Macquarie Regional coal

Picking the gems out of the ash

Prefer coking coal, Shenhua, Banpu, SAR/SRL
On our recently revised commodity price changes and performance of the coal sector, we made the following changes in recommendations and price targets:

Upgrading Shenhua, BHP and Xstrata from Neutral to Outperform; reinitiating on SAR with an Outperform, and large price target upgrades for Banpu, Fushan and Hidili and Gujarat, where we reiterate Outperforms.

Downgrading Yanzhou, PTBA, Adaro and Bayan from Neutral to Underperform and China Coal from Outperform to Neutral.

Reiterating Underperform on Indika, Bumi, Centennial and Macarthur Coal.

Preference for coking coal over thermal coal
We prefer coking coal to thermal coal, due to the former’s greater supplier discipline, product scarcity and China's larger presence in coking coal markets. We raise our coking coal forecasts by 27% from US$110/t to US$140/t in 2010. Our changes to thermal forecasts are more subdued, increasing from US$65/t to US$70/t in 2010. While we see increasing industrial production being useful for thermal demand, the Chinese import arbitrage does not work at current prices.

China – upgrade Shenhua; downgrade Yanzhou, China Coal
We upgrade Shenhua from Neutral to Outperform and raise our price target from HK$18.5 to HK$32.5, as we have increasing confidence that this company has a distinct competitive advantage leading it to double production to 400mt longer term with a highly efficient cost base and integrated supply chain. We downgrade China Coal and Yanzhou predominantly due to their valuations trading at 16x and 12x PER, respectively, and our view that the Chinese thermal market will stay roughly balanced and not as tight as the coking coal market. We reiterate our Outperform recommendations on Fushan and Hidili but raise our price target by 70%.

Asean and India – only SAR, Gujarat and Banpu stand out In general, the Asean coal sector appears stretched on valuation trading on 20x, hence our downgrades noted above. However, three stocks stand out to us:
SAR: The risk/reward of the boundary approval appears very favourable.
Banpu: We raise our price target 42% on revised views of China coal assets.
Gujarat: Great coking coal asset on its way to be a leading global exporter.

BHP and Xstrata upgrade; SRL and Felix still Outperforms
We upgraded BHP and Xstrata based on our more positive outlook on coking coal, zinc and copper. Out of the Australian predominant coal plays, we prefer SRL and Felix Resources, as we believe Gloucester and Macarthur Coal are overvalued.