This "old energy" is once again under the spotlight

Questioning AI · How can the coal industry transform from a cyclical stock to a dividend asset?

Text by Tai Luo

On March 23, the A-share coal sector performed strongly, with Shanxi Coking Coal, Pingmei Shenhua, Huaihe Mining, Lu’an Environmental Energy, Hengyuan Coal Electricity, Shanmei International, Shaanxi Coal Industry all rising.

Recently, soaring oil and gas prices have sparked imagination around “energy substitution.” Some believe in the story of “coal replacing oil.” For example, in the chemical industry, there are two main routes: oil chemical and coal chemical. Chinese coal chemical technology is quite mature. If oil prices stay high, the proportion of coal chemical could increase, boosting coal demand.

In fact, the coal sector bottomed out as early as 2020, with excellent leaders like China Shenhua and Shaanxi Coal Industry already entering a trendful upward channel as early as 2016.

As a traditional “sunset” industry, what gives coal such sustained explosive power?

At the end of 2015, supply-side reform began, marking the start of capacity reduction in the coal industry. From 2016 to 2020, about 1 billion tons of outdated capacity were eliminated, greatly optimizing the supply-demand structure.

The most direct result was a general rise in the price center of coal. Take coking coal futures prices as an example: from less than 500 yuan in the last cycle, it soared to nearly 3,900 yuan in 2021. Although it has now fallen back to around 1,200 yuan, the annual average price center is still much higher than the previous cycle.

Price increases naturally lead to improved performance and profitability. In 2024, the net asset return rate of the coal sector reached 12%, ranking third among A-share industries, compared to -0.6% in 2015.

At the company level, take China Shenhua as an example. From 2022 to 2024, the company’s net profit attributable to parent remained stable between 68.9 billion and 81.7 billion yuan, significantly higher than the 50 billion average from 2017 to 2021, and far above the less than 30 billion yuan in 2015-2016.

It’s clear that after supply-side reform, although coal prices still fluctuate, the overall center has moved upward. This is the core reason for the steady performance of coal companies and one of the key supports for the sector’s rise.

However, the recent surge in coal prices far exceeded expectations. Relying solely on the upward shift of the price center cannot fully explain this. From a market valuation perspective, a deeper reason lies in a fundamental change in trading logic.

Since 2016, China Shenhua has risen continuously for over 10 years (with only a slight correction in 2018), with a maximum increase of over 650%. During the same period, Shaanxi Coal Industry’s gains exceeded tenfold.

Such sustained and sharp rises are not driven by market sentiment alone or simple valuation repairs but indicate that the market is truly trading a paradigm shift—coal is transforming from a strong cyclical sector into a value dividend sector.

What is the trigger behind this accelerated transformation?

In September 2020, China officially announced the “dual carbon” goals—aiming for carbon peak before 2030 and carbon neutrality before 2060.

This has had a fundamental, systemic, and far-reaching impact on the high-carbon-emission industry of coal, reshaping development models and industry positioning. The most critical change is that capital expenditure has irreversibly decreased, and dividend payout ratios have genuinely increased.

A clear signal is that, despite record profits in 2021-2022, companies did not expand capacity massively as in previous cycles but sharply cut capital expenditure on traditional coal businesses, redirecting funds to dividends and clean energy.

Before 2016, China Shenhua’s capital expenditure ratio (capital expenditure/net cash flow from operating activities) was consistently above 50%, sometimes approaching 100%. Afterwards, this ratio was compressed to over 20%. In recent years, it has rebounded to over 40%, mainly because funds were invested in power generation, transportation, and coal chemical businesses, while investment in traditional coal operations continued to shrink.

On the other hand, the reduction in capital expenditure has led to a significant increase in dividend payout ratios.

Before 2016, China Shenhua’s dividend ratio was generally below 40%. Since then, it has risen sharply, exceeding 70% in the past five years. In 2021, dividends exceeded 50 billion yuan, with a payout ratio hitting 100%.

The significance of increased dividend payout ratios is not just higher yields. In the market’s view, it signals that the interests of large and small shareholders are increasingly aligned.

Meanwhile, domestic interest rates have been continuously declining, driving funds toward dividend assets like coal. Since 2020, influenced by multiple reductions in reserve requirements and interest rates by the central bank, China’s 10-year government bond yield has fallen from above 3.2% to around 1%.

The 10-year Treasury yield is often seen as a risk-free rate. Its significant decline means the cost of equity for companies has decreased, favoring the revaluation of existing assets.

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

From this perspective, after supply-side reform and the “dual carbon” commitments, coal companies’ net profits have improved, combined with higher dividend payout ratios, implying future free cash flows have increased. Looking at the denominator, the discount rate equals the cost of equity minus the long-term growth rate, and the cost of equity has decreased as interest rates fall.

Both numerator and denominator are moving favorably, causing the current value of coal to naturally expand. The deep-rooted change stems from the “dual carbon” policy convincing the market that capital expenditure reductions in coal are irreversible, significantly weakening the sector’s cyclicality, and rapidly restoring its dividend attributes.

This is also the core reason why coal stocks no longer fluctuate with coal prices in cycles.

China Shenhua, the largest listed coal enterprise domestically, has consistently outperformed the sector, making it one of the most alpha-generating leaders in the industry.

For commodities companies, product prices are determined by market supply and demand, and companies cannot set prices themselves. Therefore, core competitiveness lies in cost control. The lower the costs, the better the operational results.

For example, according to 2023 data from Huayuan Securities, China Shenhua’s mining cost was only 179 yuan/ton, only higher than Power Construction Energy among major coal companies. The scale difference is huge—China Shenhua’s coal capacity was 324 million tons, while Power Construction Energy’s was only 46.55 million tons.

Additionally, China Shenhua’s costs are significantly lower than competitors like Shaanxi Coal Industry, China Coal Energy, and Yankuang Energy.

Low extraction costs are directly related to resource endowment. China Shenhua’s coal resources are distributed in Shanxi West, Northern Shaanxi, and Inner Mongolia—areas with some of China’s highest-quality coal deposits, with over 40% open-pit mines. This resource endowment is unmatched by most other coal companies.

Centered on coal extraction, China Shenhua has also built an integrated layout of “coal, power, transportation, port, and shipping,” further strengthening transportation cost advantages and overall competitiveness.

The reason China Shenhua can develop integrated operations is its highly concentrated coal mine distribution. Its largest resource mine is ShenDong Mine, with an annual capacity of nearly 200 million tons, accounting for over 55% of the company’s total capacity. It is adjacent to the second-largest mine, Zhungeer, which is also the corridor to the coast. Such geographic advantages are difficult for other coal companies to replicate.

Of course, including China Shenhua, future potential demand shrinkage cannot be ignored. Currently, renewable energy cannot yet significantly replace traditional energy sources. The key bottleneck is the maturity and large-scale application of energy storage technology.

If revolutionary breakthroughs in energy storage occur in the future, the transition to clean energy will accelerate dramatically. Thermal power, which accounts for over 50% of coal consumption, may face significant demand reduction or even shutdown risks.

However, for this threat, China Shenhua, as one of the few low-cost suppliers of homogeneous commodities, has assets with long durations in coal and coal power, which are likely to far outlast the industry average and most peers. Of course, this day has not yet arrived, and the market has not priced it in.

Overall, the multi-year trend in the coal sector is driven by a reassessment of the industry’s underlying logic by the capital markets. Supply-side reforms optimized the supply structure, the “dual carbon” policy froze capital expenditure, and falling interest rates boosted existing value. In this wave, as cycles fade and dividends emerge, those with genuine cost barriers—leading giants—become market winners.

Disclaimer

This article involves information about listed companies, based on the author’s personal analysis and judgment from publicly disclosed information (including but not limited to interim and annual reports, official platforms, etc.). The information or opinions herein do not constitute any investment or business advice. Market Watch is not responsible for any actions taken based on this article.

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