China Power Generation Sector
INITIATION
The path to recovery
■ We initiate coverage of China’s power generation sector (IPPs) with a
MARKET WEIGHT stance relative to the MSCI China Index. Although
near-term power consumption growth may disappoint, we forecast
8-9% long-term power demand growth in China. Tariff rises, a fall in
coal (spot) prices and more interest rate cuts would help the sector.
■ Along with the economic slowdown, we expect 1.5% power consumption
growth in 4Q08, followed by 7% in FY09 and 8.9% in FY10. IPP utilisation
rates should rebound in 2010. We expect IPPs to continue expanding
capacity through greenfield projects and M&A. Via M&A, we expect CPID
and CRP to deliver higher capacity growth than Huaneng in 2009.
■ Given the easing CPI, we expect China to increase power tariffs in mid-
2009 by around 5%, with selected plants possibly seeing a tariff hike
earlier than that. CPID is likely to continue seeing a higher (or maybe
sooner) than average tariff increase. IPPs would require an additional
4.4% tariff hike in 2009 to raise their RoEs back to 2007 levels.
■ Fuel costs accounted for around 70% of IPPs’ total costs in 1H08. With
an expected 18% spot coal price fall and an 8-10% contract coal price
rise, we expect unit fuel costs for IPPs to decline in 2009. Also, an
expected 243 bp interest rate cut by the end of 2009 would be
favourable to IPPs, as they are all highly geared.
■ We initiate coverage of CPID and CRP with an OUTPERFORM rating
and Huaneng with a NEUTRAL. Our DCF-based target prices are
HK$2.90 for CPID (or HK$2.20 without the Wu Ling acquisition),
HK$23.0 for CRP and HK$4.99 for Huaneng. Huaneng’s 2009 net profit
is more sensitive to utilisation rates, tariffs, unit fuel costs and interest
rate changes than CPID’s and CRP’s.

The path to recovery
Relative to the 46% potential upside of Credit Suisse’s target for the MSCI China Index,
we initiate coverage of the China power generation sector (independent power produces
[IPPs]) with a MARKET WEIGHT stance. Our DCF-based target prices of HK$2.90
(HK$2.20 without the Wu Ling acquisition) for China Power International Development
(CPID) and HK$23.0 for China Resources Power Holdings (CRP) imply 121% and 83%
potential upside, respectively. We rate both as OUTPERFORM. Our DCF-based target
price of HK$4.99 for Huaneng Power International (Huaneng) implies 23% potential
upside. We therefore rate it as NEUTRAL. In terms of EV/replacement cost, CPID’s 0.42x
is cheaper than Huaneng’s 0.99x and CRP’s 1.71x and the five IPPs’ average of 1.11x,
but CRP has a consolidated coal investment while CPID and Huaneng do not.
Utilisation rate expected to bottom out in 2009
A bottoming out of the power consumption growth rate would be a driver for IPPs, and the
Chinese government’s economic stimulus programmes should also help.
Along with the economic slowdown in China, we expect weak power consumption growth
in the coming months. Combined with our multiplier assumptions, we expect China’s
power consumption to grow at 1.5% in 4Q08, 7.5% YoY for FY08, 7% for FY09 and then
8.9% for FY10, versus 14.8% in 2007. We also expect China’s installed capacity to grow
at 12.2%, 9.4% and 7.4% in 2008, 2009 and 2010, respectively, versus 14.7% in 2007. As
such, we expect the average utilisation rate for IPPs in China to continue declining in 2008
and 2009 before rebounding in 2010. Going forward, we expect China’s power
consumption to grow at around 8-9%, but this could be conservative as we no longer
expect it to reach 10% or more. With all plants located inland, we expect CPID’s utilisation
rate to be relatively shielded from an export slowdown compared to its peers.
We believe IPPs will continue to expand their capacity via both greenfield projects and
M&A. Via acquisitions, we expect CPID and CRP to deliver higher capacity growth than
Huaneng in 2009. As indicated by the government, China will continue to install power
generation (especially gas and nuclear) and T&D capacity to support long-term economic
growth, and we believe that Shanghai Electric (2727.HK, HK$2.62, OUTPERFORM, TP
HK$5.00) is well positioned to benefit.
Possible tariff increase with easing CPI
The Chinese government takes into account the impact on economic growth (CPI and
affordability) and cost changes for IPPs to decide the tariff adjustment. Given the easing
CPI and continuous fuel cost pressure, we expect China to increase on-grid power tariffs
by 5% again in mid-2009. There is a possibility that selected power plants may get an
earlier and higher tariff increase than the national average, and we believe CPID is better
positioned to this than its peers, given its lower than local benchmark tariff.
Huaneng would need more tariff increases in 2009E than CPID to get 2007’s industry
average (five IPPs) RoE of 11%, while CRP needs the least. Without further tariff
adjustments, CPID, CRP and Huaneng are unlikely to raise RoEs to their WACC levels
until 2011, 2009 and 2011, respectively.
Easing coal prices should help returns rebound
Fuel costs accounted for 70% of IPPs’ total costs in 1H08 and all IPPs have been hit badly
by surging coal prices in 2006-08. But CPID, CRP and Huaneng’s unit fuel costs are all
expected to drop in 2009 with combined expectations of an 18% spot coal price drop and
an 8-10% contract coal price rise. Expected interest rate cuts of 243 bps by the end of
2009 from now would also help IPPs raise RoEs, as all of them are highly geared. CPID is
better positioned than CRP and Huaneng, given all of CPID’s loans were floating rate by
the end of 2007.