We initiate coverage of Russian coal companies Mechel, Raspadskaya, Kuzbasskaya Toplivnaya Kompania (KTK) and Kuzbassrazrezugol (KZRU). Coal is vital for the world economy: it is a basic fuel for power generation, transport and steel. Russia is a strategic player in the global coal trade, hosting 18% of the world's coal reserves. Russian coal companies offer large, good-quality reserves and competitive production costs, making some of them interesting investment ideas, in our view.
World coal consumption should rise with long-term demand driven by Asia. Coal accounts for 27% of the world’s primary energy demand, making it the second-most important fuel after oil. The International Energy Agency estimates that coal demand will grow more strongly than all other energy sources at an average annual rate of 1.9% (from 4,548 Mtce in 2007 to 9,980 Mtce) in the period to 2030. Most of the projected increase in demand should come from Asia, mainly China and India.
The Fukushima effect. After a major nuclear accident in Fukushima, Japan in Apr 2011, many Asian and European countries started to reconsider their use of nuclear energy in favour of traditional fossil fuels such as coal and gas. Immediately after the incident, British mining group Xstrata signed an annual thermal coal contract with Chugoku Electric Power of Japan priced at $130/tonne, which reflected a 30% YoY gain in price, higher than the $125/tonne peak reached in 2008.
Russian coal continued its post-crisis recovery in 2011. According to Metalexpert, Russia’s total coal production last year reached 336mt (up 5% YoY), higher than the pre-crisis level of 326mt in 2008. Thermal coal output grew 7% to nearly 265mt. However, coking coal production slipped 5% YoY to 60mt due to an output decline at Raspadskaya mine, which has not yet been restored since the accident in 2010.
More floods in Australia this year. Flooding caused a production disruption in Australia, the world's second-largest coal supplier, in Feb 2011, raising coking coal prices to $367/tonne. The Fukushima blasts then drove a speculative rush on thermal coal. After that, prices began to subside. In early 2012, Australia experienced flooding similar to that seen in 2011, if less severe. News agencies reported waters rising in parts of Queensland in early February, leading to the largest evacuation in the nation’s history. Increased major flood risk in Australia should provide near-term support for coking and steam coal prices, in our view.
Higher WACC assumptions to reflect credit market risks. Our FI team expects liquidity deterioration on the eurobond market in the coming months, which could produce a chain reaction on the local bond market. We worry that companies with high debt burdens − such as Mechel or Kuzbassrazrezugol − will face serious problems with debt refinancing. In our calculations, we apply an 11.5% cost of debt for Mechel, 11% for Raspadskaya, 12.5% for KTK and 13% for KZRU to account for higher credit risks.
A BUY rating for Mechel prefs and Raspadskaya. We assign a BUY rating to our top pick Raspadskaya with a TP of $5.3. Mechel prefs are an interesting dividend story offering a 14% yield; we rate them a BUY (TP $5.6/ADR). Kuzbasskaya Toplivnaya is rated a HOLD (TP $5.6/share) as well as Mechel ordinaries (TP $12.2/ADR). Kuzbassrazrezugol is the only SELL in our coverage with TP of $0.28/share.
Back
