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Jiayou International Logistics (Jiayou) announced its plan to acquire a 20% stake in Khangad Exploration LLC (KEX) with US$88.81mn of its own funds. KEX is held by Baruun Naran S.a.r.l., a wholly-owned subsidiary of Mongolian Mining Corporation (MMC). Jiayou has signed a long-term agreement with MMC to purchase 17.5mnt of coal from the latter over 10 years.

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Expanded to upstream sectors for coal business in Mongolia; JV to boost investment income. According to corporate filings, MMC is the largest producer and exporter of high-quality purified coking coal in Mongolia, while KEX is the holder of mining licenses for the Baruun Naran (BN) area and the Tsaikhar Khudag (THG) area, with total coal reserves of about 450mnt. In 1H23, KEX’s revenue stood at about Rmb600mn and net profit reached about Rmb220mn.

The price of the 20% equity transfer in KEX is US$88.81mn, implying about 7.1x P/E for the acquisition. The P/E multiple is calculated based on annualized data, which we think is reasonable as the selling price of Mongolian 5# coking coal at Ganqimaodu port was about Rmb1,473 in 2H23, vs. Rmb1,401 in 1H23. The P/E multiple is close to 6.7x P/E (TTM) at MMC’s current price (last price on February 21). We think Jiayou’s acquisition of a 20% stake in KEX will result in considerable annual dividend income from the latter.

Solidified cooperation with MMC; secured supply for coal business in Mongolia via long-term contracts. According to MMC’s announcement, it is required to supply Jiayou with 1.5mnt of coal per year for the first five years after the commencement of the delivery, and 2mnt per year for the following five years, a total of no more than 17.5mnt. Delivery prices will be based on current market prices and calculated according to a predetermined formula specified in the marketing agreement.

We believe that for Jiayou, the acquisition will strengthen its long-term strategic cooperation with MMC, ensure stable coal supply, and satisfy　end-market demand. Furthermore, we think this could consolidate its core competitiveness in the China-Mongolia cross-border logistics market thanks to its strong capabilities in supply, logistics, and transportation. We estimate that if the 1.5mnt coal supply from MMC starts this year, it would boost Jiayou’s full-year 2024 profit by about 5.4%.

Leveraging core logistics assets and client base to enhance competitiveness. As a cross-border logistics service provider, we believe Jiayou can improve its operating efficiency and forge unique competitive advantages by leveraging its core logistics assets (including three port franchises, more than 500 vehicles, and bonded warehouses). Meanwhile, we think Jiayou can secure stable supply by cooperating with core mining clients such as MMC, driving sustained growth of its cross-border logistics business.

Financials and valuation

As the acquisition has yet to be registered or approved by relevant government departments, and MMC’s coal supply will not start until the consideration is paid, we keep our 2023, 2024, and 2025 earnings forecasts unchanged at Rmb1.03bn, Rmb1.29bn, and Rmb1.53bn. The stock is trading at 15.6x, 12.5x, and 10.6x 2023e, 2024e, and 2025e P/E. We maintain an OUTPERFORM rating and our target price of Rmb29.56, implying 16.0x 2024e P/E, offering 27.7% upside.

Risks

Geopolitical risks; disappointing economic growth.