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Spring is not far away; OVERWEIGHT
Power tariff increase-expected in 2H08
Initiate on the sector with OVERWEIGHT. We believe an improved CPI
in 2H08 and the growing number of loss-making power plants will lead to
a power tariff increase in July. We expect a 4% power tariff increase in
July 2008, with a 4-10% increase possible in 2H08. The power sector is
experiencing difficult times, including rising coal prices, a tariff freeze,
declining utilization rate, and coal shortage. We expect utilization hours
will stabilize in 2008; coal prices will rise by 12-18% this year and 5% in
2009. China utilities will have to live through an extended winter before
spring arrives. But spring will arrive.
Bottom up analysis
We believe the power tariff increase will be beneficial to all the IPPs and
ease margin deterioration. The market’s concern about negative factors
has been overdone and valuations now look attractive. Industry
replacement cost (ie new project construction cost) stands at USD0.54m
per MW; Huaneng, Datang, and CR Power trade at 0.85x, 1.33x and
1.64x replacement cost, with dividend yields of 5%, 3%, and 2%
respectively.
OVERWEIGHT China Utilities. CR Power is our top pick in the sector;
maintain BUY and raise target price by 11%. Upgrade Datang to BUY.
Initiate on Huaneng Power with a BUY.
Our target prices are based on 20% discount to DCF valuation. Our
assumptions include risk-free rate of 4.72%, and equity risk premium of
9.33%. Beta and terminal growth for Datang, CR, and Huaneng are
1.3,1.2, and 0.89, 2%, 3% and 1%, respectively. We expect utilization
hours to be around 5,700-6,100 hours in 2008, and the coal price rise to
be 12-18% in 2008 and 5% in 2009.
We remain bullish on CR Power on the back of its solid capacity
expansion, stringent cost control, and future contribution from coal mine
projects. The counter is the least vulnerable to margin squeeze. We
upgrade Datang to BUY due to the tariff increase and its leverage in
terms of up-stream business integration and diversified power energies.
Initiate Huaneng with a BUY for its quality assets and high dividend yield.
Contents
A bottom up analysis ..................................................................................................... 3
DCF valuation 3
Power tariff increase expected in 2H08 ......................................................................... 4
Coal power pass-through mechanism 4
Triggers -- CPI and rising number of loss-making IPPs 4
Market has priced in all negative factors 6
Tariff increase in 2H08 is inevitable in our view 7
Power – sustainable demand, declining supply............................................................. 8
Power demand -- growth slows down, but still strong 8
Installed capacity growth to slow down 9
Thermal power – the main power contributor 10
Declining utilization hours to turn around 11
Rising coal cost pressure............................................................................................. 12
Coal price – upward trend 12
Bottlenecks – supply is the issue, not transportation 13
Global coal price – even stronger 14
A bottom up analysis ................................................................................................... 15
Installed capacity allocation 16
Utilization hours depend on the service areas 19
Capacity growth 21
Fuel cost control 22
Coal mine project investment 24
Valuation band 25
DCF valuation method 26
Devil’s advocate: Risks to our investment case........................................................... 28
Company updates........................................................................................................ 29
China Resources Power 30
Datang International Power 33
Huaneng Power International 39
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