201202291330497685500

Company Research | HK & China Winsway Coking Coal Holdings

For ratings definitions and other important disclosure, refer to the Information Disclosures at the end of this report. 1

February 3, 2012

Winsway Coking Coal Holdings (1733.HK) BUY | Share price: HK$1.93 | Target price: HK$3.51 | Upside: +82%

Jonestown’s accusations are flawed – maintain our Buy rating

Jonestown challenges accuracy of Winsway’s numbers. Jonestown Research

(JR) released two reports on January 19 and 20, 2012, challenging the accuracy of

the value of Winsway‟s coal inventory. Here we summarised the accusations

leveled by JR, and the rebuttal by Winsway, as well as our reading of the numbers.

THE ACCUSATIONS THE REBUTALL

Winsway‟s reported inventory stockpiles are materially misstated.

We believe Jonestown‟s methodology in calculating Winsway‟s inventory is incorrect and it‟s also based on a wrong assumption of the average washout ratio (Exhibit 1). (The washout ratio is the proportion of cleaned coal obtained per unit of raw coal washed).

Official China import data shows volumes are far lower than those that Winsway reported.

The discrepancy in the import numbers is because the 3.6 million tonnes of coal that JR referred to is actually the amount that Winsway purchased rather than „imported‟.

Winsway‟s key transportation provider, Moveday, was actually an undisclosed related party.

Moveday has five Mongolia-incorporated operating subsidiaries. Neither Winsway nor any of its controlling shareholders hold any shares of Moveday.

Margins for coal trading should not be higher than ~RMB100/tonne.

Coal prices in Mongolia are much lower than China given the under-developed market and poor transportation facilities in Mongolia. The huge price gap in fact gives Winsway high profit margins. Besides, based on figures released by similar companies, we think the 10% net profit margin (or HK$120/tonne profit) reported by Winsway in 2010 is in fact quite reasonable.

Maintain “Buy” rating. Winsway denied JR‟s allegations in mid-January. Based on

our research on coal prices and similar companies, we believe Jonestown‟s

calculation approach is erroneous. Winsway‟s acquisition of GCC remains on track

and the counter should continue to recover as market doubts ease. All told, we

maintain a “Buy” rating on Winsway given its unique business model, coal-asset

acquisition and rapid growth in the coming three years.

Profit forecasts

Year to Dec 31 2009A 2010A 2011E 2012E 2013E

Turnover (HK$ mn) 5,283 9,272 14,584 17,712 21,978

Turnover growth (y-o-y, %) 374% 75% 57% 21% 24%

Net profit (HK$ mn) 515 929 1,413 1,638 1,978

Net profit growth (y-o-y, %) 111% 80% 52% 16% 21%

EPS (HK$) 0.25 0.35 0.37 0.43 0.52

Operating cash flow per share (HK$) 0.174 1.174 2.174 3.174 4.174

P/E (x) 10.2 7.3 6.9 5.9 4.9

P/B (x) 5.2 1.5 1.2 1.0 0.9

Dividend per share (HK) 0 0 0 0 0.157

Source: Guosen Securities HK

Analyst

David Lam SFC CE No.: AVL286 +852 28993130 [email protected]

Sales Contact

Dan Weil Global Head of Institutional Sales and Trading Managing Director +852 2248 3588 [email protected]

Chris Berney Managing Director +852 2248 3568 [email protected]

Joe Chan Director +852 2248 3578 [email protected]

Cancy Kong Vice President +852 2248 3538 [email protected]

Jiafeng Li Vice President +852 2899 7281 [email protected]

Chen Long Vice President +852 2248 3548 [email protected]

Shunei Kin Vice President +852 2248 3536 [email protected]

Winsway Coking Coal Holdings (1733.HK) February 3, 2012 | HK & China | Company Research |

Guosen Securities (HK) Brokerage Co., Ltd. 2

Jonestown’s calculation misses the mark

We believe Jonestown‟s methodology to calculate Winsway‟s inventory is flawed as:

It uses the ending value balance of raw coal divided by an average cost of goods sold

over the year when calculating Winsway‟s inventory value as at the beginning of 2007,

whereas it should have used the ending unit cost of inventory.

The average selling cost of RMB284/tonne has included the cost of purchase

depreciation (COGD) of raw coal value and other intermediate costs. There will be a

discrepancy by using COGD to calculate the inventory quantity instead of cost of

purchase.

It uses a 75% washout ratio on average. However, the actual washout ratio varies

from year to year as the variety and grade of coal products vary, and the annual coal

purchases fluctuate. (The washout ratio is the proportion of cleaned coal obtained per

unit of raw coal washed).

Exhibit 1: Illustration of calculation of Winway’s coal inventory vs Jonestown’s

methodology

Illustrative assumption:

As at the beginning

of 2007

Average unit cost of inventory as at the beginning of 2007

RMB/tonne 5

Average cost of goods purchased RMB/tonne 7

Inventory tonnage as at the beginning of 2007 tonne 2

Goods purchased in 2007 tonne 10

Goods sold in 2007 tonne 5

Under FIFO (First in, first out) accounting method

Average sales cost RMB/tonne 6.2

As at the beginning

of 2007 As at the end of

2007

Inventory value RMB 10 49

Inventory tonnage tonne 2 7

Assumption used in Jonestown Research’s calculation approach

A Inventory value as at the year end RMB 49

Average cost of goods sold RMB 6.2

Inventory as at the year-end tonne 7.9

B Changes in inventory value during the year RMB 39

Average cost of goods sold RMB 6.2

Net increase of inventory tonnage in 2007 tonne 6.3

C Inventory tonnage as at the year end tonne 7.9

Net increase of inventory tonnage in 2007 tonne 6.3

Inventory tonnage as at the beginning of the year tonne 1.6

Difference between the actual inventory tonnage and Jonestown’s calculation results

As at the beginning

of 2007 As at the end of

2007

Actual inventory tonnage tonne 2 7

Jonestown‟s estimates tonne 1.6 6.6

Difference

6%




Basis of Winsway’s profit forecast

Coal-price variance in different regions

Winsway purchases, transports, processes and sells coal. Winsway purchases most of

its coals from Mongolia and then sells it in northern and eastern China, with HK$120 net

profit per tonne or a 10% net profit margin.

Winsway‟s core competitiveness lies in its one-stop distribution platform and logistics

facilities. Coal prices are usually much higher in other parts of China than Winsway‟s

purchase price in Mongolia, and the company can thus generate a profit.

Previously, there were only two coal-mining companies, namely, MAK and TT Incorporate

Company, in Southern Mongolia, whose output were limited and mainly used for local

consumption purpose. Local companies, including SouthGobi and MMC, have recently

started to develop local resources and export to China on a large scale. However, the

Mongolian coal market is still under development, and its infrastructure is outdated. As

coal prices in Mongolia remain below those in many other parts of China, the price gap

can greatly benefit cross-border coal traders and logistics services providers.

The following table shows coal prices in different regions:

Exhibit 2: Coking coal prices in different regions

Sino-Mongolian border

Product Origin Sale area Ash content

(%) Volatile

content (%) Sulphur

content (%) CSN

Cementation index (G)

Price (RMB/tonne)

Note Source

Semi-soft coking coal

Ovoot Tolgoi coal mine

Ceke Port 8 30 <1 4-5 - Appro.434 Tax not included SouthGobi

Hard coking coal

Tavan Tolgoi coal mine

Ganqimaodu Port

25 25 <1 >6 - 621 Tax not included MMC

Washed hard coking coal

Tavan Tolgoi coal mine

Ganqimaodu Port

10 26 <1 >6 - 1000 Tax not included MMC

1/3 coking coal - Ejinaqi - - - - - 670 Tax not included Chinese business

agent of MXM, Mongolia

Coking coal - Ganqimaodu

Port - - - - - 684 Tax not included

Chinese business agent of MXM,

Mongolia

Coking coal Tavan Tolgoi

coal mine Ganqimaodu

Port ≤10.5% 25±2 ≤0.6% - 85 501 Tax not included coalcoke.net

Hebei


(%) Volatile

content (%) Sulphur

content (%) CSN


Price (RMB/tonne)

Note Source

Clean coking coal

- Tangshan,

China 1 23- 5 <1 - >80 1600 Ex-mine price sxcoal.com

1/3 clean coking coal

- Tangshan,

China 10 29-32 <1 - 80-90 1500 Ex-mine price sxcoal.com

Qinhuangdao


(%) Volatile

content (%) Sulphur

content (%) CSN


Price (RMB/tonne)

Note Source

Coking coal Australia Qinhuangdao 9 25 <0.6 - 85 1700 Ex-stock price Inner-Mongolia coal

trading center

Tianjin Port

1/3 coking coal Australia Tianjin Port 10 36 0.6 - 85 1330 Ex-stock price Inner-Mongolia coal

trading center

Inner-Mongolia


(%) Volatile

content (%) Sulphur

content (%) CSN


Price (RMB/tonne)

Note Source

1/3 coking coal - Wuhai, China 7 33 0.8 - - 1450 C.F. (cost and

freight) price in Hebei Inner-Mongolia coal

trading center

Rich coal - Wuhai, China <10.5

1.8-2.0 - >90 1380 C.F. (cost and

freight) price in Hebe Inner-Mongolia coal

trading center

Clean coking coal

- Baotou, China

10 24 1 - 85 1270 Ex-mine price coalcoke.net

Port of Shanghai


(%) Volatile

content (%) Sulphur

content (%) CSN


Price (RMB/tonne)

Note Source

1/3 coking coal Russia Port of

Shanghai 9 27-39 0.2 - >70 1180 Ex-dock price

Inner-Mongolia coal trading center

Shanxi clean coking coal

Shanxi, China

Port of Shanghai

<9 28 1 - >85 1750 Ex-dock price coalcoke.net

Source: Company information, Guosen Securities HK



Exhibit 3: Winsway’s coal purchase prices and selling prices to steel plants

Semi-soft coking coal (Ceke border)

Purchasing

cost

Purchasing cost for steel

plants

1. Ceke border: semi-soft coking coal price

273 HK$/tonne

1. Ceke border: semi-soft coking coal price

400 HK$/tonne

1. Ceke border: value-added taxes 46

HK$/tonne 1. Ceke border: value-added taxes

68 HK$/tonne

4. Urad zhongqi coal preparation plant: from Ceke to Urad zhongqi preparation plant

235 HK$/tonne

1. Ceke border: storage and processing expenses

10 HK$/tonne

4. Urad zhongqi coal preparation plant:coal washing cost

23 HK$/tonne

- -

4. Urad zhongqi coal preparation plant: total production cost of clean coal

769 HK$/tonne

1. Ceke border: sub-total of clean coal cost

478 HK$/tonne

Railway freight cost (1,180km)（from coal preparation plant to Hebei）

256 HK$/tonne

Truck freight cost (2,500km) (from the border to Hebei)

971 HK$/tonne

2. Hebei: sub-total 1,025

HK$/tonne - -

Gross profit of the company 300

HK$/tonne - -

Hebei: selling price 1,325

HK$/tonne 2. Hebei: total/local market price

1,449/1,500 HK$/tonne

Hard coking coal（Ganqimaodu border）

Purchasing

cost

Purchasing cost for steel

plants

3. Ganqimaodu border: hard coking coal price

702 HK$/tonne

3. Ganqimaodu border: hard coking coal price (Ganqimaodu border)

1,170 HK$/tonne

3. Ganqimaodu border: value-added tax

119 HK$/tonne

3. Ganqimaodu border: value-added tax

199 HK$/tonne

- - 3. Ganqimaodu border: storage and processing expenses

10 HK$/tonne

Truck freight cost（150km）(from Ganqimaodu border to Urad zhongqi coal preparation plant)

50 HK$/tonne

- -

4. Urad zhongqi coal preparation plant: coal washing cost

23 HK$/tonne

- -

4. Urad zhongqi coal preparation plant: sub-total of clean coal cost

1,192 HK$/tonne

3. Ganqimaodu border: sub-total甘 of clean coal cost

1,379 HK$/tonne

Railway freight cost（1,180km)（from Urad zhongqi to Hebei）

256 HK$/tonne

Truck freight cost (1,330 km) (from border to Hebei)

516 HK$/tonne

2. Hebei: sub-total 1,448

HKD/tonne - -

Gross profit of the company 300

HKD/tonne - -

2. Hebei: selling price 1,748

HKD/tonne 2. Hebei: total/ local market price

1,895/1,900 HKD/tonne

Source: Company information, Guosen Securities HK

Peer comparison

According to the figures released by China Coal Resource, in 2004, most of China‟s

import of metallurgical coal was from Australia, while less than 1.5 million tonnes was

imported from Mongolia. However, this number surged to 3 million tonnes in 2007, and

further jumped to 18 million tonnes in 2011. Winsway has a relatively new business

model and operating market, which can be rarely found in other similar companies.

1. Established in 2000, Inner-Mongolia Qinghua Group operates several businesses,

including coal mining, imports, logistics and coal chemical. Based on relevant

government reports, during January to September 2009, Qinghua Group‟s output

and import of raw coal reached 2.04 million tonnes and 1.1 million tonnes,

respectively, while its sales revenue totaled RMB4.5 billion. According to our

estimates, the group‟s net profit from the coal import business could have reached

RMB0.15 billion, while the corresponding net profit margin stood at 10%, which is

close to the net profit margin of Winsway.



2. Ejina Qi Ruyi Winsway Energy is an indirectly wholly-owned subsidiary of Winsway

that engages in coal processing and trading. Based on relevant government reports,

the company sold 0.7 million tonnes of coal during January to September 2009, with

a corresponding net profit margin of 12%.

3. China Qinfa Group (00866.HK) is a leading non-state-owned coal operator in China

that is principally engaged in the coal processing and sales businesses in relatively

well-rounded markets. China Qinfa‟s 2010 net profit margin reached 6% (Winsway:

10%).

Winsway addressed other allegations

JR claims that Moveday and Sanhe are in fact undisclosed related parties.

As stated in Winsway‟s prospectus, Sanhe was disposed off by the

company to the two named individuals, both of whom are independent third

parties. Neither of these individuals are an employee of Winsway or any of

its subsidiaries or any company controlled by its controlling shareholders.

JR questioned the role of Winsway‟s import agents. Winsway currently

engages two import agents, namely, Shenhua and Minmetals, to enhance

its credit profile. The transaction costs from these two import agents are in

the range of RMB3–RMB5 per tonne.

Investment advice

Having analysed the data on coal prices in different regions, the expenditures incurred in

each business activity and peers‟ profit margins, and after studying the information about

Winsway‟s suppliers and downstream clients, we conclude that the fraud allegations are

unfounded.

Besides, as announced by Marubeni, GCC and Winsway, the acquisition of GCC will not

be affected. The acquisition can improve the variety and quality of Winsway‟s products,

as well as boost its profit growth. Thus, we maintain a “Buy” rating on Winsway because

of its unique business model, coal-asset acquisition and rapid growth in the coming three

years, and we set a 12-month target price of HK$3.51.



Appendix 1: Winsway’s income statement

HK$ mn 2009A 2010A 2011F 2012F 2013F

Turnover 5,283 9,272 14,584 17,712 21,978

Cost of sales (4,322) (7,154) (11,162) (12,793) (15,575)

Gross profit 961 2,118 3,421 4,919 6,403

Other revenue 9 26 44 53 66

Selling expense (269) (471) (1,080) (1,949) (2,705)

Administrative expenses (104) (359) (467) (567) (703)

Other expenses (1) (11) (15) (18) (22)

Profit from operating activities 596 1,302 1,904 2,439 3,039

Finance income 7 66 145 130 130

Finance costs (42) (180) (157) (377) (523)

Net financial costs (35) (114) (12) (247) (393)

Share of losses of jointly controlled entity

0 (8) (8) (8) (8)

Profit before taxation 561 1,180 1,884 2,184 2,638

Income tax (70) (251) (471) (546) (659)

Equity shareholders of the company

515 929 1,413 1,638 1,978

Basic earnings per share 0.25 0.35 0.37 0.43 0.52

Dividend per share 0 0 0 0 0.16


Appendix 2: Balance sheet

HK$ mn 2007A 2008A 2009A 2010A 1H2011

Cash and cash equivalents 38 99 277 2,894 5,763

Trade and other receivables 251 290 1,840 2,451 3,675

Inventories 173 322 1,190 1,973 2,845

Other current assets 37 323 644 344 598

Total current assets 499 1,035 3,951 7,662 12,881

Property, plant and equipment, net

79 289 447 474 646

Intangible assets 2 1 0 0 0

Investment in the jointly-controlled entities

0 0 0 363 363

Deferred tax assets 21 37 34 48 47

Other non-current assets 49 47 67 576 1472

Other non-current assets 151 374 548 1,461 2,528

Total non-current assets 651 1,409 4,499 9,123 15,409

Total Assets 124 599 1,590 1,010 572

Short-term loans 194 264 1,729 1,317 3,533

Trade and other payables 21 9 35 91 130

Income tax payable 0 0 0 0 1

Other short-term liabilities 339 873 3,354 2,418 4,236

Long-term loans 0 0 0 63 3861

Other long-term liabilities 3 2 0 97 111

Total long-term liabilities 3 2 0 160 3972

Total equity attributable to equity shareholders of the company

1 0 1144 6469 7123

Minority interests 308 535 0 76 78

Total liabilities and equity 651 1,409 4,498 9,123 15,409




Stock ratings, sector ratings and related definitions

Stock Ratings:

Buy: A return potential of 10 % or more relative to overall market within 6 – 12 months.

Neutral: A return potential ranging from -10% to 10% relative to overall market within 6 – 12 months.

Sell: A negative return of 10% or more relative to overall market within 6 –12 months.

Sector Ratings:

Buy: The sector will outperform the overall market by 10% or higher within 6 –12 months.

Neutral: The sector performance will range from -10% to 10% relative to overall market within 6 –12 months.

Sell: The sector will underperform the overall market by 10% or lower within 6 – 12 months.

Information Disclosures

Interest disclosure statement

The analyst is licensed by the Hong Kong Securities and Futures Commission. Neither the analyst nor his/her associates serves as an

officer of the listed companies covered in this report and has no financial interests in the companies.

Guosen Securities (HK) Brokerage Co., Ltd. and its associated companies (collectively “Guosen Securities (HK)”) has no disclosable

financial interests (including securities holding) or make a market in the securities in respect of the listed companies. Guosen Securities

(HK) has no investment banking relationship within the past 12 months, to the listed companies. Guosen Securities (HK) has no

individual employed by the listed companies.

Disclaimers

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made as a result of buying and selling securities.

The content of this report does not represent a recommendation of Guosen Securities (HK) and does not constitute any buying/selling or

dealing agreement in relation to the securities mentioned. Guosen Securities (HK) may be seeking or will seek investment banking or

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This report is based on information available to the public that we consider reliable, however, the authenticity, accuracy or completeness

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objectives, financial situation or needs of individual clients and does not constitute a personal investment recommendation to anyone.

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