China, Commodities

7/28/2019 China, Commodities

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See the last page of this report for important disclosures

Chinas commodities in a soft-landing scenario

Henry Liu

Regional Head of Commodities Research

[email protected] +852 3653 8606

July 2012


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2012 Bulk Commodities

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Chinas commodities in a soft-landing scenario

Watch out for long-term weak commodity prices

Liquidity-driven FAI growth will become increasingly unsustainable in 2012 and beyond. We see a long-term price downtrend for commodities: Thermal coal, coking coal, iron ore and steel.

Be picky in trading opportunities and pick the strategic winner.

The real cost of thermal coal: An inconvenient truth We forecast Chinas QHD thermal coal price will go down to Rmb630/t by 2015.

Demand growth will slow with contracting credit and FAI growth, while supply from domestic miners and imports isgrowing at double digits.

The transportation bottleneck is not as rigid as the market assumes; there is cost flexibility. We initiated coverage on Shenhua with a BUY rating; Yanzhou Coal with a REDUCE rating; and China Coal with a

HOLD rating.

China steel value chain: Coking coal preferable to steel mills We maintain our UNDERWEIGHT view on the Chinese steel sector in 2012, as massive capacity expansion will

continue to destroy value.

We believe upstream coking coal miners are a good hedge to SOE steel mills.

We are initiating coverage on Shougang Fushan Resources with BUY and on Hidili with HOLD.

Copper: Range-bound between US$7,500/t and US$8,500/t We think copper prices above US$8,500/t are not sustainable, judging by sluggish real demand in China.

Financing activities and fund speculation are increasingly becoming the driving forces in the copper market.


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Stock coverage of Mirae Commodities Research

Mirae Commodities stock coverage

Source: Mirae Asset Research

Prices as of 17 June 2012


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The real cost of thermal coal: An inconvenient truth

Slowing FAI does not bode well for coal demand Sluggish lending activity during 1Q12 indicates that new loans in FY12 may not even reach the

comfortable credit zone of Rmb10.5tn. This does not bode well for the FAI outlook in 2012.

Our base-case China coal demand CAGR is 5.7% over 2012-2015E.

Transportation bottleneck? Think again! We see flexibility in Chinas typical marginal coal miners cost. Increasing coal railway transportation capacity and potential railway system reforms will reduce the

pressure on long-haul trucking costs from 2013.

Supply glut in 2013-2015 The top-17 coal mining firms in China will increase their capacity to 2.9bn tonnes by 2015, up 90%

from 2010.

Long-term downtrend in thermal coal prices We forecast QHD 5,500 thermal coal price will fall to Rmb630/t in 2015, from the current

Rmb770/t.

We have a BUY rating on Shenhua; REDUCE on Yanzhou Coal; and HOLD on China Coal.


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Slowing FAI does not bode well for coal demand

We observe a strong correlation between FAI new construction and apparent consumption of thermal coal. However, the sluggish lending activity during 1Q12 indicates that new loans in FY12 may not even reach the

comfortable credit zone of Rmb10.5tn. This does not bode well for the FAI outlook in 2012. More importantly, huge FAI investments - with declining investment efficiency - since 2009 have led to an

investment frenzy for commodity capacity expansion (not just in the coal sector).

Strong correlation between Chinas FAI (new construction) and coal consumption growth

Source: CEIC, SXcoal, Mirae Asset Research

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FAI new construction (LHS, YoY %) China raw coal app. Consumption (RHS, YoY %)



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Slowing FAI does not bode well for coal demand

A breakdown of Chinas power consumption clearly indicates that FAI-related industriesaccounted for the lions share of Chinese power demand and hence thermal coaldemand.

Chinas power consumption breakdown

Source: CEIC, Mirae Asset Research

Cement, 6%

Steel, 11%

Non-ferrous, 7%

Other IndustrialUsage, 34%

Residential,

12%

Others

(individual



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Our base-case: 5.7% CAGR in China coal consumption On the coal demand side, our base-case projection is 4.6bn tonnes of raw coal production by 2015, based on

assumptions of: a) 7% GDP growth over 2011-2015; b) a decline in the correlation between coal consumptiongrowth and GDP growth to 0.8x (from 1.07x in past decade).

Our base-case scenario: 5.7% CAGR in apparent coal consumption

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App. Coal consumption growth/GDP growth ratio 10-year average at 1.07

China's raw coal

production

(m tonne) YoY

China's net

imports

(m tonne)

China's apparent

raw coal

consumption

(m tonne) YoY

Averaga Annual

thermal coal price

(QHD 5500kcal,

Rmb/t) YoY

2008 2,716 -5 2,711 738.0

2009 3,050 12% 103 3,153 16% 606.8 -18%

2010 3,413 12% 146 3,559 13% 750.8 24%

2011 3,710 9% 169 3,879 9% 824.0 10%

Our base case

scenario

2012E 3,951 6.5% 185 4,136 6.6% 820.0 -0.5%

2015E 4,600 250 4,850 626.5

from 2011 to 2015 5.5% 5.7% 5.7% -6.6%

Coal consumption growth of 0.8%will beable to support 1% GDP growth: Ithappened in 2005-2008.

Ourbase-case scenario: 5.7% CAGR for coal consumption during 2012-15

Source: CEIC, SXCoal, Mirae Asset Research



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Chinas coastal provinces: Demand is slowing down

Out of the six coastal provinces, which account for 35%of Chinas thermal coal consumption, only tworecorded more than 15% industrial-value added growth in 2011; the rest saw growth of less than 10%.

Central/western China outpaces coastal regions, in terms of industrial value-added

Industrial value added >20%

Industrial value added between 15-20%

Industrial value added



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Chinas coal mining offers decent return, encouraging expansion

Source: Wind, Mirae Asset Research

Three Chinese coal miners have aggressive expansion plans (mt)

Source: Company data, Mirae Asset Research

Huge investments in coal mining leading to a supply glut

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Steel making Copper mining Coal mining

Iron ore mining Therma l power

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Shenhua Energy China Coa l Yanzhou Coa l

Chinese coal mining has been providing a decent return over the past few years, encouraging stronginvestment.

The combined mining capacity of Shenhua, China Coal and Yanzhou (including the Australian unit) will reach870m tonnes by 2015, up 86% from 2011's 467m tonnes. The top-17 coal mining firms in China will increasetheir capacity to 2.9bn tonnes by 2015, up nearly 90% from 2010, according to China Coal Industry Association.



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Transportation bottleneck? Think again!

- Increasing coal railway transportation capacity and potential railway system reforms will reduce the pressureon long-haul trucking costs from 2013.

- The capacity potential is locked due to:- The imbalance in allocation of transportation capacity between contract shipments and spot coal shipments.- Inefficient coordination between regional railway administrative powers.

Railway bottleneck to be alleviated to some extent, but not resolved completely

Source: NBS, SXCoal, Mirae Asset Research

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Raw coal production (LHS) coal transported by rail as % of total coal output (RHS)



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Transportation bottleneck? Think again!

- Due to limited funding sources, railway coal transportation has now become the cash cow for local railwaybureaus to subsidize other operations.

- With cooling downstream demand, it will be increasingly difficult for local governments and other administrativepowers to milk the thermal coal supply chain in the coming years.

How much does it cost to transport coal via railway?


Compliance cost =

Fee & taxes + difference between truck and railway price


Fee and Taxes

18%

Production

9%

Railway charge

(Ordos to Tianjin

Port)

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Profit made by

coal miners & coal

traders

19%

Differ betweentruck and railway

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Discharging fee Total railway

transportation

cost

Truck cost (Ordos

to Tianjin Port)

Rmb/t



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Chinas marginal coal miners: How flexible are their costs?

The two charts compare the cost difference between the high and low demand seasons for a private open pitcoal mine in Inner Mongolia.

This illustrates the cost flexibility at each node of the coal supply chain, in response to coal demand. Inreality, low demand seasons will reduce the traffic jam and drivers will prefer to travel along the low-grade routes, rather than the high-grade highways, to avoid toll fees and fines.

A marginal cost supplier - slack time


Note: The price here is for 4700kcal thermal coal

A marginal cost supplier peak time


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Thermal coal imports will depress coastal thermal prices,but we do not expect a flood of imports The supply competition in eastern coastal provinces will intensify in the coming years, with increased imports,

which - coupled with the slowdown in demand growth in coastal regions - will effectively depress spot prices. We do not expect the Chinese coal market to be inundated with coal imports, as there will be enough low-cost

coal supply to compete in inland China.

China's thermal coal imports by sourcing nation

Source: SXCoal, Mirae Asset Research

Cost curve of Australian thermal coal exports (A$/t, FOB)

Source: Wood Mackenzie, Mirae Asset Research

Note: Pre-royalty cash cost

2,19021,881 19,576 22,22810,851

28,64653,477

62,928

20,935

41,617

45,893

53,285

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Thermal coalMajor seaborne trade flows: Exports 767mt (2011)

Russia88mt

Australia145mtMajor exporter

Major importer

India93mt

Japan, Korea,Taiwan

345mt

China130mt

Europe199mt

Indonesia320mt

S Africa71mt

Colombia76mt

USA35mt

Source: GITIS, Mirae Asset Research

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Our framework for the seaborne thermal coal market

Chinas domestic coal prices provide a floor for the seaborne market. The IPPs in Chinas southeast coastal regionscould arbitrage between the domestic and seaborne markets.

Japan and Korea provide a cap price. Since Japan and Korea do not have domestic coal reserves, they are price-takers inthe seaborne market.

Chinas domestic coal price provides a floor for the seaborne market


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$/t,inclVAT

Newcastle thermal coal price incl. VAT, delivered to GZ port

Shanxi Premier Blended thermal coal price, delivered to GZ port

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Stock pick: Shenhua Energy (1088 HK, BUY, TP HK$42) Shenhua Energy is our top pick among Chinese thermal coal miners. We believe Shenhua is well positioned in a weak thermal coal demand environment, given its integrated coal s

upply chain across coal mines, transportation (railway) and IPPs. The companys extensive railway network enables it to stay at the lowest-end of the cost curve, while

exposure to IPPs provides an earnings hedge against coal price volatility.

Shenhuas coal cost is the lowest among peers (2011, Rmb/t)

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Shenhua Energy Yanzhou Coal China Coal Energy Marginal cost player - InnerMongolia private mines

trucking coal to ea st ports

Mine mouth cash cost Depreciat ion Transportation

Shenhua has least spot price exposure among the three companies


Volume

in 2011

(mt)

Contract

Vol (mt)

Spot

Vol

(mt)

Spot volume

as % of total

Volume in

2015 (mt)

Contract

Vol (mt)

Spot

Vol

(mt)

Spot volume

as % of total

Shenhua Energy (1088 HK) 282 172 110 39% 500 172 328 66%

China Coal Energy (1898 HK) 100 52 49 49% 180 52 128 71%

Yanzhou Coal (1171 HK) 51 9 42 82% 150 9 141 94%

2011 Actual 2015 Mirae Estimate

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Yanzhou Coal (1171 HK, REDUCE, TP: HK$13.00)

Cost is crucial to compete in the seaborne market, but Yanzhou is moving to the high end of the cost curve. We believe the companys rapid growth stage will be 2013-15. However, we see too much uncertainty in the

coal market after 2012.

Yancoal Australia is moving to the high end of the cost curve

Yanzhous coal output plan

Source: Wood Mackenzie, Mirae Asset Research

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Million tonnes

A$/t

Aus tralia ex port t hermal cash cos ts (2012, A$/t F OB)

Moolarben

A$44/t

Minerva

A$58/t

Stratford

A$68/t

Duralie

A$77/t

Abel

A$103/t

Tasman

A$85/t

2011 2012E 2012 YoY 2015E CAGR 2013-15 Note

(mt) (mt) (%) (mt) (%)

Shandong Province 35.3 35.4 40.0 4.2% Growth from Heze NenghuaOrdos+ Shanxi Province 5.6 8.2 50.0 83.1% Rapid growth in 2013-2015

Australia 10.1 12.4 50.0 59.4% Rapid growth in 2013-2015

Self-produced coal 50.9 55.9 9.7% 140.0 35.8%

Externa l purchased coa l 13.3 20.0

Total coal sales 64.2 75.9 18.2%

Moonlarben and Minerva belong toFelix, which Yancoal Australiaacquired in October 2009.

Stratford and Duralie belong toGloucester Basin, Tasman and Abebelong to Donaldson, both of whicare mining locations in Gloucester.Yancoal Australia announced theacquisition of Gloucester inDecember 2011.

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China Coal Energy (1898 HK, HOLD, TP: HK$8.50)

Mining accidents have a profound impact. China Coal will need to spend more on operational expenses thanpeers, due to spending on safety checks and infrastructure, increasing safety procedures, etc.

The company lacks a long-term strategy to deal with the weak coal market.

China Coals material cost is the highest (Rmb/t)


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Shenhua Energy Yanzhou Coal China Coal Energy

Materials, fuel and power Personnel expenses Repairs and maintenance Other costs

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China steel mills:With ebbing demand growth, it is all about competition

Massive capacity expansion destroying value

How will China consume more than 900m tonnes of steel-making capacity in 2012, once steeldemand is detoxified from liquidity stimulation and the investment frenzy of the local governments?

Structural and cyclical steel demand facing headwindsTwo drivers of Chinese steel demand are:

1. Urbanization (a structural driver): Short-term pressure from a weak property market

2. Credit growth (a cyclical driver): Losing momentum in 2012.

Large SOE mills are losing out to hybrid competitors We believe hybrid steel mills will be the future leaders in the Chinese steel sector. They enjoy

local government support and have the aggressive management style of private entrepreneurs.

HK-listed Chinese steel names are all SOEs: We have REDUCE on Angang Steel (347 HK, REDUCE,TP: HK$2.80) and Maanshan Iron & Steel (323 HK, REDUCE, TP: HK$1.70).

Raw material cost savings Steel profit margins The entry barriers in building new steel-making capacity are negligible in China.

Capital expenses of the integrated long and hot rolled coil steel mills have dropped to Rmb1,000/t(US$160/t) and Rmb2,000 (US$317/t), respectively.

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Massive capacity expansion destroying value

Chinese crude steel capacity expanded again since 2009

Source: CISA, Mirae Asset Research

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Crude steel capacity at year end, LHS Incremental capacity per year, RHS

We estimate Chinas crude steel-making capacityreached 860mtpa by the end of 2011.

It will exceed 920mtpa by 2012.

One consequence of capacity expansion is adeteriorating utilization rate.

We expect further decline in utilization in 2012, as

demand growth faces the double-whammy ofshrinking liquidity and a weak property market.

Utilization rate of steel mills is going down

Source: NBS, CISA, Mirae Asset Research

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Crude steel capacity at year end, LHS Annual crude steel output, LHS

Utilization rate, RHS

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A chronic net margin squeeze since 2003


Margins have deteriorated further since 3Q11

Source: Mysteel, Mirae Asset Research

steel sector suffering from a chronic margin squeeze

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Structural steel demand facing headwinds

The structural steel demand driver urbanization remains a valid long-term call, but it may be interruptedin 2012, due to the central governments crackdown policies on house prices.

Long steel outpaced flat steel prices in 2011, a typical FAI-driven growth model


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Since 2011, Chinese steel demandhas been driven by long steel products

which is a typical feature of thefixed asset driven growth model.

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mainly due to a weak property market in 2012

In 2012, we believe the key driver of Chinese steel demand the property market will feel the pinch of thegovernments crackdown on property prices on all fronts.

We are already seeing some early signs of the negative impact, as indicated in the chart below.

A cooling property market does not bode well for steel consumption

Source: NBS, Mirae Asset Research

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under construction area growth, 3mm

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Credit growth is also questionable

From a long-term perspective, we can see that Chinas credit growth has a correlation to its steel and cement consumption.

In 2012, as inflation remains a concern for the central government, we do not think credit growth will continueto drive steel demand.

as well as cement consumption


Credit growth pattern is in line with steel consumption


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local government spending is simply not sustainable

Since 2009, spending by local governments has been the key driver of fixed asset investment in China. It has now reached a turning point.

They now face an inevitable question: How to repay mounting debt with ever-decreasing investment returns onpet projects?

Totallocal govt debt exceeded national fiscal revenue in 2011


Local government the key spender for FAI projects


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Chinas steel consumption to slow to 3% in 2012

Crude steel balance in 2012

Source: NBS, CISA, Mysteel, Mirae Asset Research

Million tonnes 2006 2007 2008 2009 2010 2011E 2012F

Crude steel capacity 510 550 620 680 780 860 920

Crude steel output 425 495 500 568 640 690 720

Output Changes % 20% 16% 1% 14% 13% 8% 4%

Utilization rate 83% 90% 81% 84% 82% 80% 78%

Net steel exports (crude basis) 34 54 47 3 27 34 40

Apparent steel consumption (crude basis) 391 441 453 565 613 656 680

Apparent consumption changes% 10% 13% 3% 25% 8% 7% 4%

Steel inventory change -10 -5 2 30 10 5 8

Real consumption 401 446 451 535 603 651 672

Real consumption changes % 13% 11% 1% 19% 13% 8% 3%

Rebar avg. price incl Vat RMB/t 2992 3619 4691 3606 4065 4650 4400

HRC avg.price incl Vat RMB/t 3916 4283 5100 3712 4286 4680 4300

Rebar avg. ex vat US$/t 321 407 577 451 515 615 597

HRC avg. ex vat US$/t 421 481 627 464 544 620 583

We expect Chinas steel consumption will slow down further, from 8% in 2011 to 3% in 2012.

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Large SOE mills are losing out to hybrid competitors

We see an emerging league of future winners. We call them hybrid players; they enjoy strongsupport of the local governments and have the aggressive management style of private entrepreneurs.

On average, they saved Rmb234/t in cost in 2011 (compared with SOEs) by using low Fe content in iron ore.

Private steel mills reduce costs by bringing down Fe content in iron ore to 55% (2011 average)


Item Note Price (Rmb/t) Cost per ton (Rmb/t)

Iron ore 55% Indian ore 854 1,580

Coke550kg/t input due to low Fecontent iron ore 1,932 1,063

Private steel mill's iron ore and coke cost per ton 2,643

Iron ore 62% iron ore 1,315 2,104

Coke 400kg/t input 1,932 773

SOE steel mill's iron ore and coke cost per ton 2,877

Difference -234

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Hybrid steel mills have consistently been more profitablethan SOEs

There are two listed hybrid steel mills in Chinas A-share market: Jiangsu Shagang (002075 CH, NR) and

Nanjing Iron & Steel (600282 CH, NR).Both exhibited excellent profitability in 2010 and 2011, compared with SOEs such as Baosteel, Angang Steeland Maanshan Iron & Steel.

Hybrid steel mills have consistently been more profitable than SOEs


M.Cap 2010 PB 2010 1H2011 3Q2011 Ownership

Name Ticker (US$M) (x) % % %

Jiangsu Shagang 002075 CH 1,013 2.9 11.0% 9.1% 10.0%

Hybrid of private and SOE. Shen Wenrong controls 38.8% of

Shagang Group, which owns 74.88% of listco. SASAC controls

another 7.5% of listco

Nanjing Iron & Steel 600282 CH 1,709 1.1 8.8% 7.9% 6.2%

Hybrid of private and SOE. Parentco Nanjing Iron and Steel United

Co. (holds 83.78% of listco) is 60% held by Foson Int'l, and 40% by

Nanjing Iron and Steel Group (SOE)

Baoshan Iron & Steel 600019 CH 13,470 0.8 11.9% 9.4% 5.3% SOE

Angang Steel 000898 CH 5,219 0.6 7.1% 4.6% 5.8% SOE

Maanshan Iron & Steel 600808 CH 2,903 0.7 5.3% 3.5% 3.0% SOE

Gross margin

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SOE Steel mills: Nominal P/B deflated by high historic book value Our channel checks indicate that the replacement cost of steel mills is currently only Rmb1,000/t for long steel

and Rmb2,000/t for flat steel (for the full-process, from blast furnace to rolling).

Angang Steels capacity is 21mt flat steel, implying a replacement cost of Rmb42bn, while its 2011YE fixed assetbalance was Rmb53.5bn, which indicates a potential impairment loss of Rmb11.5bn.

Maanshan Steels capacity is 15mt (8mt in flat steel, 7mt in long steel), implying replacement cost of Rmb23bn,while its 2011YE fixed asset balance was Rmb32.4bn, which indicates a Rmb9bn potential impairment loss.

SOE steel mills fixed assets are overstated, versus the leading private steel mill


Ticker Flat/long steel Ownership

2010 2011 2010 2011 2010 2011

Jiangsu Shagang 002075 CH 3.0 3.0 1,518 1,443 1,278 1,385Mixture of long steel, flat steeland special steel

Hybrid of private and SOE. Shen Wenrong controls 38.8%of Shagang Group, which owns 74.88% of listco.

Maanshan I ron and Steel 323 HK 15.0 15.0 2 ,294 2 ,110 1 ,867 1 ,884 Mixture of long and f la t s teel SOE. 65% owned by Maanshan I ron and Steel Group

Angang Stee l 347 HK 25.0 25.0 2,291 2,013 2,214 2,091 Mixture of f lat ste el SOE. 67% owned by A nshan Iron and Stee l Group

Capacity (mt)

Fixed asset per

ton (Rmb/t)

Book value per

ton (Rmb/t)

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Iron ore is a step closer to being a buyers market

However, it is still too early to see a market turnaround in favor of the Chinese buyers in 2012, due to:1. A decline in Indian iron ore exports, reducing marginal supply of iron ore to the Chinese market

2. Massive expansion in Chinas steel-making capacity3. Easy exit from domestic iron ore production, making the marginal iron ore supply cost support rigid

Indian iron ore imports to China are declining

Source: China Customs, Mirae Asset Research

Iron ore prices declined since 3Q11


0%

5%

10%

15%

20%

25%

2008 2009 2010 2011

India iron ore imports to China as % of total China iron oreimports (%)

50

70

90

110

130

150

170

190

210

Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Jan-10

Mar-10

May-10

Jul-10

Sep-10

Nov-10

Jan-11

Mar-11

May-11

Jul-11

Sep-11

Nov-11

Jan-12

Mar-12

May-12

$/t,CFR,excl.VAT

Indian ore 63.5%

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Iron ore spot prices are dominant in the Chinese market

2H11s average spot price was lower than the contract price


After several years of painful negotiations, the global iron ore pricing system has finally moved from annualcontracts to spot-based pricing.

For 2H11, the average spot price was lower than the contract price; a significant game-changing sign.

SOE steel mills, which used to enjoy large discounted contract prices, are losing their input advantages.

40

60

80

100

120

140

160

180

200

Ja

n-10

Fe

b-10

Mar-10

Apr-10

May-10

Ju

n-10

J

ul-10

Au

g-10

Se

p-10

Oct-10

No

v-10

Dec-10

Ja

n-11

Fe

b-11

Mar-11

Apr-11

May-11

Ju

n-11

J

ul-11

Au

g-11

Se

p-11

O

ct-11

No

v-11

Dec-11

Ja

n-12

Fe

b-12

M

ar-12

Apr-12

May-12

$/t,

FO

PB Fines spot price PB Fine contract price

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Coking coal: Survival by being flexible

Face the reality that luck is running out Coking coal miners have to face a tough reality: A slowdown in steel production since 2H11.

We predict a gradual single-digit annual price decline over 2012-13, rather than a collapse inthe domestic market.

Coking coal market is under pressure of increasing supply- New supply is coming on stream from China (Shanxi), Australia and Mongolia.

- Integration of the domestic and Asia-Pacific seaborne markets has intensified since 2009.

Be flexible to survive the demand slowdown The competition between local and overseas resources allows for some flexibility to be built

into the cost curve, to moderately rebalance the market.

We are initiating coverage on Shougang Fushan Resources with BUY and on Hidili with HOLD.

arch

Metallurgical coal


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gMajor seaborne trade flows: Trade 237mt (2011)

USA

59mt

Canada

25mt

Australia

113mt

E Europe

6mt

Major exporter

Major importer

Brazil

14mt

India

31mt

Japan, Korea,Taiwan

83mt

China

41mt

W Europe

45mt

Source: Clarksons, Mirae Asset Research

Mongolia

16mt

Russia

9mt

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Mongolia16mt,79$/t

Australia10mt

220$/t

China591mt

Other seabornesources

7mt

Domestic supply550mt

Shanxi240mt

Rest of the country310mt

Coking coal main supplier

Coking coal demand

Cash cost from main sources(C&F,delivered to Northern China Ports, excl. VAT)

Mongolia: $125/tAustralia: $130/t

China: $130/t

2011 Chinese coking coal balance by source(C&F prices USD/t)

Canada & USA7.5mt

Canada: 233$/tUS: 180$/t

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China provides a floor for seaborne coking coal prices

Chinas domestic prices provide a floor for seaborne prices


Chinese steel mills are flexible between domestic supply and imports


100

150

200

250

300

350

400

450

Jun-

08

Aug-

08

Oc

t-

08

Dec-

08

Fe

b-

09

Apr-

09

Jun-

09

Aug-

09

Oc

t-

09

Dec-

09

Fe

b-

10

Apr-

10

Jun-

10

Aug-

10

Oc

t-

10

Dec-

10

Fe

b-

11

Apr-

11

Jun-

11

Aug-

11

Oc

t-

11

Dec-

11

Fe

b-

12

Apr-

12

$/t

,excl.

VAT

Liulin #4, spot price Australian prime coking coal, FOB (US$/t, LHS)

(140)

(120)

(100)

(80)

(60)(40)

(20)

0

20

40

Jun-08

Sep-08

Dec-08

Mar-09

Jun-09

Sep-09

Dec-09

Mar-10

Jun-10

Sep-10

Dec-10

Mar-11

Jun-11

Sep-11

Dec-11

Mar-12

0

500

1000

1500

2000

2500

3000

3500

Domestic coking coal price prem/(disc.) to Australia imports (LHS, US$/t)

Import from Australia to C hina (kt, RHS)

- Chinese coke producers and steel mills have been flexible in adopting the best economics ofraw material inputs.- We believe the competition between local and overseas resources allows for some flexibility to

be built into the cost curve, to moderately rebalance the market.

arch


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Mongolian and Australian imports are growing

Increasing imports from Australia and Mongolia pressures domestic coking coal prices. Over January-April

2012, coking coal imports were up 26.7%, with incremental supply from both Australia and Mongolia.

China's coking coal import voume has increase 26.7% YTD

Source: NBS, Mirae Asset Research

1.4

22.717.4

10.33.6 5.03.6

4.0 15.0

20.0

5.05.5

1.8

7.8

14.8

14.3

5.16.8

0

5

10

15

20

25

30

35

40

45

50

2008 2009 2010 2011 Jan-Apr 2011 Jan-Apr 2012

Australia Mongolia Others

26.7% YoY growth

arch

D bl di it th i Chi d ti ki l l


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Double-digit growth in Chinas domestic coking coal supply

Raw coal output from the four major coking coal producing regions in Shanxi was up 38% YoY in 2011 and 28%YoY over January-April 2012. This growth has largely outpaced Chinas crude steel output growth of 1% YTD.

Raw coal output of four major coking coal producing areas in Shanxi province


arch

Stock pick: Shougang Fushan (639 HK BUY TP HK$ 3 0)


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Stock pick: Shougang Fushan (639 HK, BUY, TP HK$ 3.0)

Fushan is our top pick among Chinas coking coal miners.

We like the company for its premium coking coal quality and prime location. Its clients are concentrated inHebei Province; the heartland of Chinas steel industry.

with clients mainly concentrated in Hebei province


Fushan is located in Shanxi province


Hebei

Iron&Steel

Group, 52

Shougang

Group

(parentco),

31%

Others,

12%Benxi Steel,

2%

BaogangGroup, 3%

earch

Stock pick: Shougang Fushan (639 HK BUY TP HK$ 3 0)


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Stock pick: Shougang Fushan (639 HK, BUY, TP HK$ 3.0)

Fushans margins are less volatile, due to its resilient ASP.

We think Fushan is a heads you win, tails you dont lose hedge to our UNDERWEIGHT call on steel; withgood steel demand, the coking coal price has more upside than the steel price; with weak demand, the

coal price suffers less downside than the steel price.

Fushan outperforms Angang in a bull market,

but seldom underperforms it in a bear market


Fushans ASP was resilient in 2009 and 1Q12


2011 1Q 2011 4Q 2012 1Q

2012 1Q

YoY

2012 1Q

QoQ

Fushan ASP of washed coal 1,802 1,778 1,776 -1.4% -0.1%

Liulin #4 coking coal 1,654 1,695 1,643 -0.7% -3.1%

Australian prime hard coking coal 2,017 1,561 1,378 -31. 7% -11. 7%

US$/t 2008 2009 2010 2011

Fushan ASP 198 180 219 233

YoY % -9% 22% 6%

Average of Liulin #4 208 159 187 222

YoY % -24% 18% 19%

Average of Australian prime hard coking coal 300 145 221 294

YoY % -52% 52% 33%

-150%

-50%

50%

150%

250%

350%

450%

2007 2008 2009 2010 2011 2012

YTD

Fushan Energy share performance

Angang share performance

earch

Hidili Industry (1393 HK Reduce TP HK$ 2 00)


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Hidili Industry (1393 HK, Reduce, TP HK$ 2.00)

Hidilis ASP is more volatile than that of Fushan, due to location disadvantage and coal quality.

Management has guided that raw coal production will increase from 4.1mt in 2011 to 10mt in 2015.

We think the target is likely to be revised downwards, due to: 1) tight cash flow in 2012-13E with repaymentof debt; and 2) weak coking demand during 2013-2015.

Volume increase in 2014-15 will coincide with weak prices


Hidilis ASP is lower than Fushans due to location disadvantage


Rmb/t 2008 2009 2010 2011

Hidili ASP 1,312 870 1,132 1,302

YoY % -34% 30% 15%

Fushan ASP 1,367 1,234 1,477 1,568

YoY % -9% 20% 6%Average of Liulin #4 1,436 1,088 1,483 1,675

YoY % -24% 36% 13%

Rmb/t (incl. VAT) 2009 2010 2011

Guizhou 956 1,237 1,560

Yunnan 951 1,132 1,460

Sichuan 1,016 1,333 1,512

Average price of Guizhou, Yunnan and Sichuan 974 1,234 1,511

Liulin #4 in Shanxi 1,088 1,483 1,675Discount % -10% -17% -10%

4.1

5.0

6.0

8.0

10.0

3

4

5

6

7

8

9

10

2011 2012E 2013E 2014E 2015E

(mt)

Raw coal production

earch

Hidili Industry (1393 HK Reduce TP HK$ 2 00)


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Hidili Industry (1393 HK, Reduce, TP HK$ 2.00)

Hidilis interest burden has been increasing rapidly over the past three years.

Moreover, the companys Rmb1.7bn convertible bond is at risk of being redeemed in January 2013. Hidili will have no choice but to re-finance at higher interest rates (the convertible bonds interest rate is only 1.5%).The increasing financial cost will impact Hidilis net profit margin in 2013E.

Additional interest expenses for re-financing of convertible note


Hidilis financial burden has increased rapidly


Rmb m 2008 2009 2010 2011

EBIT 1,097 514 1,036 1,240

interest expense 32 56 214 309

Interest coverage ratio 34.3 9.2 4.8 4.0

Net Debt (net cash) (535) 2,287 4,227 5,492

Net debt/Equity -9.1% 35.6% 59.2% 70.3%

2013E

Interest rate on convertible note (%) 1.50%

Re-financing interest rate (%) 6.65%

Net increase of interest rate (%) 5.15%

Convertible note Payback amount (Rmb m) 1,814

Increase of interest expense (Rmb m) 93

Estimate 2013 EBIT (Rmb m) 1200

Impact on EBIT 8%

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Copper: Range-bound between US$7,500/t and US$8,500/t

We reiterate our view from last October that the LME copper price would be range-

bound between US$7,500 and US$8,500/t in a soft-landing scenario for China.

We think the financial demand of copper imports provides a support level at US$7,000-7,500. Meanwhile, we think copper prices above US$8,500/t are not sustainable, judgingby the current sluggish real demand in China.

We are seeing receding momentum for copper imports, as LME and SHFE arbitragesuggests a loss in Cu imports.

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The recent copper price rally was not based on real demand

Refined copper imports posted a record high in Dec 2011

Source: China Customs, Mirae Asset

Chinas copper consumption breakdown by sector

Source: China Customs, Mirae Asset

Construction

products

25%

Power

Infrastructure

17%

Public

Infrastructure

2%

Transportation

5%Others*

17%

Capital Goods

10%Consumer

Durables

24%

Chinas refined copper imports volume reached an historic high in December 2011. We believe the surge incopper imports was mainly driven by financing demand and improved liquidity, while the real economy wassuffering from the aftershock of a severe credit crunch.

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

J

an-05

J

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pr-06

S

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F

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Jul-07

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Tonne

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50%

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150%

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250%

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350%

400%

chg YoY % Refined copper imports mont ly (LHS)

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LME and SHFE arbitrage suggests a loss in Cu imports

Arbitrage window reopened partly explains Chinese buying

Source: Bloomberg, Mirae Asset

The arbitrage between LME and SHFE copper price is only US$119/t, down from US$700/t when LME copperprice was at US$8,454/t on 26 April.

When copper is imported for financing purposes, such a loss is deemed a part of the cost of seeking arbitrage oninterest rate differences.

When the loss is too big to be affordable, it always ends with a decline in LME price, which narrows the loss.

-1,000

-800

-600

-400

-200

0

200

400

600

800

1,000

J

an-05

A

pr-05

Jul-05

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A

pr-06

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O

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A

pr-07

Jul-07

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ct-07

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A

pr-08

Jul-08

O

ct-08

J

an-09

A

pr-09

Jul-09

O

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an-10

A

pr-10

Jul-10

O

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an-11

A

pr-11

Jul-11

O

ct-11

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an-12

A

pr-12

USD/t,

incl.VA

T

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000

12,000

USD/t

SHFE/LME arbit rage (RHS) LME spot coppe r(LHS) SHFE spot coppe r (LHS)

earch

A di 1 S l fi i fl h


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Steel traders

Collaterals

Guarantee Parties

Banks

Warehouses

Deliver the cargo in to a warehouse

designated by the bank. Or directlytransfer warehouse receipts to the

warehouse.

Invest the cash

in higher

return projects

Steel traders are usu ally well connected

with warehouses. Some traders use the

same batch of cargo t o repeatedly get

bank loans. Some inflate the value of

their stocks to get a bigger bank loan.

Appendix 1: Steel financing flow chart

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A di 2 C i t fi i fl h t


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Domestic importers

Overseas exporters

1.Signing contracts

Issuing banks

2.15%-30%App ly for L /C. Deposit

15%-30% margin.

4. Exporter delivers cargo after verifying the

L/C.

5.Sell the cargo

in spot market

and get cash.

Higher return

projects

9., 6,Repay issuin g banks

when L/C expires in 6

months.

Paying banks

7. (6)Exporter asks for payment

using L/C and shipping bills.

Paying banks r elease

payments (discount if earlier

than 6 months).

8.Paying banks deliver the remittance bill and

shipping bills to issuing bank for payments.

Copper spot

market

6.Invest inhigherreturnprojects

Appendix 2: Copper imports financing flow chart

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A di 3 Chi t fi i t


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Appendix 3: Chinas grassroots financing cost

We use the discount rate of 6m bank acceptance bill as the benchmark interest rate

Source: Wind, Mirae Asset

0

2

46

8

10

12

14

16

18

16-Mar-07

19-Feb-08

2-Apr-08

22-May-08

4-Jul-08

15-Aug-08

6-Oct-08

19-Nov-08

8-Jan-09

24-Feb-09

8-Apr-09

21-May-09

3-Jul-09

14-Aug-09

25-Sep-09

12-Nov-09

24-Dec-09

5-Feb-10

29-Mar-10

12-May-10

25-Jun-10

6-Aug-10

17-Sep-10

4-Nov-10

16-Dec-10

10-Feb-11

23-Mar-11

11-May-11

30-Jun-11

7-Sep-11

9-Nov-11

30-Dec-11

27-Feb-12

12-Apr-12

(%)

Annua lized discount rate for 6m Bank Accepta nce Bill

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Analyst Profile


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Analyst Profile

Henry LiuREGIONAL HEAD OF COMMODITIES RESEARCH+852 3653-8606/ 6628 [email protected]

Henry joined Mirae Asset Securities in November 2010 tohead up the commodities sector.

Henry has more than eight years of experience in thecommodities sector, having previously worked at MacquarieBank, McKinsey & Company, CICC, China Asset Managementand Gerald Metals. His research notes and opinions onferrous/non-ferrous metals receive excellent feedback frominternational conferences, clients, and the market.

Henry obtained a Masters Degree in Business Administrationand a Masters Degree in Commerce (International Business)from the University of New South Wales, and another

Masters Degree in Commerce (Accounting) from theUniversity of Western Sydney.

Shirley ZhaoANALYST, METALS AND MINING+852 3653-8648/ 6928 [email protected]

Shirley joined Mirae Asset Securities in August 2011 as anequity analyst in the metals and mining sector.

Previously, she worked at Macquarie Securities for fouryears, focusing on China equity strategy for both H-sharesand A-shares. Her research was well received byinternational and China domestic clients. Also, she has asolid financial and accounting background of more than twoyear experience with Deloitte and PricewaterhouseCoopers.

She obtained her Bachelor in Economics at the FudanUniversity and she is a CFA charter holder.

search Disclosure / Disclaimer

Hong Kong Compliance DisclosureThe views expressed in this report accurately reflect the personal views of the analysts about the subject securities, issuer(s) or new listing applicant(s). Each Hong Kong analyst declares that neither he/she nor his/her


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The views expressed in this report accurately reflect the personal views of the analysts about the subject securities, issuer(s) or new listing applicant(s). Each Hong Kong analyst declares that neither he/she nor his/herassociate serves as an officer or has any financial interests in relation to the issuer(s) or new listing applicant(s) reviewed by the analyst. None of the issuer(s) or the new listing applicant(s) reviewed or any third partyhas provided or agreed to provide any compensation or other benefits in connection with this report to any o f the analysts of Mirae Asset Securities (HK) Limited (MASHK). MASHK Group and/or its employees may participate or invest in financing transactions with the i ssuer(s), referred to in this research report, perform services for or solicit investment banking business from such issuers, and/or have a principal investment position or effect transactions in the securities or other financial instruments thereon. MASHK confirms that it (i) does not own 1% or more aggregate financial interests of market capitalization in any of the issuer(s) or new listing applicant(s) reviewed; (ii) has no investment banking relationship with the issuer(s) or new listing applicant(s) covered within the preceding 12 months; (iii) does not involve in market making activities in the securities of the covered issuer(s) or new listing applicant(s); or (iv) does not have any Individual employed by or associ ated with any member companies of MASHK Group serving as an officer o f any issuer(s) or new listing applicant(s) reviewed. The aforesaid Individual means (i) any individual employed by MASHK in accordance with whose directions or instructions the analyst is accustomed or obliged to act; (ii) employed by MASHK who has influence on the subject matter or content, or the timing of distribution, of research report; or (iii) who is responsible for determining the remuneration of the analyst.This disclosure statement and above terms interpretations are made and defined pursuant to paragraph 16 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission.Disclaimer

This report was originally prepared and issued by MASHK and/or Mirae Asset Securities Co. Ltd. (MAS) for distribution to their professional, accredited and institutional investor customers. It i s not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availabil ity or use would be contrary to law or regulation or which would subject MASHK and its subsidiaries and affiliates in Hong Kong (collectively MASHK Group) to any registration or li censing requirement within such jurisdictions. None of the material, nor its contents, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, wi thout the prior express written permission of MASHK Group. All trademarks, service marksand logos used in this report are trademarks or service marks or registered trademarks or service marks of MASHK Group.The information, opinion and material presented in this report are provided for general information purposes only and shall not be used or considered as an offer or the solicitation of an offer to sell or to buy or subscribe for securities, other financial instruments or any derivative related to such securities or instruments. MASHK Group may not have taken any steps to ensure that the securities referred to in this report are suitable for any particular investor. The contents of this report do not constitute investment advice to any person and such person shall not be treated as a customer of MASHK Group by virtue of receiving this report.Information and opinions presented in this report have been obtained or derived from sources believed by MASHK Group to be reliable, but MASHK Group makes no representation or warranty, express or implied as totheir accuracy, fairness or completeness and MASHK Group accepts no liability for any direct or consequential loss arising from the use of the material presented in this report unless such liability arises under specific statutes or regulations. This report is not to be relied upon in substitution for the exercise of independent judgment. MASHK Group may have issued other reports that are inconsistent with, and reach different conclusions from, the information presented in this report. The reports reflect the different assumptions, views and analytical methods of the analy sts who prepared them. For the avoidance of doubt, views expressed in this report do not necessarily represent those of MASHK Group and may not imply comparable future performance.This report may provide the addresses of, or contain hyperlinks to, various websites. To the extent that this report refers to material outside MASHK Groups own website, MASHK Group has not reviewed the linked sites and takes no responsibility for the content contained therein. Such address or hyperlink (including addresses or hyperlinks to MASHK Group own website material) is provided solely for your convenience and information and the content of the linked sites does not in any way form part of this report. Accessing such websites shall be at your own risk.

MASHK Group may, to the extent permitted by law, participate or invest in financing transactions with the issuer(s) or the new listing applicant(s) referred to in this report, perform services for or solicit business from such issuer(s) or new listing applicant(s), and/or have a position or effect transactions in the securities or other financial instruments thereon. MASHK Group may, to the extent permitted by law, act upon or use the information or opinions presented herein, or the research or analysis on which they are based, before the material is published. MASHK Group, its officers or directors and the analysts preparing this report (each an Analyst and collectively the Analysts) may have relationships with, financial interests in or business relationships with any or all of the companies mentioned in this report (each a issuer or new li sting applicant and collectively the issuer(s) or new listing applicant(s)).Information, opinions and estimates are provided on an as if basis without warranty of any kind and may be changed at any time without prior notice. There can be no assurance that future events or results will be consistent with any such opinion. Nothing in this report constitutes investment, legal, accounting or tax advice nor a representation that any investment or strategy is suitable o r appropriate to your individual circumstances. Nothing in this report constitutes a personal recommendation to you.This report has been prepared by the research analyst(s) in Hong Kong or Korea, who are not associated persons of the member or member organization. These research analysts are not registered as research analysts with FINRA or the NYSE, but instead have satisfied the registration requirements of Hong Kong or Korean standards. These research analysts may not be associated persons of Mirae Asset Securities (USA) Inc. andmay not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. This report has beenprepared by MASHK and/or MAS for distribution in Hong Kong; in Korea by its holding company named Mirae Asset Securities Co. Ltd.; in Vietnam by its joint venture company named Mirae Asset Securities (Vietnam) Joint Stock Company; in the United Kingdom by its subsidiary named Mirae Asset Securities (UK) Ltd; in the United States by its subsidiary named Mirae Asset Securities (USA) Inc.This information may only be issued or passed on to any person in the United Kingdom if that person is of a kind described in Article 19 of the Financial Services and Markets Act 2000 (Financial Promotions) Order 2001 or otherwise pursuant to exemptions to section 21 of the Financial Services and Market Act 2000. In addition, no person who is an Authorised Person may issue or pass on this information, or otherwise promote MASHK Group, to any person in the United Kingdom other than under the rules of the Financial Services Authority (FSA) applicable to such Authorised Persons. This report and any information, material and contents here

in are intended for general circulation only and do not take i nto account the specific investment objectives, financial situation or particular needs or any particular person.Any U.S. recipient of this report that would like further information regarding any security discussed herein should contact Mirae Asset Securities (USA) Inc. Furthermore, any recipient of this report that would like to effect any transaction in any security discussed herein should contact and place the orders with Mirae Asset Securities (USA) Inc. which, without in any way limiting the foregoing, accepts responsibility (solely for purposes of an within the meaning of Rule 15a-6 under the SEC Act of 1934) for this report and its dissemination in the United States.Investments in general and, derivatives, in particular, involve numerous risks, including, inter ali a, market risk, counterparty default risk and liquidity risk. In some cases, securities and o ther financial instruments maybe difficult to value or sell and reliable information about the value or risks related to the security or financial instrument may be absent. The investment(s) mentioned in this report may not be suitable for all investorsand a person receiving or reading this report should seek advice from a financial adviser regarding the suitability of such investment(s), taking into account the specific investment objectives, financial situation or particular needs of that person, before making a commitment to purchase any of such investment(s). The suitability of any particular investment or strategy whether opined on, or referred to in this report or otherwise will depend on a persons individual circumstances and objectives and should be confirmed by such person with his advisers independently before adoption or implementation thereof.This document may not be taken or transmitted into or distributed in Japan, Canada, the Peoples Republic of China or other restricted countries.Copyright September 2011 MASHK Group. All rights reserved

China, Commodities

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