Recommendation: BUY

We suggest a BUY rating on Huaneng Power International Inc. (NYSE:HNP). Although suffered a loss in 2008, Huaneng offers long term profitability in a 5-year period. Positive profit margin and high EPS growth rate in 2009 Q1 reverses the trend of previous losses and supports high P/E. HNP is moderately valued and commands a positive outlook. In addition, technology advantage in clean energy offers HNP an edge in maintaining sustainable long term profit.

To read the report in pdf format, click on the file here CV_HNP_2008_H1.pdf

Coal prices decline, profits rally

Economic downturn has dented fuel demand. Sharp falloff in coal demand and coal oversupply have dampened coal price since the end of 2008, relieving HNP from high cost of coal supply. The trend is estimated to continue in a relatively long period, suggesting optimistic outlook of HNP’s profitability in 2009.

Positive profitability in longer term analysis

Despite loss in 2008, HNP witnesses relatively strong profitability in longer term analysis, with 5-Yr. Average Net Profit Margin of 8.62%, which is more than twice of the industry average.

Edge in clean energy

HNP’s edge in clean energy technology helps it prop up sustainable long term profit by controlling pollution cost and eschewing coal price volatility.

Moderate Valuation, supported by promising profitability

Forward P/E (18.50) is a little high compared with main peer corporations in industry. But the high EPS growth rate makes PEG ratio moderate, suggesting the stock is not expensive.

Estimates (Dec)

HNP Corporation

Summary

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 addition, from the year 2004 to 2008, HNP has got approvals from concerned authorities for a serious of acquisitions and new initiatives. HNP’s longer term profitability is promising by virtue of China’s economic booming and in turn, the rapid expansion of China’s electricity market. HNP’s centralized operation and increasing generation capacity in China helps it to take advantage of the market growth. HNP’s technology advantage in clean energy also contributes to its sustainable profit. Though suffered net loss in 2008 resulting from high coal price, the trend is reversed in the first quarter of 2009, largely due to the tumbling coal price during the economic downturn. Escalating profit margin in 2009 Q1 supports the high market expectation (P/E ratio) and suggests promising profitability in the following period. HNP is moderately valued in the stock market, and represents positive outlook, therefore, we recommend a buying rating.

1Coal prices decline, profits rally

Ø Net loss in 2008

The company recorded a net loss in 2008. Loss attributable to equity holders amounted to RMB3.938 billion. Except for negative impact of broad economy recession, the loss is largely attributed to the increasing operating 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.

Revenue has kept on increasing 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.

Table 1: Profitability of HNP

Source: www.datamonitor.com

Figure 1: Revenue of HNP

Source: www.datamonitor.com

Figure 2: Profit Margin of HNP

Source: www.datamonitor.com

Revenue has kept on increasing 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.

Ø         High coal price in 2008

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: Changes 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: The increasing trend of NEWC Index)

Figure 6: Correlation between coal price and profit margin of HNP

Source: www.datamonitor.com & www.globalcoal.com/

In addition, the electricity retail prices in China 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 explain the reasons for which HNP suffered net loss in 2008 and its profit is affected by the coal price to such great extent.

Ø         Demand declining narrows, coal price decreases, profitability picks up in 2009 

Due to the declining domestic demand under financial crisis and the declining average utilization hours resulting from introducing new generating units continuously, HNP’s total domestic power generation on consolidated basis slides continuously by 5.84% in the first half of 2009, But the power output declines have been narrowed to a fairly large extent in 2009 , compared with the almost double-digit slump late previous year, as the demand is jolted by China’s economic stimulus package in recent months. ,

At the same time, coal prices began to dive and the contracting trend is likely to continue, relieving HNP’s heavy operating cost in coal supply. From the end of last year, the dwindling domestic power demand has bought about ‘winter season ’for coal market. Spot price as of Dec, 2008 for blended coal produced in Datong, one of China’s major coal producing areas, had dropped by 35 percent from its peak in August, 2008. Coal prices at Qinhuangdao port, China’s domestic benchmark, plunged by 18% in one week in last Nov, according to Qinhuangdao Port Group. Power station coal price at Newcastle port (NEWC Index), benchmark for Asia, fell by 12% in the week ended Nov.21, 2008. The international coal price fell by 12 US dollars to 85.69 US dollars/ton in tandem with the international oil price fell to 50 US dollars/barrel at the end of 2008. Central Appalachian spot coal prices averages $48/ton in June, 2009, which is 57.5% down from $113 last June.

High coal stockpiles in power generation corporations weighs down the coal price further. Coal inventory at generation plants in US is close to an all-time high, according to David Lipschitz at Calyon Securities (U.S.A.) Inc.

The combination of sluggish power demand and increasing inventory in generating plants have aggravated the ‘winter season ’ in both domestic and international coal market and would depress the coal price further in a relatively long period. According to a Reuters poll, international Prices of thermal and coking coal will fall 20 and 26 percent respectively in 2009. According to a report by BOC International, China's coal industry would also keep on sliding in 2009. China Mining Association (CMA) forecasts that the coal price in China may fall back to 2007 level of 550 yuan/ton.

The declined coal price has reduced the largest part of HNP’s operating cost, creating net profit of 578.253million RMB in 2009 Q1. Furthermore, the prospect of coal price declining further or fluctuating at low level suggest optimistic outlook of HNP’s profitability in future periods

2, Positive profitability in longer term analysis

Though HNP suffered great loss in 2008, the longer term analysis reveals that HNP still maintains a relatively strong profitability in recent years: the 5-Yr. Average Net Profit Margin is 8.62%, which is 243.5% of the industry average.

HNP also has relatively positive performance in sales and dividend yield: 5-Yr. Sales growth rate is 23.69%, which is almost six times of the industry average; 5-Yr. dividend Yield is 3.80%, which is 178% of the industry average.

In terms of financial strength, the quick ratio of HNP is 0.28, which is 57.14% of the industry average, showing HNP’s weakness in liquidity.

The relatively higher debt to equity ratio implies HNP’s higher leverage in the sense of using debt and other liability to finance assets and in turn generate profits. The higher financial leverage ratio is partly attributable to HNP’s borrowing from banks for financing short term losses in the fiscal year 2008

The performance of HNP in 2009 Q1 reversed the adverse trend in 2008, revealing a positive perspective in the following periods.

HNP’s Quarterly Revenue Growth (YoY) in 2009 Q1 is 19.10%, which is a little lower than the industry average, but much higher than Korea Electric Power Corp. (KEP), one of HNP’s main competitors. HNP’s Qtr Rev Growth (YoY) is ranked second in the electric utilities industry in 2009 Q1 (only lower than 37.50% of Empresa Nacional de Electricidad S.A.). The leading status in promoting revenue and slumping operating cost catapult HNP’s EPS Growth Rate (Qtr YoY) to 150%, ranking first in the utilities-electric industry. The estimated EPS for fiscal year 2009 is 1.45, up from -0.32664 in 2008.

3, Edge in clean energy

HNP is the leader in developing clean generation technology in China, especially in the realm of wind power generation.

More emphasis and regulation on power generation pollution makes HNP’s advantage in clean energy technology more relevant in sustaining long term growth and profitability. From the year 2007, China has been advocating and encouraging clean and environmental friendly technologies in power generation industry (The Opinions on Implementing Further Reform in Power Industry during the "Eleventh Five-Year Plan" period issued by State Council in 2007).The leading status of clean power generation may help HNP reduce its operating cost in pollution control and emission levy.

Also, capability of developing alternative power generation technology, such as wind power, reduces HNP’s heavy dependency on coal supply; therefore, it reduces the risk of coal price fluctuation and increases HNP’s stability in long term profitability. China is aiming to be the largest producer of wind power in the world. According to 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 has recently got approval from the National Development and Reform Commission for Gansu Ganhekou Second Wind Power Project which is of 199.5MW in capacity and 2.037 billion RMB in investment.

4, Moderate Valuation, supported by promising profitability

HNP made a negative EPS in fiscal year 2008, but based on the projected positive EPS in 2009, the Forward P/E (fye 31-Dec-10) is 18.50, which is a little high compared to the figures of its main peer corporations and the electric-utilities industry average (13.30)..

Table 2: Forward P/E ratio

Figure 7: Forward P/E ratio

A high P/E ratio reflects high market expectation for HNP’s future earning growth, which is justifiably supported by HNP’s profitable performance in 2009 Q1 and its longer term profit growth rate. If we also accounts for growth, the calculated price/earnings to growth ratio (PEG ratio) of HNP is 3.4, which is much lower than other profitable corporations in electric utilities industry (i.e. SBS and CWCO). The underlying reason is that HNP’s EPS growth rate is much higher than other electric-utilities companies, amounting to 18.5 times of SBS and 11.3 times of CWCO. Therefore, the PEG figure suggests HNP is moderately valued in the market. Based on its moderate valuation and promising profitability (EPS growth rate), we propose a buying recommendation for HNP.

Table 3: PEG ratio

Figure 8: PEG ratio

Table 4: HNP Corporation - Annual Income Statement, 2004-2008 (RMB, millions)

Table 5: HNP Corporation - Annual Balance Sheet, 2004-2008 (RMB, millions)

Table 6: HNP Corporation - Annual Cash Flow Statement, 2004-2008 (RMB, millions)

Analyst Certification

I, Jiajun Yang, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report.

Copyright, user agreement and other general information related to this report:

Copyright 2009 Chinavestor.com. All rights reserved. This research report is prepared for the use of Chinavestor.com clients and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without the express written consent of Chinavestor.com.

This research report provides general information only. It is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice. Past performance is not necessarily a guide to future performance.

Fundamental equity reports are produced on a regular basis as necessary to keep the investment recommendation current.

---

If you like us, spread the word to the fellow investors on your favorite Social Bookmarking websites