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AsiaChinaResourcesMetals&Mining8December2009ChinaCoalSectorCoalinamulti-yearupcycle:bullishonChinacoalsectorFredLam,CFAResearchAnalyst(+852)22036164fred.lam@db.comBullishonChinacoalsectorinamulti-yearcoalcommodityupcycleWereinstateratingsfortheChinacoalsectorwithBuysonShenhuaandChinaCoal.OurprincipaltoppickisShenhua,asweregarditasthebestcoalcompanyinthecoalupcycleinChina.Wearebullishonthecoalcommoditymarketasweseeamulti-yearupcycleduetotightsupply-demand,anupwardshiftintheindustrycostcurveandthethreatfromtherailbottleneck.DeutscheBankAG/HongKongAllpricesarethosecurrentattheendoftheprevioustradingsessionunlessotherwiseindicated.PricesaresourcedfromlocalexchangesviaReuters,Bloombergandothervendors.DataissourcedfromDeutscheBankandsubjectcompanies.DeutscheBankdoesandseekstodobusinesswithcompaniescoveredinitsresearchreports.Thus,investorsshouldbeawarethatthefirmmayhaveaconflictofinterestthatcouldaffecttheobjectivityofthisreport.Investorsshouldconsiderthisreportasonlyasinglefactorinmakingtheirinvestmentdecision.Independent,third-partyresearch(IR)oncertaincompaniescoveredbyDBSI'sresearchisavailabletocustomersofDBSIintheUnitedStatesatnocost.CustomerscanaccessIRat(P)106/05/2009ForecastChangeToppicksChinaShenhuaEnergy(1088.HK),HKD38.55BuyCompaniesfeaturedChinaShenhuaEnergy(1088.HK),HKD38.55Buy2008A2009E2010EP/E(x)19.020.416.5EV/EBITDA(x)11.012.09.7Price/book(x)2.03.93.4ChinaCoalEnergy(1898.HK),HKD13.92Buy2008A2009E2010EP/E(x)17.619.014.7EV/EBITDA(x)10.411.28.4Price/book(x)1.22.52.2Chinacoalprice4505506507508509501,050Jan-08Mar-08May-08Jul-08Sep-08Nov-08Jan-09Mar-09May-09Jul-09Sep-09Nov-09Rmb/tShanxi(5500K)Source:WindChinaseabornecoalmarketYunnanGansuGuangdongJiangsuZhejiangInnerMongoliaShanxiHebeiShaanxiHenanShandongAnhuiHubeiHunanJiangxiFujianGuangxiHainanTaiwanGuizhouTibetQinghaiLiaoningJilinHeilongjiangBeijingNingxiaXinjiangSichuan-392mt-203mtQinhuangdao-139mt+113mt+138mt+106mt+29mt+103mtSource:DeutscheBank,CEICProducersToConsumersPricetarget(HKD)NamePTPriceUpsideShenhua$45.0$38.916%ChinaCoal$15.6$14.011%CompanyGlobalMarketsResearchTightsupply-demandtocontinueinto2013attheearliestInourview,coalwillremainthemainenergysourceinChina.WhiledemandissettogrowataslowerpacethanGDPduetoincreasingenergyefficiency,supplygrowthwilllagasitissuppressedbythegovernment’ssmallminespolicy,whichwebelievewillactasadragonsupplygrowthforyears.Webelieveminingaccidentswillpersistandkeeppressureonthegovernmenttomaintainthesmallminepolicy.Theseabornemarketisparticularlytightbecauseofthethreatfromtherailbottleneck.Therealsolutiontotherailbottleneckisathirdeast-to-westtrunkline,andtheearliestwecanseesuchadevelopmentis2013.Upwardshiftincostcurve:lowersmallminesproductionWebelieveastructuralshiftinthecostcurvefromlowerproductionbysmallminesandhighertaxationwillcontinuetoputupwardpressureonprices.Tightsupply-demandmeanscostsarebeingpassedthroughtocustomers.Smallminesarelow-costproducers.Shuttingsmallminesdownorlargerminers(highercost)takingoversmallminesshiftsaportionofthecostcurvehigher.Thisshiftbenefitslow-costproducers,i.e.ChinaShenhuaEnergy(Shenhua)andChinaCoalEnergy.Theroadmapforcoalin2010andbeyondWeexpect2010contractpricestoriseRmb60/t(11%yoy).Forthespotmarketin2010,wearemostpositivein1Q10(continuationofcurrenttightmarket)and4Q10(winterre-stocking),butseeasoftpatchinmid-2010givenapick-upinShanxisupplyandoureconomist’scallforamid-yearslowdown.Longerterm,weseehighcoalpricespersistinguntil2013.Coalupcycle:BuyShenhua(thebest)andChinaCoal(thegrowthlaggard)WerecommendinvestorsfollowourbullishcoalcommodityviewbybuyingwhatweregardasthebestcoalcompanyinChina:Shenhua.Itisaddingproductionwithtwosignificantdomesticminedevelopmentsandislookingatoverseasassetsthatcouldprovideadditionalproductionupside.WealsolikeChinaCoalEnergy,whichhasdisappointedongrowthsinceitsIPO,butweareoptimisticonprospectiveacquisitionsfromShanxismallminesandChinaCoalGroupin2010.ValuationonSOTP:life-of-mineDCFforcoalWevaluebothcompaniesontheDCFoftheirindividualsegments.Weuselife-of-mineDCFforcoalminingwitha25%premiumforacquisitionsorminesdevelopmentanduseDCFwith2.5%terminalgrowthforotherdivisions.Keyrisksforthecoalcommodityandequitiesareworse-than-expectedeconomicanddemandgrowth.WebaseourcoalforecastonGDPgrowthforecastsfromoureconomistandproductiongrowthforecastsfromourIPP,steelandcementteams.Ifgrowthismuchlowerthanourexpectation,thenourhighercoalpriceforecastwouldnotmaterialize.8December2009Metals&MiningChinaCoalSectorDeutscheBankAG/HongKongPage3TableofContentsExecutivesummary...........................................................................4Outlook.....................................................................................................................................4Valuation...................................................................................................................................4Risks...........................