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Shenhua’s Value Hidden Behind Mounds of Coal

At times like these, being China’s largest coal producer is understandably tough. It is a good thing, then, that China Shenhua has an alter ego that investors are overlooking.

As investors pick through the damage from China’s market crash, Shenhua doesn’t exactly cut a dashing figure. Earnings fell 43% year-over-year in the first half as coal prices tumbled. So unloved is coal, that Shenhua completely missed out on China’s stock market mania this year. Its Hong Kong shares fell 5.4% during Monday’s market plunge.

Coal prices at Qinhuangdao’s port, a benchmark for China’s domestic coal prices, have fallen 23% since the beginning of the year. China’s attempt to clear its skies by steering its power sources toward natural gas and renewables also didn’t help.

The gloomy sentiment clouding the coal sector, however, obscures the benefits of Shenhua’s integrated business model of owning railroads, ports, marine fleets and power plants that keep its production costs down and create a natural demand for its coal.

Coal mining itself is no longer Shenhua’s major profit driver. It accounted for 41% of Ebitda last year. Barclays forecasts that will drop to 18% this year. Its power generation division this year will be the biggest contributor to Ebitda at 49%.

As a power and logistics firm which also mines coal, instead of a coal miner that happens to sell electricity, Shenhua looks a lot more interesting. The company’s enterprise value trades at only five times its expected Ebitda this year versus an average seven times for Hong Kong-listed Chinese power producers. Driven partly by lower coal prices, shares of Hong Kong-listed Chinese power producers have surged 33% since the beginning of last year, while the three major Chinese coal producers fell 38%.

The power business itself isn’t the most promising industry as the Chinese government aims to introduce more competition. But more stable demand and pricing means it commands higher valuations than coal.

And for all the bad news that has beset the coal markets, Shenhua’s coal business is still churning out profit, at least. Two smaller rivals, China Coal Energy and Yanzhou Coal, are expected to report losses this year, according to average analysts’ estimates on FactSet.

Even a modest recovery in China’s industrial production, a key factor for electricity and coal demand, could boost both the coal and power sectors.

In a harsh Chinese market, coal is particularly unloved. But Shenhua’s power plants should bring it more investor affection.

source: http://www.wsj.com