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China IPPs
V shape recovery in sight
Michael Tong, CFA
Research Analyst
(852) 2203 6167
michael.tong@db.com
Eric Cheng, CFA
Research Analyst
(852) 2203 6202
eric-ct.cheng@db.com
The tide has turned
We are seeing four positives for the sector. First and foremost, the 30% fall in the
spot coal price in Nov indicates a yoy coal price decline in '09 is attainable.
Second, massive interest rate cuts should clearly benefit debt-ridden IPPs. Third,
coal production ramp-ups at IPPs' owned mines may pre-empt any price support
through production cuts. Last but not least, heavy investments in railways will
boost coal availability in the medium term. Though utilization may trend down, the
net impact is on the upside. It is still not too late to buy.
Deutsche Bank AG/Hong Kong
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local
exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche
Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm
may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research
is available to customers of DBSI in the United States at no cost. Customers can access IR at
http://gm.db.com/IndependentResearch/ or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE
LOCATED IN APPENDIX 1.
Industry Update
Top picks
Datang Int'l Power (0991.HK),HKD3.68 Buy
Huadian Power (1071.HK),HKD1.68 Buy
China Power Int'l (2380.HK),HKD1.59 Buy
Companies featured
Huaneng Power Intl (0902.HK),HKD5.19 Hold
2007A 2008E 2009E
P/E (x) 15.6 – 12.5
EV/EBITDA (x) 9.7 16.1 6.7
Price/book (x) 2.1 1.4 1.2
CR Power (0836.HK),HKD15.50 Hold
2007A 2008E 2009E
P/E (x) 26.1 145.2 15.4
EV/EBITDA (x) 15.8 17.3 8.4
Price/book (x) 4.4 2.5 2.2
Datang Int'l Power (0991.HK),HKD3.68 Buy
2007A 2008E 2009E
P/E (x) 20.5 198.4 10.5
EV/EBITDA (x) 10.2 12.8 8.1
Price/book (x) 2.7 1.3 1.2
Huadian Power (1071.HK),HKD1.68 Buy
2007A 2008E 2009E
P/E (x) 18.9 – 4.5
EV/EBITDA (x) 9.8 12.2 5.6
Price/book (x) 1.6 0.7 0.6
China Power Int'l (2380.HK),HKD1.59 Buy
2007A 2008E 2009E
P/E (x) 24.4 – 5.6
EV/EBITDA (x) 20.5 13.4 5.0
Price/book (x) 1.2 0.5 0.5
Spot coal price in China
-
200
400
600
800
1,000
1,200
2006-9-17
2006-10-15
2006-11-12
2006-12-10
2007-1-7
2007-2-4
2007-3-4
2007-4-1
2007-4-29
2007-5-27
2007-6-24
2007-7-22
2007-8-19
2007-9-16
2007-10-15
2007-11-12
2007-12-10
2008-1-7
2008-2-11
2008-3-10
2008-4-7
2008-5-5
2008-6-2
2008-6-30
2008-7-28
2008-8-25
2008-9-22
2008-10-20
2008-11-17
Datong Premium (>6,000kcal )
Shanxi Premium (>5,500kcal )
Shanxi Blend (>5,000kcal )
Rmb per ton
Domestic coal seafreight
‐
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
May-07
Jul-07
Aug-07
Sep-07
Nov-07
Dec-07
Feb-08
Mar-08
May-08
Jun-08
Jul-08
Sep-08
Oct-08
Coal Qinhuangdao-Shanghai
Coal Qinhuangdao-Guangzhou
CCBFI
Global Markets Research Company
November is the inflexion point, with a 30% fall in coal price
We previously expected a 10% yoy coal price increase due to a wide gap between
spot and contract coal prices in 3Q08. After a 30% drop in spot coal price this
month, we are turning positive on the sector’s recovery in 2009E. The fall in coal
prices at this time – a normally strong demand season – is very encouraging, and
makes us expect further price weakness in 1H09. We believe the quick ramp-up in
coal production at IPP-invested coal mines should reduce the chances of price
support through production cuts. Moreover, heavy investment in railways, in the
mid-term bodes well for the coal supply due to easing transportation bottlenecks.
New national power demand and supply forecasts
We provide our revised national capacity and demand growth forecasts for 2008-
10. Our new estimates for demand growth have taken into account: 1) lower-thanexpected
demand growth in July-Oct 2008, 2) an expected economic slowdown
for China, and 3) a more severe downturn in heavy electricity-consuming industries
such as aluminum and steel. We estimate that thermal utilization will decrease
from ~5,100 hours in 2008E to ~4,900 hours in 2009E and ~4,700 hours in 2010E.
Our sensitivity analysis suggests that IPPs’ FY09E earnings will decline by 3.1-
5.1% for every 1% drop in the utilization rate.
New operating assumptions
Coal price: a 10-15% yoy coal price decline in ‘09E and flat prices thereafter. Tariff:
no further adjustment. Utilization rates: down 3-5% in ‘09E and another 1-2% in
‘10E. Interest rate: another 54bps cut in ‘09E. On our new assumptions, the five
China IPPs could post an average 12% ROE in ’09E. Every 1% deviation in the
coal price from our base case would impact our ’09E earnings by 3.8-8.4%.
Buy Huadian, CPI, and Datang
After a strong rally last week, we prefer Huadian and CPI as we believe their
current valuations (0.5-0.7x FY08E P/B and 4.5-5.7x FY09E P/E) have yet to reflect
their turnaround prospects. We maintain Buy on Datang, as we believe the stock
has further upside potential with a 10.5x ’09E P/E vs. Huaneng’s 12.5x and CR
Power’s 15.4x. We rate Huaneng and CR Power as Hold as their current valuations
have already reached fair levels, unless we see more coal price downside ahead.
DCF-based target prices; major risk is uncertainty over tariff hike
We value the sector on DCF assuming WACCs ranging from 8.7-9.7%. For
companies with non-power businesses, we use sum-of-the-parts valuations to
derive their TPs. Key risks include volatility in coal prices, utilization rates, capacity
addition plans and tariff cuts.
Table of Contents
Executive summary ........................................................................... 3
Valuation and risks............................................................................ 4
Valuation ..................................................................................................................................4
Risks ........................................................................................................................................4
Ride on coal price downcycle........................................................... 7
Spot coal prices collapsing in China..........................................................................................7
Australian coal price is back to last year’s levels.......................................................................7
Collapsing sea freight is another blessing.................................................................................8
Coal production cut – should hardly to be effective..................................................................9
Easing coal transportation bottlenecks ...................................................................................10
Blended coal price outlook in 2009 .........................................................................................10
New demand and supply forecasts ............................................... 12
Assumptions/earnings/TP change................................................. 14
Key assumption changes ........................................................................................................14
Earnings and TP changes........................................................................................................14
Sensitivity analysis ..................................................................................................................17
Appendix A: China IPPs in charts ................................................... 18
Appendix B: monthly tracker.......................................................... 20
Executive summary
We are seeing light at the end of the tunnel for China IPPs after a 30% decline in spot
coal price and a 108bps interest rate cut this moth. The spread between contract and
spot price has narrowed from 50% in 3Q to 20%. Moreover, the recent weakness in the spot
coal price is bucking the seasonal uptrend, as demand is typically strong in 4Q due to heating
consumption and low hydropower outputs in the winter. Hence, we expect further coal price
downside in 1H09. On a yoy basis, we estimate that the average blended coal price could fall
by 10-15% next year with another 5-10% spot coal price decline by 1Q09.
Improvement in the coal supply is on the horizon. In the medium term, we see IPPinvested
coal mines quickly ramping production from 30mtpa in 2008 to 280mtpa in 2010,
which should weigh on any production cut planned by coal producers with an aim to support
coal price. The planned heavy investment in national railways should also bode well, as it will
address the bottlenecks in coal transportation, thus improving supply availability.
Beneficiaries of interest rate cuts. IPPs have a high level of gearing due to the capexintensive
nature of their business. Therefore, we expect them to take significant advantage of
the massive interest rate cuts announced. With further rate cuts to come, the sector appears
to be one of the biggest beneficiaries; in particular, Datang and Huadian should benefit given
their highest financial leverage.
Weak demand is a double-edged sword. Although the utilization rate could fall again in
2009 due to weak power demand stemming from the economic slowdown, the negative
effect should be outweighed by the fall in coal prices since the latter has a much bigger
impact on earnings. Indeed, weak power demand, together with sluggish coal usage from
other sectors, has contributed to the faster-than-expected fall in coal prices.
No need for tariff hike any more. We now factor in a 10-15% yoy decrease in coal prices
for FY09E, vs. a +10% rise previously. We also trim our utilization rate forecast based on our
new national power demand and supply forecasts. Nonetheless, even in the absence of any
tariff hikes, the sector should embark on a recovery based on our estimates, thanks to the
full-year impact of two tariff hikes in ’08 and great earnings leverage on coal price downside.
On average, we expect their ROEs to be back to 12% in FY09E. However, we admit that our
call is primarily based on the expectation of declining coal prices and is not without risks.
Buy Huadian, CPI and Datang. The IPP sector has seen a strong share price rally over the
last few days. We now prefer Huadian and CPI, as we believe their current valuations (0.5-
0.7x FY08E P/B and 4.5-5.7x FY09E P/E) have yet to reflect their turnaround prospects. We
maintain Buy on Datang as we believe the stock has further upside with a 10.5x ’09E P/E vs.
Huaneng’s 12.5x and CR Power’s 15.4x. We rate both Huaneng and CR Power as Hold as we
believe their current valuations have already reached fair levels, unless we see more severe
coal price downside ahead.
Valuation and risks
Valuation
Our valuations of the core power businesses are based on the DCF methodology, assuming
WACCs ranging from 8.7-9.7% and nil growth of cash flows for calculating terminal values.
For Datang and CR Power, our TPs are based on a sum-of-the-parts (SOTP) method which
comprises the value of coal mines and the coal chemistry businesses, in addition to the DCFbased
valuation of their power businesses. These two companies differ from peers given
their significant involvement in non-power businesses.
To cross-check the sector’s valuation, we compare with the HSCEI index on both P/E and P/B
metrics. Currently, HSCEI trades at an average of 9.3x FY09E P/E. IPPs now trade at an
average of 9.7x, which is in line on a sector basis. However, Huadian and CPI trade at 4.5x
and 5.6x, respectively, which we view as attractive levels. In view of a likely U-turn for the IPP
sector, we believe these two stocks should be significantly re-rated, and hence we rate both
stocks as Buy.
Though the sector has rebounded 30-40% from a 1-yr forward P/B of 0.8x a month ago, the
average of 1.1x is still below HSCEI’s 1.3x. Again, we find Huadian/CPI’s deep discounts to
book value (0.7x and 0.5x) as offering much greater upside.
Risks
A downside risk across the sector is if our assumption of 10-15% yoy decline in coal prices in
2009 proves too optimistic. For every 1% rise in coal prices in 2009, IPPs’ earnings should
fall by 3.8-8.4%. Also, there is another downside risk of more severe drops in utilization rates
for IPPs due to stalling power consumption growth as a result of economy slowdown. For
every 1% fall in the utilization rate in 2009, IPPs’ earnings should decline by 3.1-5.1%. In
addition, we view the reform of direct power supply between industrial users and IPPs
(which has been pioneered in Inner Mongolia and Sichuan) could suggest some tariff cut risk,
though there is little detail on this so far. As for the above downside risk, Huadian and CPI
should be more affected due to their higher earnings sensitivity.
Apart from sector generic risks, Datang would face another downside risk for its coal-tochemistry
project if the price of polypropylene (PP) falls below its production cost due to low
oil prices and weak product demand.
Upside risks include a more drastic fall in coal prices, a smaller decline in the utilization rate,
and another tariff hike to realize an adequate pass-through of fuel cost rises to date.
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