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China Shenhua Energy: Undervalued Cash Cow -- Barron's Blog

24 May 2017 4:15 am

By Isabella Zhong

China Shenhua Energy ( 1088.HK) grabbed headlines earlier this year when the coal miner announced a generous special dividend that sent its shares skyrocketing.

China Shenhua Energy shares have gained 64% over the past year, but Nomura analyst Patrick Xu sees more good things to come from the company. Xu initiated coverage of Shenhua today with a buy rating on the miner's Hong Kong-listed shares and a target price of HKD21.94 a share, which implies 13% upside.

We initiate coverage of the stock with a Buy rating. The company is the largest coal miner (60% of FY17F revenue) and one of the largest coal-fired power generation (34% of FY17F revenue) companies in China. We expect EPS to be +28%/-4% y-y in FY17F/18F mainly driven by coal revenue and +5% y-y in FY19F driven by power generation capacity. We find the valuation attractive at 13% average FCFE yield for FY17-19F, substantially higher than the stock's cost of equity of 11%, on our estimate. Our TP is derived from sum-of-parts DCF model.

Xu says the next major catalyst for Shenhua's share price could be tweaks to the miner's mix of debt and equity financing through higher dividends to optimize its capital structure.

We expect the company to generate 12% average ROA in FY17-19F, higher than the cost of debt of <6%. With such a substantial spread and strong free cash flows, we think management can significantly raise the equity valuation by moderately lifting the financial leverage through sustained high dividend payout. For now, we assume a flat 37% payout in FY17-19F.

While coal prices have been ravaged by an ugly rout in recent months, Xu expects the commodity to stabilize following intervention by Chinese authorities.

We expect a CNY570-580/t coal price in FY17-19F, assuming the downward pressure on coal price due to overcapacity will be offset by the NDRC's intervention on production days of inefficient coal mines. We think this is a range comfortable for both coal miners and power generation companies.

Xu also forecasts low capex for Shenhua for the next three years, which should support a high free cash flow yield.

We expect the company's capex to remain at CNY27-28bn pa in FY17-19F, with 65% of it spent on expanding power generation capacity. That should leave CNY34-38bn FCFE pa (CNY1.72-1.89 per share) in FY17-19F, implying an average 13% FCFE yield based on the current share price net of the implicit CNY2.97 dividends to be paid out.

Shenhua shares trade at 11 times forward earnings and one times book value, which is slightly below its five year average of 1.2 times. The stock pays a 1.2% dividend yield.
 More at Barron's Asia Stocks to Watch blog, http://www.barrons.com/asia-stocks-to-watch 

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May 24, 2017 00:15 ET (04:15 GMT)

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