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Morningstar | CRP's Core Recurring Profit in Line, but Change in Dividend Policy Disappointing

Despite in-line operating results, no-moat China Resources Power’s cut in its dividend payout to HKD 0.328 per share was disappointing, as it breached the company’s commitment to maintain a stable absolute dividend payout of HKD 0.875 per share throughout 2016-18 and hurt investor confidence. This led to a 15% share price decline following the result announcement. Net profit fell 15% year over year to HKD 3.95 billion, largely driven by noncash impairments, while recurring profit of HKD 6.95 billion was in line with our expectations. Despite an improving earnings outlook amid weakening coal prices, CRP’s push on wind power projects has created high capital needs in the coming two years and resulted in the change in dividend policy. We expect the industrywide capacity expansion for wind power to remain strong over the next two years amid the government’s plan to remove subsidies and lower the on-grid tariffs for new wind capacities commencing from 2021. We think this will worsen the current oversupplied situation in wind power, and we expect the curtailment rates to remain high until the capacity expansion slows from 2021. We maintain our coal price assumptions while lowering our expectations for renewable profitability. We cut our earnings forecasts for CRP by 6%-8% to HKD 7.2 billion and HKD 8.6 billion, respectively, in 2019 and 2020. Accordingly, we lower our fair value estimate to HKD 15.50 per share from HKD 16.40.

We think the shares are slightly undervalued presently, trading at 0.7 times price/book--the lowest level over the past 10 years, and well below our valuation of 1 times price/book. While the cut in dividend payout is disappointing, at the current trading level, the proposed dividend payout implies a 5.2% yield, which is attractive compared with the 3%-4% of its major peers, while its balance sheet is also relatively sound with net gearing of 114% (versus 203% for Huaneng). We think the company’s well-managed, high-quality assets, along with its sound balance sheet and an improving cash flow outlook, position the company well for long-term growth.

The Chinese government plans to implement a grid-parity policy on wind power gradually from 2021, which is to remove the subsidies and lower the wind tariffs to be at the same level as coal-fired generations. This implies about a 15%-20% cut in wind tariffs, but it’s only for the new capacity commissioning from 2021, while the capacity commencing before 2021 will still apply the current on-grid tariffs. This has encouraged Chinese independent power producers to accelerate the construction and commissioning of wind projects. We expect capacity expansion for wind power to remain strong over the coming two years, which will exacerbate the wind sector’s oversupplied situation. Although the government’s promotion of renewable energy sources and the launch of spot power trading market will help to digest some excess capacity, we expect the overall curtailment rate to stay high through 2019-20. We expect CRP’s utilization hours for wind power to be around 1,850-1,950 hours over the next three years, compared with 2,095 hours in 2018.

CRP’s operating performance in the coal-fired power segment was also in line with our expectations, with operating profit rising 13.2% to HKD 7.4 billion and operating margin expanding 1.2 percentage points to 12.0%. This was helped by robust power demand in 2018 and a 2% rise in average tariffs. We expect the profitability for coal-fired IPPs to further improve in 2019 amid weakening coal prices. The QHD 5,500 kcal benchmark coal price weakened to CNY 620 per tonne as of March 22 from its peak of about CNY 700 per tonne in mid-June last year. This is in line with our expectations. While the recent tight supply due to stricter safety controls following a few coal mine disasters in Shanxi, Shaanxi, and Inner Mongolia has keep coal prices elevated over the past month, we expect coal production to gradually recover from late March and demand to fall amid the end of winter heating season in north China. Along with a slowing economy in China and the U.S.-China trade impasse, coal prices are likely to remain constrained. We maintain our bearish long-term coal price outlook and our midcycle assumption of CNY 565 per ton. We expect softening coal prices to drive a strong rebound in CRP’s profitability, and we forecast the company’s recurring net profit at HKD 7.2 billion and HKD 8.6 billion, respectively, in 2019 and 2020.