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Morningstar | Power Assets Cautious on Regulatory Resets, Results in Line, FVE Reduced to HKD 52

CK Infrastructure’s and Power Assets Holdings’, or CKI and PAH, respectively, management team shared a cautious outlook on the risk of upcoming regulatory resets that could lead to lower returns for its U.K. and Australian utilities. Following a preliminary review of both companies’ 2018 results and the risk of lower midcycle returns, we believe concerns are largely reflected in both companies’ current share prices. While our near-term earnings projections are little changed, we reduce PAH’s fair value estimate to HKD 52 from HKD 58 with its greater earnings sensitivity to the risk of lowered market values of the regulated assets. We maintain CKI’s fair value estimate at HKD 68. Both stocks are fully valued. We see better upside potential in parent company CK Hutchison Holdings, or CKHH.

PAH faces returns resets starting with South Australia Power Networks in 2020 followed seven of its other Australian and U.K. utility assets through 2021. While the management team, in previous resets, has been confident of maintaining its target returns, it is warning that governments are keen to squeeze the benchmark cost of equity which would lower allowed returns. We think this uncertainty may weigh on further share price gains. However, its regulated asset values should continue to rise in the low- to mid-single-digit pace which should help offset the potential cut in regulated tariffs. We think a narrow moat rating is sustainable but we will review PAH’s moat trend.

Over the next five years, we think PAH will see average EPS growth of 2.4% with flat income in 2019 on the drop in Hong Kong Electric’s regulated return that will be mitigated by a full-year contribution from the Economics Benefit Agreement from CKHH. Also, we expect earnings growth from its key utilities to ramp up as the current reset periods end. We think PAH will be able to maintain a 2% growth in its dividends and a 5% forward dividend yield will support its attractiveness to long term holders.

The group is still looking into spinning off its European utilities into a separate listing but given Brexit uncertainties, delays are likely. We think investors’ risk appetites for stable and safe returns will continue to be robust, particularly with the outlook that interest rates will remain subdued, and this may actually keep market interest in PAH’s assets keen.