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CSCI-Initiation-Utilities-China Coal-fired Power Sector：Earnings recovery on-track amid tariff hikes - 20171009

Earnings recovery on-track amid tariff hikes

We expect to see c.5.1% YoY volume growth of China’s coal-fired power generation in 2017, thanks to solid social power consumption and the likelihood of a decline in hydro power generation due to the lower water flows in China’s major rivers. We believe the +7.0% YoY social power consumption growth during Jan-Aug 2017 bodes well for a strong year in power consumption in 2017, leading to an estimated 5.7% YoY growth in total power consumption in China for 2017 (following a solid 6.7% YoY growth in 2016).

We expect to see a marginal growth of China’s coal supply in 2017 (+2.9% YoY in our estimates) amid government’s ‘supply-side reform’ push. In spite of a minor growth of coal supply in 2H17, total coal supply growth in China would remain flat compared with both 1H17 and 2H16. Tight coal supply and solid downstream demand will support thermal coal prices to stay above RMB600/t for the remainder of 2017, in our view.

Despite of buoyed coal prices, we expect China’s five largest IPPs to see solid earnings recovery in 2H17, driven by the on-grid tariff hike. Effective from 1 July 2017, around 23 provinces and provincial-level cities have announced to raise the on-grid tariffs of coal-fired power by 0.4-6.4% (or RMB1.4-22.80/MWh), in order to help the IPPs mitigate pressure from rising coal prices. In our estimates, the weighted average tariffs of the five IPPs will increase by 2.4-4.5% YoY (or RMB8.6-16.3/MWh) in 2H17.

In view of the sector’s improving earnings outlook on the back of the tariff hikes and valuations at historical troughs (in terms of forward PBR), we expect to see a sector-wide re-rating, with a strong set of 3Q17 results likely the catalyst. Huaneng Power (902 HK), China Resources Power (836 HK) and Datang Power (991 HK) are our sector top picks, in light of their industry-leading position and fuel cost control. We have also initiated coverage on China Power (2380 HK) and Huadian Power (1071 HK), each with a Hold rating.