China Coal Stocks to Play: SinoCoking, Yanzhou

NEW YORK (TheStreet) --SinoCoking Coal and Coke Chemical Industries (SCOK) and Yanzhou Coal Mining (YZC) are expecting a near-term boost in performance. The pop should come from positive growth prospects, acquisitions and strong earnings outlooks of the companies; rising coal prices on increasing demand from emerging markets; and supply constraints.

However, the onslaught of government measures to ban operations at smaller mines and the directive to keep prices stable in annual supply contracts could cap the rally. China is seeking to consolidate smaller coal mines into 13 large-scale bases nationwide by 2015, and the ban is unlikely to be lifted until the next two to three quarters. The government issued pricing policies and has ordered companies to maintain stable prices and follow the agreed upon prices in annual supply contracts.

In its preliminary results for the fourth quarter and year-ended June 30, SinoCoking said that its new coking facility is on track for completion by first-quarter 2011. Operations at the unit will begin during second-quarter 2011, expanding the capacity to 1.1 million metric tonnes from the current 250,000 metric tonnes.

In order to rein in the effect of the ban on smaller coal mines, SinoCoking is entering a supply agreement with a large coal producer to meet customer needs until the government lifts the ban on operations of smaller mines.

Based on full production, this new coking facility will generate approximate revenue of $100 million-$110 million and $20 million-$25 million of net income at the current market pricing. After spending $10 million on the construction of the new coking facility, the company expects to spend an additional $70 million in capital expenditure.

For the quarter ended June 30, SinoCoking posted a preliminary net income of $2 million as compared to $6.3 million in the same quarter a year ago, while net revenues stood at $10 million as against $15.52 million in the same quarter a year ago. The performance was affected by lower market demand for both washed coal and coking products coupled with lower coking byproducts volume. In addition, the government's ban on the operation of small mines affected the company performance in the recent quarter. However, the company's efforts to find alternatives in case of a ban, strong coal demand in the second half of 2010 and various acquisitions are positives that support its performance in the upcoming quarters.

Out of the ten acquisitions planned, SinoCoking recently initiated two deals to acquire majority interest in two mines based in Henan. Through its wholly controlled affiliate Pingdingshan Hongli Coal & Coke (Hongli), SinoCoking acquired a 60% equity interest in Baofeng Shuangrui Coal and a 60% equity stake in Baofeng Xingsheng Coal, which operates Xingsheng Coal Mine, for approximately $12.4 million in total.

These two mines have 2 million metric tonnes of estimated coal reserves each and annual production capacity of 150,000 metric tonnes each. With no further planned capital expenditure on the mines, the company plans to evaluate the remaining 40% interest, in the future.

Yanzhou Coal Mining, engaged in the mining, preparation and sale of coal, reported a 34% increase in first-half net profit to 2.72 billion yuan ($397.5 million), compared to 2.03 billion yuan in the same period a year ago, as coal output increased due to the acquisition of an Australian mining company. Revenue during the first half rose 65% year-over-year to 15.22 billion yuan from 9.25 billion yuan a year earlier.

Vice Chairman Li Weimin said the company targets to increase its coal output in the next five years. Yanzhou is exploring acquisition opportunities in both domestic and overseas markets and is in talks with Japan-based trading firm Sojitz on a possible stake sale in the Minerva coal mine in Australia.

For second-half 2010, the company remains positive, based on estimated stronger sales volumes due to increasing production at its new mines in Australia and China, continued cost controls, robust selling prices and the absence of foreign-exchange concerns. (During the first half of 2010, the company acquired an Australian company, and therefore had to bear the foreign exchange loss as the Australian dollar declined sharply against the U.S. dollar. For the second half of the year, the company remains bearish toward the U.S. dollar.)

Yanzhou is currently trading at an attractive P/E of 14.35 as compared to 20.99 for Peabody Energy ( BTU), 15.64 for Consol Energy ( CNX) and 39.23 for Arch Coal ( ACI).

Karvy Global Services (www.karvyglobal.com), a subsidiary of the Karvy group (www.karvy.com), provides specialized research in asset classes including stocks, mutual funds and insurance to leading Wall Street firms.

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