Yanzhou leads China’s coal miners

While most of this year’s top-performing miners on the New York Stock Exchange are familiar names to North Americans, there is one less well-known company that keeps popping up on the winners’ list: China’s Yanzhou Coal Mining (YZC-N).

Yanzhou’s American depositary receipts hit an all-time high of US$27.75 in mid-July, representing a 35% increase since the start of the year and a 76% rise since December 2001.

At presstime, the ADRs were trading at US$25.30, generating a price-to-earnings ratio of 11.8, a 2% yield, and a market cap of US$516 million. The average weekly trading volume of the ADRs on the Big Board is 20,000.

Yanzhou Coal Mining is based in the city of Zoucheng in the coastal province of Shandong, roughly halfway between Beijing and Shanghai. The company owns and operates six underground coal mines in southwestern Shandong, and is involved in the treatment, sale and rail transport of its coal output.

Now headed by two Chinese mining engineers, Mo Liqi, chairman, and Yang Deyu, vice-chairman and general manager, Yanzhou was established in September 1997 by its state-owned parent company, the Yankuang Group Corp.

Under the terms of its formation, Yanzhou must pay Yankuang an annual fee of 12.98 million renminbi (US$1.57 million) in return for more than half a century of mining rights at the mines. The fee is fixed for the first 10 years, after which time it may be renegotiated.

In April 1998, Yanzhou’s A shares began trading on the Shanghai Securities Exchange, the equivalent H shares began trading in Hong Kong, and the ADRs began trading on the NYSE, with one ADR equal to 50 H shares.

At the end of 2002, 1.67 billion Yanzhou shares were held by the Yankuang Group (for a 58% stake), and a further 180 million publicly tradable A shares and 1.02 billion H shares were outstanding.

With a 35.4% interest, the second-largest Yanzhou shareholder is nominee and trustee HKSCC Nominees, with 1.02 billion H shares.

The company ended 2002 with 68,027 shareholders, of which 67,874 were A shareholders and 152 were H shareholders. Directors and management only held 71,000 shares of the company at the end of 2002, unchanged from a year earlier.

According to the company’s financial statements for 2002, which were audited by Deloitte & Touche’s subsidiaries in Hong Kong and mainland China, Yanzhou booked total assets of RMB12.9 billion (US$1.56 billion) and total bank borrowings of RMB1.2 billion (US$145 million). (These filings also show that the total of all the fees, salaries and benefits paid out to Yanzhou’s directors and supervisors, including the five highest-paid individuals, amounted to only RMB2 million, or US$243,000, in 2002.)

Yanzhou mostly produces high-quality, low-sulphur coal with ash contents as low as 6% and sells thermal coal suitable for large-scale electric generation, as well as coking coal for metallurgical production.

At the end of 2002, the six mines — Nantun, Xinglongzhuang, Baodian, Dongtan, Jining II and Jining III — hosted total reserves of 1,997 million tonnes of coal in seams that have an average thickness of about 9 metres.

Yanzhou added the Jining III coal mine to its portfolio early 2001 in a RMB2.45-billion (US$296-million) deal with its parent company. The acquisition was financed with cash on hand and net proceeds from the issuance of 100 million new A shares and 170 million new H shares.

In 2002, Yanzhou produced 38.4 million tonnes of raw coal, or 13% more than in 2001, making it the largest coal producer in eastern China. Of this amount, 35 million tonnes were sold, including an export volume of 14.5 million tonnes, or about 16% of China’s total coal exports. Still, Yanzhou’s 2002 production amounted to only 2.7% of China’s total coal output of 1.39 billion tonnes, which in turn represented 29% of the world’s coal production.

At the beginning of 2002, Yanzhou acquired railway assets from its parent company, a move that reduced fee payments and resulted in a net-profit contribution of RMB132 million (US$16 million) to Yanzhou’s account. These rail assets transported 27 million tonnes of coal in 2002, or 70% of Yanzhou’s total coal production. Yanzhou’s export-coal seaport facility is in the city of Rizhao in Shandong province, only 316 km to the east, and the rail system allows the company to take full advantage of its favourable location (rival coal producers are situated farther inland).

After eliminating the effects of the rail purchase, Yanzhou’s average coal price for 2002 was RMB170.23 (US$20.57) per tonne, up RMB13.12, or 8.4%, from 2001. This takes into account domestic and export coal prices of RMB163.04 (US$19.70) and RMB180.46 (US$21.80), respectively, with the realized domestic price representing a 15% increase from 2001 and the export price remaining unchanged.

Yanzhou’s domestic customers include Shanghai Baoshan Iron & Steel Co., Shanghai Power, and Zouxian Electric Power, as well as other power plants, fuel companies, metallurgical producers and chemical companies. Customers in Shandong province account for 28% of domestic sales.

Yanzhou’s major export customers are in Japan, South Korea and Taiwan, and include Tokyo Electric Power Co. and Nippon Steel.

Yanzhou was China’s most profitable coal producer last year, generating a net profit of RMB1.22 billion (US$148 million), or RMB43 (US5) per A or H share, on coal sales of RMB6.2 billion (US$751 million). A dividend for 2002 of RMB0.104 (US1.2) per A or H share was paid out in July.

The above figures for 2002 represent rises of 26% in profits and 27% in sales, compared with 2001, and increases of 50% and 68%, respectively, compared with the company’s first full year of operations, 1998. Indeed, Yanzhou has managed to maintain a profit margin of about 20% throughout its rapid growth period from 1998 to 2002.

Yanzhou Chairman Mo attributes 2002’s rise in profits to three factors: an increasing emphasis on clean-coal products; an optimization of the variety of coal products produced; and further elevation of quality standards in its coal production, preparation and transportation activities (all the mines have at least an ISO9000 quality certification).

The company also improved its patented long-wall, top-coal caving mining techniques for medium and thick coal seams, which can be up to 12 metres thick, and renewed its research and development efforts in this area.

For 2003, Yanzhou has lined up sales of 39.3 million tonnes of coal, up 4.2 million, or 12%, from 2002, and export volumes are expected to hold steady at 14.5 million tonnes.

The company predicts that coal demand in both domestic and overseas markets will be stable throughout 2003 and that domestic coal prices will be similar to last year’s, though export prices could weaken slightly.

Yanzhou notes that the Chinese government will likely continue its policy of the past few years of closing down the country’s smaller coal mines for safety reasons — a move that should ensure that any added production from Chinese majors such as Yanzhou will not oversupply the market.

The company says it will continue to use more powerful coal-washing techniques to improve product quality, and increase the ratio of coal products from its higher-end product line, such as clean coal.

Within a couple of years, Yanzhou wants to be producing coal at the annual rate of 40 million tonnes. It intends to achieve its goal by improving the equipment it uses in long-wall top-caving so that annual production from a single working panel is boosted to 4-7 million tonnes from 3.5 million tonnes.

With about 44% of the world’s electricity being derived from coal, and Asian power demands growing steadily, Yanzhou sees a strong future for thermal coal demand in the region.

According to the BP Statistical Review of World Energy (available free at the web site www.bp.com), total coal consumption in the Asia Pacific region in 2002 shot up 16%, year over year, to 1.18 billion tonnes, and accounted for virtually half the world’s total coal demand.

On its own, China consumed 663 million tonnes of coal in 2002, or 28% of the world total — up an astounding 28% from 2001.