce

Target price Reduced from 27.70

HKD 17.10


HKD 19.28

Potential downside -11.3%

Action: Downgrade to Reduce, TP cut TP to HKD17.1 In our view, Yanzhou’s bigger exposure in the spot market (75% vs.

Shenhua at 55% and China Coal at 44%), regional market (19%, vs. Shenhua at 2% and China Coal’s nil) and coking coal market (40%, vs. Shenhua’s nil and China Coal’s 2%) is unfavourable amid a weakening thermal/coking coal price trend and CNY appreciation against the AUD.

Yanzhou appears to have insufficient resources for growth; however, we think its latest acquisitions of Xintai in China, Potash in Canada and Premier/Syntech/GCL in Australia are expensive and with back-end loaded growth.

We are cautious on management’s goal to triple 2015F raw coal production to 150mnt vs. our 105mnt estimate. Yanzhou’s parent is unlikely to have many coal assets to inject. Given Yanzhou’s current pricey assets, further growth by acquisitions could remain ROE-dilutive.

Yanzhou has the highest leverage to spot. Our estimate of a 10-15% fall in the 1H12 spot price (-9.2% for 2011-15F) should drive the shares lower near term and help underperformance (de-rating) in the long term.

Despite Yanzhou having the highest sales volume growth vs peers in 2012F, it yields low margins and just 1.6% earnings growth for 2012F.

Valuation and catalysts: From re-rating in 2010 to de-rating in 2012F Spot coal price movement, asset acquisition, and production ramp-up are likely catalysts. The stock currently trades at 2012F P/E of 8.3x vs. China Coal at 8.6x, but cheaper than Shenhua (10.6x); it is not cheap given our low 2012-13F single-digital earnings growth estimates. As well, Shenhua is distinctive for its quality; we would prefer China Coal over Yanzhou for similar valuation.



Revenue (mn) 33,944 41,266 40,656 49,551 47,366 48,015 49,944



Normalised EPS 1.46 1.69 1.84 2.14 1.87 1.88 1.96

Norm. EPS growth (%) 74.6 15.9 25.8 26.6 1.6 -12.2 4.7

Norm. P/E (x) 11.2 N/A 8.5 N/A 8.3 N/A 7.7

EV/EBITDA (x) 7.6 6.7 6.1 5.0 5.6 5.2 4.7



ROE (%) 27.9 20.7 21.0 22.6 18.9 17.3 16.3

Net debt/equity (%) 43.5 45.5 61.1 31.5 46.5 16.2 29.8


Anchor themes

China remains in coal deficit in 2012-13 due to transportation constraint but not production. Coal price to fall by 10-15% in 1H12F and rebound in 2H due to slowing GDP growth and Beijing’s effort to cap CO2/Energy intensity.

Nomura vs consensus

Our 2012-13F earnings and TP are 2-6% and 25% below consensus, respectively, owing to our more bearish view on ASP.

Research analysts




Nomura | Yanzhou Coal February 1, 2012

135

Key data on Yanzhou Coal Income statement (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13F

Revenue 20,677 33,944 40,656 47,366 49,944Cost of goods sold -11,547 -18,887 -21,502 -27,078 -29,858

Gross profit 9,130 15,058 19,154 20,289 20,087SG&A -3,820 -5,094 -6,098 -6,898 -5,761

Employee share expense


EBITDA 7,148 12,740 16,879 18,118 19,820

Depreciation -1,793 -2,427 -3,021 -3,926 -4,692Amortisation -44 -350 -803 -803 -803

EBIT 5,310 9,964 13,055 13,390 14,326Net interest expense -45 -603 -863 -970 -1,288

Associates & JCEs 110 9 9 9 9

Other income 311 302 302 302 302Earnings before tax 5,686 9,671 12,503 12,731 13,349

Income tax -1,553 -2,458 -3,438 -3,520 -3,704

Net profit after tax 4,133 7,213 9,065 9,211 9,644Minority interests -15 -25 -23 -23 -23

Other items

Preferred dividends

Normalised NPAT 4,117 7,188 9,042 9,188 9,621

Extraordinary items 2,093 -580 0 0Reported NPAT 4,117 9,281 8,462 9,188 9,621

Dividends -1,967 -1,230 -2,646 -2,707 -2,718

Transfer to reserves 2,150 8,052 5,816 6,480 6,903


FD normalised P/E (x) 20.3 11.2 8.5 8.3 7.7

FD normalised P/E at price target (x) 36.3 20.0 15.2 14.8 13.7

Reported P/E (x) 20.3 8.7 9.1 8.3 7.7Dividend yield (%) 2.4 1.5 3.4 3.6 3.7

Price/cashflow (x) 12.8 14.9 7.5 5.4 4.9

Price/book (x) 2.9 2.2 1.8 1.4 1.1EV/EBITDA (x) 13.5 7.6 6.1 5.6 4.7

EV/EBIT (x) 18.0 9.7 7.9 7.6 6.5Gross margin (%) 44.2 44.4 47.1 42.8 40.2

EBITDA margin (%) 34.6 37.5 41.5 38.3 39.7

EBIT margin (%) 25.7 29.4 32.1 28.3 28.7Net margin (%) 19.9 27.3 20.8 19.4 19.3

Effective tax rate (%) 27.3 25.4 27.5 27.6 27.8

Dividend payout (%) 47.8 13.2 31.3 29.5 28.3Capex to sales (%) 10.1 10.5 30.0 19.8 19.4

Capex to depreciation (x) 1.2 1.5 4.0 2.4 2.1ROE (%) 14.7 27.9 21.0 18.9 16.3

ROA (pretax %) 13.9 16.6 17.5 15.0 14.7

Growth (%)

Revenue -17.0 64.2 19.8 16.5 5.4

EBITDA -27.0 78.2 32.5 7.3 9.4EBIT -38.4 87.6 31.0 2.6 7.0

Normalised EPS -36.5 74.6 25.8 1.6 4.7Normalised FDEPS -36.5 74.6 25.8 1.6 4.7

Per share

Reported EPS (CNY) 83.72c 1.89 1.72 1.87 1.96

Norm EPS (CNY) 83.72c 1.46 1.84 1.87 1.96

Fully diluted norm EPS (CNY) 83.72c 1.46 1.84 1.87 1.96Book value per share (CNY) 5.93 7.59 8.77 11.01 13.03

DPS (CNY) 0.40 0.25 0.54 0.55 0.55Source: Company data, Nomura estimates



(%) 1M 3M 12M

Absolute (HKD) 15.2 4.3 -15.3

Absolute (USD) 15.5 4.5 -15.0

Relative to index 7.7 -2.4 -1.5



52-week range (HKD) 32.95/13.72


45.83


Yankuang Group 52.9


Notes

Slower earnings growth due to unfavourable coal price


136

Cashflow (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FEBITDA 7,148 12,740 16,879 18,118 19,820

Change in working capital -1,326 -5,325 -1,662 -907 67

Other operating cashflow 698 -2,015 -4,898 -3,172 -4,806Cashflow from operations 6,520 5,400 10,319 14,039 15,080

Capital expenditure -2,086 -3,562 -12,201 -9,384 -9,694Free cashflow 4,435 1,838 -1,882 4,656 5,386

Reduction in investments 0 0 0 0 0

Net acquisitions -20,377 -3,251 -5,900 0 0Reduction in other LT assets -1,417 -4,253 0 -788 53

Addition in other LT liabilities 1,807 927 0 677 -46

Adjustments -2,771 4,255 0 111 -8Cashflow after investing acts -18,323 -485 -7,782 4,656 5,386

Cash dividends -2,015 -1,231 -2,331 -5,529 -2,722Equity issue 0 2,515 3,350

Debt issue 20,652 -129 11,473 1,862 1,901

Convertible debt issue

Others -231 94 0 0 57

Cashflow from financial acts 18,406 -1,267 9,142 -1,152 2,585

Net cashflow 83 -1,751 1,360 3,504 7,971Beginning cash 8,440 8,522 6,771 8,131 11,635

Ending cash 8,523 6,771 8,131 11,635 19,607Ending net debt 13,987 16,244 26,357 25,180 19,077


Balance sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13F

Cash & equivalents 8,522 6,771 8,131 11,635 19,607

Marketable securities

Accounts receivable 4,724 10,017 11,998 13,449 13,681

Inventories 886 1,646 1,874 2,382 2,534Other current assets 5,868 5,847 6,363 6,942 6,983

Total current assets 20,001 24,281 28,367 34,408 42,804

LT investments 940 1,075 6,984 6,993 7,002Fixed assets 18,877 19,875 29,055 38,467 43,176

Goodwill 1,305 1,197 1,197 1,197 1,197

Other intangible assets 18,867 19,633 18,831 18,256 17,438Other LT assets 2,442 6,695 6,695 7,483 7,430

Total assets 62,432 72,756 91,128 106,804 119,047Short-term debt 1,598 615 700 1,015 1,030

Accounts payable 1,367 1,554 1,770 2,566 2,730

Other current liabilities 7,445 7,964 8,813 9,648 9,974Total current liabilities 10,410 10,134 11,283 13,228 13,734

Long-term debt 20,912 22,401 33,789 35,800 37,654

Convertible debt

Other LT liabilities 1,856 2,783 2,783 3,460 3,414

Total liabilities 33,178 35,317 47,854 52,488 54,803Minority interest 102 107 125 146 165

Preferred stock 0 0 0 0 0

Common stock 4,918 4,918 4,918 4,918 4,918Retained earnings 24,233 32,414 38,230 49,251 59,161

Proposed dividends

Other equity and reserves

Total shareholders' equity 29,152 37,332 43,148 54,170 64,079

Total equity & liabilities 62,433 72,756 91,128 106,804 119,047

Liquidity (x)

Current ratio 1.92 2.40 2.51 2.60 3.12Interest cover 117.7 16.5 15.1 13.8 11.1

Leverage

Net debt/EBITDA (x) 1.96 1.28 1.56 1.39 0.96

Net debt/equity (%) 48.0 43.5 61.1 46.5 29.8

Activity (days)

Days receivable 68.0 79.3 98.8 98.3 99.1Days inventory 27.0 24.5 29.9 28.8 30.0

Days payable 36.0 28.2 28.2 29.3 32.4

Cash cycle 58.9 75.5 100.5 97.8 96.8Source: Company data, Nomura estimates

Notes

Sufficient cash flow to fuel capex need

Notes

High D/E ratio due to aggressive acquisitions


137

Downgrade to Reduce with a new TP of HKD17.1 We downgrade Yanzhou Coal to Reduce from Buy, and cut our DCF derived TP to HK$17.1, implying 11.3% downside from the current share price. Accordingly, we raise our 2011F and 2013F normalised net profit estimates by 8.6% and 3.9% to CNY9,042mn and CNY9,621mn, respectively, but cut our 2012F normalised net profit forecast by 12.8% to CNY9,188mn to reflect the following changes to our assumptions:

• We increase our 2011F-15F commercial coal production volume estimates by 1-32%: We raise our 2011F, 2012F, 2013F, 2014F and 2015F raw coal production volume estimates by 3%, 14%, 26%, 35% and 41% to 55mnt, 70mnt, 81mnt, 93mnt and 105mnt, and also lift our commercial coal production volume by 1%, 11%, 18%, 27% and 32% to 50mnt, 62mnt, 69mnt, 79mnt and 89mnt, respectively, for the same period to factor in the recent acquisitions of Premier, Syntech and Gloucester Coal (“GCL”, we assume completion of the acquisition by end-June 2012) .

• We raise our 2011F-15F total sales volume estimates by 1-35%: In line with the commercial coal production increase, we raise our sales volume estimates of self-produced coal accordingly by 1%, 11%, 18%, 27% and 32% to 50mnt, 62mnt, 69mnt, 79mnt and 89mnt for 2011-15F. In addition, we slightly raise our third-party trade volume from 6mnt pa in 2011-15F to 6mnt, 7mnt, 8mnt, 9mnt and 10mnt, respectively.

• Overall 2011F-15F ASP estimates cut by 2-16%: We cut our overall ASP estimates by 2%, 13%, 5%, 7% and 16% to CNY709/t, CNY680/t, CNY690/t, CNY649/t and CNY592/t for 2011-15F, respectively, to reflect our new coal price forecasts in our industry outlook for both domestic and international markets.

• Change in unit cost estimates: Due to the easing CPI and the initial stage of acquired mines, our unit cost of self-produced coal estimate is almost similar to our previous assumptions (increased by 1% to CNY347/t for 2012F and revise down 1% to CNY366/t for 2013F). However, we raise our unit cost estimates for 2014F and 2015F to factor in the likely value based resource tax of 5% to be implemented in July 2014. Our extra resource tax assumption is based on the 5% of ASP after deducting the prevailing resource tax (CNY3.6/t in Shandong and Inner Mongolia and CNY3.2/t in Shanxi).

• Change in effective interest rate estimate: We cut our 2011F interest cost estimate to 3% from 5%, based on 9M11 results. Our economist, Zhiwei Zhang, expects interest rates will be cut by 25bps in 2012F and rebound by 75bps in 2013F. As a result, we cut our interest rate assumption to 2.75% (from 5%) for 2012F and raise our estimate to 3.5% (from 3%) for 2013F and beyond.

• A higher tax rate: Owing to the higher corporate tax rate in Australia (30% vs. 25% in China) and the expansion of Australia’s coal business, we raise our effective tax rate estimates to 28% for 2011-15F from 25% in 2011F and 27% in 2012-15F.

As a result of the changes to our assumptions, we raise our EBITDA margin estimates to 38-42% (from 36-39%), sales volume estimates by 1-20% and blended ASP cut by 2-13% for 2011-13F. Thus, we raise our earnings estimates by 4-9% for 2011F and 2013F, but cut our estimate by 13% for 2012F.


138

Fig. 171: Changes in our key assumptions


2011F 2012F 2013F 2014F 2015FCoal production VolumeTotal raw-coal productionNew model (mnt) 55 70 81 93 105Old model (mnt) 54 62 65 69 75

Change (%) 3% 14% 26% 35% 41%Total commercial coal productionNew model (mnt) 50 62 69 79 89Old model (mnt) 49 56 58 62 67

Change (%) 1% 11% 18% 27% 32%

Sales VolumeSelf-produced coalNew model (mnt) 50 62 69 79 89Old model (mnt) 49 56 58 62 67

Change (%) 1% 11% 18% 27% 32%Third-party tradeNew model (mnt) 6 7 8 9 10Old model (mnt) 6 6 6 6 6

Change (%) 0% 17% 33% 50% 67%Total sales volumeNew model (mnt) 56 69 77 88 99Old model (mnt) 55 62 64 68 73

Change (%) 1% 12% 20% 29% 35%Contract sales as a % of domestic salesNew model (%) 25 25 25 25 25Old model (%) 25 25 25 25 25


PriceASP of self produced coalNew model (CNY/t) 705 676 683 637 582Old model (CNY/t) 714 776 712 684 685

Change (%) -1% -13% -4% -7% -15%ASP of 3rd party purchased coalNew model (CNY/t) 745 715 751 751 676Old model (CNY/t) 809 849 866 883 901

Change (%) -8% -16% -13% -15% -25%Overall ASPNew model (CNY/t) 709 680 690 649 592Old model (CNY/t) 724 783 727 702 703

Change (%) -2% -13% -5% -7% -16%

CostUnit cost for self produced coalNew model (CNY/t) 328 347 366 388 417Old model (CNY/t) 323 344 369 370 366

Change (%) 1% 1% -1% 5% 14%Unit cost of 3rd party purchased coalNew model (CNY/t) 738 708 744 744 670Old model (CNY/t) 802 842 859 876 893

Change (%) -8% -16% -13% -15% -25%Overall unit costNew model (CNY/t) 372 384 408 427 444Old model (CNY/t) 375 393 415 414 409

Change (%) -1% -2% -2% 3% 9%Interest rateNew model (%) 3 2.75 3.5 3.5 3.5Old model (%) 5 5 3 3 3

Change (pcts) -2 -2.25 0.5 0.5 0.5Tax rateNew model (%) 28 28 28 28 28Old model (%) 25 27 27 27 27



139

Key investment theme for 2012

Coal sector earnings and margins were driven by robust ASPs and moderate volume sales growth over the last two years, despite rising unit production costs. However, we expect the Chinese spot coal price to remain range-bound at RMB720-830/t and the average price to fall by 9.2% during 2012-15F, while the key contract price should be more resilient and rise by 10% over the same period. As a result, sales volume growth (the company’s own production, a third-party trade or asset injection or M&A) becomes the only driver from this year, while more existing percentage sales in contract could alleviate the pricing risks, in our view.

For 2012F, given the underlying risks on spot price, while the key contract price for 2012F has been fixed, we would prefer companies with the following attributes in their order of significance. These should provide higher earnings visibility in 2012F.

1) Robust self coal production growth.

2) Sufficient resources.

3) Higher likelihood of asset injection.

4) Less exposure to spot (more on contract).

5) A power portfolio.

Yanzhou Coal: Cheap for a reason

Our price target of HK$17.1 is based the DCF valuation with the WACC of 8.2% and terminal growth rate of 2.5%.

Yanzhou’s bigger exposure in spot market compared with peers (75%, vs. Shenhua 55% and China Coal 44%), regional market (19%, vs. Shenhua 2% and China Coal nil) and coking coal market (40%, vs. Shenhua nil and China Coal 2%) have compelled us to downgrade the shares to Reduce given the unfavourable pricing trend from this year. As well, the depleting coal resources at its home base and insufficient resources have pushed Yanzhou to make several expensive acquisitions in 2011; the latest being GCL, which may not be able to improve Yanzhou’s ROE.

Highest pricing risk: We estimate the Chinese spot coal price to be weak in 2012F (falling 10-15% in 1H with a rebound in 2H, translating into a full-year average decline of 4% y-y), due to the price cap introduced by the NDRC and less demand caused by decelerating real GDP growth. In the longer term, we expect the Chinese spot coal price to fall 9% and the Australia Newcastle (seaborne) price to fall 11% during 2011-15F. Meanwhile, we expect the Chinese coking coal price to fall 6% during 2011-15F due to flat crude steel production and Australian coking coal price declining by a 12.5% CAGR during 2011-15F. Owning to the highest exposure to the spot sales, coking coal and regional market, Yanzhou Coal is likely to be the most vulnerable among the three coal giants under such scenario.

Currencies are moving against Yanzhou: The acquisitions of Syntech, Premier and GCL in 2011, along with Felix, should further transform Yanzhou Coal to an international player, given 30% of its earnings are expected to be attributed from overseas (mainly Australia) in 2012F. That is to say we believe Yanzhou is likely to be affected more seriously by the weakening international coal price and foreign currencies than its peers (Shenhua and China Coal), which focus mostly on the domestic market.

Our global metals and mining team has cut the Australian Newcastle price forecasts by 10% and now they forecast the regional thermal coal price to rise by merely 1% and 4% in 2012-13F and the coking coal price will start to fall since 2012F.

In addition, our economist and currency strategist expects the AUD to depreciate by 7% by end-2012F to 1.05 AUD/USD (from 0.98 in 2011) and the RMB to appreciate by 2.5% by end-2012F to 6.17 RMB/USD (from 6.33 in 2011).


140

Growth by acquisition at a lower return: Yanzhou Coal’s existing coal mines are depleting and have insufficient resources for growth in China; however, we think its latest acquisitions of Xintai in Inner Mongolia China, Potash in Canada and Gloucester Coal, Premier and Syntech in Australia (all during 2011) are all expensive in terms of P/E valuations or EV/ton of production/reserves. As well, Yanzhou’s parent may not have many meaningful coal assets to inject. This could indicate further growth by acquisitions, either domestically or overseas, which may yield a lower return and be ROE dilutive to existing shareholders. Going forward, this does not appear to bode well for quality and sustainable growth.

Excluding lower quality volume growth in overseas, self-production growth is the lowest among peers: Due to Yanzhou’s lower profitability and the initial stage of the acquired mines, we should not able to see impressive earnings stimulus from the acquisitions in the near term. That said, despite the company being expected to achieve the highest production and sales volume growth in 2012F, the growth (mainly from the acquisition of GCL at 37x June-11 P/E) is expected to yield a lower return and translates into a 1.6% earnings growth for 2012F. Thus, stripping out the lower quality production volume growth in overseas, its self-production in China is indeed growing at merely a 6.5% CAGR for 2011-15F, the lowest among its peers.

Cheap for a reason: The stock currently trades at an undemanding 8.3x 2012F P/E, similar to that of China Coal (8.6x), but cheaper than Shenhua (10.6x), while Shenhua is distinctive for its quality, we would prefer China Coal over Yanzhou for similar valuation.

Fig. 172: Valuation and sensitivity table



NPV $90,478.94 --- Terminal Growth Rate ---Cash 10,699 17.10 1.75% 2.00% 2.25% 2.50% 2.75% 3.00% 3.25%Debt (34,489) 7.4% 18.58 19.38 20.26 21.24 22.31 23.51 24.85

$66,689.35 7.6% 17.65 18.39 19.19 20.08 21.05 22.13 23.33 No of share 4,918 7.8% 16.79 17.46 18.20 19.01 19.89 20.87 21.95 RMB per share 13.56 8.0% 15.98 16.60 17.28 18.02 18.82 19.71 20.69 HK$ per share 17.10 8.2% 15.22 15.80 16.42 17.10 17.84 18.65 19.54

8.4% 14.51 15.05 15.62 16.24 16.92 17.66 18.47 Risk free rate 2.50% 8.6% 13.85 14.34 14.87 15.44 16.07 16.74 17.49 Market risk premium 7.50% 8.8% 13.22 13.68 14.17 14.70 15.27 15.90 16.57 Beta 1.368 9.0% 12.63 13.06 13.51 14.00 14.53 15.10 15.73 Tax rate 28%Cost of debt 4%Cost of equity 12.8%WACC 8.2%

D/(D+E) 44% #

---

WA

CC

---


141

Fig. 173: Valuation comparisons

Note: pricing date as of 26 Jan 2012. Bloomberg estimate for not rated companies



cap Fiscal PEG


Coal



China

Datong Coal 601001 CH n.a. n.a. 13.39 3551.41 Dec 16.9 14.8 13.2 1.5 2.2 2.0 1.8 1.7 1.8 2.0 n.a. n.a. n.a. 14.5 14.7 15.9Shanxi Xishan Coal & Electricity 000983 CH n.a. n.a. 16.3 8139.67 Dec 15.8 13.3 12.6 0.9 3.4 2.8 2.4 2.4 2.6 2.8 n.a. n.a. n.a. 23.5 23.7 25.3Pingdingshan Tianan Coal Mining Co 601666 CH n.a. n.a. 11.83 4426.44 Dec 12.7 10.7 9.6 0.7 2.3 1.9 1.6 2.5 2.7 3.2 n.a. n.a. n.a. 20.3 19.6 19.6Shanxi Guoyang 600348 CH n.a. n.a. 18.65 7107.83 Dec 14.7 12.9 11.4 0.7 4.0 3.1 2.5 1.2 1.3 1.5 n.a. n.a. n.a. 29.5 26.7 24.5Shanghai Energy 600642 CH n.a. n.a. 4.63 3469.55 Dec 15.7 12.9 11.0 1.2 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.Hengyang Coal 600971 CH n.a. n.a. 15.83 2508.57 Dec 12.5 10.9 11.9 1.3 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 17.4 17.7 16.9Lu'an Environmental Energy 601699 CH n.a. n.a. 24.92 9087.06 Dec 14.4 12.6 10.5 0.8 3.5 3.5 2.9 3.6 4.2 5.2 n.a. n.a. n.a. 29.1 27.5 28.3SDIC Xinji 601918 CH n.a. n.a. 11.77 3451.3 Dec 13.5 10.8 10.3 0.7 2.3 1.9 n.a. 2.4 2.9 n.a. n.a. n.a. n.a. 16.4 17.4 n.a.China Average 14.5 12.4 11.3 1.0 2.9 2.5 2.2 2.3 2.6 2.9 n.a. n.a. n.a. 21.5 21.0 21.8

S.E Asia

Banpu BANPU TB n.a. n.a. 584 5075.18 Dec 9.6 9.6 8.9 n.a. 2.0 1.8 1.6 3.3 3.4 3.5 0.6 0.4 0.2 25.7 19.8 18.6Bumi BUMI IJ Buy 3000 2525 5850.85 Dec 16.8 14.8 9.0 0.5 3.1 2.6 2.1 1.1 1.2 1.4 169.6 120.7 66.6 19.7 19.1 25.7ITMG ITMG IJ Reduce 37300 37750 4757.91 Dec 9.1 11.4 8.5 0.3 4.5 4.4 3.6 4.2 8.3 6.6 net cash net cash net cash 59.2 39.6 46.9Bukit Asam PTBA IJ Buy 26000 20000 5140.28 Dec 14.9 13.6 12.1 0.6 5.6 4.6 3.8 2.6 3.4 3.7 net cash net cash net cash 42.3 36.8 34.3Indika Energy INDY IJ Neutral 2500 2500 1452.08 Dec 11.9 8.3 6.2 0.2 2.0 1.7 1.4 1.0 3.4 4.8 76.9 57.0 34.9 18.5 22.6 25.2Adaro ADRO IJ Buy 2450 1840 6564.88 Dec 13.7 12.6 10.5 0.4 2.7 2.3 2.0 1.5 2.3 1.5 49.5 44.9 21.9 21.4 20.0 20.3S.E Asia Average 12.7 11.7 9.2 0.4 3.3 2.9 2.4 2.3 3.6 3.6 74.2 55.8 30.9 31.1 26.3 28.5

Asia Average



Yield (%) Net debt/equity (%) RoE (%)P/E (x) P/B (x)


142

Appears most vulnerable to the unfavorable price trend Given its higher portion of spot sales and coking coal, Yanzhou coal enjoys a higher realised average selling price than its peers. In 2010, the ASP of self-produced coal was RMB654/tonne, 53% and 43% higher than that of Shenhua and China Coal, respectively. According to our industry outlook, the spot price is likely to drop by 4% in 2012F (-9% during 2011-15F), while the key contract price should increase 5% in the respective period (+10% during 2011-15F). In this scenario, we believe Yanzhou will be the largest casualty, given:

• Yanzhou’s highest exposure of spot coal sales (75% vs. Shenhua’s 55% and China Coal’s 44%);

• Least beneficiary from the contract price increase;

• Highest portion of coking coal (40% of 2011F sales volume is coking coal vs. Shenhua’s nil and China coal’s 2%), which will be negatively affected by the flat crude steel output; and

• Most affected by the weak regional coal prices (19% of Yanzhou’s 2011F sales volume, vs Shanhua’s 2% and China Coal’s nil).

Unfavourable price trend in 2012F

Due to the highest exposure to spot sales vs peers (75% vs. Shenhua’s 55% and China Coal’s 44%), Yanzhou Coal was the biggest beneficiary from the robust spot price trend since 2009. However, when the spot price turns weak, Yanzhou is likely to underperform its peers, like from this year.

We believe Yanzhou Coal will be the largest beneficiary vs peers from the strong spot price, as seen in 2010 and 2011F, when the spot price increased 24% and 10%, respectively. However, this favourable price trend is unlikely to be duplicated in 2012F and 2013F. Owing to the slow expected GDP growth (7.9% in 2012F and 8.2% in 2013F), we believe the coal spot price will correct 4% in 2012F and remain flat in 2013F and decline by 9% during 2011-15F.

In addition, in order to protect the profitability of IPPs, the NDRC announced the spot price cap of RMB800/tonne, effective from January 2012. As a result, we expect Chinese spot price to hit the low of RMB720/t in April (down 10-15% from the current RMB800/t) as the GDP growth should slow to 7.5%, according to our economist, Zhiwei Zhang. In this scenario, Yanzhou Coal is likely to suffer the most among the three coal giants in China.

Fig. 174: Yanzhou Coal: Spot/Contract sales mix


Fig. 175: 2012 domestic spot coal price trend forecast


23% 25% 25% 25% 25% 25% 25%

77% 75% 75% 75% 75% 75% 75%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2009A 2010A 2011F 2012F 2013F 2014F 2015F

Contract Spot(%)

700

720

740

760

780

800

820

840

860

No

v-1

1

Dec

-11

Jan

-12

Feb

-12

Mar

-12

Ap

r-12

Ma

y-12

Jun

-12

Ju

l-1

2

Aug

-12

Sep

-12

Oct

-12

No

v-1

2

Dec

-12

(CNY/t)


143

Fig. 176: Nomura coal price forecast

Source: CCTD, Nomura estimates

Least likely to benefit from contract price rise

Owing to the lowest contract sales portion, Yanzhou Coal was the least affected versus peers in 2011 when contract price was frozen at RMB570/tonne. On 30 November, 2011, the NDRC guided that the magnitude of contract coal price increases for 2012 will be at a max of 5%. In our view, the policy is likely to favour those with high exposure of contract sale, instead of Yanzhou Coal, as the contract price growth can partially offset the negative impact of the spot price decline.

Coking coal price is expected to peak from 2012F

More than 80% of the coking coal is used in the production of steel. The flat crude steel output assumptions from our steel analyst, Matthew Cross, will no longer support the strong coking coal demand.

Yanzhou does not produce hard coking coal in China; however, 37% of Shandong’s output is high-quality thermal/pulverised coal injection blend No1 and No 2 clean coals sold to steel producer at coking coal prices. Also, c.20-25% of its capacity in Australia (post acquisition of GCL) is semi-soft or semi-hard coking coal.

As coking coal sales volume accounted for 34% of Yanzhou’s total sales in 2010 (vs. Shenhua’s nil and China Coal’s 1%), if coking coal price falls due to the insufficient demand caused by the flat crude steel production, Yanzhou is likely to suffer the most amongst its peers. We expect Chinese coking coal price peaked from end -2011 and will fall 6% during 2011-15F. Our global mining team is more bearish and expects the Australian coking coal price to fall at a 12.5% CAGR during 2011-15F.

CNY/tonne (5,500 kcal/ton) 2009 2010 2011F 2012F 2013F 2014F 2015F 2016F 2017FKey contract price (FOB)-40% of total contract sales 540 570 570 599 599 628 628 597 567

y-y (%) 18 6 0 5 0 5 0 -5 -5


y-y (%) 6 5 7 0 5 0 -5 -5

Blended contract price (FOB) increase (%) 6 3 6.2 0 5 0 -5.0 -5.0

Spot price (CNY/t, 5,500kcal/t) 600 744 820 787 827 827 744 632 569

y-y (%) -17 24 10 -4 5 0 -10 -15 -10


CNY/USD 6.33 6.17 5.96 5.96 5.96 5.96 5.96

Average selling price (50% contract; 50% spot) 570 657 695 696 713 727 686 615 568

15% 6% 0% 2% 2% -6% -10% -8%



144

Fig. 177: Production mix comparison (2010)


Fig. 178: Domestic sales mix comparison (2013F)

Note: Yanzhou includes the acquisition of GCL. GCL’s output from its NDR slides and the coking coal portion from Yanzhou’s management in the conf. call.


Most affected by the weak regional coal market

Unlike domestic annual contracts, Australia coal contracts are signed on a quarterly basis, with prices varying little from the market.

After the aggressive acquisitions in Australia, Yanzhou transformed itself into an international player, while its peers, Shenhua and China Coal, are mainly focused domestically. With the expansion of Felix, Syntech, Premier and GCL in the coming years, Yanzhou should enjoy more exposure in the regional market (48% in 2015F vs. 24% in 2010). Thus, the international price will have more significant impact on Yanzhou.

According to the coking coal contract between Pesco and Anglo American, which will be served as the benchmark for the coal price in Australia, the settled coking coal price for 1Q12 was at US$235/t FOB Australia (down US$50/t from Q4 2011) and a low-volatile PCI coal contract at US$171/t (down from US$208/t in Q4 2011). The q-q decrease illustrated the weak demand from the international market. Our global metal and mining team had cut their global coal prices forecasts by 10% and cut their global coking coal price forecasts by 10-18%, and now forecasts regional thermal coal prices to rise by a slower 1-4% pa in 2012-13F and coking coal prices to fall since this year.

Fig. 179: Nomura Australia coal price forecast


In line with Australia’s coal price trend, we forecast Felix’s ASP to decrease slightly to RMB887/t (down 5% y-y) in 2012F and another -4% y-y to RMB848/t in 2013F. As a typical thermal coal mine, we expect Syntech’s ASP to have a similar growth rate as the regional thermal coal price. However, Premier’s ASP is capped at AU$44/t by the long-term 20 year contract price.

In addition, our global metals and mining expect a sharp decrease of Australian thermal coal price from since 2015F. The ramp-ups of Moolarben (16mnt in 2015F vs. 10mnt in 2012F, up 60%) and Syntech (12mnt in 2015F vs. 2mnt in 2012F, up 600%) should magnify the negative effect of ASP decline.

100 99

66

0 1

34

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10093

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Thermal Coking(%)

(USD/tonne) 2008 2009 2010 2011F 2012F 2013F 2014F 2015F

Thermal coal 125 70 98 124 125 130 130 110

% y-y -44 40 26 1 4 0 -15

Coking coal 305 129 216 274 256 230 190 160

% y-y -58 67 27 -6 -10 -17 -16


145

Narrowing ASP spread with peers

Given that we think Yanzhou Coal stands to be the biggest casualty of unfavourable coal price trends, we expect the ASP spread between Yanzhou Coal and its peers to narrow over the next two years.

Fig. 180: Yanzhou Coal: ASP (self produced) comparison (2009-2013F)

Note: Yanzhou’s self-produced ASP does not include GCL


388427 444 445 465

416456

504536 564

529

654705

676 683

0

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2009 2010 2011F 2012F 2013F



146

Aggressive acquisitions = strong output growth + diminishing return The acquisition of Australia-based Felix Resources in December 2009 was a strategic breakthrough for Yanzhou, which has helped raise its reserves and production, and re-rated the company since 2010. Thanks to contributions from Felix, Yanzhou achieved a 36% y-y growth in its raw coal production and recurring EPS growth of 74%.

Following the Felix coal mine acquisition in 2009, the company purchased another six mines and GCL. However, even though the series of acquisitions in Australia should significantly boost Yanzhou’s production volume from 2012F and beyond, we expect a 26% y-y raw coal production growth for Yanzhou in 2012F to 70 mnt. The expected earnings growth would be merely 1.6% for the year due to:

• Weak AUD expected in 2012F/13F: Our Global team forecasts the AUD/USD to reduce 3% to 1.02 in 2012F, and further down to 1.05 in 2013F, the weak AUD coupled with appreciated RMB is likely to negatively affect Yanzhou’s earnings.

• Company’s Premier (in Australia) mine ASP cap by long-term contract: In spite of the 5mnt raw coal capacity added to the company from Premier coal mine from 2013F, we believe the earnings stimulus will be very limited, given the coal produced is sold at AU$44/tonne under the 20-year long-term contract instead of marking-to-market.

• Low Australia coal price forecast in long term: Our Global Metals & Mining team believes the low 2012F thermal coal forecast (US$125/t) reflects the recent Newcastle thermal contract for Q1/12 of ~US$115/t and expectation of a weak H1/12 for China domestic thermal coal prices. In addition, they forecast a long term (post 2016F) price of US$90/t, which again drag down the long-term Yancoal Australia’s contribution to the Company.

Target to triple production by 2015

Management provided an aggressive guidance of tripling the 2010 production volume to 150mn tonnes by 2015F. In order to achieve this goal, Yanzhou has become active in acquisition mode since 2009, owing to depleting resources in its headquarters (while its main operating mines reached full capacities), accounting for 91% of total raw coal output in 2009. Following the Felix coal mine acquisition in 2009, the company purchased an additional six mines in Inner Mongolia Ordos and Australia, and proposed to acquire GCL in the form of a reverse takeover, with total annual capacity of 40mnt, which could take the company’s production to 105mnt by 2015F.


147

Fig. 181: Nomura’s forecast for Yanzhou raw coal production volume


Equity Coal Reserve

stake (%) type (mnt) 2010 2011F 2012F 2013F 2014F 2015F

Existing mines

The company 100 thermal&PCI 1,797 34.3 34.8 34.8 34.8 34.8 34.8

Shanxi Nenghua 98 thermal 27 1.5 1.6 1.6 1.6 1.6 1.6

Heze Nenghua 96 1/3 coking 105 1.6 2.9 3.5 3.5 4.5 5.5

Yancoal Australia

Austra 100 semi-hard 51 1.7 1.8 1.8 2.0 2.0 2.0

Yarrabee 100 PCI 60 2.3 2.1 2.3 2.3 2.3 2.3

Minerva 51 thermal 24 1.4 0.0 0.0 0.0 0.0 0.0

Ashton 90 semi-soft 61 2.7 1.2 2.8 2.8 2.8 2.8

Moolarben 80 thermal 352 3.9 6.8 10.0 13.1 13.8 16.0

Subtotal from existing mines 2,477 49.4 51.2 56.8 60.1 61.8 65.0

New acquisition

Ordos Nenghua

Anyuan 100 thermal 41 0.0 2.0 2.0 2.0 2.0 2.0

Xintai 80 thermal 75 0.0 1.3 3.0 3.0 3.0 3.0

Haosheng-Shilawusu 61 thermal 1,644 0.0 0.0 0.0 0.0 2.0 3.0

Zhuanlongwan 100 thermal 548 0.0 0.0 0.0 1.0 3.0 5.0

Yancoal Australia

Syntech 100 thermal 440 0.0 1.0 2.0 2.0 7.0 12.0

Premier 100 thermal 138 0.0 0.0 3.5 5.0 5.0 5.0

GCL 100 g 275 2.7 8.1 9.6 10.2

GCL 2,886 0.0 4.3 10.5 13.0 22.0 30.0

Subtotal from new acquired mines incl. GCL 3,161 0.0 4.3 13.2 21.1 31.6 40.2

Total (excl. GCL) 5,363 49.4 55.5 67.3 73.1 83.8 95.0

Total (incl. GCL) 5,638 49.4 55.5 70.0 81.2 93.4 105.2

yoy growth (%) 12.3% 26.2% 16.0% 15.1% 12.7%

In which:

Total production in China 37.4 42.6 44.9 45.9 50.9 54.9

yoy growth (%) 13.8% 5.5% 2.2% 10.9% 7.9%

Total production in Australia (incl. GCL) 12.0 12.9 25.1 35.3 42.5 50.3

yoy growth (%) 7.5% 94.2% 40.7% 20.5% 18.5%

Production (mnt)


148

Starting with Felix and Inner Mongolia Ordos in 2009-10

Felix In December 2009, Yancoal Australia acquired Felix for a consideration of AU$3,333mn. With the acquisition, the company gained access to four operating mines and two mines under construction, totalling 516mn tonnes of proven and probable reserves (JORC standard), 394mn tonnes attributable to Yanzhou (see below for a detailed breakdown). While the Yarrabee, Minerva and Ashton mines were operational at the time of the acquisition, the Moolarben mine became operational in May 2010.

Ordos Nenghua On 6 September 2010, Yanzhou announced the acquisition of a 35.49% stake of Haosheng coal mining for a consideration of RMB4.62bn and that it was in the bidding process for another 15.51% stake for RMB2.02 bn. On 6 May, 2011, Yanzhou acquired another 10% stake of Haosheng with the consideration of RMB1.3bn. On completion of the transaction, Yanzhou would hold 61% of Haosheng Mining, which further holds Shilawusu mine field in Inner Mongolia, with annual capacity of 10mn tonnes. The acquisitions would boost Yanzhou’s equitable production capacity by 10mn tonnes (with 6.1mn tonnes equitable), 2mn tonnes of which will likely be operational by 2015F and then ramp up to 5mn tonnes in 2016F.

After the Felix acquisition, the 12mnt raw coal production volume of Yancoal Australia drove the raw coal production volume to surge 34.6% yoy to 49.4mnt in 2010, successfully solving the problem of the production growth limitation at its home base.

Moreover, both acquisitions provided output growth potentials by the end of 2015F and 2016F.

Remain active in acquisition in 2011…

Yanzhou Coal retained its aggressive stance in M&A projects in 2011. In 2011, the company acquired Xintai, Syntech, Premier and Canadian Potash projects. Excluding the potash project, the other three acquisitions will add to Yanzhou’s coal production capacity by 24mnt - 3mnt from Xintai, 16mnt from Syntech and 5mnt from Premier. As well, Yanzhou announced a share swap to acquire a 100% stake of GCL on 23 December 2011 with the acquisition being subject to the approvals of both GCL and Yanzhou Coal shareholders, the due diligence of both parts and various regulatory agencies. Based on GCL’s NDR information, GCL will contribute another 10.2mnt raw coal production by 2015F. Base on the production schedule of existing coal mines and GCL, we believe the raw coal production will reach 105mnt by 2015, 50.3mnt (48%) of which will come from Yanzhou’s Australian business.

Fig. 182: Yanzhou Coal output volume (2009-2015F)

Note: Include GCL’s output since June 2012


Fig. 183: Yanzhou Coal output breakdown-2015F


34 37 43 45 46 51 552

1213

2535

4250

010

203040

5060

708090

100110

120

2009 2010 2011F 2012F 2013F 2014F 2015F

Domestic Australia(mnt)

Domestic, 52%

Australia, 48%


149

Fig. 184: Domestic coal production breakdown by mines (2009-2015F)


… but limited earnings impact is likely to be expected from the recent acquisition

However, the five acquisitions accomplished in 2011 will be either low profitability or at the initial stage. We are unlikely to witness significant earnings contributions from these projects in the foreseeable future. This is due to

1) GCL acquisition values Yancoal Australia’s injected assets (four operating mines and 15.4% in Newcastle port) at AU$6.9bn (~12.7x 2011F P/E and 7x Jun-11 book) and GCL at AU$2.061bn (37x Jun-11 P/E and 2x Jun-11 P/B). We believe the deal looks more favourable to GCL than Yanzhou Coal in terms valuation.

2) The Premier mine is of low quality, in our view, and has a long-term 20-year contract selling at merely AU$44/ton.

3) The Potash acquisition will take three to five years to construct the mines and a capex of US$3bn. Thus, we are unlikely to see earnings contributions in the next six to eight years. Even though the potash market is currently attractive, it does not necessarily mean the same situation will exist in six years from now. As well, there is substantial execution risk, in our view, given a new market for Yanzhou.

4) The development of the Syntech project is at the early stage and may take at least four years before the coal mines ramp up to its designed capacity of 16mnt. In addition, management guided for total capex for the project will be c.AU$200mn, which will be spent in the next four to five years. It is only after 2015F, in our view, Yanzhou Coal is likely to benefit from the project. Currently, raw coal production will remain at 2mnt pa in 2012-13F for phase 1.

5) The Inner Mongolia (Ordos) based mine has the unit profit of RMB120/tonne, lower than Yanzhou’s average unit profit of domestic self produced coal of RMB377/tone in FY11F

GCL acquisition: Valuation is not cheap, and EPS-dilutive for Yanzhou Coal • According to Yanzhou’s announcement on 23 Dec, 2011, Yancoal Australia, Yanzhou

Coal’s 100% subsidiary, will acquire GCL’s 100% share capital by form of share swap (one for one share swap and one for one share swap plus CVR shares). Post the merger, GCL will become a wholly owned subsidiary of New Yancoal Australia and Yanzhou Coal and the existing GCL shareholders will hold 77% and 23% of the share capital of New Yancoal Australia, respectively.

• The current Yancoal Australia will inject the four operating mines (Austar, Ashton, Moolarben and Yarrabee) and 15.4% stake of Newcastle Coal Infrastructure Group (Newcastle port) into the new company. Felix’s Greenfield project (Harrybrandt, Athena and Wilpeena projects) and the stakes of two other companies (Yanzhou Technology Development Pty and UCC Energy Pty) are excluded from the acquisition.

33.4 34.3 34.8 34.8 34.8 34.8 34.8

0.01.6 2.9 3.5 3.5 4.5 5.52.0 2.0 2.0 2.0 2.01.3 3.0 3.0 3.0 3.02.0 3.0

1.03.0

5.0

0

10

20

30

40

50

60

2009 2010 2011F 2012F 2013F 2014F 2015F

The company Shanxi Neng Hua Heze Neng Hua

Anyuan Xintai Haosheng

Zhuanlongwan

(mnt)


150

• The New Yancoal Australia will pay the existing GCL shareholders the dividend of AU$3.2/share (totalling AU$700mn, including AU$0.56/share special dividend and AU$2.64/share capital return to be paid six months after the merger) and offer the CVR shares of cash payment if the share price of New Yancoal Australia is less than AU$6.96/share, based on three-month VWAP, 18 months after the implementation date, subject to a cap of AU$3.00/share.

• The share swap values Yancoal Australia’s injected assets (four operating mines and 15.4% in Newcastle port) at AU$6.9bn (~12.7x 2011F P/E and 7x Jun-11 book) and GCL at AU$2.061bn (37x Jun-11 P/E and 2x Jun-11 P/B). We believe the deal looks more favourable to GCL than Yanzhou Coal in terms valuation. Also the US$2bn consideration and GCL’s AU$99mn debt represents an EV of US$7.63/t of JORC reserve, which is more expensive than peer transactions (US$3-6/tonne from our global selected M&A during 2007-09), and more expensive than Yanzhou’s recent acquisition of Premier and Syntech (US$2.1/t and US$1.1/t of JORC reserve). The transaction would be US$350/t of raw production based on GCL management’s 6mtpa near-term target, more expensive than similar M&As worth US$220-250/t from our global selected M&As from 2007 to 2009 and US$83.6/US$237 for Premier and Syntech separately.

• According to Yanzhou’s promise of the acquisition of Felix, Yancoal Australia will need to be listed on the Australia Stock Exchange by end-2012 and Yanzhou has to cut its stake in Yancoal Australia to no more than 70%. In addition, as some of the coal mines (Moolarben and Ashton) are owned by the JVs between Yancoal Australia and third-party companies, Yancoal has to reduce its economic benefit in the JVs to less than 50% in the current mines. If the economic conditions and other factors prevent the commitment to be met, Yancoal will ask for the Australian Finance Minister’s approval to amend the agreement.

• We believe the deal will be finished in 2012F. Based on the 77%/23%’s equity swap structure, we expect Yanzhou is likely to reduce its stake in the New Yancoal Australia by 7% in 2012 and further cut 10% in 2013F considering the current market situation. Looking back to our 23 December 2011 report, EPS dilutive from the GCL merger we value the injected four mines and one port together with the GCL as AU$8.9bn. The New Yancoal Australia will raise AU$624mn (7% of injected asset and GCL) and AU$892mn (10% of the injected asset and GCL) in 2012 and 2013, respectively. In addition, New Yancoal Australia will have to pay AU$700mn dividend to the existing GCL shareholders.

• Supposing the deal to be finished in May 2012, guided by Yanzhou’s management in the conference call, we have factored in 70% of New Yancoal Australia’s earnings during the last seven-month in 2012 and 60% earnings since 2013 in our model.

Syntech acquisition: limited impact in the short term • Yancoal Australia, a wholly owned subsidiary of Yanzhou Coal, signed an equity sale

agreement through its wholly owned subsidiary Austar Coal Mine Pty Limited (“Austar”) to acquire 100% equity interests in Syntech Resources Pty Ltd and Syntech Holdings II Pty Ltd (“Syntech”) for a consideration of AU$202.5mn (equivalent to approximately RMB1,429mn) payable in cash. The equity transfer was completed by Austar on 1 Aug 2011.

• The Syntech project is situated in the Surat Basin in Queensland, Australia, c.360 km northwest of Brisbane. The coal mines are open pit, high-quality thermal coal (6,300 kcal/kg) and proved JORC reserves of 440mnt.

• In our view, the consideration is favourable in terms of EV per tonne of reserves but in line EV per tonne of output. With AU$202.5mn total consideration paid for this transaction and AU$229mn total liabilities for Syntech projects, it represents EV of US$1.1 per tonne of JORC reserves (vs. US$3-6 per tonne of JORC reserves from our global selected merger and acquisitions during 2007-09). However, due to the relatively small current production, the EV per tonne of raw coal production is US$237, in line with US$220-250 average per tonne of production from our global selected merger and acquisitions during 2007-09.

• The development of the Syntech project is at the early stage and should take at least four years for the coal mines to ramp up to its designed capacity of 16mnt. In addition,


151

management guided for total capex for the project at c.AU$200mn, which will be spent in the next four to five years. We believe only after 2015F will Yanzhou Coal benefit from the project. Currently, the raw coal production will remain to be 2mnt in 2012-13F.

Premier: low profitability • Yancoal Australia signed a share sale agreement on 27 Sep 2011 with Wesfamers to

acquire the 100% equity interest in Premier Coal and Wesfarmer Chars for AUD296.8mn in Cash.

• The coal mine is open pit with reserves of 138mnt and resources of 535mnt, respectively, under JORC standard as of 30 June 2011.

• Premier is an operating mine with the designed capacity 5mnt and 3.5mnt production volume last year.

• The AUD296.8mn consideration represented the EV of USD1.1 per tonne of JORC reserves and EV of USD83.6 per tonne of raw coal production, lower than our global selected M&A valuation during 2007-09. However, considering the low quality at 4,200kcal/kg, the transaction deserved the discount

• In spite of the 5mnt raw coal capacity added to Yanzhou, we believe the earnings impact will be very limited, given:

– The coal produced is sold at AUD44/tonne under the long-term contract lasting for about 20 years instead of mark-to-market;

– Although the capacity can be upgraded to 7mnt, the additional CAPEX will be needed for the infrastructure.

Potash: no earnings contribution • In September, Yanzhou Coal paid a total consideration of US$260mn to acquire 19

potash mineral exploration permits in the Province of Saskatchewan, among which 11 were acquired from Devonian Potash and the remaining 8 were from North Atlantic Potash. Management was confident of the rich potash resources in the target areas and plans to build a mine with the designed capacity of 2.5mnt.

• Although management is optimistic about the project due to China’s strong potash demand and insufficient domestic supply (over 50% of the potash consumed in China will rely on import), we remain conservative on Yanzhou’s action in potash market, given:

– Yanzhou never had potash exposure before. In our view, Yanzhou’s execution risk will be high as it is entering an unfamiliar market. In addition, we estimate it will take about 10 years for the newcomer to develop its potash exploration technology, as disclosed by the A share listed company, Qinghai Salt Lake.

– According to management, it will take three years for the company to obtain the mining licence and another three to five years to construct the mines and a capex of USD3bn. Consequently, we are unlikely to see any earnings contributions in the following six to eight years.

– The potash market is attractive for now, with high concentration (top 5 producers accounting for 65% of the total capacity and 80% of the total supply) and favourable price (2H11 CIF price increase 17.5% hoh). However, it is difficult to gauge what the market will be when the project comes into operation.

Xintai: lower unit profit than the current mines Yanzhou Coal acquired the operating mine with 3mnt designed capacity in July. We expect the mine to contribute 1.25mnt output to Yanzhou in 2011F and 3mnt to the company from 2012F. The Inner Mongolia based mine has the unit profit of RMB120/tonne, lower than Yanzhou’s average unit profit of domestic self produced coal of RMB377/tone in FY11F.


152

Fig. 185: Yanzhou’s coal mine assets


Equity stake (%)

Reserve (mnt)

Coaltype

Reserve attributable to Yanzhou (mnt)

Calorific value (Kcal/kg, Per cal.) Weight

Calorific value (Kcal/kg, Weighted Avg.)

Shandong Province

Nantun 100 115 thermal & PCI 115 6,025 2.0% 121

Xinglong Zhuang 100 319 thermal & PCI 319 6,025 5.6% 337

Baodian 100 282 thermal & PCI 282 6,025 5.0% 298

Dongtan 100 451 thermal & PCI 451 6,025 7.9% 476

Jining II 100 409 thermal & PCI 409 6,025 7.2% 432

Jining II 100 222 thermal & PCI 222 6,025 3.9% 234

Shanxi Nenghua

Tianchi 81 27 thermal 22 5,267 0.4% 20

Heze Nenghua

Zhaolou 98.33 105 1/3 coking 103 6,222 1.8% 113

Wanfu 98.33 1/3 coking - 6,222 0.0% -

Yancoal Australia

Austra 100 45 semi-hard 45 7,925 0.8% 63

Yarrabee 100 57 PCI 57 7,122 1.0% 71

Ashton 90 84 semi-soft 76 7,122 1.3% 94

Moolarben 80 315 thermal 252 6,596 4.4% 291

New acquisition

Haosheng 61 1,644 thermal 1,003 7,000 17.6% 1,231

Anyuan 100 41 thermal 41 5,400 0.7% 38

Zhuanlongwan 100 548 thermal 548 5,200 9.6% 500

Xintai (wenyu) 80 75 thermal 60 5,200 1.1% 55

Jintian 25 1,343 thermal 336 5,900 5.9% 347

Yushuwan 41 1,246 thermal 511 5,900 9.0% 529

Syntech 100 440 thermal 440 6,300 7.7% 486

Premier 100 138 thermal 138 4,200 2.4% 102

Gloucester Basin 100 75 coking & thermal 75 6,750 1.3% 89

Middlemount 50 96 coking & thermal 48 7,100 0.8% 60

Donaldson 100 152 coking 152 7,500 2.7% 200

Monash 100 coking & thermal -

Total 8,228 5,703 6,187


153

We are cautious on management’s production growth plan Management reaffirmed its raw coal production expansion plan from 50mnt in 2010 to 150mnt by 2015. Since 2009, Yanzhou coal has been seeking coal resources in both the domestic and international markets. After checking with prevailing coal resources, we are cautious about management’s aggressive output guidance.

We only expect 105mnt raw coal output by 2015F; we are less optimistic than management’s view of 150mnt

Except for Anyuan, Xintai and Premier mines, the majority of the acquisitions appear to be back-end loaded and are only likely to contribute production after 2013F. As a result, we revise our 2015F production forecast of 105 mnt (from previous 75mnt) to reflect the acquisition of Premier, GCL and more details about Syntech. Our new production forecast only accounts for 70% of management’s target.

• Anyuan mine: One operational mine with a capacity of 1.2mnt p.a. Given that it’s 1H11 output has already reached 1.3mnt and management’s guidance is 2mnt (or above) annual output, we expect production of 2mnt p.a. from 2011F and beyond.

• Xintai: This was acquired in July, with one operating coal mine of Wenyu (3mnt annual capacity). We expect production contribution of 1.25mnt in 2011F and remain stable at 3mnt pa from 2012F, and beyond.

• Haosheng mine: One of Yanzhou's key greenfield projects with 10mnt p.a. designed capacity. The mine is now under construction and is scheduled to commence production by 2014- 15F, according to management. We expect 3mnt p.a. output for 2015F and 10mnt p.a. from 2016F, and beyond.

• Wanfu: One of the coal mines in Heze Nenghua, with a capacity of 1.8mnt p.a. Management asserts that production can be upgraded to 3mnt p.a. Given its depth, we maintain our less aggressive target of 1mnt p.a. for 2015F, and beyond.

• Zhuanlongwan: Although the company is awaiting government approval for mining rights, management expects production contribution in 2013. Considering its construction period, we maintain our previous forecast of 3mnt p.a. output in 2014F, growing to 5mnt p.a. in 2015F and beyond.

• Sytech: Management guided that the project will contribute 16mnt raw coal production volume after the two phases come into operation. Now it is at the initial stage and will contribute 2mnt in 2012-13F. We expect Yanzhou will fully benefit from the project in 2016F and the output will reach 12mnt by 2016F.

• Premier: One operating mine with the capacity of 5mnt. Although management the capacity can be expanded to 7mnt, we still stick to our conservative forecast of 5mnt for 2016F, and beyond.

• GCL: Yanzhou acquire 100% stake of GCL through equity swap. GCL produced 2.9mnt raw coal in FY11. According to the GCL’s NDR slides, the output will ramp up to 10mnt by 2015F. If the deal is successfully accomplished, Yanzhou should realise its target of 50mnt output by 2015F in Australia.


154

2010 earnings boom unlikely to repeat

Revenue growth to slow

Yanzhou experienced rapid revenue growth in 2010 (+64% y-y), due to strong ASP growth (+24% y-y) and production expansion by 36% y-y contributed by Yancoal Australia.

Nevertheless, we believe no such revenue boom will repeat in 2011F-13F and revenue growth will slow to 19.8%, 16.5% and 5.4% from 2011-13F respectively, given:

• Ashton’s production cut in 2011 caused by the depleting resources, which requires a shift in working surface;

• The weak spot price in China’s domestic spot market in 2012F and 2013F, correcting 4% y-y in 2012F and rebounding 5% y-y in 2013F;

• Less robust coal price performance in Australia: According to our global metals and mining team, international coking coal is projected to fall 6% and 10% in 2012-13F separately in spite of the 1%/4% y-y growth of thermal coal price for the respective period. However, both coking coal and thermal coal prices enjoy the sharp increase in 2010/11; and

• Consecutive appreciation of RMB: As Yanzhou is recorded in RMB, the consecutive appreciation of RMB is likely to cause less recorded revenue for a given USD amount. Our economist, Zhiwei Zhang, expects that the RMB will appreciate 2.5% and 3.4% in 2012-13F, respectively.

Resource tax: another issue of cost hike

China announced the resource tax reform on 11 October, 2011. According to the new regulation, the government will introduce a value-base tax on oil and gas (eg, 5-10% of sales) effective from 1 November, 2011. For coal miners, the tax remained to be volume based. The government will levy a tax of RMB8-20/tonne on coking coal and RMB0.3-5/tonne for other coal grades. As a Shanxi based coal producer levying heavily on thermal coal, Yanzhou Coal paid RMB3.2/tonne for thermal coal in Shanxi and RMB3.6/tonne in Shandong and Inner Mongolia, within the range of RMB0.3-5/tonne. We believe the current resource tax reform will have limited impact on the company.

However, Beijing aims to accelerate the resource tax reform for the fossil fuels from the volume based to value based. According to our industry outlook, the reform is likely to be introduced in mid-2014 when the coal market will change to surplus from the current deficit and power pooling is established. Our value based extra resource tax assumption is based on 5% of selling price after deducting the prevailing volume based one.

Also, major coal production provinces, such as Inner Mongolia, Shaanxi, Shanxi, Hunan, Guizhou and Sichuan, have already introduced a coal price adjustment fund (CPAD). For raw coal, the CPAD ranges from RMB8/tonne to RMB40/tonne, while the charge is between RMB25/ton and RMB60/ton for coking (clean) coal.

These CPAD and levies are indeed a form of resources tax pre-collected by local governments and are similar to the potential 5% resources tax rate. Therefore, these CPAD may be eliminated or reduced by NDRC after the official lifting of resources taxes to value-based, which can alleviate part and even all of the impact to Yanzhou.

Key profit divers and sensitivity

After 25.8% y-y increase in FY11F normalised net profit to RMB9,042mn, we expect a 1.6% rise to RMB9,188mn FY12F, with a net profit margin of 19.4% (vs. 27.3% in FY10 and 20.8% in 2011F), due to weak ASP performance, the slowdown of unit cost driven by the mild CPI in 2012F (4.0% vs. 5.6% in 2011F) and the GCL’s dilution. Per our 2012F net profit driver analysis, sales volume growth is likely to be the largest driver for net profit. On a consolidated basis, we expect coal to contribute 6.8% of net profit growth while the other businesses contribute the remaining 0.6% without considering the earnings dilution of GCL. In addition, GCL’s acquisition should dilute 5.8% of the earnings growth.


155

Fig. 186: Net profit divers (2012F)


By comparison with its peers, Yanzhou is most sensitive to coal price changes, given its higher-than-peers’ ASP due to a higher spot sales mix.



Balance sheet and cash flow

After the acquisition of Felix, Yanzhou Coal has remained active in domestic and global M&As. In 2011, Yanzhou acquired Syntech and Premier with a total consideration of AUD499.3mn and Xintai with a consideration of RMB2,801.6mn, which will make its gearing ratio to stand at 61.1% in 2011F (vs. 9.9% of China Coal and net cash of Shenhua). According the management’s guidance in 1H11 results, capex for 2011F will be RMB8,664mn (excluding the M&A), representing a y-y growth of 143%. In order to achieve this goal, we believe Yanzhou should maintain high capex in 2012F. With rich operating cash inflow, ample cash position, strong credit pipelines from banks and bond issuance facilities, we believe Yanzhou Coal will be able to finance its capex needs without additional equity financing. However, in order to meet the regulation requirements, Yancoal Australia is likely to raise AU$624mn and AU$892mn in 2012-13F, respectively.

9.7%

-1.9%-0.5%

6.8%

0.6%

7.4%-5.8%

1.6%0%

2%

4%

6%

8%

10%

12%

Increase in sales

volume

Decrease in ASP

Increase in coal unit

cost

Coal business

Other business

Earning growth before GCL's dilution

GCL's dilution

Group




% chg in net profit on 1% change in unit cost (1.70) (3.50) (1.89)



156

Results recap

1H results recap

Yanzhou Coal's 1H11 profit came in at RMB5,183mn (EPS RMB1.05, + 91% y-y), driven by: 1) 17% y-y sales volume growth, 2) 15% y-y ASP increase and 3) RMB 1,243 FX gain (vs. RMB 1,060 FX loss in 1H10). However, stripping out one-off items (FX gain of RMB 1,243mn, asset disposal loss of RMB 8mn and the tax effect of RMB348mn), recurring earnings rose slower at 27% y-y to RMB4,297mn, mainly due to a lower-than-expected ASP in 2Q and unexpected cost hike. Gearing ratio (net debt-to-equity) was 44.5% (vs. 43.4% in end 2010). No dividend was declared for the interim. Effective tax rate was 28%

Fig. 188: 1H result details


Our take: • Yanzhou Coal's 1H11 profit came in at RMB5,183mn (EPS: RMB1.05, + 91% y-y),

driven by:

– 12% production volume growth to 25.7mnt driven by its Australian operations (+30% y-y to 5.8mnt).

Profit & Loss (CNYmn) 1H 10 1H 11 y-y change

Revenue 15,219 20,224 33%

Gross sales of coal 14,451 19,327 34%Railway transportation 258 243 -6%

Gross sales of Electricity power 86 162 88%Gross sales of Methanol 409 477 17%

Gross sales of heat supply 15 15 1%

Cost of sales (8,249) (11,186) 36%

Gross profit 6,970 9,038 30%

SG&A (3,366) (2,900) -14%Other operating expenses (income) 128 1,510 1083%

Profit from operations 3,732 7,648 105%

Finance costs, net (158) (426) 170%Share of profits of associates & JCE -8 14 -278%

Profit before income tax 3,566 7,236 103%Income tax expense (833) (2,041) 145%

Profit for the year 2,734 5,195 90%-23% -28%

Profit attributable to:

Equity holders of the Company 2,715 5,183 91%Minority interests 18 12 -36%

Basic and diluted EPS (CNY) 0.55 1.05 90%

FX gain (1,060) 1,243Disposale of equity interest (7) (8)

Tax effect of one off 249 (348)Recurring profit 3,533 4,297 22%

EBITDA 4,861 7,535 55%

Key ratios: 1H 10 1H 11 Change in pcts

Gross Profit Margin 46% 45% -1pctsEBITDA Margin 32% 37% 5pcts

Net Profit Margin 18% 26% 8pcts


157

– 17% y-y sales volume growth to 26.7mnt, driven by third-party trade (+52% y-y to 3.2mnt).

– 15% y-y ASP increase to RMB729/t, driven by a larger portion of sales coming from the higher ASP Australian coal (+49% y-y to RMB1,006/t).

– RMB 1.2bn FX gain from its USD3bn debt exposure due to appreciation of AUD/USD (vs. a RMB 1bn FX loss in 1H10).

• Yanzhou recorded revenue of RMB20,224mn in 1H11 (up 33% y-y, 96% from coal business), 47% consensus FY11 forecast, owing to the disappointing ASP in 1H (RMB729/tonne, +15% y-y). This is due to weaker-than-expected ASP performance in China and Australia. The ASP of domestic self-produced coal was RMB652/tonne due to the product mix change and the ASP in Australia was RMB1,006/tonne owing to Austar’s order cancellation from one Korean client.

• Gross margin ratio narrowed by 1pp y-y to 45% in 1H11, 3pp below consensus estimates. The surprising cost hike mainly came from Shanxi Nenghua and Yanzhou Australia. The unit cost of Shanxi Nenghua rose a sharp 45% y-y to RMB313/tonne, and the unit cost of Yanzhou Australia increased 3% y-y to RMB454/tonne due to the production suspension of Ashton.

3Q results recap

Yanzhou Coal announced 9M11 net profit attributed to shareholders of RMB6,130mn and EPS of RMB1.25, -3% y-y under PRC GAAP, mainly due to the higher-than-expected FX loss in the 3Q (9M11 FX loss of RMB249.6mn vs 1H11 FX gain of RMB1,243mn). Stripping out the FX gain/loss and the related tax impact, (FX loss of RMB249.6mn and the tax effect of RMB68.6mn), Yanzhou’s 9M11 recurring profit would have arrived at RMB6,311mn. Gearing ratio (net debt to equity) was 35% (vs. 44.5% by June 2011). No dividend was declared for 3Q11. The effective tax rate was 27.5%.

Fig. 189: 3Q results details


Profit & Loss (CNYmn)

Jan to Sep 10

Jan to Sep 11

y-ychange

July to Sep 11

q-qchange

Revenue 24,951 32,606 31% 11,849 4%

Cost of sales (13,754) (18,692) 36% (7,236) 8%

Gross profit 11,197 13,914 24% 4,613 -2%

SG&A (3,848) (4,676) 22% (1,581) -2%

Other operating expenses (income) (8) 8 -203% 14 -234%

Profit from operations 7,341 9,246 26% 3,046 -1%

Finance costs, net 1,192 (784) -166% (1,610) -390%

Share of profits of associates & JCE 11 31 177% 15 -42%

Profit before income tax 8,544 8,493 -1% 1,450 -60%

Income tax expense (2,224) (2,336) 5% (336) -69%

Profit for the year 6,321 6,157 -3% 1,114 -57%

Profit attributable to:

Equity holders of the Company 6,314 6,130 -3% 1,096 -57%

Minority interests 7 28 318% 18 223%

6,321 6,157 -3% 1,114 -57%

Basic and diluted EPS (CNY) 1.28 1.25 -2% 0.23 -55%

Key ratios:

Jan to Sep 10

Jan to Sep 11

Change in pts (y-y)

July to Sep 11

Change in pts (q-q)

Gross Profit Margin 45% 43% -2.2pcts 39% -2.3pcts

Net Profit Margin 25% 19% -6.4pcts 9% -13pcts


158

Our takes: • Yanzhou Coal recorded 3Q raw coal and commercial coal production volume of

14.4mnt (+8% qoq) and 13.3mnt (+8% q-q), respectively. The 9M11 output reached 40.1mnt and 36.9mnt for raw coal and commercial coal, respectively, implying wash rate stood at 92%. Coal sales volume hit 16.2mnt in 3Q, +11% q-q, mainly contributed by the 35% q-q growth of third-party trade. The 9M11 sales volume reached 42.9mnt.

• Yancoal Australia reported the 3Q operational data with 2.3mnt sales volume (+14% qoq) and 3.1mnt raw coal output (+4.5% qoq), which is in line with management’s guidance at the analysts’ briefing after the 1H11 results announcement. The suspended production at Ashton and order cancellation by a Korean client of Austar caused the weak 2Q performance for the Australian unit. According to management, the 0.46mnt volume, which was cancelled by the Korean client, will be recorded in 2H. Therefore, we witness the 14% q-q sales volume increase in 3Q. As Ashton is expected to resume production in the 4Q, the 4.5% q-q production volume increase will likely be largely within our expectation.

• The ASP at the group level for the first three quarters rose 9% y-y to RMB710/t. The lower-than-expected ASP is mainly driven by the weak ASP in Australia and third-party trade. Unfortunately, the overall ASP has been coming down for two consecutive quarters. Due to the high exposure of spot sales, Yanzhou is likely to be mostly vulnerable to the spot price pull back.

• The unit cost declined 4% q-q to RMB389/t in the 3Q, transferring the 9M11 unit cost to be RMB383/t, mainly driven by the worse-than-expected unit cost in Australia. With the resumption of Ashton in the fourth quarter, the unit cost may come down as the fixed cost will be allocated to the larger quantity of production volume.


159

Appendix A-1

Analyst Certification

I, Ivan Lee, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory DisclosuresMentioned companies Issuer name Ticker Price Price date Stock rating Sector rating Disclosures China Shenhua Energy 1088 HK HKD 34.10 31-Jan-2012 Neutral Not rated 4,8,48,55,58 Yanzhou Coal 1171 HK HKD 18.60 31-Jan-2012 Reduce Not rated 4,58 China Coal Energy 1898 HK HKD 9.74 31-Jan-2012 Buy Not rated 4,58

Disclosures required in the U.S.

48 IB related compensation in the past 12 months Nomura Securities International, Inc and/or its affiliates has received compensation for investment banking services from the company in the past 12 months.

Disclosures required in the European Union

4 Market maker Nomura International plc or an affiliate in the global Nomura group is a market maker or liquidity provider in the securities / related derivatives of the issuer.

8 Investment banking services Nomura International plc or an affiliate in the global Nomura group is party to an agreement with the issuer relating to the provision of investment banking services which has been in effect over the past 12 months or has given rise during the same period to a payment or to the promise of payment.

Disclosures required in Hong Kong

55 Nomura financial interest/business relationships disclosures: Nomura International (Hong Kong) Limited has received compensation or mandate for investment banking services within the preceding 12 months from the issuer.

58 Nomura financial interest/business relationships disclosures: Nomura International (Hong Kong) Limited or an affiliate in the global Nomura group is a market maker or liquidity provider in the securities / related derivatives of the issuer.

Previous Rating Issuer name Previous Rating Date of change China Shenhua Energy Buy 31-Jan-2012 Yanzhou Coal Buy 31-Jan-2012 China Coal Energy Neutral 31-Jan-2012

Rating and target price changes

Ticker Old stock rating New stock rating Old target price New target price

China Shenhua Energy 1088 HK Buy Neutral HKD 44.40 HKD 38.10

Yanzhou Coal 1171 HK Buy Reduce HKD 27.70 HKD 17.10

China Coal Energy 1898 HK Neutral Buy HKD 10.86 HKD 12.25


160

China Coal Energy (1898 HK) HKD 9.74 (31-Jan-2012) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 19-Apr-11 10.86 10.40 18-Jan-11 Neutral 12.40 18-Jan-11 13.90 12.40 14-May-09 Not Rated 8.11

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology Our new target price of HKD12.25 (from HKD10.86) is premised on a DCF valuation assuming WACC of 9.3% and a terminal growth rate of 2.5%. The cashflows are discounted back to FY12F. Risks that may impede the achievement of the target price Upside risks include: 1) Greater-than-expected output growth and 2) a better-than-expected wash rate. Downside risks include: 1) lower-than-expected spot price increase; 2) weaker coal demand due to weaker-than-expected economic growth in China; 3) higher-than-expected cost hike due to resource tax and inflation; and 4) worse-than-expected sales mix.

China Shenhua Energy (1088 HK) HKD 34.10 (31-Jan-2012) Rating and target price chart (three year history)

Neutral (Sector rating: Not rated)

Date Rating Target price Closing price 12-Apr-11 44.40 36.60 18-Jan-11 41.00 33.05 28-May-10 44.60 31.25 27-Nov-09 Buy 36.75 27-Nov-09 47.00 36.75 13-May-09 Not Rated 24.00 10-Feb-09 20.00 18.70


Valuation Methodology Our target price of HKD38.10 is based on DCF valuation, with a WACC of 9.9% and terminal growth rate of 2.0%, implying a FY12F P/E of 11.5x, a 20% premium to the prevailing industry average. Risks that may impede the achievement of the target price Downside risk includes: 1) lower-than-expected spot price increase; 2) weaker coal demand due to weaker-than-expected economic growth in China and 3) higher-than-expected cost hike due to resource tax and inflation. 4)worse than expected sales mix


161

Yanzhou Coal (1171 HK) HKD 18.60 (31-Jan-2012) Rating and target price chart (three year history)

Reduce (Sector rating: Not rated)

Date Rating Target price Closing price 24-Aug-11 27.70 20.35 12-Apr-11 34.40 28.85 18-Jan-11 Buy 24.30 18-Jan-11 30.40 24.30 14-May-09 Not Rated 8.57 10-Feb-09 5.70 5.86


Valuation Methodology Our target price of HKD17.1 is based on DCF valuation, with a WACC of 8.2% and terminal growth rate of 2.5%, discounted back to 2012. Risks that may impede the achievement of the target price Key risks include: 1) lower-than-expected spot price increase, 2) weaker coal demand due to weaker-than-expected China economic growth, and 3) higher-than-expected cost hike due to resources tax, less-than-expected cost cutting at Felix and Zhaolou and inflation risk: and 4) FX risk.


162

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