Key points of investment

Description of the event

Star Electric Power announced its performance report for the first three quarters of 2016: According to preliminary accounting, the company completed revenue of 1,063 million yuan in the first three quarters, an increase of 16.17% over the previous year; it achieved net profit of 889.5919 million yuan, an increase of 1.86% over the previous year.

Incident comments

The increase in sales volume of the main business increased operating income, and the increase in depreciation costs and labor costs led to a low increase in the company's performance. From January to September 2016, the company sold 1,355 million kilowatt-hours of electricity, an increase of 10.12% over the previous year; the wholly-owned subsidiary Water Company sold 23.74 million tons of water, an increase of 5.92% over the previous year. As investment promotion in Suining City gradually showed results, the company's operating income increased year-on-year due to rising demand in the supply region. In January-May 2016, the total amount of incoming water from the Fujiang River Basin where the company's power plant is located was 3,048 billion cubic meters, which is 22.92% higher than the annual average; in June, the amount of incoming water from the Fujiang River fell, falling off the previous year; since July, the amount of incoming water from Fujiang has rebounded, which is basically the same as the annual average in the third quarter, which is higher than the same period last year. Due to the fact that Fujiang's overall incoming water volume in the first three quarters was abundant year on year, the company's own power stations achieved feed-in electricity capacity of 423 million kilowatt-hours, an increase of 11.33% over the previous year. In a situation where the price of outsourced electricity purchased from the State Grid was higher than the company's self-generating production cost, the company's electricity purchase costs were optimized. However, during the reporting period, the company increased settlement work for overhaul projects such as power grids and water networks, and the company's operating profit for the first three quarters fell 6.21% year on year due to the increase in depreciation expenses due to the increase in fixed assets due to the increase in infrastructure and technical improvement projects and the increase in policy wage surcharges. Furthermore, the company's gross margin did not rise but fell by 14.71% year on year. In the first three quarters, the company confirmed compensation revenue of at least 13.5 million yuan (semi-annual report data) to partially make up for the decline in operating profit, which helped the company's performance improve slightly.

Located at the junction of the Chengdu-Chongqing economic circle, rapid economic growth is expected to bring high demand for electricity. The economic base of Suining City, where the company is located, is relatively weak (Suining's GDP in 2015 was 91,581 billion yuan, ranking 16th in Sichuan Province, 6th from the bottom). However, since Suining is located at the link between Chengdu and Chongqing, thanks to the development of the Chengdu-Chongqing economic circle, economic growth was rapid: in 2015, Suining's GDP growth rate reached 13.2%, ranking first in Sichuan Province. The company's main power supply business areas are Chuanshan District and Anju District of Suining City. It is the central urban area of Suining. Electricity demand in this region is expected to grow rapidly. Currently, in addition to building the ASEAN International Industrial Park and Wanda Plaza, Suining City is also planning to build a Sino-German China-Europe industrial park. The commissioning of such large-scale industrial and commercial projects will effectively increase the company's electricity demand in the supply region, and the prospects for sales growth in the main business are good.

The phased completion of the restoration of the Quhe River will no longer be affected, and it is expected that the supply costs of electricity will be further reduced over a long period of time. The company began river remediation for the Quhe River in 2013, and infrastructure projects to lower the water level are needed. Since the Quhe River blocks Fujiang River, incoming water from the Fujiang River Basin where the company's power stations are located has been affected, making it difficult to increase self-generated electricity. At the end of 2015, the treatment of the Quhe River was completed in stages. The amount of incoming water from the Fujiang River was no longer affected by the construction. The company's power generation supply capacity was increased this year. In addition, the power stations under the company in the Suining region are all connected to this network and are not limited by the current weak electricity demand of the whole society. Moreover, since Suining is currently in a period of rapid development and supply in the supply area is in short supply, the power plants under the company are expected to be in full bloom for a long time. Moreover, the power to approve the company's electricity sales prices rests with the Suining Development and Reform Commission. The current reduction in electricity sales and sales prices across the country is expected to further reduce the company's power supply costs and improve the company's performance.

Water prices are expected to rise, and the water supply business is expected to grow. On February 2, 2015, the Suining Municipal Development and Reform Commission issued the “Notice Concerning the Adjustment of Urban Water Supply Prices and Sewage Treatment Fees in Urban Areas”. The price of water supply in Suining was adjusted for the first time in nearly 10 years, with an average increase of 0.6 yuan/cubic meter, in two installments: the first adjustment was implemented on March 1, 2015, and the second is expected to be implemented in 2017. The local market share of Star Water Co., Ltd., a holding subsidiary of the company, is high, about 90%. After the second price adjustment is implemented, it will significantly increase the profit of the company's water supply business. Furthermore, the water loss rate of the company's water supply business has been reduced from around 42% in 2012 to around 32% now through technology and management measures. It is expected to continue to decrease in the future, and water supply costs will be further controlled.

Investment advice and valuation: We maintain the company's profit forecast. We expect the company to achieve EPS of 0.341 yuan, 0.384 yuan and 0.403 yuan in 2016-2018, corresponding to PE36.10 times, 32.12 times, and 30.54 times, maintaining the company's “increase in holdings” rating.

Risk warning: systemic risk, risk of incoming water falling short of expectations, demand growth falling short of expected risk