From Mac Bank:
1H15 continued to be tough for China’s domestic thermal coal market. Prices have recently dropped to the lowest level since 2004, and the restocking by power plants in May and June failed to translate into a noticeable rise in prices (Fig 1). According to the NBS, net profit margin for the whole sector has contracted to mere 1.6% in May, close to one tenth of the level seen in 2011.
Like any companies in a distressed situation, the Chinese coal miners have also tried hard to cut costs. The NBS industrial enterprise database suggests the miners’ administrative expense has been contracting (on a YoY basis) since late 2012, which corresponds to the anecdotes of massive pay cuts or delays of salaries at some mines. Growth of Interest payment has also been decelerating (Fig 2). These signs suggest the current prices are already deep into the cost curve.
The benefits of cost cuts, however, have only helped to bring down prices and have largely been passed through to the miners’ customers. Moreover, leverage is still rising at the miners (Fig 3), with the ratio between total liabilities and total assets having picked up by 8 percentage points since 2011, despite the fact that coal mining FAI growth has been deeply negative for 12 months.
So the struggle of survival is still going on, with the strength of balance sheet being the key variable for miners. As the battle draws on, further cost cuts are probably going to happen, although the room should become increasingly limited.
Indeed, we have seen significant supply cuts already made so far this year, with production by the key state-miners down by YoY 8-9% in 1H15 (including both thermal and coking coal). The unexpectedly weak demand has, however, outshone in the eyes of many investors – by our estimate, the real consumption of thermal coal dropped by YoY 4.5% in 1H15, and if the stock change (at miners, ports and power plants) is considered, apparent demand was 7.3% lower in 1H15 than a year ago (Fig 5). (On our estimate inventory covers key power plants, 6 ports and key major state-owned miners. It doesn’t include all thermal coal inventory in the economy, but already seems quite representative of main players on the market.)
Fast forward one year, replace coal with iron ore and you can leave everything else unchanged.
