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Morningstar | Strong Power Demand and Tariff Hike Drive Datang’s Decent First Half, Shares Slightly Undervalued. See Updated Analyst Note from 27 Aug 2018

In line with the industrywide profitability recovery, no-moat Datang’s decent first-half net profit of CNY 1.2 billion was no surprise, with 11% organic growth in power sales volume and 2.5% increase in average tariff the key drivers. Following the acquisition of 14 GW in generation assets from its parent, Datang’s total installed capacity rose 29.5% to 62 GW. However, these assets still made a net loss of CNY 335 million in the first half, compared with over 40% net profit growth of Datang’s existing assets. While our bearish view on the coal price should mean a profit turnaround for these assets in the midterm, we have little faith in the company’s capital allocation strategy, which is reflected in our Poor stewardship rating for Datang. We maintain our full-year 2018 net profit forecast of CNY 3.4 billion, but we lower our fair value estimate slightly to HKD 2.72 per share from HKD 2.86, after taking into account the weaker Chinese yuan against the Hong Kong dollar. We think the shares, currently trading at only 0.6 times price/book, are slightly undervalued, well-below its 10-year average of 0.9 times and our valuation of 0.8 times price/book, despite the improving return outlook following the company’s disposal of loss-making chemical assets.

Helped by the extreme weather conditions (cold winter and hot May) and pick-ups in property construction activity due to low inventory, nationwide power demand remained strong, rising 9.4% year over year in the first half. The strong power demand, along with Datang’s increased generation assets and higher average tariff, drove its power segment net profit up 155% to CNY 3 billion in the first half, despite a 3.8% rise in unit coal cost. Looking into the second half, we think the U.S. trade war may dampen power demand growth, and our expectation of stronger hydro-water flows and China’s promotion of the use of gas to replace coal in power generation should mean coal-fired power growth will be less exciting.

As coal-fired generation accounted for 86% of Datang’s total power output in the first half, we think declining coal prices will be the key growth driver in second-half 2018. The recent fall in coal price to CNY 610-CNY 615 per metric ton from around CNY 700 in mid-June, reaffirms our bearish long-term coal price outlook, and we expect coal prices to continue to weaken as we expect coal production to recover. In addition, China’s “Blue-sky Protection Campaign” should see continued expansion in coal-to-gas conversion amid winter heating, dampening coal demand. We’re confident that the coal price will fall to the preferred “Green Zone” range of CNY 500-CNY 570/ton, and we maintain our midcycle coal price assumption of CNY 565 per ton. This should drive a meaningful margin recovery for coal-fired power plants in midterm.

We see Datang’s strength coming from its diversified generation sources, with clean energy and renewables making up about 24% of the company’s total generation capacity, which is well-above the 10%-12% for nationwide mix and is also the highest among the three independent power producers we cover. This is in line with China’s energy plan to raise the share of non-fossil fuels in its energy mix and better positions the company amid the launch of carbon trading in the power section as well as the power sector’s reform that seeks to promote cleaned and renewables generation sources.