China is the world's latest electric power hog. Here's who's pumping out the juice
By Roger Conrad
& Yiannis Mostrous
Personal Finance
China's economy has lots of catching up to do in order to match the US, Europe or Japan. But growing nearly 10 percent a year, it's headed in the right direction.
Ironically, for the past couple years, it's been relatively difficult to make money in China's stocks. Even seemingly no-brainer industries like autos have a checkered track record - auto profits actually fell 40 percent last year.
As China has powered up its low-cost manufacturing base and consumer economy, its share of total world electricity use has risen to 13.5 percent from just 7.2 percent in 1973. That's meant soaring sales for power producers.
Huaneng Power's output, for example, rose 32 percent in 2005. And China-based power companies overall added 15 percent more generation last year, much of which was coal-based.
The four Chinese power companies recommended in the Feb. 26, 2003, issue have certainly ridden the trend, returning an average 67.6 percent, nearly twice the return on the S&P 500. However, during the past year or so, profits have come less easily. The reason: The jump in power generation has increased fuel prices.
According to the International Energy Agency, China accounted for 42.3 percent of global hard coal production in 2004, up from 18.6 percent in 1973. Even that failed to curtail massive imports.
The country is now the world's biggest coal producer and consumer. Coal accounted for 79.4 percent of total power plant fuels in the country in 2003. In contrast, oil fired just 3 percent of plants, nuclear 2 percent and hydro 15 percent.
Coal costs rose 17 percent last year. And with expectations that they'll tack on another 8 percent in 2006, Chinese power companies' margins are being squeezed.
The good news: Regulators are starting to pass on those costs to consumers, with 70 percent recovery granted last May. Companies are securing new reserves globally, and transportation bottlenecks in the rail network are being resolved.
Chinese power producers look set to cash in on growing demand moving forward. With valuations lower than they've been in a while, it's time to pick up some shares for a second leg up.
Below we look at four players primed for profits.
With more than 160 years of vibrant capitalism under its belt, Hong Kong (HK) is by far the most investor-friendly place in China. Its utilities are the safest place for US investors to land first.
The best of the bunch is CLP Holdings (OTC: CLPHY), which is a rapidly becoming one of the most important utility companies throughout Asia and on China's mainland. Two factors are helping its strategy.
One is the continuous improvement in the Asian economies, a development that will increase the region's capacity requirements. The other is the fact that many foreign power companies have been decreasing their Asian operations after failing to develop the necessary local expertise and political relationships needed to operate successfully. CLP and other local utilities are ideally positioned to take advantage of these developments.
CLP has been increasing its presence in the region with operations in Australia, where it own Yallourn Energy, a 1,480 megawatt (MW) merchant power station, one of the lowest-cost electricity generators in Australia. It also has growing stakes in India, Thailand, Taiwan and China's mainland, where it's a prospective bidder for a coal gasification venture.
Given CLP's solid long-term strategy, the recent weakness in its share price is overdone. The main reason is concern about HK's government proposal to cut return rates for utility companies after 2008.
Cost cutting and growth, however, will balance the government actions, and a compromise on the new rules appears increasingly likely. With a solid 4.8 percent dividend yield, CLP Holdings is a buy below 6.
On the mainland, the best play is also the biggest: Huaneng Power (NYSE: HNP). The company develops, constructs, operates and manages large thermal power plants.
It's also the lead player in the coal gasification plant mentioned above.
The company is the largest independent power producer in China with 18,832 MW generating capacity, a portfolio continues to grow rapidly.
Huaneng Power had a good 2005 as newly acquired plants in Central, Northwest and Northeast China added to its output. It's experienced weak generation in some of its operating regions (especially East China), an indication of greater regional supplies. This was offset by good growth in other parts (e.g., Shandong Province).
Like other Chinese power companies, the shares have been weak lately. Profits have fallen due to higher coal costs and a decline in generation in some regions.
But with the shares now off more than a third from all-time highs and trading valuations more typical of US utilities, the stock is back on the bargain rack for more aggressive investors. And the strong 4.4 percent dividend yield will protect the downside. Buy Huaneng Power up to 30.
The two remaining companies are less direct plays on China power demand growth. US power giant AES Corp. (NYSE: AES) stood at death's door in early 2003, as its far-flung global power generation and distribution empire threatened to collapse under the weight of staggering debt and problems with its Brazil investments.
At that point, the company's two founders, Dennis Bakke and Roger Sant, took a step back and turned the business over to financial wizard Paul Hanrahan and ultimate insider Richard Darman of the Carlyle Group.
Since then, AES' fortunes have radically reversed. It's slashed debt and costs, dumped dodgy projects and expanded into more profitable markets.
Much of the business is now contract generation, which allows it to take advantage of supply opportunities globally while avoiding commodity price risk. AES currently has seven major plants in China and is seeking more.
Accounting glitches forced the company to restate earnings for 2002 through 2005 this month, hurting the stock. But with adjustments inline with guidance and profits surging 15 percent for the most recent quarter, the future looks bright. Trading at little more than one times sales AES is a buy up to 18.
Korea Electric Power (KEPCO) shares have had a great run since June 2004 and are set for a solid 2006. Rising profits continue to flow through to higher dividends, which are on track for another good year.
Furthermore, a relaxation of regulatory risk and positive external factors, such as falling coal prices and appreciation in the Korean won against the US dollar, have also helped KEPCO. The company was allowed to raise electricity tariffs by a 1.9 percent average in January 2006, marking KEPCO's first rate hike in more than five years.
Like the China-based utilities, the price of coal in Asia is a make or break issue for KEPCO. Indications are that newly acquired production in Indonesia and transportation improvements in China will get better this year, lowering the price of coal in Asia.
KEPCO doesn't have a cost pass through mechanism in place, so a decline in coal prices will be very beneficial. About 34 percent of the company's fuel costs will be from coal in 2006; the rest will be from nuclear (5 percent), oil (14 percent) and liquid natural gas (47 percent).
Given the developed nature of South Korea's economy, power demand growth is expected to stabilize at around 6 percent a year, making it difficult for KEPCO to experience high growth rates. We expect continued dividend hikes, as the company pays out a higher share of earnings.
Likewise, given KEPCO's strong cash flow, it's expected to continue paying down debt. The debt-to-equity ratio was 45 percent at the end of 2004, and forecasts call for a dip to around 28 percent by 2007. With a 2.6 percent yield, KEPCO is a buy below 23 for conservative investors.
Editor's Note: Roger Conrad is associate editor of Personal Finance, 1750 Old Meadow Rd., Ste. 301, McLean, VA 22102, 1 year, 24 issues, $97, and editor of Utility Forecaster, Canadian Edge and the free weekly e-zine www.utilityandincome.com. Yiannis Mostrous is PF associate editor and editor of www.growthengines.com.
|
