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Morningstar | Cross-Provincial Power Supply Weighs on Coal-Fired IPPs; Falling Coal Price Will Be a Growth Driver

Despite a nationwide slowdown in power consumption growth, China Resources Power's operating performance in November lagged industry peers, with power sales volume falling 8.4% year over year versus 3.6% nationwide growth. This was largely driven by an 8.8% decline in the firm’s coal-fired power output, reflecting rising pressure coming from the cross-provincial power supply amid stricter environmental controls in coastal regions. This is in line with our expectations, and we expect west-to-east power transmission, along with the rising share of clean and renewable power sources, to continue to weigh on coal-fired power generation volume in 2019. We maintain our assumptions of flattish utilization hours for the coal-fired independent power producers. Nevertheless, the decline of the QHD 5,500 Kcal spot coal price to CNY 588 per tonne as of Dec. 21 from CNY 696 at mid-June reaffirms our view that coal prices have peaked. We maintain our midcycle coal price forecast of CNY 565 per tonne and expect coal prices to fall another 6%-8% in 2019, which should drive decent earnings recovery for coal-fired power plants.

We maintain our fair value estimates of HKD 16.40 per share for China Resources Power, HKD 5.60 per share for Huaneng, and HKD 2.50 per share for Datang. We think the shares of China Resources Power and Huaneng, which are trading at 0.8-0.9 times price/book, are fairly valued while the shares of Datang are undervalued, trading at only 0.5 times price/book compared with its 10-year average of 0.9 times and our valuation of 0.7 times. We think this indicates market concerns about the firm’s corporate governance and long-term outlook, which is reflected in our Poor stewardship ratings, while the potential long-term positive cash flows under rationalized coal prices and a more comprehensive coal power price linkage mechanism should drive the share price close to our fair value estimate.

Our midcycle coal price forecast of CNY 565 per tonne suggests Datang should be able to earn a sound operation margin of 19.1% compared with our estimated 13.2% in 2018, with robust free cash flow of more than CNY 5 billion on an annual basis.

China’s power consumption grew 8.5% for the cumulative 11 months this year, while growth in November slowed to 6.3% despite the need for winter heating from early November. We think this probably suggests some negative impacts from the prolonged U.S.-China trade war, and we expect demand growth to fall further to 3.5% in 2019. Growth for coal-fired power output in November was 3%, underperforming growth of 4.8% for nationwide generation volume. We think this should be attributed to stricter environmental controls in coastal regions and the priority dispatch of renewable power sources, given the decent 14.4% growth of the cross-provincial power transmission in November, according to the China Electricity Council. In particular, power outputs in eastern regions, such as Shanghai, Jiangsu, and Shandong, continued to fall, while west-to-east power transmission volume continued to rise robustly. We think China Resources Power is worst positioned amid the west-to-east power transmission, given that coal-fired output from Jiangsu province accounts for about 27% of the firm’s total coal-fired generation volume, compared with 5%-10% for Datang and Huaneng.

Despite the coming of the heating season, the QHD 5,500 Kcal spot coal price fell to CNY 588 per tonne as of Dec. 21 from CNY 696 at mid-June. This is in line with our expectation, and with coal inventory at the six major power plants remaining sufficient at 22-23 days, we think coal prices have peaked and expect price upside should be limited. We maintain our bearish long-term coal price outlook and our midcycle assumption of CNY 565 per tonne. This should drive a meaningful margin recovery for coal-fired power plants in the midterm. Key drivers of lower prices are capacity expansions in China, with a repeal of the 276-day production constraints, and growth in supply from Inner Mongolia. In addition, we think the improving coal rail transport infrastructure, with the new rail corridor Menghua line commencing service in 2020, will help to reduce bottlenecks and flatten the cost curve. In the long term, we think the decline in the electricity intensity of the Chinese economy and the shift toward an anything-but-coal energy policy will continue to dent coal demand and limit any material price increase.