Company Research | HK & China

Winsway Coking Coal Holdings

February 3, 2012

Winsway Coking Coal Holdings (1733.HK)

BUY | Share price: HK$1.93 | Target price: HK$3.51 | Upside: +82%

Jonestowns accusations are flawed maintain our Buy rating

Jonestown challenges accuracy of Winsways numbers. Jonestown Research (JR) released two reports on January 19 and 20, 2012, challenging the accuracy of the value of Winsways 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 Winsways reported inventory stockpiles are materially misstated. THE REBUTALL We believe Jonestowns methodology in calculating Winsways inventory is incorrect and its 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). 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. Moveday has five Mongolia-incorporated operating subsidiaries. Neither Winsway nor any of its controlling shareholders hold any shares of Moveday. 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.

Analyst David Lam

SFC CE No.: AVL286 +852 28993130 david.lam@guosen.com.hk

Sales Contact Dan Weil

Global Head of Institutional Sales and Trading Managing Director +852 2248 3588 dan.weil@guosen.com.hk

Official China import data shows volumes are far lower than those that Winsway reported. Winsways key transportation provider, Moveday, was actually an undisclosed related party. Margins for coal trading should not be higher than ~RMB100/tonne.

Chris Berney
Managing Director +852 2248 3568 chris.berney@guosen.com.hk

Joe Chan
Director +852 2248 3578 joe.chan@guosen.com.hk

Cancy Kong
Vice President +852 2248 3538 cancy.kong@guosen.com.hk

Maintain Buy rating. Winsway denied JRs allegations in mid-January. Based on our research on coal prices and similar companies, we believe Jonestowns calculation approach is erroneous. Winsways 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.

Jiafeng Li
Vice President +852 2899 7281 lijf@guosen.com.hk

Chen Long
Vice President +852 2248 3548 chen.long@guosen.com.hk

Profit forecasts
Year to Dec 31 Turnover (HK$ mn) Turnover growth (y-o-y, %) Net profit (HK$ mn) Net profit growth (y-o-y, %) EPS (HK$) Operating cash flow per share (HK$) P/E (x) P/B (x) Dividend per share (HK) 2009A 5,283 374% 515 111% 0.25 0.174 10.2 5.2 0 2010A 9,272 75% 929 80% 0.35 1.174 7.3 1.5 0 2011E 14,584 57% 1,413 52% 0.37 2.174 6.9 1.2 0 2012E 17,712 21% 1,638 16% 0.43 3.174 5.9 1.0 0 2013E 21,978 24% 1,978 21% 0.52 4.174 4.9 0.9 0.157

Shunei Kin
Vice President +852 2248 3536 shunei.kin@guosen.com.hk

Source: Guosen Securities HK

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

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

Jonestowns calculation misses the mark

We believe Jonestowns methodology to calculate Winsways 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 Winsways 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 Winways coal inventory vs Jonestowns methodology
Illustrative assumption: As at the beginning of 2007 Average unit cost of inventory as at the beginning of 2007 Average cost of goods purchased Inventory tonnage as at the beginning of 2007 Goods purchased in 2007 Goods sold in 2007 RMB/tonne RMB/tonne tonne tonne tonne 5 7 2 10 5

Under FIFO (First in, first out) accounting method Average sales cost RMB/tonne 6.2 As at the beginning of 2007 Inventory value Inventory tonnage RMB tonne 10 2 As at the end of 2007 49 7

Assumption used in Jonestown Researchs calculation approach A Inventory value as at the year end Average cost of goods sold Inventory as at the year-end B Changes in inventory value during the year Average cost of goods sold Net increase of inventory tonnage in 2007 C Inventory tonnage as at the year end Net increase of inventory tonnage in 2007 Inventory tonnage as at the beginning of the year RMB RMB tonne RMB RMB tonne tonne tonne tonne 49 6.2 7.9 39 6.2 6.3 7.9 6.3 1.6

Difference between the actual inventory tonnage and Jonestowns calculation results As at the beginning of 2007 Actual inventory tonnage Jonestowns estimates Difference tonne tonne 2 1.6 As at the end of 2007 7 6.6 6%

Source: Guosen Securities HK

Guosen Securities (HK) Brokerage Co., Ltd.

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

Basis of Winsways 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. Winsways core competitiveness lies in its one-stop distribution platform and logistics facilities. Coal prices are usually much higher in other parts of China than Winsways 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 Semi-soft coking coal Hard coking coal Washed hard coking coal 1/3 coking coal Coking coal Coking coal Origin Sale area Ash content Volatile (%) content (%) 8 25 10 10.5% 30 25 26 252 Sulphur content (%) <1 <1 <1 0.6% CSN 4-5 >6 >6 Cementation index (G) 85 Price (RMB/tonne) Appro.434 621 1000 670 684 501 Note Tax not included Tax not included Tax not included Tax not included Tax not included Tax not included Source SouthGobi MMC MMC Chinese business agent of MXM, Mongolia Chinese business agent of MXM, Mongolia coalcoke.net Ovoot Tolgoi Ceke Port coal mine Tavan Tolgoi Ganqimaodu coal mine Port Tavan Tolgoi Ganqimaodu coal mine Port Ejinaqi Ganqimaodu Port

Tavan Tolgoi Ganqimaodu coal mine Port

Hebei
Product Clean coking coal 1/3 clean coking coal Origin Sale area Tangshan, China Tangshan, China Ash content Volatile (%) content (%) 1 10 23- 5 29-32 Sulphur content (%) <1 <1 CSN Cementation index (G) >80 80-90 Price (RMB/tonne) 1600 1500 Note Ex-mine price Ex-mine price Source sxcoal.com sxcoal.com

Qinhuangdao
Product Coking coal Tianjin Port 1/3 coking coal Australia Tianjin Port 10 36 0.6 85 1330 Ex-stock price Inner-Mongolia coal trading center Origin Australia Sale area Qinhuangdao Ash content Volatile (%) content (%) 9 25 Sulphur content (%) <0.6 CSN Cementation index (G) 85 Price (RMB/tonne) 1700 Note Ex-stock price Source Inner-Mongolia coal trading center

Inner-Mongolia
Product 1/3 coking coal Rich coal Clean coking coal Origin Sale area Wuhai, China Wuhai, China Baotou, China Ash content Volatile (%) content (%) 7 <10.5 10 24 33 Sulphur content (%) 0.8 1.8-2.0 1 CSN Cementation index (G) >90 85 Price (RMB/tonne) 1450 1380 1270 Note Source C.F. (cost and Inner-Mongolia coal freight) price in Hebei trading center C.F. (cost and Inner-Mongolia coal freight) price in Hebe trading center Ex-mine price coalcoke.net

Port of Shanghai
Product 1/3 coking coal Shanxi clean coking coal Origin Russia Shanxi, China Sale area Port of Shanghai Port of Shanghai Ash content Volatile (%) content (%) 9 <9 27-39 28 Sulphur content (%) 0.2 1 CSN Cementation index (G) >70 >85 Price (RMB/tonne) 1180 1750 Note Ex-dock price Ex-dock price Source Inner-Mongolia coal trading center coalcoke.net

Source: Company information, Guosen Securities HK

Guosen Securities (HK) Brokerage Co., Ltd.

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

Exhibit 3: Winsways coal purchase prices and selling prices to steel plants
Semi-soft coking coal (Ceke border)
Purchasing cost 1. Ceke border: semi-soft coking coal price 1. Ceke border: value-added taxes 4. Urad zhongqi coal preparation plant: from Ceke to Urad zhongqi preparation plant 4. Urad zhongqi coal preparation plant:coal washing cost 4. Urad zhongqi coal preparation plant: total production cost of clean coal Railway freight cost (1,180km)from coal preparation plant to Hebei 2. Hebei: sub-total Gross profit of the company Hebei: selling price 273 HK$/tonne 46 HK$/tonne 235 HK$/tonne 23 HK$/tonne 769 HK$/tonne 256 HK$/tonne 1,025 HK$/tonne 300 HK$/tonne 1,325 HK$/tonne 1. Ceke border: semi-soft coking coal price 1. Ceke border: value-added taxes 1. Ceke border: storage and processing expenses 1. Ceke border: sub-total of clean coal cost Truck freight cost (2,500km) (from the border to Hebei) 2. Hebei: total/local market price Purchasing cost for steel plants 400 HK$/tonne 68 HK$/tonne 10 HK$/tonne 478 HK$/tonne 971 HK$/tonne 1,449/1,500 HK$/tonne

Hard coking coalGanqimaodu border

Purchasing cost 3. Ganqimaodu border: hard coking coal price 3. Ganqimaodu border: value-added tax Truck freight cost150km(from Ganqimaodu border to Urad zhongqi coal preparation plant) 4. Urad zhongqi coal preparation plant: coal washing cost 4. Urad zhongqi coal preparation plant: sub-total of clean coal cost Railway freight cost1,180km)from Urad zhongqi to Hebei 2. Hebei: sub-total Gross profit of the company 2. Hebei: selling price 702 HK$/tonne 119 HK$/tonne 50 HK$/tonne 23 HK$/tonne 1,192 HK$/tonne 256 HK$/tonne 1,448 HKD/tonne 300 HKD/tonne 1,748 HKD/tonne 3. Ganqimaodu border: hard coking coal price (Ganqimaodu border) 3. Ganqimaodu border: value-added tax 3. Ganqimaodu border: storage and processing expenses 3. Ganqimaodu border: sub-total of clean coal cost Truck freight cost (1,330 km) (from border to Hebei) 2. Hebei: total/ local market price Purchasing cost for steel plants 1,170 HK$/tonne 199 HK$/tonne 10 HK$/tonne 1,379 HK$/tonne 516 HK$/tonne 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 Chinas 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 Groups 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 groups 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.

Guosen Securities (HK) Brokerage Co., Ltd.

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

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 Qinfas 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 Winsways 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 Winsways 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 RMB3RMB5 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 Winsways 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 Winsways 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.

Guosen Securities (HK) Brokerage Co., Ltd.

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

Appendix 1: Winsways income statement

HK$ mn Turnover Cost of sales Gross profit Other revenue Selling expense Administrative expenses Other expenses Profit from operating activities Finance income Finance costs Net financial costs Share of losses of jointly controlled entity Profit before taxation Income tax Equity shareholders of the company Basic earnings per share Dividend per share 2009A 5,283 (4,322) 961 9 (269) (104) (1) 596 7 (42) (35) 0 561 (70) 515 0.25 0 2010A 9,272 (7,154) 2,118 26 (471) (359) (11) 1,302 66 (180) (114) (8) 1,180 (251) 929 0.35 0 2011F 14,584 (11,162) 3,421 44 (1,080) (467) (15) 1,904 145 (157) (12) (8) 1,884 (471) 1,413 0.37 0 2012F 17,712 (12,793) 4,919 53 (1,949) (567) (18) 2,439 130 (377) (247) (8) 2,184 (546) 1,638 0.43 0 2013F 21,978 (15,575) 6,403 66 (2,705) (703) (22) 3,039 130 (523) (393) (8) 2,638 (659) 1,978 0.52 0.16

Source: Guosen Securities HK

Appendix 2: Balance sheet

HK$ mn Cash and cash equivalents Trade and other receivables Inventories Other current assets Total current assets Property, plant and equipment, net Intangible assets Investment in the jointly-controlled entities Deferred tax assets Other non-current assets Other non-current assets Total non-current assets Total Assets Short-term loans Trade and other payables Income tax payable Other short-term liabilities Long-term loans Other long-term liabilities Total long-term liabilities Total equity attributable to equity shareholders of the company Minority interests Total liabilities and equity 2007A 38 251 173 37 499 79 2 0 21 49 151 651 124 194 21 0 339 0 3 3 1 308 651 2008A 99 290 322 323 1,035 289 1 0 37 47 374 1,409 599 264 9 0 873 0 2 2 0 535 1,409 2009A 277 1,840 1,190 644 3,951 447 0 0 34 67 548 4,499 1,590 1,729 35 0 3,354 0 0 0 1144 0 4,498 2010A 2,894 2,451 1,973 344 7,662 474 0 363 48 576 1,461 9,123 1,010 1,317 91 0 2,418 63 97 160 6469 76 9,123 1H2011 5,763 3,675 2,845 598 12,881 646 0 363 47 1472 2,528 15,409 572 3,533 130 1 4,236 3861 111 3972 7123 78 15,409

Source: Guosen Securities HK

Guosen Securities (HK) Brokerage Co., Ltd.

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

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.

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