Hong Kong stocks are weak, and capital is pouring into coal stocks. But what I'm going to write about today is thermal power, which hasn't risen much yet.

They say “it hasn't risen much yet,” but in the past two months, if it comes to the “steady rise” segment, it definitely came out on top:

$HUANENG POWER (00902.HK)$From 3.22 on October 25 last year to HK$4.42 yesterday, an increase of 37.3%.

$DATANG POWER (00991.HK)$From 1.06 on October 24 to HK$1.28 yesterday, an increase of 20.8%.

$HUADIAN POWER (01071.HK)$From 2.81 on October 25 last year to HK$3.65 yesterday, an increase of 29.9%.

$CHINA RES POWER (00836.HK)$From 13.55 on October 26 to HK$13.92 yesterday, an increase of 27.3%.

The above four were almost the same as the rise and fall, rising steadily, and the pullback was very small.

The one that “lags behind”$CHINA POWER (02380.HK)$From 2.72 on October 24 to 2.89 today, the increase was only 6.25%, but the range increase was also quite impressive. On November 16 last year, it reached a high of HK$3.07.

In fact, since the beginning of September last year, research institutes have been shouting that “thermal power has ushered in an opportunity to revalue”, mainly based on the following logic:

First, there was a high increase in profits in the thermal power industry in the first half of the year. The main reason is the increase in electricity consumption. Taking the Shenwan Thermal Power Index as an example, the first half of 2023 achieved operating income of 602.1 billion yuan, an increase of 9.1% over the previous year, and achieved net profit of 27.4 billion yuan, an increase of 522.3% over the previous year. Many thermal power companies achieved high profit growth. Since the beginning of 2023, the electricity consumption of the whole society has continued to increase. As of July, the total electricity consumption of the whole society was 5.2% year-on-year, and electricity consumption continued to rise.

Second, due to the decline in coal prices within the third quarter, it can be expected that the Q3 results will fully reflect the cost reduction benefits brought about by the decline in coal prices.

Let's take the comprehensive transaction price trend of Qinhuangdao thermal coal (Q5000) as an example. The third quarter showed a sharp drop compared to the first half of the year (see chart below).

Third, since some provinces have taken the lead in implementing capacitive electricity price policies, the market already anticipates that the thermal power capacity price reform will be fully implemented within the year. Some industry insiders said it may be implemented, and thermal power companies are expected to increase profits under the stimulus of this policy. The industry anticipates that in the future, more provinces will introduce policies related to capacity electricity prices, which is expected to raise the overall valuation of the thermal power sector.

Capacity electricity prices can be simply understood as thermal power companies levy a certain percentage of fees on downstream users based on the fixed costs of daily operations. China's industrial electricity prices have a two-part system, which mainly includes two parts: basic electricity price and electricity price. The basic electricity price is a fixed fee. Similar to the landline fee for a fixed telephone, how much you have to pay depends on the capacity or maximum demand of the end user (because this involves the cost of electricity construction such as transmission and distribution). The electricity price per hour, on the other hand, is similar to the standard tariff for a fixed telephone. For example, you charge 5 cents per kilowatt hour of electricity, and if you use more, you also pay more for electricity.

The price of capacitive electricity is a fixed cost. It shows that even if the user does not use electricity, the depreciation of the thermal power unit will still generate costs. In the past, this part was borne by thermal power plants, but in the context of electricity price reform, terminal users will bear the costs in the future.

Under the current pricing mechanism, thermal power plants are extremely susceptible to huge losses due to rising upstream coal prices. If at this time, they also have to bear the additional costs caused by depreciation of fixed assets, which will undoubtedly increase the burden on the thermal power industry and are not conducive to playing the role of ballast stone in electricity security and supply. The introduction of capacity electricity prices can be transmitted downstream, and the normal progress of electricity investment by reducing the burden on enterprises is a supporting measure.

Fourth, in mid-September, the National Development and Reform Commission and the National Energy Administration issued a notice on the “Basic Rules for the Electricity Spot Market”.

This notice became the first national-level electricity spot market rule in China. The rules state that in order to give full play to the decisive role of the market in the allocation of electricity resources, the recent focus will be on promoting the construction of inter-provincial, intra-provincial or regional markets in accordance with the “unified market and collaborative operation” framework. The spot market includes the current, daily, and real-time markets. Participants will include new types of operators such as distributed power generation, load aggregators, energy storage, and virtual power plants. This means that China's multi-level unified electricity market has gradually been improved. The transaction cycle covers medium- to long-term transactions and spot transactions; trading types have expanded to auxiliary services and capacity electricity prices; and operators have expanded to new types of entities such as distributed power generation, energy storage, and virtual power plants.

All in all, a sentence: The spot market is beneficial to power supply plants with the ability to regulate, and thermal power is expected to reap positive returns in the spot market. Why do you say this, because the Changxie electricity price is generally determined in advance. For example, the 2024 Changxie electricity price in a certain province will be negotiated in November 2023. If the Changxie electricity price in a certain province does not meet negotiation expectations, for large thermal power plants, efforts can still be made to raise the company's electricity price level through spot and timeslot transactions. This is equivalent to providing a means to raise electricity prices in disguise.

Two policy side benefits, plus 1 cost side advantage, and 1 demand side advantage. The logic is just right.

However, it is no use for the agency alone to shout loudly. The Hang Seng Index fluctuated sideways during this period, while Thermal Power's stock price was still dragging down. This situation continued for almost two months, and it wasn't until October 24 that there was a turning point.

Why is that?

Because around October 25, coal and power companies successively disclosed their results for the third quarter, showing continuous recovery from quarter to quarter, and the basic orientation of the industry has been verified.

With thermal power giants$HUANENG POWER (00902.HK)$For example, its announced results for the third quarter of 2023 showed that operating income was about 65.289 billion yuan, down 2.67% year on year; net profit attributable to shareholders of listed companies was about 6.255 billion yuan, up about 7.7 times year on year; net profit attributable to shareholders of listed companies after deducting non-recurring profit and loss was about 3.824 billion yuan, up 410.89% year on year; basic earnings per share were 0.35 yuan. Here are a few key points:

(1) Electricity prices weakened in Q3. The company improved the electricity price level through spot trading and timeslot trading, which slightly exceeded market expectations;

(2) Capacitive electricity price revenue for the first three quarters was 1,913 billion yuan, all depreciated by combustion engines. Some provinces have only just begun implementation; in the future, different provinces will join, and coal machine depreciation will also be included.

(3) The company's coal machine losses gradually improved. By the end of Q3, only 27% of the coal machines were still losing money; all others turned into profits.

(4) Fourth, and a very important factor, Q3 turned a loss into a profit from the mother's net profit, which means that dividends are expected to be distributed in the future. According to the company's tradition, after turning profit, the profit distributed in cash every year is, in principle, not less than 50% of the profit that can be distributed in the consolidated statement achieved in the current year.

I have to say that the style of the Hong Kong stock market is the proper “don't see rabbits, don't throw eagles”!

If you miss this first stage of take-off, you can still stand in the present and think again. Has anything happened in these more than two months?

First, the electricity price mechanism for coal-to-electricity capacity has been implemented as scheduled.

On November 10, the National Development and Reform Commission and the National Energy Administration jointly issued the “Notice on Establishing a Coal-to-Electricity Price Mechanism” (“Notice”), deciding to establish a coal-to-electricity pricing mechanism starting January 1, 2024. This is a far-reaching policy.

The “Notice” makes it clear that the current single electricity price system will be changed to a “two-part system” of electricity price and capacity electricity price. The electricity price is “formed through a market-based method”, and the capacity electricity price level is determined by recycling a certain percentage of the cost of coal power units, and “gradually adjusted according to actual conditions such as the progress of the coal power transformation.” Among them, the fixed cost of coal power units used to calculate capacity electricity prices is based on a unified national standard, which is 330 yuan per kilowatt per year; in 2024-2025, the proportion of fixed costs recovered through capacity electricity prices in most places is about 30%, and in some places where the coal power function transformation is faster, it is appropriately higher; starting in 2026, the proportion of fixed costs recovered through capacity electricity prices in various regions will increase to no less than 50%.

What is the concept of 330 yuan per kilowatt per year? The total installed capacity of coal and electricity in the country exceeds 1.3 billion kilowatts, and the annual expenditure is over 430 billion yuan in the electricity price category. The annual power generation capacity of 1.3 billion kilowatts of coal power is about 4.9 trillion kilowatts, and the price of electricity with a capacity of 430 billion yuan is equivalent to 8.8 cents of the electricity subsidy. ——Also take Huaneng International as an example. According to the Huaxia Energy Network article, it has nearly 130 million kilowatts of coal power installed, and the electricity price per capacity can obtain a stable income of nearly 43 billion yuan per year.

There are also calculations with a different caliber. According to Galaxy International, central power enterprises and provincial enterprises that account for a high share of coal and electricity benefit the most. Under the current level of compensation, Huaneng International will increase profits by nearly 10 billion yuan a year. Datang Power Generation,$Huadian Power International Corporation (600027.SH)$It will increase profits by about 5 billion yuan.

Regardless of the caliber, it is many times larger than “capacity electricity price revenue of 1.913 billion yuan in the first three quarters of 2023.”

Second, Changxie electricity prices in major electricity consuming provinces have been settled one after another.

[Jiangsu]

On December 19, the Jiangsu Electric Power Trading Center announced the 2024 annual transaction results: the total annual transaction volume of electricity in Jiangsu Province in 2024 was 360,624 million kilowatt-hours, an increase of 6.38% over the previous year; the weighted average price was 452.94 yuan/megawatt-hour, up 15.84% from the benchmark price for coal combustion.

[Guangdong]

On December 22, the Guangdong Electric Power Trading Center announced the results of Guangdong Province's 2024 annual transaction and annual green power transaction. The total transaction volume of electricity in 2024 was 258.201 billion kilowatt-hours, up 4.42% year on year: the average transaction price was 465.62 cm/kwh, up 2.79% from the benchmark price of coal combustion, up 2.79%, and a decrease of 15.93% from the average transaction price of 553.86 per kilowatt-hour in 2023. The price of electricity traded in Guangdong fell year on year in 2024, but it remained higher than the benchmark electricity price. Furthermore, after considering capacity electricity prices in 2024, the upward ratio is expected to increase further.

[Hebei]

The weighted average price for each period of the 2024 bilateral negotiation transaction was 0.41,917 yuan/kilowatt hour, up 15% from the benchmark electricity price for coal combustion in Hebei Province. Based on the highest 20% increase in electricity prices in 2023 (no publicly disclosed data in 2023, but based on the 19.99% increase in average direct transaction prices in 2022), the 2024 Changxie (electricity price) fell by about 0.018 yuan/degree (-4.1% year over year). If you add the capacity electricity price of 0.0237 yuan/degree in Hebei Province, the total electricity price package is 0.4429 yuan/kilowatt, an increase of 0.006 yuan/degree (+1.3% year over year).

The average transaction price of bilateral negotiations in Guangdong in 2024 was 465.6% per degree, down 15.93% from the previous year, adding 0.024 yuan/kilowatt of electricity. Guangdong coal and electricity can obtain electricity prices of about 489.66% per kilowatt hour, which is about 5.76% higher than Guangdong's benchmark electricity price. The determination of transaction volume prices in Jiangsu, Hebei, etc., provides a signal that in provinces where electricity consumption is tight and coal costs are high next year, thermal power prices are expected to remain high; however, the results of the signing of electricity and electricity prices in Guangdong are lower than expected, so the situation in various provinces varies greatly. Overall, in terms of electricity prices, it is not appropriate to be too optimistic. Investment in thermal power needs to focus on major contradictions. After provincial governors agree to implement electricity prices, investors should pay more attention to changes in economic data and usage hours.

On the cost side, from the chart above, coal prices have rebounded somewhat in 2023Q4. Affected by the international situation after the outbreak of the Russian-Ukrainian war, there is still a possibility that international coal prices will fluctuate and soar for some time to come, while domestic coal prices maintain a price comparison relationship with international coal prices, compounded by factors such as China's violation of safety and environmental protection, and the imposition of sanctions on coal supply. It is expected that coal prices will continue to drop sharply for a long time to come. This is an obvious risk factor.

Finally, speaking of investment, coal and electricity PB is still low (some can even be described as “low residual”). Coal-fired power prices are likely to remain high in the future. After the introduction of the superimposed capacity electricity price mechanism, coal power unit profits are expected to continue to improve, forming a growing trend. It is expected that profits for coal-fired power plants will continue to improve, forming a growing trend. After profits are corrected, they will also be sought after by the market as a high-yield stock, so overall, the investment cost performance ratio is still OK.

As for which one to choose, it is necessary to analyze the specific company. The main factors involved include: energy structure (share of thermal power and business location, profit situation of new energy sources), transaction structure (share of market-based electricity transactions), intention to pay dividends, size of the marketable market, flexibility in subsequent stock prices, etc., before taking the opportunity to invest.