As Coal Prices Dip, A Massive China Utility Shows Signs of Life

(Bloomberg) -- Long-suffering investors in Huaneng Power International Inc. may be about to get a reprieve, with Chinese power producers expected to make bigger profits this year as coal prices drop.

The country's largest listed thermal power producer is seen benefiting from lower fuel costs, as well as a favorable dividend policy and the prospect of an asset injection from its state parent, say analysts. Huaneng shares, ranked as one of the cheapest by book value among peers, have gained about 4.7 percent this year after sinking 53 percent in the previous three years.

Out of 13 analysts tracked by Bloomberg who updated their views on the state-run power major this year, 8 called for buying its Hong Kong-listed stock and only two assigned underperform rating for the shares. Their consensus price target for the stock is about 15 percent higher than the current level, according to data compiled by Bloomberg as of the close of trading Tuesday in Asia.

"We think Huaneng is undervalued at the moment, mostly due to our bearish coal price outlook," said Jennifer Song, an analyst with Morningstar Inc., who believes the fair value of the stock should be at 0.9 times its book. "We expect the softening coal prices to drive a strong rebound in Huaneng's profitability."

Huaneng's Hong Kong stock is trading at a 27 percent discount to book, versus an average of a 4 percent premium for the Chinese power sector, according to data compiled by Bloomberg. Shares of Huaneng and other major Chinese power producers tumbled between 2015 and 2017 as surging prices of coal, the dominant fuel for their power generation, and weakening utilization rates combined to eat into profitability.

China's benchmark spot coal price averaged about 637 yuan a metric ton in 2017, up 36 percent from a year ago, according to data from industry website www.sxcoal.com. But coal prices may fall about 5 percent this year on the expectation of stronger hydropower output and China's campaign to replace coal boilers with gas to fight pollution, according to Shanxi-based Fenwei Energy that runs the website.

Huaneng, with more than 80 percent of power-generating capacity fired by coal, is expected to see a 290 percent surge in earning-per-share this year and another 44 percent in 2019, according to consensus forecast compiled by Bloomberg. The company reported a more than 80 percent slump in net income last year as fuel costs surged 34 percent.

To be sure, the profitability of Chinese power producers like Huaneng will be limited by relatively low plant utilization rates amid power overcapacity in the nation, according to Bloomberg Intelligence. The producers' inability to fully pass on fuel costs to end users has also been cited by analysts as a concern for investors.

The Chinese government usually adjusts power prices once a year based on a coal-tariff pricing mechanism, which requires changes in tandem with coal prices. However, the government has been reluctant to raise power rates in a timely manner for fear of stoking inflation. Electricity tariffs still need to be increased by 0.02 yuan a kilowatt hour to catch up with the surge in coal prices last year, said Alex Liu, an analyst with UBS Securities Asia Ltd.

For now, a sharp increase in Huaneng's dividend payout ratio, along with hopes of asset injection from its parent over the next 3-5 years, are boding well for the company's valuation, said analysts including Edison Lee at Jefferies Group LLC, who raised the target price for Huaneng Power to HK$7.23 on March 15 from HK$6.59.

After posting its worst financial performance since 2011 last month, Huaneng pledged to pay out at least 70 percent of distributable profit as dividends over 2018-2020, compared with as much as 52 percent in the past five years. In its 2017 annual report, Huaneng said its parent will continue to inject "high quality" assets into the listed company.

Huaneng Power has the scope to acquire more capacity from its parent, following the latest purchase in 2017, Bloomberg Intelligence said in March, adding that China's 2018 power sector outlook has improved as the country is likely to consume about 6% more power in the year, a little better than the 5.5% expected by the industry.

To contact Bloomberg News staff for this story: Jing Yang in Shanghai at jyang251@bloomberg.net.

To contact the editors responsible for this story: Charlie Zhu at qzhu46@bloomberg.net, Ken Wills

©2018 Bloomberg L.P.

With assistance from Jing Yang