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Executive summary
Outlook
We are rolling out the full coverage of the China power generation equipment sector with
two new initiations – of Dongfang Electric (1072, Buy) and Harbin Power (1133.HK, Buy). We
believe Chinese power equipment players will enjoy an extended upcycle thanks to
strong power demand growth, small capacity closure, greater export potential and
future development in hydro, nuclear, wind, gas and service spaces.
In this report, we are addressing the following key sector trends as well as the outlook for
various end-markets.
What’s the outlook for China’s power generation equipment sector after a record
performance in FY07? Is the cycle going to witness a downtrend or continue to enjoy a
robust order pipeline? What is the implication of new government initiatives, such as the
clamp-down on small inefficient plants? What’s the market outlook for China’s
equipment exports? What are the projections vis-à-vis sales output for the three Chinese
players?
What are the prospects for hydro power equipment orders and who are the key
beneficiaries? Is China emerging as a global leader in the hydro space? How big is the
nuclear power equipment market? What market shares are left for China and foreign
players, and what are the individual positions of the three local players?
Will gas power equipment development be stalled in China given the current gas
shortage? Is it still an important area for the future? Who will benefit from the wind
power capacity boom? What’s the outlook for the equipment service market in China?
Overall, our findings point to a robust outlook for China’s power equipment sector.
Therefore, we believe a further multiple re-rating is justified as the market seems to
value the Big Three with peak-cycle earnings against our earnings expectation of stable
growth over the next 2~3 years. (our FY09 earnings forecasts are above consensus). And
we believe we are also the first on the street to list all the secured orders for the Big Three,
with detailed delivery schedules, which are included in our separate, published company
reports.
Valuation
We think all three power equipment stocks have upside to our TPs, which use an EV/EBIT of
8.5x for Harbin Power, 12x for Dongfang Electric and an average 11x for Shanghai Electric.
We believe our target EV/EBIT multiples are reasonable compared to the trading range of
8.9~25.1x for global peers. The lower multiple we use for Harbin is due to its low margin,
poor track record and weak disclosures. We note that Indian and Russian players are
currently trading at much higher FY08F EV/EBITs (FY08:16~21x, FY09: 12~14x) due to their
stronger growth outlook, evidenced by a >50% EBIT CAGR in FY06-08F. European players,
which offer a more comparable EBIT growth prospect, are currently trading at an average
11.5x FY08F EV/EBIT.
Risks
The biggest downside risk to our investment thesis is an unexpected macro slowdown in
China, which is likely to negatively impact new order inflows. Other downside risks include
deteriorating product ASPs, a higher cost base, and higher tax rates.
Table of Contents
Executive summary ........................................................................... 3
Outlook ....................................................................................................................................3
Valuation ..................................................................................................................................3
Risks ........................................................................................................................................3
Extended power equipment upcycle benefits all ........................... 4
Strong power consumption growth requires more capacity.....................................................4
Closure of small units to trigger replacement demand .............................................................5
Revised capacity forecast points to modest new order decline ...............................................6
Export market – entering onto global stage ................................... 7
Unrivaled cost advantage and delivery time..............................................................................7
Proven track record in quality....................................................................................................8
A leap in technology .................................................................................................................9
Benefit from enhanced export financing and overseas investment ........................................10
Ride on coal capacity renaissance ..........................................................................................10
Global position of Chinese players..........................................................................................11
Hydro power: more favorable to Dongfang and Harbin............... 14
Late cycle exposure - helps to smooth out earnings volatility.................................................14
Three Gorges Project – cornerstone of China’s hydro manufacturing ability ..........................15
Pump storage – another growth engine..................................................................................17
Nuclear power - a boon for all........................................................ 18
A Rmb110b market with further upside..................................................................................18
Westinghouse’s AP1000 is preferred over Areva’s EPR for 3rd generation technology..........18
Localization is a must; more opportunity for Shanghai/Harbin in AP1000...............................19
2+ generation technology in parallel development – opportunity for Dongfang .....................19
Gearing up to capture the market share..................................................................................19
Wind power –Dongfang is an early bird ........................................ 21
The official target of 5GW in 2010 and 30GW in 2020............................................................21
Government policy favors China-made equipment .................................................................21
Six times higher ASP per MW than thermal equipment .........................................................22
Wind exposure of the three ....................................................................................................22
Gas power – gas shortage is a short-term glitch.......................... 24
Gas field findings in China could reignite CCGT interest .........................................................24
Not just natural gas .................................................................................................................25
An important export market to combat...................................................................................25
Service/EPC – a growing revenue contributor............................. 26
Enlarged installed capacity base and leaner plant staff base ..................................................26
Changing capacity mix and more competitive wholesale market ...........................................26
Turnkey solutions for export orders ........................................................................................26
Appendix A: Catalogue of preferred projects & capacity mix
forecasts ........................................................................................... 27
Harbin Power ................................................................................... 30
Dongfang Electric ............................................................................ 50
Shanghai Electric............................................................................. 72
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