China Yangtze Power 600900.CH
August 06, 2018 - 10:34am EST by
marwari25
2018 2019
Price: 16.39 EPS 0.97 0.99
Shares Out. (in M): 22,000 P/E 17.1 16.8
Market Cap (in $M): 54,027 P/FCF 11.4 11.6
Net Debt (in $M): 13,745 EBIT 3 3
TEV ($): 67,200 TEV/EBIT 19.5 19.1

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  • Renewables
  • Unique assets
  • China A
 

Description

Why is China Yangtze Power Worth Your Attention?

  • High quality assets: China Yangtze Power has a strong moat due to its ownership of the most scarce hydropower assets in the world. It owns 3 out of the world's 10 largest hydro power stations
  • Reasonable Valuation: the Company is trading at a reasonable 8-9% FCF yield, 4%+ dividend yield; this is cheap compared to peers with consideration to its high quality assets
  • Key risks include unpredictable policy changes related to on-grid electricity pricing and climate fluctuations that affect Yangtze River water flow

 

Strong Moat Due to Ownership of High Quality, Scarce Hydropower Assets

  • China Yangtze Power’s moat comes from its perpetual ownership of the world’s most prime hydropower stations
  • In other hydropower-rich countries such as Brazil, hydropower companies need to renew operating leases every 30 years
  • The quality comes from the sheer size of CYP’s projects - very few locations in the world now are suitable for hydropower projects as large of CYP’s
  • With hydropower, larger size means higher efficiency from better capabilities of water-level management (less water wasted during peak season), which leads to greater bargaining powers from lower costs of production
  • See appendix for mapped locations of CYP’s hydropower stations in context with peer stations in China

 

Defensive & Profitable Business with More Upside From New Hydropower Stations Built Upstream

  • China Yangtze Power has a profitable business that has close to no real cost of good sold (water is free); EBITDA margin has been >66% for past 10 years, currently at 78.5%
  • Revenue contribution: 99% of revenues are from power generation through its 58 sets of 700MW generators at 4 hydropower stations listed above, supplying electricity to 50-80mm people per year
  • Main Customers: virtually all electricity generated is supplied to the SGCC (State Grid Corp of China and CSG (China Southern Power Grid Company), 2 national SOEs formed post China's inclusion in WTO in 2001 to facilitate power distribution
  • Contracts: Electricity procurement contracts are usually signed every 3 years (disclosed in public filings), including details on various items:
    • Contracted supply volume (monitored daily, paid each month)
    • Base price, for example for the Three Gorges Dam, this is set in accordance to NDRC’s [2011 Notice No.1101, link in appendix], which specifies “the on-grid electricity tariff for the Three Gorges electricity plant shall be RMB0.2506/KWh when delivered to Hubei, and an additional RMB0.19/KWh when delivered to other region.”
  • CYP’s revenues are sensitive to two variables: i) volume: total electricity generated and ii) price: on-grid price at which CYP can sell to power distributors
  • i) Volume is a function of installed capacity (a constant unless increase through acquisition or capex) and efficiency.
  • Efficiency, or average utilization hours, is defined as how many hours per year can the generators run at full capacity?
  • CYP’s volume is expected to grow by 10% by 2022 and another 10% by 2026 due to improvement in efficiency from “cascade optimization”:
  • the simple concept is, when you build large scale hydropower plants upstream and operate it rationally, all downstream hydropower projects benefit from increased water flow regardless of ownership
  • Because 1) during peak season, due to more reservoir capacity built upstream, downstream plants such as CYP’s Three Gorges Dam can raise their water heads to higher levels, which boosts gravitational potential energy that hence electricity output
  • 2) during the low season, downstream plants benefit from increase water flow as upstream reservoirs release excess water stored from the peak season
  • Efficiency also varies depending on the climate from year to year, but CYP is generally less impacted than peers due to its better capabilities of water level management
  • See appendix for list of upcoming upstream project
  • ii) On-grid price/tariff - is the price at which power generators sell to distributors. For CYP, this should stay flat or grow slightly in the foreseeable years to come.
  • This is set mostly by the NDRC (National Development and Reform Commission) in China, who issues notices/guidance post indefinite time intervals
  • See appendix for examples ie. 2011 Notice 1101, 2015 Notice 962
  • Hydropower is the cheapest form of energy worldwide - ​in China, average on-grid price for various types of power generators are:
    • RMB350-420/MWh for coal fire plants
    • RMB250-320/MWh for hydropower
    • RMB420/MWh for Nuclear
    • RMB550/MWh for Wind
    • RMB650/ MWh for Solar
  • ​CYP's average on-grid price has seen an increasing trend in the past 10 years (2% CAGR) from
    • RMB199/MWh in 2008 to
    • RMB218/MWh in 2010-2011 to
    • RMB230/MWh 2013-2014 then to
    • RMB238/MWh from 2016-2017  
  • At the macro level, China’s electricity consumption is expected to grow by 2.5% per year until 2020, while at the same time seeking to reduce coal-generated electricity as % of total electricity consumed from as 60% to lower than 58% by 2020 (hydropower currently accounts for about 15%)
  • With increased demand for the cheap, renewable energy that CYP generates, this should induce favorable support on CYP’s on grid price given large-scale hydropower has limited supply

 

Disciplined Management with Favorable Track Record

  • Majority shareholder: CYP is 58% owned by China Yangtze Three Gorges Corporation, a national SOE founded in 1993 to construct and operate the Three Gorges Dam
    • CYP is Three Gorges Corporation’s main electricity generation subsidiary; other 9 subsidiaries include solar/wind power generators, consultant & management services, tourist and hotel operations etc
    • Incentives: Chinese national SOEs carry more social responsibility pure profits, usually forming natural monopolies in their industries. Tangible benefits to CYP include access to cheap financing (blended financing rate in 2017 was 4.14%).
  • ​4% owned by Sichuan Development Holding and 3.67% owned by Yunnan Investment Group - both of whom are proxies of local provincial governments
  • Good track record evidence by expanding ROE/ROCE: So far, management track record has been good as ROE expanded from 10% in 2008 to 16% in 2017, ROCE from 9% in 2008 to 12% in 2017
  • From meeting with the Company, we get a sense that CYP’s management is judicious in acquisitions with a strict 11-13% ROA requirement
  • Cash investments made have been quite reasonable (investments income was 4.6% of total revenues in 2017)
    • Strategic investments: 4.79% stake in SDIC and 4.5% stake in Chuantou Energy - companies who own hydropower stations in upstream of CYP’s portfolio. These strategic investments allow CYP to potentially further optimize water flow among its stations.
    • Financial investments (around 10 stocks in portfolio with 3-5yr horizons): ​China Construction Bank H-shares, Industrial and Commercial Bank of China (601398 CH), Yunnan Copper (00878 CH)
  • Dividends:
    • 2016 - 2020: the Company has pledged paying at least RMB0.65 per share in dividends (DPS was RMB0.68 in 2017)
    • 2021 - 2025: dividend payout to be 70% of net profits (I estimate to be RMB0.75 per share in 2021, RMB0.79 per share in 2022)

 

Valuation

i) DCF

  • A 20-year DCF forecasting a 32% cumulative growth in top-line revenues over the next 10 years driven by increase in output volume due to factors mentioned in i) “volume” above, with EBITDA margin peaking at 78% (this is conservative given non-D&A operating costs do not scale as much as increase in revenues).
  • DCF output shows a 30% upside, using a 7% discount rate (-27% downside if we use a 10% discount rate)

 

ii) Global peers comparison for reference

  • This table intends to place CYP's valuations in perspective - there are cheaper global peers however none offers the profitabiltiy and defensive cash generation of CYP

 

Risks to Our Thesis

  • Changes in oin-grid electricity pricing: as mentioned, this is determined by the national government whose methodologies remain unclear. Could they cut on-grid tariffs for hydropower companies?
    • Based on my talks with analysts and experts, in the short-term this is unlikely as hydropower tariffs generally correlate with on grid pricing for coal-fire electricity which cannot go any lower as many coal-fire plants are struggling to make a profit
    • In the long-term, supply and demand dynamics is favorable for hydropower assuming other renewables ie. wind, solar, nuclear do not make substantial technological breakthroughs that change electricity generation costs as a whole significantly
  • Climate risk: water flow in Yangtze River fluctuates year by year which may cause unexpected decrease in output volume whether due to a dry year or an overly wet year
    • this risk is reduced substantially due to CYP’s scale which gives it strong capabilities of cascade/coordinated optimization. For example, 2016 was a dry year but CYP still managed to grow output and revenues
  • M&A risk: injection of Wudongde & Baihetan hydropower stations into the CYP listco from the parent group by 2022 carries uncertainty both on the upside and downside

 

APPENDIX

A. Map of China's major hydropower stations​

Source: China Reality Research

  • Circled in red are CYP’s hydropower stations: Three Gorges, Xiangjiaba, Xiluodu, Baihetan (by 2022), Wudongde (by 2022) located in the Yangtze River and Yangtze's upper branch Jinsha River - the most prime locations for hydropower generation in China.
  • As an indicator, CYP's hydropower stations have average utilization hours of 4,399/7,344/4,889/5,482 hours for Three Gorges, Gezhouba, Xiluodu, Xiangjiaba respectively; which are higher than 3,579 hrs on average for hydropower plants in China

B. Brief history of CYP:

  • 2002: founded in 2002 from joint stock reform of Gezhouba Hydropower Station, the 1st large-scale hydropower station project on Yangtze River
  • 2002 - 2012: acquired Three Gorges dam through 6 phases with RMB154.6bn paid to Three Gorges Corporation
  • 2016: the Company acquires 100% of Chuanyun (owner of Xiluodu and Xiangjiaba hydropower stations) with RMB79.7bn
  • Today: the company currently owns the 3 largest hydropower stations in China (Three Gorges, Xiluodu, Xiangjiaba)
  • 2022E: the Company will own the top 5 largest hydropower stations in China (Three Gorges, Xiluodu, Baihetan, Wudongde, Xiangjiaba)

C. Pipeline of new upstream projects that are expected to bring additional output volume for CYP:

  • 2019-2020: +10,000 GWh volume (5% of 2017 total output) / +RMB6-7bn in revenues from Lianghekou Dam, owned by SDIC (600886; 11% owned by CYP) & Chuantou (600674; CYP bought 5% stake in March 2018 as strategic investment)
  • 2020-2021: + 10,000 GWh volume from Wudongde and Baihetian (constructed by Three Gorges Corporation, to be injected into CYP listco by 2022)
  • 2026-2027: +10,000 GWh from Longtan Dam

 

D. Examples of NDRC Guidance of On-grid Electricity Pricing:

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Higher than expected volume in 2H18 due to better optimization
  • On-grid tariff hikes
  • MSCI China-A inclusion
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    Description

    Why is China Yangtze Power Worth Your Attention?

     

    Strong Moat Due to Ownership of High Quality, Scarce Hydropower Assets

     

    Defensive & Profitable Business with More Upside From New Hydropower Stations Built Upstream

     

    Disciplined Management with Favorable Track Record

     

    Valuation

    i) DCF

     

    ii) Global peers comparison for reference

     

    Risks to Our Thesis

     

    APPENDIX

    A. Map of China's major hydropower stations​

    Source: China Reality Research

    B. Brief history of CYP:

    C. Pipeline of new upstream projects that are expected to bring additional output volume for CYP:

     

    D. Examples of NDRC Guidance of On-grid Electricity Pricing:

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

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