CLP Holdings (0002.HK)

Transcription

1 Asia Pacific Hong Kong Electric Utilities (GICS) Electric Utilities (Citi) Equities 30 pages Profit Growth and Event Catalyst from Australia Summary We raise our CLP FY11-13E net profits by 6-9% and DCF TP by 7% to HK$73 mainly on more profits from Australia after NSW acquisition on 1 March. With HK government on hold for its 2020 s fuel mix targets and CLP without acquisition near term, the next catalyst would be potential listing of TRUenergy in Australia in 1H12E to raise transparency and unlock hidden value. CLP s 13.9x FY12E PER is 2% above historical mean, but low interest rate environment helps to support premium valuation. 1H11 results beat expectations - CLP's 1H11 net profit was -2% yoy to HK$5,800m, which was 7-10% above Citi's and consensus (Bloomberg) forecasts. Stripping out one-off items, operating earnings were up HK$565m or 13% yoy to HK$5,000m, with HK$705m incremental contribution from Australia. HK remains its key profit source making 65% of 1H11 total operating earnings. Australia as the bright spot Recurrent earnings were +1.5x yoy to HK$1,166m due to (i) HK$635m from EnergyAustralia and Delta Western GenTrader in NSW acquired on 1 March; (ii) sustained electricity and gas margins in Victoria; (iii) favorable fair value movement on energy contracts and MTM gains. For 2H11E, CLP expects its profit from Australia to rise hoh on more gain from integration and price hikes in Victoria in July. Company Update Target Price Change Estimate Change Hold/Low Risk 2L Price (16 Aug 11) HK$68.10 Target price HK$73.00 from HK$68.00 Expected share price return 7.2% Expected dividend yield 3.6% Expected total return 10.8% Market Cap HK$163,858M US$21,036M Price Performance (RIC: 0002.HK, BB: 2 HK) HK s 2020 energy mix target on hold - Hong Kong government has put its 2020 s fuel mix target (50% nuclear, 40% gas and 10% coal) for electricity generation on hold after the nuclear accident in Japan, pending Beijing government review of national nuclear policy. We understand from the HK government that the percentage from nuclear by 2020 might be lowered. But the revision will unlikely be announced this year. Earnings & TP uplifts We raise FY11-13E net profits by 6-9% on more profit from Australia. Our TP is +7% to HK$73. CLP s 13.9x FY12E PER is 2% above historical mean, but the US Gov t keeping interest rate low the next 2 years would be positive to share price, with high correlation (59%) between yields of HK utilities & US Treasury. Statistical Abstract Year to Net Profit Diluted EPS EPS growth P/E P/B ROE Yield 31 Dec (HK$M) (HK$) (%) (x) (x) (%) (%) 2009A 8, A 10, E 11, E 11, E 12, Source: Powered by datacentral Asian Utilities Hong Kong Utilities Pierre Lau, CFA pierre.lau@citigroup.com Cathy Chan cathy.wh.chan@citi.com Charles Wang charles.w.wang@citi.com See Appendix A-1 for Analyst Certification, Important Disclosures and non-us research analyst disclosures. Citi Investment Research & Analysis is a division of Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 For further data queries on Citi's full coverage universe please contact CIRA Data Services Asia Pacific at or Fiscal year end 31-Dec E 2012E 2013E Valuation Ratios P/E adjusted (x) EV/EBITDA adjusted (x) P/BV (x) Dividend yield (%) Per Share Data (HK$) EPS adjusted EPS reported BVPS DPS Profit & Loss (HK$M) Net sales 50,668 58,410 84,850 95,108 99,695 Operating expenses -39,821-46,013-69,216-79,206-83,291 EBIT 10,847 12,397 15,634 15,901 16,404 Net interest expense -3,408-4,111-4,989-5,106-4,876 Non-operating/exceptionals 2,415 2,893 3,359 3,218 3,786 Pre-tax profit 9,854 11,179 14,004 14,013 15,314 Tax -1, ,515-1,970-2,266 Extraord./Min.Int./Pref.div Reported net income 8,196 10,332 11,293 11,828 12,817 Adjusted earnings 8,196 10,332 11,293 11,828 12,817 Adjusted EBITDA 15,179 17,462 20,073 20,430 21,023 Growth Rates (%) Sales EBIT adjusted EBITDA adjusted EPS adjusted Cash Flow (HK$M) Operating cash flow 11,175 11,886 15,983 14,557 17,889 Depreciation/amortization 4,332 5,065 4,439 4,529 4,619 Net working capital 2, Investing cash flow -7,039-10,263-19,514-5,447-4,983 Capital expenditure -7,449-10,137-22,328-6,751-6,846 Acquisitions/disposals -2, , Financing cash flow 2,393-4,915 3,779-7,246-11,496 Borrowings 8,360 1,069 9, ,486 Dividends paid -5,967-5,984-5,973-6,405-7,011 Change in cash 6,529-3, ,865 1,410 Balance Sheet (HK$M) Total assets 156, , , , ,350 Cash & cash equivalent 7,994 4,756 5,004 6,869 8,279 Accounts receivable 9,018 11,118 13,553 14,745 15,278 Net fixed assets 98, , , , ,584 Total liabilities 85,663 99, , , ,002 Accounts payable 9,134 11,509 13,513 14,463 14,944 Total Debt 43,285 48,602 58,454 57,764 53,437 Shareholders' funds 70,868 79,758 85,597 91,365 97,348 Profitability/Solvency Ratios (%) EBITDA margin adjusted ROE adjusted ROIC adjusted Net debt to equity Total debt to capital

3 1H11 Results Beat Expectations Figure 1. CLP s 1H11 Results Highlight (HK$m) 1H10 FY10 1H11 yoy Commentary Consolidated revenue 27,618 58,410 40, % Earnings: SOC earnings in HK 3,014 6,129 3, % * Profit rise for increased in SOC asset base in Hong Kong Asia Pacific energy businesses: - Australia 461 1,303 1, % * HK$635m profit in 1H11 from NSW acquisition effective 1 March 2011 * Sustained electricity and gas retail margin (4%) in Victoria * Favorable fair value movement on energy and offtake contracts plus MTM gains * HK$160m gain from 18% AUD$/HK$ appreciation - Guangdong Nuclear Power & % * Steady operation HK Pumped Storage - Other projects in China % * Negative impact from coal cost +12% yoy, not offset by 2-3% tariff hike in 2Q11 - India % * Profit surge from exchange related gains and more profits from wind farms - Southeast Asia & Taiwan % * Less important after selling 13.36% EGCO stakes in Feb 2011 * Ho-Ping in Taiwan able to pass through higher fuel cost but with one-year delay Total 1,576 3,312 2, % Other earnings: - Sales from HK to China % * Electricity sold to Guangdong -13.3% yoy to 1,433GWh for less contract volume - Non-energy activities % Total % Unallocated net finance costs % * Net debt/equity ratio +25bps to 75% in 1H11 for NSW acquisition on 1 Mar 2011 Unallocated group expenses % Total operating earnings 4,435 9,148 5, % Tax consolidation benefit from Australia n/a * One-off tax consolidation benefit from changes in Australian tax legislation Recovery from coal mine subsidence n/a * Insurance recovery from Yallourn coal mine subsidence in 1H10 Provision for OneEnergy n/a * Goodwill impairment of Roaring 40s for uncertainty at 3 development sites Disposal gain of Anshun II n/a * Gain from disposal of 70% interest in Anshun power plant in Apr 2010 Disposal gain of ECGO n/a * Gain from disposal of 13.36% interest in ECGO plant in Feb 2011 Stamp duty for NSW Acquisition n/a * Stamp duty paid for NSW Acquisition on 1 Mar 2011 Gain on re-organization of Roaring 40s n/a * Disaggregation of Roaring 40s in Australia with Hydro Tasmania on 30 Jun 2011 Valuation gain on Hok Un redevelopment * Property revaluation gain of commercial section at Fisherman's Wharf in HK Total earnings 5,921 10,332 5, % Total earnings ex-one off items 4,435 9,148 5, % EPS (HK$) % DPS (HK$) % Payout ratio 42% 58% 43% +1ppt Capex of HK electricity business: CLP Power 1,782 4,552 1, % CAPCO 1,643 3,198 1, % Total 3,425 7,750 3, % CLP's 1H11 net profit was -2% yoy to HK$5,800m, which is above Citi's forecast by 7% and consensus estimate according to Bloomberg by 10%; the profit was higher than expected primarily due to more than anticipated operating earnings +13% yoy to HK$5,000m in the period, with the sharpest growth from Australia after the A$2.2bn NSW acquisition effective 1 March 2011, though Hong Kong remained its key profit source generating 65% its operating earnings in 1H11. A second interim DPS of HK$0.52 (unchanged yoy and same as the first interim DPS) was declared, implying a payout ratio of 43% in 1H11, +1ppt yoy. The second interim DPS will be payable on 15 Sep 2011 to shareholders whose names appear on the company's register of members on 5 Sep CLP's performance in each country in FY10 is stated below. 3

4 Figure 2. CLP s profit sources in 1H11 (by country) 1H10 Mix 1H11 Mix YoY Hong Kong 3,014 68% 3,114 62% 3% PRC investments supporting HK business 351 8% 361 7% 3% Sales from HK to China 25 1% 11 0% -56% Australia * % 1,166 23% 153% China * % 349 7% -24% India * 115 3% 183 4% 59% Southeast Asia and Taiwan * 191 4% 28 1% -85% Other earnings 53 1% 55 1% 4% Unallocated net finance costs -8 0% -17 0% 113% Unallocated group expenses % % 11% Operating earnings before one-off items 4, % 5, % 13% Non-recurring items for Australia 1,086 24% % -126% Non-recurring items for HK 0 0% 202 4% n/a Non-recurring item for China 400 9% 0 0% -100% Non-recurring item for Southeast Asia and Taiwan 0 0% % n/a Total earnings 5, % 5, % -2% Total earnings from overseas (marked with *) 1,225 28% 1,726 35% 41% HK - Steady Growth under Regulatory Regime CLP s electricity sales in Hong Kong were +1% yoy to 14,345GWh in 1H11 driven by continued strong economy and more demand from residential sector during hot weather in 2Q11. Its sales from Hong Kong to mainland China however were -41% yoy to 848GWh due to lower contract volume. Total electricity sales therefore were down 2.8% yoy to 15,193GWh in the period. With effect from 1 Jan 2011, there was a 2.8% average net tariff increase. CLP s SOC profit from Hong Kong was +3% yoy to HK$3,114m in 1H11. The profit is decided by an asset base formula at a maximum permitted return of 9.99% ROA. The return rate has been agreed with local government by contracts effective until end And the higher profit was driven by increased average net fixed assets partly offset by higher interest expense on increased borrowings. Though its capex in 1H11 was -9.8% yoy to HK$3,090m, it was in line with development plan under a five-year capex plan from Oct 2008 to Dec 2013, the maximum capex in the period is HK$39.9bn (or HK$7.6bn pa), including HK$20.8bn up to end 1H11. On these numbers, we forecast CLP s SOC asset base in Hong Kong to +4% pa in E. Longer term, the central government in Beijing is targeting to reduce the CO 2 emission per unit of GDP output by 40-45% in 2020, from that in 2005); as a part of China, the Hong Kong government would like to follow the same direction. But the Hong Kong government has put its 2020 s fuel mix target (50% nuclear, 40% gas and 10% coal) for electricity generation on hold after the nuclear accident in Japan in March, pending Beijing government review of national nuclear policy. We understand from the Hong Kong government that the percentage from nuclear by 2020 might be lowered. But the revision will unlikely be announced this year, pending clarification of the PRC government s long-term nuclear policy. 4

5 Australia Integrating NSW Acquisition Figure 3. CLP s profit from Australia (HK$m) 1H10 1H11 Yoy Gross margin Electricity 2,521 4,765 89% Gross margin Gas % Operating expenses and others -1,178-2, % EBITDAF 1,912 3,146 65% Fair value movement % EBITDA 1,754 3, % Depreciation & amortization % Net interest expenses % Development and integration expenses % Tax expense % Solar Systems final distribution from liquidator 0 37 n/a Share of results of Roaring 40s % Operating earnings before one-off items 461 1, % NSW Acquisition stamp duty n/a Gain on reorganization of Roaring 40s n/a Tax consolidation effect % Coal mine insurance recovery % Total earnings 1, % In 1H11, CLP s EBITDA from Australia was +105% yoy to HK$3,592m due to (i) HK$635m contribution in four months (March-June) from EnergyAustralia and Delta Western GenTrader in NSW, increasing its customer accounts by 125% to 2.81m, acquired on 1 March. The deal has solidified TRUenergy s position as one of the top three national retailers and generators in Australia; (ii) sustained electricity and gas margins in Victoria; (iii) favorable fair value movement on energy and offtake contracts due to rising forward prices and MTM gains. It also benefitted from an extra HK$160m operating earnings due to 18% AUD/HK$ appreciation in the period. Meanwhile, acquisition-related costs charged to profit or loss (included in fuel and other operating expenses) were HK$769m, which comprised stamp duty of HK$615m and other costs of HK$154m. Figure 4. NSW acquisition balance sheet summary Consideration (HK$m) Cash 15,453 Deferred consideration 1,894 Others -44 Total consideration 17,303 Recognized amounts of identifiable assets acquired and liabilities assumed Fixed assets 6,151 Other intangible assets 1,799 Trade receivables 5,620 Derivative financial instrument assets 1,261 Other current assets 1,057 Trade and other payables -4,987 Deferred tax liabilities -2,652 Derivative financial instrument liabilities -4,976 Total identifiable net assets 3,273 Goodwill 14,030 Total 17,303 For 2H11E, CLP expects profitability in Australia to be higher than that in 1H11 because (i) integration would boost the profitability of EnergyAustralia and Delta 5

6 Western GenTrader in NSW; (ii) electricity and gas margins in Victoria would be sustained, or even increase, as regulated prices for EnergyAustralia residential and small business customers were allowed to raise average 17.9% from 1 July 2011, that would be able to offset a 9% increase for higher net work costs and 6% due to the increased costs associated with the Australian government s Renewable Energy Target Scheme. CLP nevertheless pinpointed that a full-year profit from the newly acquired EnergyAustralia and Delta Western GenTrader in NSW would be much less than that in the four months from March to June multiplied by three due to seasonal factor. Longer term, we expect CLP will be able to improve the return of this acquisition in the next two years via synergy by consolidating the new assets into TRUenergy. Strategic Gas Acquisition for TRUenergy On 18 July, TRUenergy has agreed to acquire an effective interest in over 500PJ of coal seam gas reserves in the Gunnedah basin for A$284m from Santos, one of the largest producers of natural gas to the Australian domestic market. In earlier time, Santos has reached binding agreements to acquire 100% stake of Australian coal seam gas company Eastern Star Gas (ESG). Subject to the successful completion of the Santos' acquisition of ESG, TRUenergy will own 20% of ESG s permits, while Santos will own 80% and will be the operator. ESG has the largest natural gas reserves position in NSW, with current gross reserves across its permits of 988PJ (2P) and 1,818PJ (3P), and a large inventory of contingent and prospective resources. In CLP s post 1H11 meeting, the company regarded this upstream investment as a long-term hedge and would represent 15% TRUenergy s NG requirement. Catalyst from TRUenergy Listing in Australia With net debt to equity ratio up 25bps to 75% in 1H11 primarily driven by NSW acquisition, CLP believes that it is time to halt acquisition, though it does not feel any credit rating downgrade risk, in particular credit rating agencies have removed its negative outlook recently. The company has financial flexibility in fund raising from debt financing, asset sales and spin-off. CLP admitted it is interested in potential spin-off of TRUenergy by local listing in Australia. The cash to be generated from such listing would be replenished back to its headquarters in Hong Kong which has financed TRUenergy buying NSW assets on 1 March. By end 1H11, CLP s net asset in Australia was about A$6bn (based on A$9bn assets and A$3bn debts). If 30% stake is listed at 1.2x PB, the listing would be able to raise A$2.2bn (=A$6bn*30%*1.2); equal to 27% total debt of HK$66bn of CLP s group by end 1H11. Additionally, renewable energy projects represented 17% of CLP s total generating capacity by end 1H11. 6

7 China Niche Strategies in Low-Carbon Generations Figure 5. CLP s profit from China (HK$m) 1H10 1H11 Yoy Coal-fired projects % Renewables projects - Wind % - Jiangbian Hydro % - Other Hydro and Biomass % Operating expenditure % Earnings from operations % RMB appreciation gain/net fair value gain 6 6 0% Development expenditure % Impairment loss of Shenmu % Release of Jiangbian s translation reserve % Reversal of over-accrued tax provision 0 6 n/a Operating earnings % Gain on sale of CLPPC Anshun % Total earnings % CLP s profit from China was -59% yoy to HK$349m in 1H11 dragged by (i) increase in coal costs average 12% yoy, which could not be fully offset by the 2-3% tariff hike on 10 April, in spite of high generation volume amid strong demand; and (ii) the absence of disposal gain in 1H11 (versus HK$400m in 1H10). Profit from renewable projects were increased including +40% yoy to HK$112m from wind farms due to expanded capacity (+52% yoy to 438MW by end 1H11) and new contribution from Jiangbian Hydropower Plant commenced operation in June We expect CLP s profit from China to rise hoh in 2H11E benefitted from (i) tariff hike effective for the full period while assuming the relatively stable coal prices in July-August to persist in Sep-Nov; and (ii) full-period contribution from Jiangbian Hydropower Plant. Longer term, CLP is pursuing niche strategies in low-carbon generations. In July, it agreed to invest in the 6X1,000MW Yangjiang Nuclear Power Station Project in Guangdong, China (around 220km away from Hong Kong). The matured Chinese pressurized water reactor technology (CPR1000) will be used in this plant. The total project cost is Rmb70bn (or Rmb11.7m/MW), with the capex being funded 80% by debts and 20% by equity. The equity amount is Rmb14bn (=Rmb70bn*20%); CLP will own 17% stake. CLP will pay Rmb4.8bn for the 17% stake. The company will make an upfront payment and further investment in stages based on the progress of the project construction. Given that the amount will be spent gradually in the run up to 2017E, the equity amount would not be material. CLP would be able to finance it by internal funding. The plant will supply electricity to Guangdong province and gradually be completed by phases in E. During 1H11 results analyst meeting, CLP emphasized that the return of this nuclear project would be high in view of its competitive capex; we estimates CLP able to make mid-teen return, higher than its investment hurdle rate around 12% IRR, if this project could get tariffs similar to Lingao s nuclear power plant, which is a newly commissioned nuclear power plant also in Guangdong province. In China, CLP will continue transition to lower carbon emitting generation and seek potential disposal of its minority owned coal fired plants. 7

8 India Risk from Coal Shortfall at Jhajjar in 2012E Figure 6. CLP s profit from India (HK$m) 1H10 1H11 Yoy From GPEC: - operating earnings % - unrealized exchange gain/(loss) on translation of FX receivables under PPA % - interest income % - dividend distribution tax provision % Total GPEC earnings % Renewables - operating earnings(including development expense) 0 11 n/a Renewables - pre-operating loss % Jhajjar - fair value gain/(loss) on financial derivatives % Jhajjar - pre-operating loss % Total earnings % CLP s profit from India was +59% yoy to HK$183m in 1H11; the profit surge was primarily driven by (i) unrealized exchange gain on translation of FX receivables under power purchase agreements of GPEC; (ii) fair value gain on financial derivatives of the under constructed Jhajjar coal-fired power plants driven by exchange gains; (ii) more contribution from renewable wind farms. These increments however were partly offset by a HK$55m pre-operating loss at Jhajjar due to higher interest related to US$ loans coupon only swap and US$ loan forward premium amortization in We forecast CLP to make around HK$200m (+9% hoh) from India in 2H11E, assuming steady performance at GPEC with revenue from both capacity payment and volume payment, though dispatching at lower levels than in the past due to the commissioning of several large coal-fired power projects in Gujarat, and more profits from renewable projects while stripping out one-off forex related items. Given that Jhajjar was 84% completed and with all equipment on site by end 1H11, it would likely be completed on schedule in 1H12E, though construction of this project has continued under difficult conditions due to shortage of local labor. The challenge in India nevertheless would come from inadequate local coal supply in principle, Jhajjar would have all its coal supply from Coal India domestically; in practice, owing to local coal shortage, the supply from Coal India would be 20-30% below previous expectation. CLP therefore might have to import coal to abridge the shortfall; CLP is in negotiation with the local grid to pass through the higher fuel cost to use imported coal; in our opinion, the negotiation would not be easy since (i) certain grid companies in India are of low profitability or even loss making; and (ii) the price of imported coal is expensive at about 2.5x of that of domestic ones. To mitigate coal cost and supply risk at Jhajjar, CLP is looking for some long-term supply arrangement from Indonesia. To avoid similar issue, CLP prefers to invest in mine-mouth projects in future and avoid exposure to Coal India. 8

9 SE Asia & Taiwan Less Important after EGCO Disposal Figure 7. CLP s profit from India (HK$m) 1H10 1H11 yoy Ho-Ping earnings % EGCO earnings % Thailand renewable business 0-2 n/a Development expenditure % Operating expenditure % Operating earnings before one-off items % Gain on sale of ECGO n/a Total earnings % CLP made HK$904m profit from SE Asia & Taiwan in 1H11 including HK$876m gain from the sales of its 13.36% stake in ECGO, at a consideration of HK$2,122m after the company failed to gain controlling stake in the latter for years. Excluding these one-off items, CLP s profit from this region was only HK$28m in 1H11 as a result of (i) less contribution from Hoi Ping affected by major overhaul in 1Q11 and increased coal prices; and (ii) the reduced recurrent earning from ECGO. For 2H11E, CLP s profit from SE Asia and Taiwan would remain low around HK$40m. While Ho-Ping will eventually be compensated for coal price increases through an energy tariff adjustment linked to the off-taker Taiwan Power Company s coal price, but with a one-year delay. In other words, Ho-Ping profitability would only rebound in 2012E. In Vietnam, we think the development of the greenfield projects; namely, Vung Ang 2 and Vinh Tan 3 coal-fired power projects, to take time since the local regulatory framework seems preliminary. 9

10 Australia - Limited Effect of Carbon Price in Early Stages Coal-fired generation currently accounts for around 75% of Australia s electricity. For every unit of electricity produced, conventional coal-fired generation releases around twice as much carbon pollution as generating electricity by burning natural gas. Yet gas-fired generation currently only accounts for around 16% of Australia s electricity. Generating electricity from renewable resources like wind or solar power puts no carbon pollution into the atmosphere. Renewable electricity currently accounts for around 8% of Australia s power supplies. Australia relies more heavily on coal-fired electricity generation than most other countries, and this is reflected in the higher pollution intensity of our electricity supplies. The International Energy Agency highlights that, in 2008, Australia s electricity generators released an average of 0.88 tonnes of carbon pollution for every megawatt hour of electricity generated. This is significantly higher than countries like the United States (which released 0.54 tonnes for every megawatt hour of electricity generated), the United Kingdom (0.49), New Zealand (0.21) and Canada (0.18). In fact, Australia had the highest polluting electricity sector of all OECD countries. And among the 80 developing countries examined by the International Energy Agency, only India, Cambodia and Cuba had more polluting electricity sectors. Figure 8. Global comparison overall and per person emissions in 2005 Source: Climate Analysis Indicators Tool, Version 8.0 (World Resources Institute, 2010). On 10 July, the Australian Government announced its revised carbon pricing mechanism. The Government has committed to reduce carbon pollution by 5% from 2000 levels by 2020 irrespective of what other countries do, and by up to 15 or 25% depending on the scale of global action. The proposed carbon pricing mechanism, subject to endorsement from Parliament, will include the following: (i) From 1 July 2012 a three years fixed carbon price period will commence, with annual surrender of permits and no permit banking. The fixed carbon price will start at A$23 per tonne. In each of the next two years, it will rise by 2.5% in real terms, assuming inflation of 2.5% a year, which is the mid-point of the Reserve Bank of Australia s target range for inflation. The carbon price will be A$24.15 per tonne in and A$25.40 per tonne in In the fixed price period, as many carbon permits as businesses require to meet their obligations will be available at the set price; 10

11 Figure 9. Carbon Price Year ending 30 Jun [UNIT] 2013E 2014E 2015E Carbon price [$/tco2-e] % chg pa [%] 5.0% 5.2% Source: Treasury, Citi Investment Research and Analysis (ii) (iii) From 1 July 2015 The carbon pricing mechanism will transition to a cap and trade emissions trading scheme. In this second flexible price stage, the carbon price will be set by the market. And it will commence including a 50% limit on the importation of international permits for surrender by domestic liable parties each year (until 2020); and From 2014 the Australian Government plans to determine and release five years of emissions caps commencing 1 July It is anticipated that updated five year forecasts will be released on a rolling annual basis. Figure 10. Australia s carbon pollution profile Electricity generation 37% Direct fuel combustion 15% Agriculture 15% Transport 15% Fugitive emission 7% Industrial processes 5% Deforestation and forestry 3% Waste 3% Total 100% Source: 2009 emissions from the National Greenhouse Gas Inventory 2011, DCCEE analysis A price on carbon pollution will create a powerful incentive for businesses to cut their pollution by investing in clean technology and finding more efficient ways of operating. It will ensure that pollution is reduced at the lowest cost to the economy. Around 500 of the biggest polluters in Australia, in particular power plants which produced 37% carbon pollution of the country in 2009, will be required to pay for their pollution under the carbon pricing mechanism. And the 50 largest polluters will be responsible for around 75% of the pollution covered by the carbon pricing mechanism. In the flexible price period, the number of permits issued by the Government each year will be limited by a cap on annual carbon pollution. The price will then be determined by the market. Businesses will compete to buy the number of permits they need to meet their obligations. Businesses that value these carbon permits most highly, because the cost of reducing their pollution is higher, will be willing to pay the most for them. For some businesses, it will be cheaper to reduce missions than buy carbon permits. From the start of the flexible price period, businesses will also have access to international carbon markets to buy permits which represent credible reductions in carbon pollution internationally. In both the fixed and flexible price period, large polluters will have to pay a price for every tonne of carbon pollution they release. These businesses will choose to reduce their emissions if they can do so at a cost that is less than the carbon price. In both periods, the market will determine the most cost-effective ways to reduce carbon pollution. Thus the market will create incentives to cut carbon pollution. 11

12 Figure 11. Effects on average weekly household expenditure of a A$23 carbon price in Weekly expenditure (A$) Consumer prices % Electricity Gas Food 0.8 < 0.5 Overall effect The carbon price is expected to increase the CPI by 0.7% in E. The overall increase in prices is expected to be quite modest: the average increase in expenditure across all households is expected to be around A$9.90 a week in This includes an average estimated increase in household electricity expenditure of round A$3.30 per week, and gas of A$1.50 per week. On average, food will go up by less than A$1 per week for households. Expecting Limited Impact on CLP The introduction of climate change legislation may result in impairment on Yallourn brown coal-fired power station due to either a reduction in the earnings from reduced output and/or increased costs, which might not be fully offset by higher electricity prices and/or a reduction in the useful life of the asset. The earnings impact of the Australian Carbon Pricing Scheme, with carbon price at A$23/ton from July 2012, looks limited on CLP s 100%-owned TRUenergy in our opinion because: 1. The extra cost of Yallourn brown coal plant would be significantly offset by the gain of higher tariffs of its gas and wind projects with emission intensities below average; and 2. The Government has plans to close 2,000MW of highly emissions-intensive coal-fired generators (generator intensity at least 1.20t CO2-e will be eligible), by 2020; and we think Yallourn not among them. Those with emissions intensity of above 1.2t CO2-e, including Yallourn, will be eligible to participate in an expression of interest process for closure, subject to system security and costs associated with the closure. Playford and Hazelwood (not Yallourn), which have the highest emission intensity, are the most likely to be closed, in our view. 12

13 Figure 12. Emissions Intensity of Brown Coal-Fired Generators 1.8 2,500 Emissions intensity (tco2-e/mwh) ,000 1,500 1, Capacity (MW) Hazelwood Playford B Energy Brix Yallourn Loy Yang B Loy Yang A Anglesea Northern Emissions intensity Eligibility for closure Capacity Source: Company Reports, ACIL Tasman, Citi Investment Research and Analysis 3. A$5.5bn in permits for coal-fired generators Coal-fired generators with emissions intensity above 1.0t CO2-e will receive free permits above 0.86t CO2-e until , to the value of A$5.5bn. These will be capped at 1.3t CO2-e. This would cover Yallourn (1.29t CO2-e), mitigating certain negative impact. CLP anticipates being eligible for 25% of the transitional assistance. The net book value of Yallourn Power Stations was A$1,710m by end 1H11, equal to 17% CLP s net book value. Assessment is under way for impact on TRUenergy according to CLP hence the latter could not quantify it so far. Regarding timing, legislation is expected to be presented to Parliament during the Spring Sitting which begins in mid August. If introduced in mid-august, it might receive loyal assent and become law in early Sep. 13

14 Earnings Uplift by 6-9% for FY11-13E Figure 13. CLP s earnings revision New vs. Old New Old % change Revenue (HK$m) FY11E 84,850 65, % FY12E 95,108 71, % FY13E 99,695 74, % Operating profit (HK$m) FY11E 15,634 15, % FY12E 15,901 15, % FY13E 16,404 15, % OP margin FY11E 18.4% 22.9% -4.5% FY12E 16.7% 21.4% -4.7% FY13E 16.5% 21.0% -4.5% Profit from associates (HK$m) FY11E 3,359 3, % FY12E 3,218 2, % FY13E 3,786 3, % Net profit (HK$m) FY11E 11,293 10, % FY12E 11,828 10, % FY13E 12,817 11, % NP margin FY11E 13.3% 16.3% -3.0% FY12E 12.4% 15.4% -3.0% FY13E 12.9% 15.8% -2.9% EPS (HK$) FY11E % FY12E % FY13E % DCF (HK$) % Rating HOLD HOLD We raise our FY11-13E net profits by 6-9% primarily due to more revenues and profits in Australia; meanwhile, we also added our profits from China and India with reference to better than expected performance in 1H11 results. Figure 14. CLP s net profit forecasts Citi vs. consensus Net profit (HK$m) Citi Consensus % diff FY11E 11,293 10, % FY12E 11,828 10, % FY13E 12,817 11, % Source: Bloomberg and CIRA Estimates Our FY11-13E net profits are 8-13% more than consensus. We expect consensus to be revised up in view of the better than expected 1H11 profits. 14

15 Figure 15. CLP s DCF breakdown Method Value Per share By project By country (HK$m) (HK$) SOC DCF 116, % 51% Non-SOC Australia: TRUenergy ex-yallourn DCF 32, % Yallourn DCF 15, % 21% China: Guangdong Nuclear Power DCF 13, % Guangxi Fangchenggang DCF 7, % CLP Guohua DCF 2, % Shandong JV DCF 2, % Guangzhou Pumped Storage 15x P/E % Shenmu II DCF % Huaiji 15x P/E % Sichuan Jiangbian Hydro DCF 1, % Yunnan Dali Yang Er Hydro DCF % 13% India: GPEC DCF 7, % Jhajjar DCF 11, % 8% Other countries: Taiwan (Ho-Ping) DCF 5, % 2% Others BV 10, % 4% Total 229, % 100% Net debt -53, DCF 175, And our DCF TP could be changed using various WACCs and discount rates. Figure 16. CLP's DCF sensitivity to WACC and Terminal Growth Rate (HK$/share) WACC = 6.55% WACC = 6.80% WACC = 7.05% Terminal growth = 2.5% HK$70.7 HK$68.0 HK$65.7 Terminal growth = 3.0% HK$76.4 HK$73.0 (base case) HK$70.1 Terminal growth = 3.5% HK$83.9 HK$79.5 HK$75.7 Figure 17. CLP s Historical Rolling PE Chart Figure 18. CLP s Historical Rolling PB Chart Figure 19. CLP s Dividend Yield Chart x Historical average P/E: 13.6x Max: 31.8x Min: 7.8x 0 Dec-88 Dec-92 Dec-96 Dec-00 Dec-04 Dec-08 +2SD +1SD mean -1SD -2SD x Historical average PB: 2.8x Max: 7.8x Min: 1.6x +2SD +1SD mean -1SD 0-2SD Dec-88 Dec-92 Dec-96 Dec-00 Dec-04 Dec-08 8% 7% 6% 5% 4% 3% 2% 1% Historical average: 4.6% Max: 7.1% Min: 1.8% 0% Dec-88 Dec-92 Dec-96 Dec-00 Dec-04 Dec-08 +2SD +1SD mean -1SD -2SD Source: Citi Investment Research and Analysis Source: Citi Investment Research and Analysis Source: Citi Investment Research and Analysis 15

16 Figure 20. HK Utilities Valuation Comparison (Price as at 16 Aug 2011) RIC Rating Price PE P/B Net D/E Yield Current Target FY11E FY12E FY11E FY12E FY11E FY12E FY11E FY12E CLP 0002.HK Hold (2L) HK$68.10 HK$ % 55.8% 3.6% 4.1% Power Assets 0006.HK Buy (1L) HK$58.10 HK$ % 33.9% 4.3% 4.4% CKI 1038.HK Buy (1L) HK$46.00 HK$ % 14.0% 3.2% 3.4% HKCG 0003.HK Sell (3L) HK$17.24 HK$ % 28.3% 2.0% 2.5% Average % 34.6% 3.7% 3.9% Source: Citi Investment Research and Analysis estimates 16

17 High correlation between dividend yield of HK utilities and US Treasury Yield Figure 21. HK Utilities Average Dividend Yields vs. US 10 Years Treasury Note Yield Figure 22. HK Utilities Average Dividend Yield Spread over US 10 Years Treasury Note Yield % 7.00 % Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 HK Utilities average dividend yields US 10 years TN Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 HK Utilities average dividend yield spread Source: Citi Investment Research and Analysis Source: Citi Investment Research and Analysis Historically, the average dividend yield of the four HK utility companies (namely, CLP, Power Assets, CKI and HKCG) had high correlation of 59% with US 10-year treasury note yield (see figures above). With the US Government planning to keep interest rate low in next two years, the yield of US 10-year Treasury note would remain low. HK utility companies would remain attractive for their dividend yield. 17

18 Financial Statement & Key Assumptions Figure 23. CLP Income Statement by Business Nature (HK$m) Year to 31 Dec FY09 FY10 FY11E FY12E FY13E SOC earnings 5,964 6,129 6,173 6,510 6,864 Non-SOC earnings 3,160 3,476 4,783 5,908 6,590 GNPJVC & PSDC Other power projects in China ,032 Power projects in AP 1,860 1,834 3,058 3,954 4,583 Sales to the Chinese mainland Electricity-related businesses Total earnings 9,124 9,605 10,955 12,418 13,454 Less: Unallocated net finance costs Less: Unallocated group expenses Pre-exceptional earnings 8,690 9,148 10,433 11,828 12,817 Exceptional items , Net profit 8,196 10,332 11,293 11,828 12,817 % chg -21.4% 26.1% 9.3% 4.7% 8.4% EPS % chg -21.3% 26.1% 9.3% 4.7% 8.4% Figure 24. CLP Income Statement in Ordinary Format (HK$m) Year to 31 Dec FY09 FY10 FY11E FY12E FY13E SOC business 28,437 30,349 31,111 32,252 33,466 Other businesses 22,231 28,061 53,739 62,856 66,229 Total revenue 50,668 58,410 84,850 95,108 99,695 Purchases of electricity from CAPCO -18,306-21,740-22,755-23,706-24,705 Purchases of nuclear electricity -8,849-9,746-5,406-5,406-5,406 Pumped storage service fee Staff costs -1,819-2,189-2,233-2,277-2,323 Other operating costs -6,163-6,921-34,031-42,936-45,886 EBITDA 15,179 17,462 20,073 20,430 21,023 Depreciation -4,332-5,065-4,439-4,529-4,619 EBIT 10,847 12,397 15,634 15,901 16,404 Net finance cost -3,408-4,111-4,989-5,106-4,876 Share of Profits of JVs and associates 2,415 2,893 3,359 3,218 3,786 PBT 9,854 11,179 14,004 14,013 15,314 Tax -1, ,515-1,970-2,266 Minority interest Net profit 8,196 10,332 11,293 11,828 12,817 % chg 21.4% 21.2% 18.4% 16.7% 16.5% EPS % chg -21.3% 26.1% 9.3% 4.7% 8.4% 18

19 Figure 25. CLP Balance Sheet (HK$m) As at 31 Dec FY09 FY10 FY11E FY12E FY13E Fixed assets 97, , , , ,855 Goodwill 8,105 9,150 9,150 9,150 9,150 Investment in associates & JV 20,651 22,854 20,154 19,652 19,159 Other LT assets 7,767 8,441 9,665 10,889 12,113 LT assets 137, , , , ,742 Cash & cash equiv. 7,994 4,756 5,004 6,869 8,279 Debtors & prepayments 9,018 11,118 13,553 14,745 15,278 Other current assets ,017 1,096 1,106 Current assets 19,329 18,714 21,519 24,655 26,608 Total assets 156, , , , ,350 Creditors & accruals 8,926 11,344 13,021 14,078 14,501 Current portion of LT debt 6,892 7,816 16,815 16,555 19,168 Other current liabilities 4,062 4,144 4,571 4,614 4,831 Current liabilities 22,438 26,231 37,334 38,174 41,428 Share capital 12,031 12,031 12,031 12,031 12,031 Reserves 58,730 67,630 73,272 78,825 84,578 Shareholders' funds 70,761 79,661 85,303 90,856 96,609 Minority interest Long-term debt 32,539 36,807 37,560 36,979 29,881 Development Fund 1,653 1,505 1,183 1,053 1,107 Rate Reduction Reserve Other LT liabilities 28,415 33,971 33,971 32,326 33,220 Liabilities & shareholders' funds 156, , , , ,350 Figure 26. CLP Cash Flow Statement (HK$m) Year to 31 Dec FY09 FY10 FY11E FY12E FY13E Operating profit 10,847 12,397 15,634 15,901 16,404 Depreciation & goodwill 4,332 5,065 4,439 4,529 4,619 Other non-cash items -1, Rebates Changes in working capital 2, Net finance cost -3,299-4,100-1,952-2,087-1,860 Tax ,312-3,721-1,314 Operating CF 11,175 11,886 15,983 14,557 17,889 Capex -7,449-10,137-22,328-6,751-6,846 Disposal/lease ,192-1,192-1,192 Investments -2,268-3,324-1,224-1,224-1,224 Dividends received 2,557 2,594 2,837 3,403 3,959 Investing CF -7,356-10,263-19,514-5,447-4,983 FCF 3,819 1,623-3,531 9,110 12,906 Change in bank loans 8,360 1,069 9, ,486 Dividends paid -5,967-5,984-5,973-6,405-7,011 Financing CF 2,393-4,915 3,779-7,246-11,496 Chg in cash & equiv 6,212-3, ,865 1,410 19

20 Figure 27. CLP Key Assumptions Year to 31 Dec FY09 FY10 FY11E FY12E FY13E HK's tariff & sale volume: Basic tariff (HK$/kWh) Fuel clause rebate SOC rebate Special Rebate Net tariff (HK$/kWh) Local unit sales (m kwh) 30,570 30,929 31,238 31,707 32,182 % chg 1.7% 1.2% 1.0% 1.5% 1.5% Export unit sales (m kwh) 3,731 2,609 2,087 2,296 2,526 % chg 5.0% -30.1% -20.0% 10.0% 10.0% SOC: Rate of return (%) 10.1% 10.1% 10.1% 10.1% 10.1% Capex (HK$m) 7,798 7,750 7,905 8,813 8,990 Permitted return (HK$m) 5,964 6,129 6,173 6,510 6,864 - yoy -21.0% 2.8% 0.7% 5.5% 5.4% Development fund balance (HK$m) 1,653 1,505 1,183 1,053 1,107 Profit mix: % SOC earnings 72.8% 59.3% 54.7% 55.0% 53.6% % non-soc earnings 27.2% 40.7% 45.3% 45.0% 46.4% Figure 28. CLP Key Ratios Year to 31 Dec FY09 FY10 FY11E FY12E FY13E Valuations Payout ratio 73% 58% 53% 56% 56% Profitability EBITDA margin 29.7% 29.2% 23.7% 21.5% 21.1% SOC EBITDA margin 45.1% 44.1% 45.0% 46.1% 47.1% EBIT margin 21.4% 21.2% 18.4% 16.7% 16.5% SOC EBIT margin 34.0% 33.1% 33.7% 34.8% 35.7% Net profit margin 16.2% 17.7% 13.3% 12.4% 12.9% Interest coverage (x) Dividend coverage (x) Return ROA 5.7% 6.2% 6.0% 5.9% 6.3% Gearing Net Debt/Equity 49.8% 55.0% 62.4% 55.7% 46.4% Net Debt/Asset 22.5% 24.4% 27.2% 25.3% 22.1% Total debt/ebitda

21 CLP Holdings Company description CLP is the larger of Hong Kong's two electric utilities, generating 74% of power in FY09. It serves 2.3m customers in Kowloon, the New Territories and outlying islands, a franchise area with 80% of Hong Kong's population. CLP's generation assets in Hong Kong are owned by CAPCO, 40%-held by CLP Power HK and 60% by Exxon Mobil, while CLP wholly owns the T&D network in its service areas. CLP Power Hong Kong and CAPCO are governed by a Scheme of Control (SOC) agreement. The old agreement was signed in 1993 and the new one, which was signed in Jan 2008, is effective from Oct 2008 to Sep CLP also owns power projects in Australia, China, India, Taiwan and Thailand; it engages in non-electricity businesses such as property development and engineering services. Investment strategy We rate CLP shares as Hold/Low Risk (2L), with a target price of HK$73.0. We expect more investment opportunities in Hong Kong given the government's fuel mix target by 2020, which includes an approval in FY11E for building a wind farm. CLP could also expand its overseas business through potential acquisition from NSW privatization in Australia. However, we view the stock as fairly valued at current levels. Valuation Our target price of HK$73 is based on a DCF approach, factoring in our earnings forecasts up to 2015 and a terminal value thereafter. We think this method is suitable for power companies such as CLP Holdings that work in a relatively static industry with predictable cash flows. Our WACC for CLP is 6.68% (except 9% for Yallourn, 10% for GPEC and Jhajjar, 8-10% for Chinese power plants, 8% for Ho Ping and 10%-12% for TRUenergy), which assumes (i) a risk-free rate of 5.2%, (ii) a market risk premium of 6.8%, (iii) an equity beta of 0.49x, according to Bloomberg, (iv) a cost of debt of 5.2%, (v) a target gearing ratio of 40%, and (vi) a 16.5% corporate tax rate. We assume a terminal growth rate of 3.0% beyond Risks We rate CLP as Low Risk based on our quantitative risk rating system, which tracks 260-day historical share price volatility. Key factors that could cause the shares to trade above our target price include: (1) Unexpected sizable gain or loss from overseas assets. (2) Unexpected interest rate change; our DCF-based target price is highly sensitive to the risk-free rate, which depends on interest rates. Key downside risks to our target price are 1) Regulatory risk in Australia regarding carbon pricing; and 2) Higher than expected coal prices in China. Cheung Kong Infrastructure Holdings (1038.HK; HK$46.00; 1L) Valuation Our DCF-based target price of HK$50.0 is derived by using DCF of our earnings forecasts up to 2015 and a terminal value thereafter. This method is suitable for utility companies such as CKI in a relatively static industry with much of its operations regulated and generating predictable cash flows. Our WACC is 7.48% 21

22 (but 10.5% for PRC toll road project and 8.5% for other overseas projects). This assumes: 1) a risk-free rate of 5.2%, 2) a market risk premium of 6.8%, 3) an equity beta of 0.57, 4) a cost of debt of 5.2%, 5) a target debt-to-capital ratio of 33.3%, 6) a 16.5% corporate tax rate, and 7) a 2% terminal growth rate beyond FY15E. At our target price, CKI would trade at 15.3x FY11E P/E. Risks We assign a Low Risk rating for CKI based on our quantitative risk-rating system, which tracks 260-day historical share-price volatility. The key factors that could impede the stock from reaching our target price include: 1) further interest rate cuts would lower its interest income; 2) regulatory issues relating to its Australian operations, and 3) failure to have acquisitions due to competition. Hong Kong & China Gas (0003.HK; HK$17.24; 3L) Valuation Our sum-of-the-parts target price is HK$17.0, including HK$8.40 from the HK gas business calculated using DCF, HK$1.24 from other HK businesses based on NAV and HK$8.36 from the China gas and water business determined primarily by DCF. The DCF values are determined with reference to earnings forecasts up to 2015 and a terminal value thereafter. This method is appropriate for gas distribution companies such as HKCG in a relatively static industry with predictable cash flows. Our WACC for HKCG is 7.9% (plus extra 1ppt for its China business), which assumes: 1) a risk-free rate of 5.2%; 2) a market risk premium of 6.8%; 3) an equity beta of 0.61x, according to Bloomberg for the last two years; 4) cost of debt of 5.2%; 5) a target debt to capital ratio of 28.6%; and 6) a 16.5% corporate tax rate. We assume a terminal growth rate of 2.5% beyond Risks Our quantitative risk-rating system, which tracks 260-day historical share-price volatility suggests a Low Risk rating for HKCG. Upside risks that could prevent the stock from achieving our target price include: 1) higher- and earlier-than-expected profit contribution from upstream gas businesses; 2) higher-than-expected gas sales growth; and 3) higher-than-expected profit from connection fees. Power Assets (0006.HK; HK$58.10; 1L) Valuation Our DCF-based target price of HK$68.0 factors in our earnings forecasts up to 2015 and a terminal value thereafter. This method is suitable for power companies such as Power Assets, which operate in a relatively static industry with predictable cash flows. Our WACC is 6.4% (however, 8.5% for Australian and New Zealand power distribution, UK gas distribution, Canadian power generation and China power generation, and 10% for Thai power generation), which assumes: 1) a risk-free rate of 5.2%; 2) a market risk premium of 6.8%; 3) an equity beta of 0.36x, according to Bloomberg; 4) cost of debt of 5.2%; 5) a target debt to capital ratio of 37.5%; and 6) a 16.5% corporate tax rate. We assume a terminal growth rate of 2-4% beyond 22

23 2015. At our DCF-based target price, Power Assets would trade at a 16.4x PER and 4.0% yield in FY11E. Risks We rate Power Assets as Low Risk in accordance with our quantitative risk-rating system, which tracks 260-day historical share-price volatility. Negative risk factors include: 1) failure to meet emission targets, resulting in a lower rate of return; 2) an unfavorable regulatory regime for the Australian operation. If these risk factors have a greater impact than we anticipate, shares will likely have difficulty attaining our target price. Appendix A-1 Analyst Certification The research analyst(s) primarily responsible for the preparation and content of this research report are named in bold text in the author block at the front of the product except for those sections where an analyst's name appears in bold alongside content which is attributable to that analyst. Each of these analyst(s) certify, with respect to the section(s) of the report for which they are responsible, that the views expressed therein accurately reflect their personal views about each issuer and security referenced and were prepared in an independent manner, including with respect to Inc and its affiliates. No part of the research analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendation(s) or view(s) expressed by that research analyst in this report. IMPORTANT DISCLOSURES Ratings and Target Price History Fundamental Research Analyst: Pierre Lau, CFA HKD Covered Not covered Chart current as of 13 August 2011 Date Rating Target Price Closing Price 1 26-Nov-08 3L * Feb-09 3L * Aug-09 3L * S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A Date Rating Target Price Closing Price 4 25-Feb-10 3L * Aug-10 3L * Nov-10 *2L * Date Rating Target Price Closing Price 7 24-Feb-11 2L * * Indicates change Rating/target price changes above reflect Eastern Standard Time 23