China’s power demand recovery has led to consensus upgrades. That
said, we believe the overhang from the tariff policy uncertainty and cost
pass-through mechanism have been behind the sector’s year-to-date
underperformance.
■ Industry experts and players agree that the current tariff policy is
unsustainable. We believe the proposals for power capacity growth targets
in China’s five-year plan (FYP) may be linked to some form of tariff policy
clarification as an incentive for the sector to deliver. With a framework in
place, the sector returns as a proxy for China’s economic growth with
certainty of returns.
■ We believe the market is not pricing in any policy changes. On a P/B
versus ROE (2010E) basis, the sector is either at fair value or cheaper than
the market. Given the sector’s operating leverage, even if there is no policy
change, our sensitivity analysis shows that it takes just one tariff hike (4-7%)
to maintain the valuation status quo if 2010 coal prices are 10% above our
estimates of a 5% YoY increase. The risk-reward is favourable.
■ Our top pick is CPID, followed by CRP and Huaneng. CPID has volume
growth from its parent’s injection, and is the best proxy to policy changes,
given its attractive valuation. CRP offers the best efficiency, execution and
organic 2008-11E capacity CAGR among the three IPPs. We rate Huaneng
as a trading buy, as it has the most broad-based exposure to China’s power
demand recovery and has the highest operating leverage to key drivers.