|Shares Out. (in M):||22,000||P/E||15||15|
|Market Cap (in $M):||48,200||P/FCF||8.67||8.8|
|Net Debt (in $M):||12,300||EBIT||0||0|
China Yangtze Power is not the most exciting idea out there but it is a very stable name that will provide a single digit return in the short term and compound at mid-teen returns longer term.
China Yangtze Power Company Ltd. (CYPC) is the largest hydropower company in China, with 44GW of generation capacity in four dams operating along the Yangtze River Valley, including the world’s largest hydropower plant, the Three Gorges Dam. CYPC’s generation capacity is fully utilized and 100% of its electricity is sold, largely to regions of rapid industrialization, with high economic and population growth, where the demand for electricity in intense and growing -from Chongqing in Central China, to Shanghai in the East, and to Guangdong Province on the Pearl River Delta in the South.
Hydro power is the second largest power source in China with total installed capacity of 341GW accounting for ~20% of total capacity and 17% of total power generation. Major hydro players in China are SOEs (~60% of total capacity) as most developments require large investments and need to deal with migration/displacement issues. China Yangtze Power owns 3 of the largest hydro power plants in the world and with the acquisition of two additional assets in 2021/2022, CYPC will own of 5 of the 12 largest hydropower stations in the world. Hydropower is expected to be the most effective way for China to achieve its stated 15% and 20% non-fossil fuel targets by 2020 and 2030. Hydropower capacity in China is expected to grow from 341GW in 2017 to 450GW in 2030, contributing 43% of China’s 2030 clean energy target (growth will be slower than wind and slower given capacity constraints). Barriers to entry are not only high due to the large investment cost but also due to the social issues regarding displacement/migration cost. In addition, capacity growth in the sector is expected to be low due to declining commercially exploitable hydro resources resulting in an oligopolistic market structure.
Hydropower generation capacity tends to be fully utilized with 100% of its electricity sold. China prioritizes renewable distribution by law. Hydropower output is reliant on the water flow of rivers which will vary with seasonal rainfall levels (summer and fall are peak seasons) - on average, hydro power generation has fluctuated between 3,020 to 3,650 utilization hours. Hydro power tariffs are the lowest cost fuel at a large discount to coal. Technically electricity tariffs for power plants are either based on a cost+ model (pre-2014 power plants) or net-back model pegged to coal prices (post-2014 power plants) but as all things in China, government has a strong hand on electricity tariffs and most of the hydro power tariffs are negotiated on a province by province desitnation basis with the underlying goal of pricing hydro at a discount to coal prices.
CYPC was established in 2002 as a subsidiary of China Three Gorges Corporation, an SOE that was responsible for the construction of the Three Gorges Dam. CYPC as established to take over the operations and management of the Three Gorges Dam and went public in 2003. Today, CYPC owns 4 assets along the Yangtze River with total capacity of 44GW. Three Gorges is the largest hydropower plant in the world with a capacity of 22GW. The remaining 3 assets are Xiluodu (14GW), Xiangjiaba (6GW) and Gezhouba (3GW).
From a operating metrics point of view, the drivers of the top line are capacity, utilization hours and tariffs. Capacity is constrained to the installed capacity (growth has mainly come from asset injections from the parent company) while utilization flucturates year over year depending on rain fall (YoY growth has fluctuated ~2-7% over the past few years) while tariffs for the most part have remained fixed over the past couple years on average. As such, in the short-term, growth is really not a driver of returns and most of the return will be driven by dividends which is currently yielding 4.5%.
Business has consistently generated 80% EBITDA margins. Given that there is no fuel cost expense (biggest cost variable for other IPPs), margins are high and there is low capex/working capital, as such ~80% of the EBITDA is converted into free cash flow. The company has spent the cash paying interest, dividends, paying down debt and investments. Due to the high free cashflow generation, company has a 70% dividend payout ratio and has guaranteed dividend payments between 2016-2020.
The growth story comes from the planned injections in 2021/2022 where the company plans to buy 2 assets being developed by the parent company. The two plants will add ~26GW of capacity, bringing capacity from 44GW to 70GW by 2022. The cost of the two projects is estimated to at $39Bn. Given that the projects are still in development mode, details on the destination of the power and potential tariffs have not been announced, but assuming that these two plants get same rates and utilization rates as the Xiloudu plant (similar geography and water levels to the two new plants), one can get to an IRR of mid-teens. This assumes no growth in tariffs nor optimization of utilization which management has prioritzed. The assumption also has FCF growing from around 30bn RMB to 50bn RMB post asset injections with limited growth on a going forward basis.
Company has done 7 asset injections in its history, with two big ones in 2009 and 2015. In both cases, markets rewarded the company's growth story by pushing the stock up by 1.5x-2x in the period during the asset injections. There is no certainty that this will happen, but the downside is limited given the existing dividend yield and upside is driven by the growth story of the asset injections.
- Asset injection from parent company in 2021/2022 which will increase generation capacity by ~60%