HK Utilities | Examining potential corporate actions and 1H23 results preview

With the end of Fed rate hikes in sight, we believe this is a good time to revisit HK utilities that offer >5% yields on average. They also offer unique exposure to investors that seek names with geographically diversified earnings (Figure 1). What’s more, these companies have become more active in rationalizing their capital allocations to de-gear their balance sheets and improve shareholder returns, which are likely overlooked by the market (Table 1). Based on company statements as outlined below, we believe the possibilities include: (1) the potential disposal of low-ROE business (Australia segment by CLP, >HK$30bn of NAV on JPMe); (2) the spin-off of non-core segments (extended services by HKCG, >HK$10bn of NAV on JPMe); (3) the partial disposal of regulated assets at decent valuations (CKI/PAH); and (4) rationalizing capex targets (HKCG may trim renewable targets). These events could lift sentiment if they materialize, apart from improving earnings. On 1H23E results (Table 2), we expect CLP to post the strongest earnings growth of >10%, followed by HKCG (mid-single-digits) and CKI/PAH.

The company mentioned in its FY22 presentation that it will consider an IPO for its extended services and renewable businesses “at an appropriate time.” With net gearing reaching >60% in FY22, we believe management could consider gradually spinning off non-core businesses to degear its balance sheet and also trim its renewable capacity targets:

o Potential spin-off of extended business: With China Gas announcing a spin-off of its VAS business earlier this year, we believe HKCG may follow suit to spin off its extended services unit to de-gear its balance sheet. The company reported ~HK$9bn of segment revenue last year. Assuming a 15-20% PBT margin and a <10x 2023E P/E, we estimate that the NAV of the business could reach >HK$10bn and that a 50% spin-off could improve HKCG’s cash position by >HK$5bn.

o Revisit solar capacity targets: HKCG rolled out an ambitious plan for distributed solar capacity (Figure 3). With economic uncertainties ahead and elevated gearing, we believe management may revisit those targets. If the company were to lower the 2025 capacity target from 8GW to 6GW, the capex commitment on solar projects in 2023E-25E would likely be reduced to HK$13bn-16bn, assuming two-thirds effective ownership.

o More practical cash flow projections: HKCG disclosed its rolling three-year cash flow projections until FY21. With the disposal of Shanghai Gas (note) and the above potential corporate actions, we believe management may work out a new cash flow projection to demonstrate to investors how to balance growth and dividend commitment. We estimate the cash flow gap at HK$5bn-10bn (Table 4), and net gearing for HKCG could stay below 70% by 2025E and then gradually improve.

o Spin off renewable business in the medium term: Management targets breakeven for the renewable segment this year and has stated that it may consider an IPO for the segment in the next few years.

While Macquarie has reportedly ended discussions with CLP over the potential purchase of a 50% stake in its Australia business, the company is still in discussions with other interested parties for the sale. We believe the partial disposal is still possible, as gearing for the company remains elevated (48% in FY22) and the company is incentivized to keep its dividend commitment (>30 years of dividend hike or stable dividends). The recent appointment of a senior executive in HK as the CEO of the firm reaffirms the company’s shift of focus back in HK/China, in our view.

o Wholesale power prices may sustain at A$90-100/MWh: Our Australia utilities analyst recently upgraded AGL Energy to OW, as he forecasts mid-cycle power prices to sustain at A$90-100/MWh, based on the economics required to build new firmed capacity. Higher wholesale power prices will likely benefit CLP’s Australia business with better margin once the legacy forward contracts roll off.

CKI/PAH sold a 25% share in Northumbrian Water to KKR last year at a 1.5x EV/RAV, with net proceeds of >HK$4.8bn. Management has mentioned during previous roadshows that the company has no urgency to sell off its assets, but that it may consider offers from third parties if it received decent offers. As elevated inflation in the U.K. may inflate multiples for regulated assets, the company may consider selling off minority stakes in the future at good prices, in our view. CKI’s cash balance increased by ~HK$10bn yoy, to HK$18bn at end-2022, with a reduction in loans to associates/JV, which may be an indication of more cash preservation for acquisition opportunities.

o Corporate restructuring unlikely near-term: While CKI and PAH both trade at undemanding valuations, we believe management may not consider a merger near-term. CKI proposed a merger with PAH in 2015. We believe the chance of this now is low, as PAH’s net cash balance is much lower than in 2014 (~HK$2.7bn in FY22 vs. >HK$50bn in FY14), and a potential merger now may provide limited benefits for CKI. Also, the duo may not prefer a merger now that could lead to the consolidation of some regulated assets, which could lead to an increase in gearing at a consolidated level, on our estimates.

o PAH’s share repurchase may recommence: PAH repurchased >3mn shares in Sep-Oct’22 when share prices hit HK$35-40. We believe share repurchases could recommence if share prices remain at current levels, as the company is at a net cash position.

1) CLP: Sequential improvements in 1H23 results across segments: While the HK business is likely to remain stable, we expect sequential improvements in CLP’s 1H23 earnings across other markets, as lower coal prices are likely to benefit thermal plants. Also, the net loss for Australia’s power generation is likely to narrow on the back of less unplanned outage and lower coal prices during 1H23, on our estimates. We expect operating profits to grow >10% yoy.

2) CKI/PAH: 1H23 likely to be uninspiring: We expect CKI’s 1H23 earnings to drop ~5-10% yoy, to HK$4.2bn-4.5bn. Factors dragging 1H momentum include: (1) the depreciation of currencies in the U.K., Australia, Canada and others against USD; (2) a regulatory reset for UKPN; and (3) the impacts of inflation linked debt on some U.K. assets (like Wales & West). While high inflation can lead to better regulatory earnings, this would likely come with a time lag.

3) HKCG: No major surprises in 1H23 results: We expect the company to grow recurring earnings 8% in 1H23, to HK$3bn, which is likely in line with market expectations. The two major associates/JV that had hefty losses last year (Xian and Nanjing) have announced residential tariff hikes, and Wuhan is likely to announce one soon, as Hubei province has already announced cost pass-through documents, which should set the stage for a margin rebound in 2H, in our view.