China Power Utilities：Take profits on YTD outperformance and uncertainties on tariff cut

We recommend taking profits on China Power utilities post >5% outperformance YTD (IPPs: flat, HSCEI: -5%). We believe tailwinds from lower coal prices are likely priced-in with strong rebound in 1H23 earnings. Yet, margin may be at risk on potential tariff cut next year, as the IPPs may reset the power contracts with lower tariff from 1Q24 amid a sluggish economy and subdued coal prices. Also, utilization hours may face headwinds in the medium term amid rapid approval of new coal-fired units since 2021 (~150-200GW on JPMe). These make coal-fired IPPs’ valuation less attractive at >20% premium over renewable operators. Uncertainties on tariff, margin and utilization lead us to neutralize our view and downgrade CR Power and China Power to Neutral. We are placing Huaneng-A on Negative Catalyst Watch as the company is most vulnerable to lower tariff/utilization, and valuation is hefty at ~120% premium over Huaneng-H (<100% over the past five years) at >2.0x 23E P/B.

Concerns on tariff cut may start to emerge in 4Q: Power generators have enjoyed 20% tariff hike above benchmark prices since early 2022. We believe tariff cut may occur next year amid >30% decline in coal prices YTD, as the government may trim power tariff to support the industrial sector. While the magnitude of the tariff cut is uncertain, we assume 5-10% tariff cut in our model, which is close to the recent monthly power prices. A 1% tariff cut will shave IPPs’ ~5% 24E PBT on our estimates, hurting Huaneng the most (~8%). While coal prices have remained sluggish amid weak demand, any rebound next year may hurt IPPs, as honor rate for long-term contracts only reached ~70% for Huaneng and China Resources Power in 1H23.

Utilization outlook remains uncertain on sharp increase in new approvals for coal-fired plants. The government has approved >150GW of new coal-fired capacity since 2021 (Figure 5), which leads to uncertainties on utilization for thermal plants in the medium term, in our view. We forecast lower utilization (100 hours) to shave 2024E earnings by >3% on average. This may not be fully compensated by other services provided by power plants, as ancillary services only account for low single-digit of profits for IPPs now, on our estimates.

Earnings and PT changes. We trim our 2024E/25E earnings by >8% on average to reflect assumptions on lower power tariff, exchange rate and also utilization hours. We downgrade CR Power (Jun-24 PT from HK$21 to HK$17.5) and China Power In’tl (from HK$3.8 to HK$3.2) to Neutral to reflect assumptions on earnings cuts and lower multiples.