Coal, from cycle to value

Ask AI · Why can coal stocks break free from cycle volatility and keep rising?

By Taro

On April 7, the A-share coal sector led the market. Coal stocks including Shaanxi Heimao, China Coal Energy, Xinjì Energy, Dian Tou Energy, Shanghai Energy, and China Shenhua all rose.

In recent times, the sharp surge in oil and gas prices has sparked imagination about “energy substitution.” People in the market have started to believe the story that “coal replaces oil.” For example, in the chemical industry, there are mainly two routes: petrochemical and coal-to-chemical. China’s coal-to-chemical technologies have become quite mature. Once oil prices continue to stay at high levels, the share of coal-to-chemical is expected to increase, which in turn can boost demand for coal.

In fact, the coal sector already bottomed out and reversed as early as 2020. High-quality leading companies represented by China Shenhua and Shaanxi Coal Industry had already started a trend-based upward channel back in 2016.

As a traditional “sunset” industry, why does coal have such sustained explosive power?

At the end of 2015, supply-side reform kicked off, and the coal industry began a major push to cut capacity. From 2016 to 2020, the coal industry cumulatively eliminated about 1 billion tons of outdated capacity, and the supply-demand landscape was significantly optimized.

The most direct result is that the coal price center of gravity has risen overall. Taking coking coal futures prices as an example, the price in the previous cycle was below 500 yuan, but it once skyrocketed to nearly 3,900 yuan in 2021. Today, although it has fallen back to around 1,200 yuan, the annual average price center of gravity is still far higher than that of the previous cycle.

Higher prices naturally lead to improved performance and profitability. In 2024, the coal sector’s return on net assets reached 12%, ranking third among all industries in A-shares; in 2015, this figure was still -0.6%.

At the enterprise level, taking China Shenhua as an example: from 2022 to 2024, the company’s net profit attributable to shareholders has remained stable in the range of 68.9 billion to 81.7 billion yuan, clearly higher than the average level of 50 billion yuan from 2017 to 2021, and far above the performance of less than 30 billion yuan in 2015 to 2016.

As can be seen, after supply-side reform, although coal prices still fluctuate, the overall center of gravity has moved up. This is the core factor behind the steady performance of coal enterprises, and also one of the important supports for the coal sector’s rise.

However, coal’s rally over the past few years has far exceeded expectations. Simply relying on the upward shift in the earnings center of gravity cannot fully explain it. In terms of what can be observed from market capitalization, the deeper reason is that the logic of market trading has undergone a fundamental change.

Since 2016, China Shenhua has risen for more than 10 consecutive years (only a small pullback in 2018), with a cumulative maximum gain of over 650%. Over the same period, Shaanxi Coal Industry’s gain has even exceeded 10 times.

Such sustained and sharp increases are not driven by market sentiment, nor is it a simple valuation reset. Instead, the market has truly begun to price in a real paradigm shift—coal is transforming from a strong cyclical sector into a value and dividend-driven sector.

What is the fuse behind this acceleration?

In September 2020, China officially announced its “dual carbon” goals—striving to achieve carbon peaking before 2030 and carbon neutrality before 2060.

This has had fundamental and systemic long-term impacts on the coal industry, a high carbon-emissions sector; it has reshaped development models and industry positioning. The most core change is that capital expenditures will decline irreversibly, while dividend payout ratios increase in a tangible, real way.

One clear signal is that although industry profits reached historical highs in 2021 and 2022, companies did not expand production capacity at a large scale as in previous cycles. Instead, they sharply reduced capital expenditures in their traditional coal business, used the money to pay dividends, and redirected it toward clean energy.

Before 2016, China Shenhua’s capital expenditure ratio (capital expenditures / net cash flow from operating activities) had been maintained at more than 50% for years, and in some years it even approached 100%. After that, this ratio was compressed to the low 20% range. In the past one to two years, it has rebounded to over 40%, mainly because the money was invested in power generation, transportation, and coal chemical businesses, while investment in traditional coal business has continued to shrink.

The other side of reduced capital expenditures is a significant increase in the dividend payout ratio.

In 2016 and earlier, China Shenhua’s dividend payout ratio was basically below 40%. After that, it rose sharply, and the average over the past five years has been above 70%. In 2021 in particular, it was extremely generous: the dividend amount exceeded 50 billion yuan, and the dividend payment ratio was pushed all the way to 100%.

The significance of a higher dividend payout ratio is not just that the dividend yield becomes higher. In the eyes of the market, this is also a signal that the interests of major and minority shareholders are moving toward alignment.

At the same time, domestic interest rates have continued to fall, which is also driving funds to gravitate toward dividend-style assets like coal. From 2020 to the present, affected by the People’s Bank of China’s multiple RRR cuts and interest rate cuts, China’s 10-year government bond yield has fallen steadily from above 3.2% to around 1%.

The 10-year government bond yield is often regarded as the risk-free rate. When it declines sharply, it means the equity operating cost for companies is lowered, which benefits the reversion of existing value.

As early as more than 50 years ago, Buffett proposed in “The Theory of Investment Value” that a company’s current value equals the sum of free cash flows generated during its lifetime, discounted at an appropriate interest rate. This is the classic DCF valuation model.

Using this perspective on coal: after supply-side reform and the “dual carbon” commitments, coal companies’ net profits have stepped up. Combined with the increase in the dividend payout ratio, it implies that future free cash flow will thicken. Looking at the denominator, the discount rate equals the cost of equity minus the long-term growth rate, and the cost of equity is falling as interest rates decline.

With both the numerator and denominator working together, the present value of coal naturally continues to expand. And this entire deep-seated shift originates from the “dual carbon” policy causing the market to believe that coal companies’ capital expenditures declining is an irreversible trend, coal’s cyclicality is being greatly weakened, and its dividend attributes are rapidly returning.

This is also the core reason coal stocks no longer fluctuate along with the coal price cycle.

China Shenhua is the largest publicly listed coal enterprise in China. It can continuously outperform the coal sector and is arguably one of the most obvious alpha leaders in the industry.

For commodity companies, the selling price of products at the end-market is determined by supply and demand in the market, and the company itself cannot set the price. Then the key competitive advantage lies on the cost side: the lower someone’s costs are, the better their operating results.

For example, according to 2023 data compiled by Huayuan Securities: China Shenhua’s mining cost is only 179 yuan per ton, which is higher than only Dian Tou Energy among major coal companies. But the two companies’ scale are absolutely not in the same order of magnitude—China Shenhua’s coal production capacity in that year was 324 million tons, while Dian Tou Energy had only 46.55 million tons.

In addition, China Shenhua’s costs are clearly lower than those of competitors such as Shaanxi Coal Industry, China Coal Energy, and Yanzhou Energy.

Low coal mining costs are directly related to resource endowments. China Shenhua’s coal resources are distributed across Jinxi West, northern Shaanxi, and southern Inner Mongolia—China’s best-quality coal producing areas—where the proportion of open-pit mines is as high as more than 40%. Such resource endowments are beyond comparison for the vast majority of coal companies.

Around the core business of coal mining, China Shenhua has also built an integrated layout of “coal-power-transport-port-shipping-chemicals,” further widening its transportation cost advantage and strengthening its overall competitiveness.

The most core reason China Shenhua can operate an integrated business is that its coal mines are highly concentrated. Specifically, its largest resource mine is the Shendong mining area, with annual capacity of nearly 200 million tons, accounting for more than 55% of the company’s total production capacity. Right next to it is the second-largest mining area, the Zhun Ge’er mining area, which is exactly on the route for shipping coal to coastal areas. With such geographic conditions, other coal companies find it hard to replicate.

Of course, including China Shenhua, coal companies in the future may not be able to avoid the threat of potential demand contraction. At present, new energy cannot temporarily replace traditional energy on a large scale; the key bottleneck lies in the maturity of energy storage technology and its large-scale application.

If energy storage technology achieves a revolutionary breakthrough in the future, the transition to clean energy could accelerate significantly. Thermal power generation, which accounts for more than 50% of coal consumption, may face the risk of a sharp decline in demand and even shutdowns.

But regarding this threat, China Shenhua, as one of the few low-cost suppliers in a market of homogeneous goods, has the duration of its coal and coal power assets destined to be far longer than the industry average and most peers. Of course, that day has not arrived yet, and the market has not yet fed back into pricing.

Overall, the deep underlying drivers of this long multi-year uptrend in the coal sector come from the capital market’s reassessment of the industry’s underlying logic. Supply-side reform optimizes the supply structure; “dual carbon” policies lock in capital expenditures; and falling interest rates also lift the present value. In this wave, as the cycle fades and dividend attributes become visible, those true leaders with cost barriers become the winners in the market.

Disclaimer

This article involves content related to listed companies. The author’s personal analysis and judgments are based on information publicly disclosed by listed companies according to their legal duties (including but not limited to interim announcements, periodic reports, and official interaction platforms). The information or opinions contained in this article do not constitute any investment or other commercial advice. The “Market Value Observer” assumes no responsibility for any actions taken based on the adoption of this article.

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