China Guangdong Nuclear Power [1816 HK]

November 27, 2014 China Guangdong Nuclear Power [1816 HK] Pure Nuclear Power Operator to Enjoy Scarcity Valuation Premium Nuclear Power China Guangdong Nuclear Power (CGN) will become the first pure nuclear play after listing on the Hong Kong Exchange (HKEx), which we believe will be the best proxy for the expected nuclear plant construction boom in China over the coming few years. According to the prospectus, the offer price range is HK$2.43-2.78 (market cap: HK$107.2bn-122.7bn), which implies 13x-16x 2015E PER (according to media reports). This represents some discount (or at par at the high-end of pricing range) to the valuation of other renewable energy operators (16x on average). We expect the stock will enjoy a scarcity valuation premium after listing. The largest nuclear power operator in China. As of June 2014 CGN operated and managed 11 nuclear power generating units with total installed capacity of 11,624MW. According to China Nuclear Energy Association (CNEA), total installed capacity for the 11 nuclear generating units and attributable capacity accounted for 64.1% and 43.5%, respectively, of the China market. Strong capacity growth over the coming years. CGN has nine nuclear power generating units under construction, which will increase its total operating installed capacity by 9,846MW (+85% from current capacity) to a total of 21,470MW on completion. Besides, CGN has entered into an agreement with CGNPC (CGN s controlling shareholder) to acquire an additional equity interest in Taishan Nuclear Power Station (currently 10% owned by CGN). Taishan Nuclear owns two nuclear power generating units with total capacity of 3.5GW on completion (now under construction). CGN plans to spend HK$12.2bn (RMB9.7bn) to purchase 41% of Taishan Nuclear, taking the stake to 51%. Favourable sector outlook on potential resumption of new project approval. The Chinese government has set clear targets to reach 40GW/50GW/58GW of nuclear installed capacity by 2015E/2017E/2020E, up from 14.6GW as of end-2013. We believe the Chinese government will soon resume the longawaited approval of new projects, which will trigger a robust construction cycle over the coming years. Huge capex growth in 2015E. CGN s capex will drop slightly by 7% year-onyear (YoY) to RMB11.5bn this year but will jump substantially in 2015E by 146% YoY to RMB28.4bn for capacity construction and acquisition. Investment concerns: (1) Nuclear plant construction cycle is long, increasing the risk of project delays; (2) the capital-intensive nature of nuclear power plants (even higher than wind and solar power in our view) implies huge capital requirement in future to support its capacity growth; (3) fluctuations in nuclear fuel cost will affect CGN margin, although this is not a significant factor; (4) potential increase in the provision for a spent fuel disposal fund will increase CGN s cost pressure; (4) any accidents at nuclear power facilities anywhere in the world will potentially lead to tightening government policies on nuclear power. Global Offering Offer price range HK$2.43-2.78 Market Cap range HK$107.2-122.7bn Shares Outstanding: -Without over allotment 44,125m -With over allotment 45,449m Free Float after listing 20.00%-20.33% Auditor Deloitte Major Shareholding CGNPC (75.44%-78.00%) Wayne Fung, CFA Analyst (852) 3698-6319 waynefung@chinastock.com.hk John Mulcahy Head of Research (852) 3698-6889 johnmul@chinastock.com.hk 1

Business of CGN Background. CGN was established on March 25, 2014 as a joint stock limited company through reorganization. Its controlling shareholder is China General Nuclear Power Corporation (CGNPC), which is 90% owned by SASAC and 10% owned by Henjian Investment. The largest nuclear power operator in China. As of June 2014, CGN operated and managed 11 nuclear power generating units with total installed capacity of 11,624MW, consisting of seven units in which CGN has a controlling interest, two units owned by Ningde Nuclear (a joint venture in which CGN owns 46%) and another two units owned by Hongyanhe Nuclear (an associate company in which CGN owns 45%). CGN ranks number one in China in terms of installed capacity and attributable capacity. According to China Nuclear Energy Association (CNEA), total installed capacity of the 11 nuclear generating units and the attributable capacity accounted for 64.1% and 43.5%, respectively, of China s market as of June 2014. Strong capacity growth over the coming years. As of June 2014 CGN was managing the construction of nine nuclear power generating units. These units are expected to increase total operating installed capacity by 9,846MW (+85% from the current capacity) to a total of 21,470MW on completion. Besides, CGN has entered into an agreement with CGNPC to acquire an additional equity interest in Taishan Nuclear Power Station (currently 10% owned by CGN). Taishan Nuclear owns two nuclear power generating units with total capacity of 3.5GW on completion (current under construction). CGN plans to spend a total of HK$12.2bn (RMB9.7bn) to purchase a further 41% of Taishan Nuclear, taking its stake to 51%. CGN has a right of first refusal to acquire these plants outright. All generating units that CGN operates and manages use the technology derived from mature French GW-level pressurized water reactor (PWR) technology. These units comprise three major parts: (1) the nuclear island which mainly includes the nuclear steam supply system; (2) the conventional island which mainly includes the steam turbine sets; and (3) the balance of plant (BOP) which mainly includes peripheral buildings and systems. Major customers. CGN sells most electricity generated to local power grid companies, including Guangdong Power Grid (the largest customer), State Grid Fujian Electric Power and State Grid Liaoning Electric Power. For Daya Bay Nuclear Power Station, 70% of the power generated is sold to Hong Kong. Hong Kong Nuclear Investment Company is CGN s second largest customer. Procurement of nuclear fuel and related services. Nuclear plants use fuel assemblies which are produced by assembling fuel rods that contain enriched uranium, processed from natural uranium. CGN procures the nuclear fuel mainly through CGN Uranium Resources (wholly owned subsidiary of CGNPC). The import and trading of natural uranium is strictly regulated in China. CGN Uranium is one of the two entities to be awarded operating permits and licenses. Change in nuclear fuel cost to have limited impact on earnings. The cost of nuclear fuel accounted for 26%-30% of the CGN s cost of sales over the past three years. About half of the cost of nuclear fuel consists of the cost of natural uranium. CGN s sensitivity analysis suggests that even if the nuclear fuel cost in 2013 were to rise 20%, net profit impact would only be 5%. Figure 1: Peer comparison Ticker Company Rating Price Market cap PE (x) PB (x) EV/EBITDA (x) (local currency) (US$ m) 2013A 2014E 2015E 2013A 2014E 2015E 2013A 2014E 2015E Chinese nuclear power equipment 2727 HK Equity Shanghai Electric - H - 4.69 11,887 20.9 19.6 18.5 1.5 1.4 1.4 13.0 11.0 10.5 1072 HK Equity Dongfang Electric - H - 14.22 5,124 11.2 13.1 11.9 1.2 1.2 1.1 7.7 8.8 7.9 Chinese renewable energy operator 916 HK Equity China Longyuan BUY 8.49 8,794 28.8 22.4 21.9 1.7 1.7 1.6 12.0 11.2 10.1 958 HK Equity Huaneng Renewables BUY 2.81 3,270 19.8 24.6 15.3 1.5 1.4 1.3 10.4 9.0 6.6 1798 HK Equity Datang Renewable HOLD 1.13 1,059 36.5 n/a 41.5 0.7 0.7 0.7 9.8 10.0 8.6 956 H Equity China Suntien HOLD 1.97 943 10.5 14.9 13.2 0.9 0.8 0.7 7.4 7.6 6.2 816 H Equity Huadian Fuxin - 4.12 4,237 15.3 12.9 9.9 2.0 1.9 1.6 12.2 9.4 7.7 579 H Equity Jingneng Clean Energy - 3.78 3,347 16.2 13.9 9.1 1.8 1.6 1.4 12.7 11.4 8.1 735 HK Equity China Power New Energy - 0.55 838 19.1 15.0 9.1 0.7 n/a n/a 8.1 7.4 4.3 182 HK Equity China Windpower - 0.53 611 18.1 10.8 7.0 0.9 0.9 0.8 14.7 6.7 3.8 Average 20.5 16.4 15.9 1.3 1.3 1.2 10.9 9.1 6.9 Sources: Bloomberg, Company, CGIHK Research estimates for stocks under our coverage 2

CGN key statistics and capex Figure 2: CGN key operating data 2011 2012 2013 1H14 Number of nuclear power generating units (period end) 6 6 6 6 Consolidated installed capacity (MW) 6,122 6,122 6,122 7,208 Weighted average consolidated installed capacity (MW) 5,471 6,122 6,122 6,706 Utilization hours 7,773 7,750 7,586 3,883 Net power generation (GWh) 40,519 45,113 44,157 24,753 On grid tariff (ex-vat) 0.3695 0.3661 0.3684 0.3668 Sales of electricity (RMB m) 14,972 16,514 16,268 9,080 Figure 3: CGN capex RMB m 30,000 25,000 20,000 15,000 10,000 5,000 0 146% -7% -21% -8% 2012 2013 2014E 2015E 160% 140% 120% 100% 80% 60% 40% 20% 0% -20% -40% Total capex (LHS) Change (YoY) 3

Favourable industry Why nuclear power? Similar to other renewable energy sources such as hydro, wind and solar power, nuclear power is a form of alternative energy that is a low-carbon clean energy source. The advantage of nuclear power vs. other renewable sources is that a nuclear station is less affected by weather, seasonality and other environmental conditions. Therefore, the average utilization hours of nuclear power can reach 7,600-7,900, much higher than hydro, wind, solar and other fossil fuel (figure 3). Figure 4: China primary energy consumption breakdown Hydro electric 7% 2013 Renewables 2% Nuclear Energy 1% Oil 18% Natural Gas 5% Coal 67% Sources: BP, CGIHK Research Figure 5: Utilization hours in China (breakdown by type of energy) 9,000 8,000 7,679 7,716 7,840 7,759 7,855 7,893 7,000 6,000 5,000 4,885 4,865 5,031 5,303 4,982 5,012 6,171 4,000 3,000 2,000 3,589 3,328 3,404 2,046 2,077 2,047 3,591 3,318 3,019 1,890 1,929 2,080 3,867 3,103 1,506 1,000 0 2008 2009 2010 2011 2012 2013 2014 (1-10) Wind Hydro Fossil-fuel Nuclear Sources: CEC, CGIHK Research 4

Strong installation over the coming years. Nuclear power accounted for only 1% of China s primary energy consumption in 2013, according to BP statistics. The Chinese government has set clear targets to reach 40GW/50GW/58GW of nuclear installed capacity by 2015E/2017E/2020E, up from 14.6GW as of end-2013. This will represent a CAGR of 36% between 2013 and 2017E, and a CAGR 5% between 2017E and 2020E. Figure 6: China nuclear installation (cumulative) 70 60 2017E-2020E CAGR: 5.1% 58.0 50 2013-2017E CAGR: 36% 50.0 40 30 31.4 34.0 33.5 33.8 33.9 30.8 40.0 30.0 30.0 20 10 12.1 9.1 9.1 10.8 12.6 12.6 14.6 17.8 18.0 0 2008 2009 2010 2011 2012 2013 As of 10/2014 2015E 2017E 2020E Capacity in operation (GW) Capacity in construction at year end (GW) Sources: WIND, NEA, CGIHK Research Government policy support Priority on grid connection and dispatch. According to Chinese laws and regulations, nuclear power enjoys priority over coal-fired, oil-fired and natural gas-fired generating units in grid connection and dispatch. Benchmark on-grid tariff. The NDRC set the benchmark tariff for nuclear power plants at RMB0.43/kwh (for power plants commencing operation after Jan 1, 2013). Preferential tax treatment. Nuclear power companies in China are subject to the policy of refund-after-collection for VAT for up to 15 years (on a sliding scale from 75% to 55%) from the month following the commencement of operations. In addition, nuclear power projects approved on or after Jan 1, 2008 are exempted from China corporate income tax for three years starting from the first year when electricity sales generate revenue, and are entitled to a 50% reduction for the subsequent three years. 5

Figure 7: CGN income statement Income statement 2011 2012 2013 1H13 1H14 (RMB m) Revenue 15,881 17,575 17,365 8,171 9,754 Sales of electricity 14,972 16,514 16,268 7,784 9,080 Service revenue 755 796 843 262 615 Sales of other goods 154 265 254 125 59 Less: Tax surcharge (221) (250) (255) (103) (121) Revenue after tax surcharge 15,660 17,325 17,110 8,068 9,633 Cost of sales (7,987) (9,155) (8,961) (3,991) (4,496) Cost of nuclear fuel (2,099) (2,785) (2,658) (1,236) (1,350) Depreciation (2,234) (2,413) (2,240) (1,004) (1,189) Spent fuel disposal fund (797) (787) (732) (358) (395) Staff costs (1,260) (1,311) (1,455) (734) (931) Operating maintenance fee (1,050) (1,118) (1,204) (523) (382) Others (547) (741) (673) (138) (249) Gross profit 7,674 8,170 8,148 4,076 5,137 Administrative expenses (811) (917) (1,027) (446) (584) Selling and distribution expenses (1) (4) (4) (2) (2) Other income 1,224 1,489 1,506 1,317 989 Other expenses (230) (108) (175) (83) (38) EBIT 7,855 8,630 8,448 4,863 5,502 Finance costs (2,114) (3,118) (2,804) (1,414) (1,515) Other gains and losses 447 323 (24) 161 (57) Shares of results of associates 151 (5) 149 23 (39) Share of results of joint ventures 2 (4) 144 95 (155) Change in fair value of derivatives (8) 42 157 (48) (109) Pretax profit 6,332 5,868 6,070 3,679 3,626 Taxation (936) (890) (998) (532) (537) After tax profit 5,396 4,977 5,071 3,147 3,090 MI 669 833 877 495 518 Net profit 4,727 4,145 4,195 2,653 2,572 Core net profit 4,289 3,780 4,061 2,540 2,738 6

Figure 8: CGN balance sheet Balance sheet 2011 2012 2013 (RMB m) Non-current assets Property, plant and equipment 70,068 79,185 87,042 Intangible assets 511 629 765 Investment properties 219 199 183 Interests in associates 11,211 5,872 6,730 Interests in joint ventures 2,769 3,325 4,364 Available-for-sale investments 110 2,090 2,475 Deferred tax assets 74 84 98 Derivative financial instruments 89 127 185 Value added tax recoverable 1,369 2,141 2,385 Prepaid lease payments 548 1,068 1,007 Deposits for property, plant and equipment 451 449 682 87,421 95,167 105,914 Current assets Inventories 7,531 7,514 8,384 Properties under development for sale 353 252 267 Completed properties for sale - 67 47 Prepaid lease payments 21 20 35 Trade and bills receivables 1,659 1,837 1,629 Prepayments and other receivables 988 1,175 1,143 Amounts due from related parties 3,084 8,009 286 Loans to fellow subsidiaries 200 370 450 Derivative financial instruments 104 117 120 Restricted bank deposits 16 14 7 Cash and cash equivalents 10,453 5,434 6,640 Other deposits over three months 1,878 2,286 2,752 26,287 27,096 21,761 Total assets 113,708 122,263 127,675 Balance sheet 2011 2012 2013 (RMB m) Current liabilities Trade and other payables 8,398 11,183 10,350 Amounts due to related parties 18,831 3,687 1,825 Loans from ultimate holding company 6,473 19,368 9,131 Loans from a fellow subsidiary 1,607 1,512 1,566 Income tax payable 273 175 356 Provisions 1,820 1,153 737 Bank borrowings- due within one year 3,046 2,709 2,401 Derivative financial instruments 98 100 96 40,546 39,887 26,462 Non-current liabilities Bank borrowings-due after one year 30,044 37,861 48,722 Notes payable 8,500 8,500 8,500 Deferred tax liabilities 671 958 1,200 Deferred income 279 445 618 Provisions 1,135 1,217 1,286 Derivative financial instruments 293 274 165 Loans from a fellow subsidiary 3,168 3,041 3,100 Loans from ultimate holding company - 400 400 Payables to ultimate holding company 5,530 5,530 5,530 49,619 58,226 69,521 Capital and reserves Paid-in/share capital 15,709 18,280 19,768 Reserves 1,743 (1,976) 3,284 Equity attributable to owners of the company 17,452 16,304 23,052 Non-controlling interests 6,091 7,845 8,640 Total Equity 23,543 24,150 31,692 Total equity and liabilities 113,708 122,263 127,675 7

Figure 9: CGN cash flow and key ratios Cash flow 2011 2012 2013 (RMB m) Operating cash flow 10,218 8,660 9,493 Investing cash flow (11,818) (14,979) (4,482) Financing cash flow 5,692 1,301 (3,937) Key ratios 2011 2012 2013 Growth rate Revenue n.a 10.7% -1.2% Gross profit n.a 6.5% -0.3% EBIT n.a 9.9% -2.1% Core net profit n.a -11.9% 7.5% Operating ratios Gross margin 48.3% 46.5% 46.9% EBIT margin 49.5% 49.1% 48.6% Core net profit margin 27.0% 21.5% 23.4% Asset Turnover n.a 14.9% 13.9% Fixed assets turnover n.a 23.6% 20.9% ROE (core net profit) n.a 22.4% 20.6% ROA (core net profit) n.a 3.2% 3.2% Interest coverage 3.7x 2.8x 3.0x Net debt / equity 183.4% 350.7% 242.6% Current Ratio 0.6x 0.7x 0.8x Quick Ratio 0.5x 0.5x 0.5x 8

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