Publish date:

Two Undervalued China Coal Stocks

SinoCoking Coal and Yanzhou Coal are value picks that will benefit from growth in China.

NEW YORK (TheStreet) -- Coal remains a key energy source contributing about 30% toward world electricity generation. It is the most abundant and widely distributed fossil fuel and it's an affordable energy source. China is the world's largest producer and consumer of coal and will continue to remain one with the kind of growth forecasted for the power and steel industry.

We have identified two stocks which we believe are value picks, will benefit from the growing China story and should carry weight in a portfolio. The stocks are

SinoCoking Coal and Coke Chemical Industries


, and

Yanzhou Coal Mining


. Both the stocks have corrected between 15% to 35% during the past month and present an attractive buying opportunity.

According to the International Energy Agency, electricity production in China is expected to more than double to about 5,000 terawatts-hours by 2015 from 2,300 TWh in 2004, thereby indicating a huge demand for coal. According to data released by the China National Bureau of Statistics, the country's coal production grew 28% year over year to 751 million tonnes during the first quarter ended in March.

Strong domestic demand and the supply-demand mismatch have rocketed coal prices in China to stratospheric levels during the past few years. Average prices of coal at Qinhuangdao port, the benchmark price in China, have gone up by 38% to $117.27 per metric ton in May from $84.90 per metric ton in July 2009.

Moreover, on the steel front, crude steel demand is expected to grow 8% to 10% during 2010 to 610-620 million tons, driven by the stimulus packages, increasing fixed-asset investment, strong retail sales, and higher exports, according to the China Iron and Steel Association. This will have a positive impact on demand for coke and coking coal, the primary ingredient used in steel production.

Furthermore, the severe demand-supply mismatch in coking coal and China's emergence as a major importer of coking coal are likely to be the key drivers of coke prices in the future. According to Business


TheStreet Recommends

, the demand for coking coal in China is expected to grow at about 8% annually vis a vis domestic coking coal production growth of 4%.

SinoCoking, based in China, produces two types of coke, metallurgical coke used in steel manufacturing, and chemical coke used for synthesis gas production.

For the third quarter, the company said third-quarter revenue declined 2% to $15.2 million from $15.6 million during the same quarter a year ago, mainly as coal product revenue declined. To leverage on the high margins of coke products, the company contracted its coal volumes and increased coke volumes in which prices moderated in early 2010.

Adjusted net income, excluding one-time charges, fell 32% to 19 cents a share from 28 cents a share, primarily due to a one-time acquisition-related expense of $1.2 million.

In March, the company completed its private placement equity financing and raised a total of $44.1 million to finance the construction of a new coke manufacturing facility and associated working capital needs. Looking ahead, the company is seeking to benefit from the government's policy to restructure and consolidate the industry on concerns such as safety and productivity.

SinoCoking has identified 10 mine-owning companies for acquiring a majority stake by the end of 2010. These companies have an aggregate licensed production capacity of 1.5 million tonnes per year, and aggregate coal reserves of 25 million tones, as per China's geological standards. If the acquisition is complete, SinoCoking's production capacity will increase six-fold from the current 300,000 million tonnes per year.

Yanzhou Coal is principally engaged in underground coal mining, preparation and processing, sales, and railway transportation of coal. The company posted a net profit of approximately $300 million during the first quarter of 2010 compared to about $103 million a year ago. This increase is attributed to higher average selling price and the Felix acquisition.

During 2010, Yanzhou Coal expects to increase its coal output by 50% to 60 million tonnes and to double its capital expenditure to $560 million from $290 million in 2009.

Earlier this year, the company released a strong production outlook for the year owing to its Felix acquisition in 2009. Felix, based in Australia, expects production to exceed 20 million tons when it reaches full capacity during the upcoming three years, and generate an annual net profit of $560 million.

The acquisition has also helped the company gain access to more than 1.5 billion tonnes of approved coal reserves in Australia, with its domestic mines already holding 1.8 billion tons.

Earlier this week,

JPMorgan Chase

(JPM) - Get Report

acquired 3.4 million shares of the company for HK$57.94 million taking its total stake to 11.13%.