There is a stock which was traded at 9.466 Hong Kong dollars on the last trading day of 2019. Holding it until now, it goes ex-dividend on June 27th, 2024, with a total dividend received of 12.07 Hong Kong dollars in five and a half years, equivalent to not only breaking even but also a profit of 2.604 Hong Kong dollars, a 27% gain. This is not even counting the increase in the stock price itself.

The current closing price of this stock is HKD 34. Therefore, it can be calculated as follows: investing HKD 9.46 on the last day of 2019, and with the increase in the stock price plus dividend, the total net value is HKD 46.07, an increase of 3.867 times, equivalent to an annualized rate of return of up to 37%. It far outperforms the Hang Seng Index, the Shanghai Composite Index, the CSI 300 Index, the S&P 500, and the NASDAQ during the same period and may even outperform Buffett in the short term if the trend continues.

This topnotch stock is on the Hong Kong stock market, and everyone is familiar with it, but many people have overlooked its value. It is: China Shenhua Energy (01088).

This article introduces the long-term investment value of China Shenhua Energy, as well as the key stocks and analysis methods in the coal sector.

1. Investment Logic of China Shenhua

The example at the beginning of the article is not just made up. It is based on real data. Please see the chart below.

This is the time series of China Shenhua's dividend and EPS since 2006. More detailed data for the past five years is shown in the table below.

From 2019 to 2023, five years in total, Shenhua paid dividends of 1.38, 2.16, 3.13, 2.91, and 2.49 HKD, respectively. All of them are cash dividends, or real silver and gold. The sum of these five numbers is the aforementioned HKD 12.07. The ex-right date for the last dividend is June 27 this year. Due to speculation about the ex-right, Shenhua's stock price fell sharply by 5.53% that day but then recovered the decline. (For the routines and strategies surrounding ex-rights trading, please refer to our previous articles.)

Because of the high dividend feature, Shenhua's valuation model is different from that of most stocks. The market generally tends to adopt the simplest and crudest model for value stocks: dividend yield model. There is no need to calculate EPS or PE.

Due to dividend payment, comparing the dividend rate of the stock with that of major bonds in the same period can tell the value of the stock. For example, according to Shenhua's algorithm, assuming a risk-free rate of return of 4.1% (10-year US Treasury bond) for the 2023 dividend of HKD 2.49, and a required rate of return for holding stocks of 6%, the corresponding stock price is HKD 41.5. This price is close to the local high of 38.3. Even with a requirement of 10% dividend rate, the stock price is HKD 24.9. This value is actually Shenhua's stock price at the beginning of this year.

In summary, knowing the annual dividend and deducing the company's stock price based on a certain rate of return can reveal the company's stock price. And what factors are related to the company's dividend payment?

There are mainly two factors: first, earnings per share, and second, dividend payout ratio. In fact, the company's annual financial statements disclose these two factors.

Historically, the company's dividend payout ratio was relatively low before 2016, generally below 40%, and below 35% before 2009. The company's dividend payout ratio has continued to increase since 2017, from 39.2% in 2017 to 40% in 2018, and 58% in 2019. The dividend payout ratio for 2020 and 2021 is 100%. And it's 70% for 2022 and 2023.

The increase in dividend payout ratio is almost consistent with the timetable for supply-side reform and environmental production restriction policies. In the earlier state-owned enterprise reform, increasing the dividend payout ratio of state-owned enterprises was also a major goal. In the future, the company's dividend payout ratio may be maintained at a high level for a long time.

In terms of specific business performance, from the data of the past five years, it can be seen that China Shenhua has maintained steady growth in revenue and has not been affected by the epidemic. EPS has also maintained an upward trend, with a slight decline in 2023.

From the perspective of business segments, according to the company's 2023 financial report data, the coal business accounts for 66.5% (about one-third), followed by power generation, accounting for 26.88%. Rail transportation, coal chemical, ports, and shipping businesses have relatively low proportions.

The biggest feature of the company's business is the linkage between coal and power generation, which can internally offset the business fluctuations caused by coal price fluctuations. Specifically, when coal prices rise, coal business grows but low-cost power generation is negatively impacted. Conversely, when coal prices fall, the coal business is damaged, but power generation benefits from lower costs.

2. Other Coal Stocks in the Sector

2 coal sector other stocks

In addition to China Shenhua Energy, other important coal stocks in the Hong Kong stock market include Yankuang Energy, Shougang Res, and Yancoal Aus. Yankuang Energy and Yancoal Aus mainly engage in thermal coal business, while Shougang Res is mainly focused on coking coal. These companies are all concentrated in the coal industry and do not have the coal-electricity linkage effect of Shenhua, so they are relatively sensitive to changes in coal prices.

For example, taking Yankuang Energy as an example, the graph below shows that the company's revenue and profits have fluctuated greatly in the past five years. In 2022, stimulated by the rise in global commodity prices and coal prices, the company's revenue and profits increased significantly. However, in 2023, with the fall of coal prices, the company's performance declined across the board.

In addition, looking at dividend distribution, the company's dividend payout ratio is also not as stable as Shenhua's. For example, starting in 2018, the dividend payout ratio for that year was 30%, with two dividend payments in 2019 and a total dividend payout ratio of 50%, followed by a dividend payout ratio of 79% in 2020, 55% in 2021, 67% in 2022, and so on. It can be seen that the dividend payout ratio fluctuates greatly.

Large fluctuations in earnings per share, combined with large fluctuations in dividend payout ratios, mean that Yankuang Energy cannot be treated as a dividend stock like Shenhua, but can only be calculated using PE models. And for stocks with large earnings fluctuations, the Hong Kong stock market generally cannot provide too high a PE.

All of the above factors have led to Yankuang Energy not having the long-term holding value of Shenhua. In addition, the company occasionally undergoes rights issues, such as in early June of this year, when it sold 0.285 billion shares at a discount of nearly 10%, raising HKD 4.96 billion. This also undermines the confidence of investors who plan to hold the stock for the long term.

At the time of the rights issue, the stock price was at a high for the year and a historical high, but fell after the rights issue. As of today's closing price, it has fallen 25% below the rights issue value.

The other two stocks, Yancoal Aus and Shougang Res, are similar to Yankuang Energy, with their business mainly focused on coal mining and related coal products, and are therefore more affected by fluctuations in coal prices. It is worth mentioning that Yancoal Aus's business is concentrated in Australia, and its coal prices are influenced by Australian thermal coal rather than domestic thermal coal prices.

Shougang Res's main business is coking coal, with the main influencer being the price of coking coal futures on the Dalian Commodity Exchange. Unlike thermal coal, which is mainly used for power generation, coking coal is mainly used for steelmaking.

3 Conclusion

Coal is an important sector in the Hong Kong stock market. China Shenhua Energy is a relatively special stock, with less sensitivity to coal price fluctuations and long-term stability in stock prices and dividend payouts, making it a long-term value stock with some characteristics of high-yield bonds.

On the other hand, Yankuang Energy and other coal stocks, whose business is concentrated in coal mining, coal processing, and coal sales, are more susceptible to coal price fluctuations, with large fluctuations in performance and dividends, and are typical cyclical stocks.

From an investment strategy perspective, if you want to hold long-term and stable dividends, focus on Shenhua; if you expect explosive growth in stock prices due to rising coal prices, stocks like Yankuang Energy are more sensitive.