Coal Price Could Fall Further;Sell China Coal and Shenhua

花旗环球金融Claire Jie Yuan,Sandy Niu

　　Market looks optimistic on coal price: While slowing demand and oversupply in China’s coal industry are well understood by the market, a recent spike in coalshare prices suggests investors are expecting a near-term rebound in the coal price. Excess inventory levels mean a price recovery is unlikely to be imminent, in our view, while a flat cost curve offers little support to pricing in the medium term. We initiate with Sells on China Coal and Shenhua, with respective 2014E EPS that are 23% and 11% below consensus, which appears to be baking in a coal price recovery. By contrast, we forecast QHD benchmark price to fall below Rmb500/ton. 　　High inventories to cap near-term price upside: We estimate inventories at Chinese coal producers have risen by >20% since YE2012. Based on normal inventory of ~15 days, excess inventories could supply IPPs for another ~6 days, raising IPP inventory level from 19 days to 25 days. Thus, even with such positive factors as a production slowdown, DQR maintenance and seasonally strong winter demand, we expect excess inventory to cap upside for the coal price. 　　Demand growth to slow to 4% p.a.: We forecast demand growth for Chinese coal to slow to ~4% p.a. for 2013-15E, from ~10% in 2002-11 – the result of a domestic economic slowdown that has lowered energy intensity, the diversifying of energy sources and enhanced coal use efficiency. Incremental demand is forecast to drop to ~150mn tons p.a. from previous ~270mn tons. However, coal-to-gas projects could become a new growth driver (if no delays) from 2017, upping growth to ~5%. 　　Flat cost curve + still-good profit margin = scope for further price cuts: Railway capacity expansion and a surge in imported seaborne coal have largelypushed out expensive tonnages that were transported by road. Total cost of movingone ton of coal to Guangzhou from Inner Mongolia, Shanxi or Indonesia is very similar at US$61.6, US$64.6, and US$64.9; at current prices, producers can still make a profit of ~US$15/ton. As such, competition will likely continue between Three West coal and seaborne coal, further lowering the price. We do not expect sharp declines in imports, as seaborne coal is not necessarily uncompetitive. 　　Upside risks: Our negative view on the Chinese coal stocks is based on structural, rather than cyclical, changes in the industry. We could turn more constructive if:China’s economic growth re-accelerated, driven by an upsurge in industrial activity;the need for cheap energy (coal) outweighed concerns about air pollution and quality-of-life issues; and/or China banned imported coal.