CHINA POWER AND COAL ： More coal price cuts, no contract conclusion

PREPARED BY NON-US BROKER-DEALER(S): BNP PARIBAS EQUITIES (ASIA) LTD, BNP PARIBAS SECURITIES (ASIA) LTD THIS MATERIAL HAS BEEN APPROVED FOR U.S DISTRIBUTION. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES CAN BE FOUND AT APPENDIX ON PAGE 19 More coal price cuts, no contract conclusion n We expect more coal price cuts given high coal inventory and weakening demand The spot 5,500kcal coal price plunged RMB40/tonne this week, and China Shenhua’s weekly offering price of RMB614/tonne on 1 January was 2.6% lower than the previous price. However, we see more downside potential in spot coal prices near term, given stable coal inventory at QHD Port (4.8m tonnes), sufficient inventory at IPPs (15-23 days), increasing coal production in Shanxi Province and shrinking power demand around CNY. We believe the 2013 year-end spot coal price rally stemmed from coal suppliers continuously lifting their offer prices, rather than strong coal demand. n 2014 contract coal negotiations: no conclusion yet Our channel checks suggest that few IPPs have finalised 2014 contract coal negotiations. In 2013, most IPPs had signed 70-80% of contracts at the beginning of the year, with the price based on a RMB10/tonne discount to the Bohai-bay index price for 2013 contract coal. This year, most IPPs have confirmed they are not in any rush to conclude contract negations, given weakening power demand and sufficient inventory. According to Sxcoal, China Shenhua offered two kinds of contract coal price; one based on the monthly Bohai-bay price and the other based on the quarterly Bohai-bay price. Although China Shenhua’s first contract coal offering price of RMB590 was 4%/10% below the current spot coal price/spot coal price of end-2013, IPPs still believe this is too high to accept. n Positive on power, negative on coal; Huaneng and Huadian our top picks; Yanzhou key avoid We remain positive on the China power sector and expect a return to earnings growth in 1Q14 on the back of low fuel costs and a stable tariff. Meanwhile, we believe valuations in the coal sector are too stretched and do not reflect the potential downside in the coal price. Thus, we suggest investors switch out of Yanzhou Coal Mining and into Huaneng Power/Huadian Power. BNPP recommendations Company BBG code Rating Share price Target price Upside/downside Huaneng Power 902 HK BUY 7.07 10.35 +46.4% Huadian Power 1071 HK BUY 3.09 4.09 +32.4% CR Power 836 HK BUY 17.66 21.33 +20.8% Datang Int'l Power 991 HK BUY 3.52 4.00 +13.6% Shenhua 1088 HK HOLD 22.85 25.10 +9.9% Yanzhou Coal 1171 HK REDUCE 6.36 5.06 -20.5% Source: BNP Paribas 3 JANUARY 2014 SECTOR REPORT CHINA POWER AND COAL Daisy Zhang, CFA daisy.zhang@asia.bnpparibas.com +8621 6096 9025 Yong Liang Por yongliang.por@asia.bnpparibas.com +852 28251877 Our research is available on Thomson One, Bloomberg, TheMarkets.com, Factset and on http://eqresearch.bnpparibas.com/index. Please contact your salesperson for authorisation. Please see the important notice on the back page. China Power and Coal Daisy Zhang, CFA 2 BNP PARIBAS 3 JANUARY 2014 Investment thesis We maintain our IMPROVING outlook for China IPPs. We do not expect the proposed fuel cost pass-through mechanism to be in place any time soon, given the increasing fuel cost in 4Q13. We expect a return to earnings growth in 1Q14 on a stable tariff and low fuel cost. We believe China IPP valuations are inexpensive, given their higher ROE and dividend yield potential versus both domestic peers and HK utilities. We maintain our DETERIORATING outlook for China’s coal sector in 2014, due to production oversupply, mild demand and easing transportation bottlenecks on rail and at ports. We expect more coal price cuts in the near term, on the back of stable coal inventory at QHD Port, sufficient coal inventory at IPPs, weakening power demand around CNY and increasing coal production from Shanxi Province. Coal sector de-rating has just begun Most coal stocks are trading in trough historical P/E or P/B ranges; nonetheless, we believe the de-rating of coal sector has only just begun. Coal stocks have historically enjoyed high valuations on consistently high coal prices, but as we see a structural decline in prices, so we believe historical valuation comparisons are now inappropriate. We suggest investors switch out of coal and into IPPs As we expect more coal price cuts in the near term, we suggest investors switch out of Yanzhou Coal Mining and into Huaneng Power/Huadian Power. Coal inventory at coastal IPPs Source: Sxcoal Domestic spot coal price at QHD Port Source: Sxcoal 0.000.100.200.300.400.500.600.700.800.9001020304050Oct-09Oct-10Oct-11Oct-12Oct-13(m tonnes)(days)Inventory days (LHS)Daily consumption (RHS)02004006008001,0001,200Jan-05Jan-07Jan-09Jan-11Jan-13(RMB/tonne)Qinhuangdao FOB (>5,800 kcal)Qinhuangdao FOB (>5,500 kc