China ADR stock research

Huaneng Power (NYSE:HNP), the largest Chinese power generator, has enjoyed an over 15% rally in the last two weeks, placing the stock on the spotlight. As the following analysis reveals despite a more than 100 percent increase in revenue over the last 4 years, cash is extremely tight as coal price creeps higher. This report highlights the correlation between coal price and profitability of HNP. As a result, HNP is  expected to remain a volatile stock but offers clear value for the long term buyer.

Net Loss in 2008

The company recorded a net loss in 2008. Loss attributable to equity holders amounted to RMB3.938 billion. Loss per share was 0.33billion. Except for negative impact of broad economy recession, the net loss is largely attributed to the increased manufacturing cost. Power plants of HNP are fueled mainly by coal, which is obtained through key contracts and in the open market, both affected by the market price of coal.

Source: www.datamonitor.com

Figure 1:

Source: www.datamonitor.com

The revenue of HNP has kept an increasing trend from the year 2003-2008; even under the global recession in 2008, the revenue still increased by 2% (Figure 1). But the profit margin histogram shows almost the opposite picture, squeezing out from 23.20% in 2003 and going red in 2008. The underlying factor contributing to these opposite trends is the ever-increasing price of coal.

Generally, the coal price fluctuates in tandem with oil prices (Figure 3)

Figure 3: Change in World Price of Crude Oil and Coal (2003-2008)

Source: NEWC Index from Global COAL (www.globalcoal.com); World Crude Oil Prices (Dollars per Barrel) from Energy Information Administration (www.eia.doe.gov).

Though in some years, the percentage change in coal price seems not consistent with that of oil, in 2008, they stick together and increased significantly (Figure 4).

Figure 4: Change in World Price of Crude Oil and Coal

Source: NEWC Index from Global COAL (www.globalcoal.com); World Crude Oil Prices (Dollars per Barrel) from Energy Information Administration (www.eia.doe.gov)

Graph of Power station coal prices at Australia's Newcastle port(NEWC Index) serves as a benchmark for Asia market and reflects the increasing trend of coal price in Asia(mainly China) market in recent years(Figure 5). Furthermore, the comparison of HNP’s profitability profile and coal price aptly illustrates the dependency of HNP’s profit on the fluctuation of coal price (Figure 6)

Figure 5: Catching Fire

Figure 6:

Source: www.datamonitor.com and www.globalcoal.com

In P.R. China, the electricity retail prices are set by National Development and Reform Commission (macroeconomic management agency under the State Council) as part of macro-economic controls, therefore, power generation companies such as HNP cannot elevate its product price freely, which helps to understand why HNP suffered net loss in 2008 and why HNP’s profit is affected adversely by the price of coal to such great extent.

SWOT analysis 

Strength:

HNP is one of the largest power generation companies in China. HNP has 17 wholly-owned operating power plants, and has controlling interests in 13 operating power companies and minority interests in 5 operating power companies in 12 provinces and 2 municipalities of China. In addition, from the year 2004 to 2008, HNP has got approvals from concerned authorities for a serious of acquisitions and new initiatives (acquisition of Yingkou Power Plant, Huaneng Chongqing Luohuang Power Generation Company, Huaneng

Hunan Yueyang Power Generation Company, Jinggangshan Huaneng Power Generation Company, and Hebei Hanfeng Power Generation Company in 2004; acquisition of Huaneng Sichuan Hydropower Company, Gansu Huaneng Pingliang Power Generation Company, Jiangsu Huaneng Huaiyin Power Company, and Huaneng Finance in 2005; first trial of 390 MW gas fired generating unit at its Shanghai Combined Cycle Power Plant in 2006; construction of the expansion project of two 600 MW domestic supercritical coal-fired generating units at Huaneng Rizhao Power Plant Phase II , Henan Huaneng Qinbei Power Plant Phase II and Zhejiang Huaneng Yuhuan Power Plant Phase II in 2007; acquisition of Huaneng Nanjing Jinling Power in 2008).

By virtue of China’s economic booming, China’s electricity market is growing quickly, by 26.6% in value in 2007 to reach $220.7 billion and 16.6% in volume in 2007 to reach 2,978.8 terawatt hours (TWh). HNP’s centralized operation and increasing generation capacity in China helps it to take advantage of the market growth to boost its profitability.

Weakness

HNP has only one wholly owned subsidiary outside China. The clustered operation in China reduces HNP’s opportunity to add to its revenue from other booming economies. It also increases HNP’s exposure to the volatility of China’s macro-economic control policies.

HNP’s coal-fired power plants will subject to more rigid environment protection laws and inspection by the State Ministry of Environmental Protection. From 2003, a new pollutant discharge levy system was introduced, which increased the discharge fees paid by power plants in China. As a result, HNP has to incur extra cost and suffer profit reduction consequently.

Opportunity

The Opinions on Implementing Further Reform in Power Industry during the "Eleventh Five-Year Plan" period issued by State Council of China in 2007 encourages more clean and environmental protection technologies in power generation industry. It is good new for HNP because it is a leader in developing clean energy in China’s power industry. The development of alternative energy may help HNP reduce its heavy dependency on coal; therefore, wean HNP off the risk of increasing coal price and rigid scrutiny for its pollutant and CO2 emission.

China is aiming to be the largest producer of wind power in the world. According to China’s National Energy Administration, the annul growth rate of wind power would be 20% for the foreseeable future and the target for wind power capacity is more than tripled to 100 gigawatts by 2020. HNP responds quickly to the trend of wind power, it has recently got approval from the National Development and Reform Commission for the Gansu Ganhekou Second Wind Power Project which is of 199.5MW in capacity and 2.037 billion RMB in investment

Threat

The unprecedented high price of coal in 2008 contributed to the net loss. Key thermal coal contracts have not been signed up to date. Therefore, it’s hard for HNP to control the manufacturing cost in the following year. The volatility in coal price imposes uncertainty and threat to HNP’s profitability.

Cash position

In 2008, the company successfully issued RMB4 billion corporate bonds, RMB5 billion short-term debentures, obtained RMB84 billion credit facilities. Its net cash provided by financing activities amounted to RMB41.255billion, increased by 397.78%. Cash and cash equivalents was RMB 5.567billion, only 3.35% of total asset, decreased by 23.87% due to decreased cash flow from operating activity and increased investment. The interest burden of 2008 was RMB4.065 billion, representing a 90.64% increase, primarily due to the extra financing to pay increased fuel costs, expensing interest upon commercial operation of new generating units and the acquisition of SinoSing Power.

Changes in Balance Sheet

Total assets increased by 33.49%, of which non-current assets increased by 37.97% (primarily due to the acquisition of SinoSing Power), current assets increased by7.91%. Cash and cash equivalents decreased by RMB1.746 billion. Total liabilities increased by 70.82% (primarily attributable to the acquisition of Tuas Power and increased borrowings for construction projects).  Company’s equity items decreased, primarily due to the decreased fair value of the listed shares the company held

Changes in Income Statement

Revenue increased by 35.8%, while operating expense increased by 64.8%, so profit  from operating decreased by 115.9%.Interest expense increased by 190.6%. Loss on fair value revaluation was 55million, compared with a gain of 87million in 2007. Investment income was less than 10% of that in 2007. Proposed dividend of 2008 was only 33.3% of that in 2007.

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