Equity Research Industrials 2H16 Power Equipment Sector Outlook Opportunities in power grid construction Dominic Chan, CFA, FRM SFC CE No. APP609 dominicchan@gfgroup.com.hk +852 3719 1218 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Sector View Neutral China continues to increase investment in power grid construction, including in the modernization of rural power grids, as a way of solving the imbalance in its power supply. The government will also focus on developing the distribution grid, with plans to invest Rmb2trn in this area during 2015-20. There are currently 13 UHV transmission lines under construction, and the SGCC plans to build Five Vertical and Five Horizontal UHV transmission lines by the end of 2020. This should push up demand for power cables. However, the industry faces two main problems: 1) a slowdown in power equipment purchases, including purchases of power meters; 2) high account receivables. Key themes over next 3-6 months SGCC usually offer tenders 6-7 times each year. Investors should pay attention to tender offer results in 2H16. New UHV transmission line approvals. Valuation analysis Low valuation as investor concerns linger The power equipment sector is currently trading at 7x FY16E P/E, which is significantly lower than its historical average of 12x, indicating that downside risk from bad debts and poor interim results may have been largely priced in. Any further de-rating will depend on upcoming interim results. Investment strategy Cherry picking based on companies financial situations Investors are cautious about the financial situations at specific companies. We suggest choosing companies that are seeing improvements in their financial situations. Top picks Jiangnan Group (1366 HK, Buy) The company will benefit from steady growth in demand for power cables, its key product, and is attractively valued. Risks Upside risks: China speeds up power grid construction. Downside risks: Receivable turnover may increase, leading to tight cash flow or even bad debts.
Opportunities in power grid construction SGCC and CSG investment to remain stable in 2016 Total investment by the State Grid Corporation of China (SGCC) came in at Rmb450bn in 2015, up 18.5% on the previous year. This year, the corporation targets to invest Rmb439bn. China Southern Power Grid (CSG) aims to increase investment from Rmb70bn in 2015 to around Rmb96bn this year, meaning a potential combined investment from the two corporations of about Rmb535bn, up 2.5% YoY. Figure 1: SGCC investment (2011-16) Figure 2: CSG investment (2011-16) Sources: SGCC, CSG, GF Securities (HK) Over the longer term, SGCC plans to invest around Rmb2.3trn during the 13 th Five Year Plan period, which would be a 28% increase on the amount invested during the 12 th Five Year Plan period, and mean investment of Rmb460bn per annum. Although CSG has not given a target, we believe its investment will also increase significantly due to the rise in investment in smart grids, rural power grid modernization and distribution network upgrades. However, the automation rate for China s distribution network is much lower than in developed countries. In order to support smart grid construction, we believe power distribution network construction will grow more rapidly over the next five years. According to the National Energy Administration, China will invest Rmb2trn in power distribution network construction during 2015-20 (it invested Rmb300bn in 2015). The plan will help to enhance power supply stability in China, with the aim being to increase the power supply stability rate to 99.99% in cities in central China and 99.88% in urban areas by 2020. Figure 3: China s distribution automation rate is much lower than in developed countries 70 60 50 40 30 20 10 0 China Korea Germany Japan Distribution automation rate (%) In addition, SGCC and CSG will invest Rmb700bn in rural power grid modernization during the 13 th Five Year Plan period, much higher than the Rmb500bn invested during the 12 th Five Year Plan period and the Rmb300bn during the 11 th Five Year Plan period. 2
Rapid UHV transmission line construction in China Thanks to the rise in investment in power grid construction in China, the total length of 110kv-andabove power transmission lines in China increased at a CAGR of 7.7% during 2009-14. Frost & Sullivan expects this to continue to grow at a CAGR of 8.1% during 2015-20 given rapid ultrahigh-voltage (UHV) network construction. There will be rapid development of UHV transmission grids during 2015-20 in order to combat air pollution and resolve curtailment issues caused by the unbalanced geographic distribution of new energy power generators across China. There were six UHV transmission lines in operation at the end of 2015, and eight further lines were approved during that year (two AC and six DC). Altogether, there are currently 13 UHV transmission lines under construction. Frost & Sullivan expects the total length of UHV transmission lines to grow at a CAGR of 23.4% during 2015-20. According to SGCC, China targets to build Five Vertical and Five Horizontal UHV transmission lines by the end of 2020, meaning 27 UHV transmission lines will be in operation. We believe this rapid growth in UHV transmission grids will drive growth for the power cables sector. Figure 4: Total length of power transmission lines (110kv and above) Figure 5: Total length of UHV transmission lines 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 701 771 818 879 2015-20 CAGR of 8.1% 1,614 1,488 1,372 1,268 1,175 1,091 953 1,015 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 2015-20 CAGR of 23.4% 0 2009 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E Total length of power transmission lines (thousand km) 1000KV AC 800KV DC Sources: China Electricity Council, Frost & Sullivan, GF Securities (HK) Exponential growth ahead for the EV charging station market The rise in demand for new energy vehicles in China will mean a substantial increase in the number of charging stations needed over the next five years. By the end of 2020, China targets to install 12,000 charging stations and 4.8m individual charging posts, which will provide the charging infrastructure needed for around 5m new energy vehicles. The charging post market is therefore expected to remain strong. Titans Energy (2188 HK, NR) is one of very few HK-listed companies involved in the charging post business. High accounts receivable in the industry Due to the economic downturn, many small and medium-sized enterprises are facing funding problems, meaning most power equipment companies are seeing deteriorating account receivables. Figure 6: Working capital comparison Ticker Company FY14 AR FY15 AR FY14 AP FY15 AP FY14 inventory FY15 inventory 1685 HK Boer Power 329 533 280 322 36 24 1366 HK Jiangnan GP 99 110 29 31 115 155 3393 HK Wasion GP 206 320 66 59 215 376 1206 HK Technovator 161 184 117 174 115 175 2188 HK Titans Energy 558 565 215 189 203 227 3996 HK China Energy eng 80 79 92 102 91 90 3
Figure 7: Peer valuation comparison EPS P/E ratio P/B ratio Tricker Name Currency Price 2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E HK peers 1685 hk equity BOER POWER HOLDINGS LTD HKD 3.38 0.85 0.90 1.12 3.97 3.77 3.03 1.02 0.90 0.77 3393 hk equity WASION GROUP HOLDINGS LTD HKD 4.11 0.52 0.527 0.66 7.93 7.80 6.25 0.88 0.84 0.79 1366 hk equity JIANGNAN GROUP LTD HKD 1.24 0.23 0.23 0.32 5.72 5.30 3.94 0.89 0.79 0.70 1206 HK equity TECHNOVATOR INTERNATIONAL LT HKD 3.94 1.32 0.34 0.47 12.64 11.54 7.81 1.31 1.27 1.02 2188 HK equity CHINA TITANS ENERGY TECHNOLO HKD 1.14 - - - - - - 1.94 - - 3996 HK equity CHINA ENERGY ENGINEERING COR HKD 1.28 0.23 0.19 0.27 5.46 6.74 5.69 0.76 0.70 0.64 Average 7.14 7.03 5.34 1.13 0.90 0.78 A shares peers 600406 ch equity NARI TECHNOLOGY CO LTD-A CNY 13.37 0.65 0.71 0.94 24.46 21.58 18.71 3.98 3.53 3.10 000400 ch equity XJ ELECTRIC CO LTD-A CNY 15.44 0.88 1.05 1.59 20.76 17.36 12.73 2.45 2.21 1.91 000400 ch equity GUODIAN NANJING AUTOMATION-A CNY 7.58 0.06 0.17-186.42 53.93 37.75 2.70 2.29 2.19 600268 ch equity ZHEJIANG CHINT ELECTRICS-A CNY 18.85 1.64 1.78 1.85 14.13 12.58 11.51 3.55 2.48 2.24 601877 ch equity JIANGSU LINYANG ENERGY CO -A CNY 41.85 1.59 1.86 2.70 32.22 26.69 20.17 3.38 2.87 2.56 601222 ch equity NINGBO SANXING ELECTRIC CO-A CNY 14.75 0.62 0.79-25.25 21.97 15.93 5.58 4.82 3.70 601567 ch equity QINGDAO TGOOD ELECTRIC-A CNY 21.69 0.20 0.37 0.55 136.12 69.30 55.47 8.65 8.00 7.22 300001 ch equity SHENZHEN CLOU ELECTRONICS-A CNY 11.75 0.22 0.34 0.55 68.30 41.33 31.84 6.01 5.26 4.50 002121 ch equity SIEYUAN ELECTRIC CO LTD-A CNY 10.95 0.63 0.74-21.77 17.24 14.20 2.05 1.59 1.43 002028 ch equity FAR EAST SMARTER ENERGY CO-A CNY 10.3 0.26 0.41 0.61 48.44 29.74 22.82 5.00 4.43 3.77 600869 ch equity QINGDAO HANHE CABLE CO LTD-A CNY 4.34 0.12 - - 38.36 - - 3.42 - - 002498 ch equity BAOSHENG SCIENCE AND TECH-A CNY 7.88 0.30 0.28 0.47 30.69 34.74 26.63 2.12 - - 600973 ch equity HENAN TONG-DA CABLE CO LTD-A CNY 11.59 0.17 0.24-88.34 56.80-3.30 - - 002560 ch equity TONGDING INTERCONNECTION I-A CNY 17.06 0.20 0.30 0.58 80.07 63.54 48.16 7.22 6.94 6.24 002491 ch equity ZHEJIANG WANMA CO LTD -A CNY 19.81 0.36 0.45 0.70 67.64 52.18 42.12 6.22 5.73 5.14 Average 58.87 37.07 27.54 4.38 4.18 3.67 International peers Abbn eu equity ABB LTD-REG CHF 19.12 6.74 8.66 10.52 23.45 17.65 15.64 2.87 3.15 2.96 bmi us equity BADGER METER INC USD 73.03 13.95 18.34 22.50 35.45 30.89 27.41 4.45 - - itri us equity ITRON INC USD 43.1 2.56 16.43 20.21 630.43 20.36 17.92 2.70 2.31 2.10 su fp equity SCHNEIDER ELECTRIC SE EUR 53.06 21.26 31.80 36.83 21.43 14.30 13.42 1.49 1.43 1.37 sie gy equity SIEMENS AG-REG EUR 91.81 78.75 59.46 69.53 14.96 13.29 12.22 2.47 2.11 1.98 6644 jp equity OSAKI ELECTRIC CO LTD JPY 788 2.16 3.42 4.10 24.06 16.63 14.68 0.93 0.93 0.90 Average 124.96 18.85 16.88 2.49 1.99 1.86 Sources: Company data, Bloomberg, GF Securities (HK) Market cap (USD m) 337.12 537.67 651.95 404.83 135.93 4960.09 4819.24 2326.21 720.35 3763.33 3169.06 3090.44 3264.14 2108.79 1227.17 3191.12 2158.57 1086.38 730.57 2975.28 2774.97 45588.04 1061.74 1648.29 34604.54 86841.10 361.52 4
Jiangnan Group (1366 HK, Buy) Buy (maintained) Target price: HK$1.50 Steady increase in power cable demand; attractive valuation Leading Chinese cable supplier Jiangnan Group is the third largest electrical wire and power cable supplier in China, with a 1.4% market share based on 2010 revenue. The company has four main product categories. Power cables are its main product, accounting for 69.7% of FY15 revenue. Its second biggest revenue contributor is wires and cables for electrical equipment, which accounted for 18.6% of revenue during the year. Bare wires and special cables accounted for 5.5% and 6.2% of revenue respectively. Strong demand from UHV cables Demand for UHV cables is rising amid accelerating power grid development in China. According to a report by Frost & Sullivan, the total length of power transmission lines in China is expected to grow at a CAGR of 8.1% during 2015-20, with growth in UHV transmission line construction to be particularly strong. Steady growth over the past five years During 2011-2015, the company maintained steady growth in both revenue and net profit. Revenue rose from Rmb4.9bn to Rmb9.1bn (CAGR of 16.8%), while net profit increased from Rmb735m to Rmb1,482m (CAGR of 19.2%). Management targeting 15-20% revenue growth in FY16 As the company has adopted a costplus pricing model, a rebound in the copper price may provide an extra boost to revenue growth this year. That said, we are somewhat conservative, forecasting 14% revenue growth in FY16. Stable margin Thanks to a changing product mix, GPM increased slightly from 15.6% in FY14 to 16.2% in FY15 despite plunging copper prices in 2015, while NPM remained flat at 7.7% due to an increase in distribution costs (the distribution cost to revenue ratio increased from 1.7% to 2.2%). The ability to maintain a stable margin is one of the company s key strengths. Maintain Buy China s accelerated construction of power grids, particular of UHV transmission lines, will mean an increase in demand for power cables. We maintain our positive view on the company and estimate FY16/17 EPS of Rmb0.2/0.23 respectively. The stock is currently trading at 5x 2016E P/E. We maintain our Buy rating and TP of HK$1.50, based on 6.5x 2016E P/E (its historical average P/E). Key risks 1) slower-than-expected recovery in the company s overseas business; 2) order volume could be affected by potential capex cuts at industrial customers. Figure 8: Stock performance (HK$) Figure 9: Key data Jun 30 close (HK$) 1.24 Share in issue (m) 4,079 Major shareholder Chu Hui (34.72%) Market cap (HK$m) 5,058.00 3M avg. vol. (m) 6.63 52W high/low 0.96/2.32 Sources: Bloomberg Figure 10: Stock valuation Revenue (Rmb m) YoY (%) Net Profit (Rmb m) YoY (%) EPS (Rmb) YoY (%) P/E BPS (Rmb) P/B DPS Dividend (Rmb) yield (%) 2013 6,477 21% 504 34% 0.16 25% 6.2 0.74 1.4 0.03 2.8 24.2 2014 8,155 26% 626 24% 0.20 21% 5.1 1.02 1.0 0.04 4.4 22.7 2015 9,167 12% 703 12% 0.19-6% 5.4 1.30 0.8 0.05 4.6 17.3 2016E 10,465 14% 808 15% 0.20 6% 5.1 1.39 0.7 0.05 4.9 15.3 2017E 11,535 10% 937 16% 0.23 16% 4.4 1.55 0.7 0.06 5.7 15.6 ROE (%) 5
Figure 11: Business model Figure 12: FY15 revenue breakdown Figure 13: Margin Trend 5% 6% 19% 70% Power cables Wires and cables for electrical equipment Bare wires Special cables Figure 14: Client list Key customers % of 2015 revenue SGCC, CSG 55% PetroChina, Sinopec 27% China Railway 8% Evergrande, Wanda 10% 6
Figure 15: Financial statements Income Statement Balance Sheet Year end Dec 31 (Rmb m ) 2013 2014 2015 2016E 2017E Year end Dec 31 (Rmb m ) 2013 2014 2015 2016E 2017E Revenue 6,477 8,155 9,167 10,465 11,535 Inventories 1,842 2,169 3,269 3,612 3,973 YoY 21% 26% 12% 14% 10% Trade receivables 2,006 2,396 3,122 3,154 3,476 Cost of Sales (5,477) (6,883) (7,685) (8,788) (9,667) Bill receivables 255 233 283 344 379 Gross Profit 1,000 1,271 1,482 1,677 1,867 Other receivables 68 79 187 430 474 GPM (%) 15.4 15.6 16.2 16.0 16.2 Pledged bank deposits 808 1,305 1,893 2,093 2,307 Other Income 27 58 74 84 92 Bank balances and cash 1,683 1,666 2,131 2,010 1,965 Selling expenses (110) (135) (203) (230) (254) Total current assets 6,661 7,848 10,885 11,642 12,575 Administrative expenses (133) (148) (179) (209) (231) PPP 633 602 790 814 843 Other Cost (18) (23) (31) (31) (35) Land use rights 208 204 258 258 258 Other losses (6) (21) (29) (31) (35) Goodwill 0 0 110 110 110 Gain on bargain purchase 42 - - - - Interests in associates 15 15 14 14 14 Operating profits 804 1,002 1,114 1,289 1,441 Loan to an associate 30 25 20 20 20 OPM (%) 12.4 12.3 12.2 12.3 12.5 Available-for-sale investments 3 3 7 7 7 Finance Cost (195) (242) (243) (290) (283) Deferred tax assets 7 5 4 4 4 Share of loss of associates (3) (2) (1) (1) (1) Other non current assets 1 16 31 31 31 Profit before taxation 605 758 870 998 1,157 Total noncurrent assets 896 870 1,234 1,258 1,288 Taxation (102) (132) (166) (190) (220) Total Assets 7,557 8,718 12,119 12,900 13,862 Effective tax rate 16.8 17.4 19.1 19.0 19.0 NP 504 626 703 808 937 Trade payables 602 480 820 722 795 YoY 24.3% 12.4% 14.9% 15.9% Bill payables 1,137 1,512 1,756 1,926 2,119 Other payables 485 417 677 602 662 Bank borrowings 2,922 2,922 3,770 3,770 3,770 Other current liabilites 58 83 122 122 122 Total current liabilites 5,203 5,415 7,146 7,143 7,468 Long term borrowings 0 0 0 0 0 Other non-current liabilites 68 73 77 77 77 Cash Flow Statement Total non-current liabilities 68 73 77 77 77 Year end Dec 31 (Rmb m ) 2013 2014 2015 2016E 2017E EBIT 605 758 870 998 1,157 Equity Finance Costs 201 242 243 290 283 Share capital 25 27 33 30 30 Depreciation and Amortization 48 56 56 81 86 Share premium 345 805 1,449 1,489 1,529 Changes in working capital (518) (520) (1,140) (338) (403) Retained profits 1,916 2,397 3,414 4,161 4,758 Income tax paid (102) (132) (166) (190) (220) Non-controlling interests 2,286 3,230 4,896 5,680 6,317 Other operating activieites 364 (66) 923 (1) (1) Total Equity 7,557 8,718 12,119 12,900 13,862 Net Cash from operating activities 700 471 952 841 902 Capex (18) (42) (64) (105) (115) Financial Ratio Acquisitions (412) (76) (106) - - 2013 2014 2015 2016E 2017E Changes in pledged bank deposits (53) (497) (588) (200) (214) EBITDA margin (%) 13.1 13.0 12.8 13.1 13.2 Other financing activities 177 47 191 139 126 EBIT margin (%) 12.4 12.3 12.2 12.3 12.5 Net cash used in investing activities (305) (568) (568) (166) (204) NPM (%) 7.8 7.7 7.7 7.7 8.1 Debt changes 988 0 848 - - ROA (%) 7.8 7.7 6.8 6.5 7.0 Interest paid (195) (242) (243) (290) (283) ROE (%) 24.2 22.7 17.3 15.3 15.6 Dividend paid (88) (141) (176) (202) (234) Capital changes - 491 - - - Gearing Ratio (%) 54.2 38.9 33.5 31.0 28.6 Other (539) (30) (351) (306) (229) Interest Coverage ratio (%) 4.1 4.1 4.6 4.4 5.1 Net cash from financing activities 166 78 78 (799) (746) Current Ratio (%) 1.3 1.4 1.5 1.6 1.7 Effect of foreign exchange rate (16) 2 2 3 3 Net change in cash 545 (16) 465 (121) (45) AR turnover (day) 105 99 110 110 110 Cash at beginning of year 1,138 1,683 1,666 2,131 2,010 Inventory Turnover (day) 123 115 155 150 150 Cash at end of year 1,683 1,666 2,131 2,010 1,965 AP turnover (day) 32 29 31 30 30 7
Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 15% Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15% Hold Expected stock relative performance ranges between -5% and 5% Underperform Stock expected to underperform benchmark by more than 5% Sector ratings Positive Sector expected to outperform benchmark by more than 10% Neutral Expected sector relative performance ranges between -10% and 10% Cautious Sector expected to underperform benchmark by more than 10% Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report. 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