China utilities: the worst is over
Spot coal price collapse, blended coal-cost savings
Recent spot coal price has come down by 40% from the peak in July.
With high inventory at port and with independent power producers
(IPPs), coal spot price may remain weak. Our coal analyst assumes spot
coal price will decline by 33% y-y and contract coal price will increase by
5% y-y in 2009. We assume only 10% y-y spot coal price downside in
2009E. We cut our 2009 spot coal price assumption to 30% y-y decline
and maintain contract price unchanged at 5% y-y increase. Based on
blended effect, we lower 2009 coal cost to 10% y-y decline, from
previous 5% y-y increase. IPPs’ earnings sensitivity to 1% coal cost
downside is 5-15%. Coal accounts for 60-70% of total cost of goods sold
(COGS).
Potential margin gain from cost savings in coal
Power demand reached a decade low, with -2.2% in October. With weak
power demand, tariff upgrade is unlikely. We cut our 2009 tariff
assumption to flat y-y, from 5% increase in 1H09. We also apply 150bp
interest rate cut since 2009. With coal cost saving, lower power tariff
assumption and finance cost saving, our 2009E net margin increases by
160-470bp to 2.6-10.8%.
Utilization cut to be more than offset by margin gain
We forecast power demand will increase 6.5% in 2009 and 7.0% in
2010. We assume an average of 5% utilization hour downside in 2009
and 2010 each for all IPPs. IPPs’ earnings sensitivity to 1% utilization
cut is 1.5-5.4%. The 5% utilization cut can be more than compensated
by the margin gain from coal cost saving.
Worst is over: BUY Datang and Huaneng
IPPs’ earnings recovery is faster than expected given the coal price
collapse. We upgrade the sector to NEUTRAL. We raise 2009 earnings
forecast by 256% for Datang, 149% for Huadian, and 53% for CR
Power. We raise TP to HKD4.76 on Datang, HKD1.77 on Huadian, and
HKD12.98 for CR Power. Maintain Huaneng’s TP at HKD5.87. Upgrade
Huadian to HOLD and maintain REDUCE on CR. Reiterate BUY on
Datang & Huaneng Power. Datang remains our top pick in the sector.

Contents
Power sector outlook is improving................................................................................. 3
Valuation; Upgrade to NEUTRAL 4
Coal price is declining faster.......................................................................................... 6
Coal price decline more than expectation 6
Weak power demand and utilization rate ...................................................................... 8
Power demand hit historic-low 8
Utilization rate continues to drop 9
Benefit from interest rate cuts...................................................................................... 13
Benefit from interest rate cuts 13
Worst is over – upgrade to NEUTRAL......................................................................... 15
Worst is over, outlook is improving 15
Valuation 15
Devil’s advocate: Risks to our investment case........................................................... 17
Company updates ....................................................................................................... 19
Datang Int’l Power 20
Huaneng Power 24
Huadian Power 28
China Resources Power 33
Power sector outlook is improving
Recently, we have seen coal price dropping faster than we expected mainly due to the
coal price collapse. Based on our sensitivity analysis, we found all IPPs are most
sensitive to on-grid tariff, followed by coal price, and lastly utilization rate. Sharp coal
price drop will help save IPPs’ fuel cost, which usually accounts 60-70% of total cost of
goods sold (COGS).
In addition, the weak power demand, especially from the secondary industry, dragged
down the utilization hour. We estimate the declining utilization hour trend will continue
in the next couple of years. On the other hand, the weak demand in power & coal will
increase IPPs’ pricing power for the 2009 annual contract coal negotiation.
Overall, IPPs’ earnings recovery will be faster than we previously estimated because
the sharp coal price decline will counter off the decreasing utilization rate. And the
recent interest rate cut could further boost IPPs’ earnings recovery.

We prefer Datang Power as our top pick in the sector and maintain BUY given its
aggressive up-stream business integration, most diversified power categories, and
attractive valuations (around 1.2x 2009 P/BV). We maintain BUY on Huaneng Power
with TP at HKD5.87 since the sector proxy will be the first to benefit from the improving
industry outlook. We upgrade Huadian Power to HOLD due to its cheapest valuation
0.7x 2009 P/B. We maintain CR Power as REDUCE since we believe its low-teens
ROE would not deserve such high valuation (around 2.0x 2009 P/BV).