Top Buys: Fuxin, CPI, Huadian, HNR, Longyuan, SIIC, BEH, Pinggao
Heading into 2016, we are generally positive on the broad utility/renewable/environmental sector with our preference going to IPPs, wind developers, selective environmental and power T&D equipment plays. Meanwhile, we are neutral on Hong Kong utility, gas distributor, and power generation equipment plays. Our top Buys are Huadian Fuxin, CPI, Huadian Power, Huaneng Renewables, Longyuan, SIIC Environment, Beijing Enterprise and Pinggao Electric.
IPPs – three catalysts ahead
First, the tariff cut should be announced soon, removing an overhang. Second, we expect new project approvals to come to a halt, reducing oversupply concerns. Third, asset injection remains a firm commitment. Last but not least, IPPs show a resilient return profile in our stress testing of utilization and dark spread downside. Valuations of 6x FY16E P/E and 8% yield look attractive.
Wind developers – tariff cut and curtailment concerns overdone
In our view, wind stocks are oversold on tariff cut and curtailment concerns. We expect tariff cuts to be milder than the proposal once finalized in 1H16. The grid curtailment should be gradually relieved, with most of the planned UHV lines operational in 2017-18. A potential renewable surcharge hike could further help accelerate subsidy payments and improve wind cash flow.
Environmental – cautiously optimistic
We expect continuously supportive policies, with new five-year plans and the Soil Pollution Control Plan to be announced. Admittedly, the valuation does not look cheap. In our view, consensus earnings expectations have been set slightly too high, especially in view of the VAT rule change and RMB depreciation. However, we believe the premium valuation is sustainable in the policy year of 2016. SIIC is our top pick, as we view its valuation as most attractive.
Macro implications for sector and stocks
We think the current macro outlook does not support strong top-line growth. We expect only modest improvement for national power and gas consumption. For power, plant utilization will continue to fall, although this is largely expected by the market; for gas, the expectation of volume recovery is high while downside risk is more likely. Volume risk is more of an issue for gas than power, in our view. Beijing Enterprise is our only Buy-rated gas name given its secured volume growth from gas-replacing coal in Beijing. Meanwhile, power overcapacity is not a positive for equipment makers, except for those riding on the secular growth of UHV/distribution investment (Pinggao is our top pick). Among the stocks under coverage, Hong Kong utilities tend to be more negatively correlated with the Fed’s rate hikes. Gas distributors have a large amount of HKD/USD-denominated debts, which pose higher currency risks given a depreciating RMB trend.
Valuation and risks
We use DCF as the major valuation tools for utilities given their visible cashflow profile, except for some multi-business players, for which we employ a SOTP approach. For equipment producers, we adopt P/B multiples. Key downside/upside risks, please refer to the sections for each sub-sector details. (Read Report)
Source : Deutsche Bank Markets Research