Recently, the power index has continued to reach new stage highs, forming a sharp contrast with the weak large-cap market. Looking at a longer time frame, this sector has accumulated an 18% increase since the beginning of this year, while the Shanghai and Shenzhen 300 index has only risen by 4% during the same period.

Regarding specific individual stocks, China Yangtze Power increased by 21%, Huaneng Lancang River Hydropower Inc. increased by 24%, and SDIC Power Holdings increased by 39%. All three of them are large-cap stocks with a market cap of over 100 billion yuan, and have continued to hit historical highs, providing sufficient surprises and returns for value investors.

Some people say that the end of technology is AI, the end of AI is computing power, and the end of computing power is electrical power.

So where is the end for electrical utility stocks? Will they continue to be bullish?

01

The continuous rise of the electrical utilities sector is not as simple as funds locking up. There are undoubtedly good reasons behind it. In my opinion, there are mainly two aspects.

Firstly, due to the low risk appetite of the large-cap market, the main funds have selected the defensive electrical utilities sector with high dividends.

Since the beginning of this year, although the large-cap market has rebounded to some extent, the market's risk appetite has remained sluggish. The main logic has two aspects: on the one hand, the macroeconomic growth has actually declined, and there is also no strong stimulus measure on the policy side. Correspondingly, at the micro level, the market is expected to be weak towards growth stocks and cannot be reversed for the time being.

For example, the CSI SW Food & Beverage index has been falling steadily since February 2021. Many consumer leaders continue to fall even after falling by 70-80%.

The main logic is that the growth rate of the social retail consumption has declined and the overall trend has shifted from consumption upgrade to consumption downgrade, which has significantly impacted the performance growth and profit-making ability of consumer stocks. This has led to many companies already hitting the ceiling of their business and their valuations have dropped significantly.

On the other hand, it will take time for the real estate market to recover from the bottom.

Although on May 17th, a series of policies geared towards the real estate market were released, the recent effects have shown some improvement, but the degree of force has not exceeded expectations. Also, the purpose of these policies is to stabilize the market, not to stimulate the market as in 2015. The market will require time to clear itself out through marketization.

The weakness of the real estate sector not only affects the expansion of credit, but also directly impacts the overall market's risk appetite.

Secondly, the electrical utilities sector has a stable growth logic and is increasing in both volume and price.

The national social electricity consumption has continued to grow, from 3.6595 trillion kilowatt-hours in 2009 to 9.2241 trillion kilowatt-hours in 2023. In terms of the power structure, the contribution of fossil energy will decrease, while the proportion of green energy, led by hydroelectric, nuclear, and renewable energy, will increase.

Regarding specific individual hydropower capabilities, SDIC Power Holdings is still the most capable. For example, in the years between 2026 and 2030, the construction of three hydropower stations installed capacity amounted to 3,930,000 kilowatts. There are also four planned power stations in the distant future, with a cumulative installed capacity of 7.38 million kilowatts. In total, there are 11.31 million kilowatts, which accounts for 53.1% of the already installed capacity that has been put into production.

In addition to the dimension of capacity expansion, there is still an expectation of a slight increase in electricity prices.

In 2022, the marketization trading volume of electricity will reach 52.5 billion kilowatt-hours, accounting for more than 60% of the total social electricity consumption. According to the guidance opinions of the National Development and Reform Commission and the National Energy Administration at the beginning of 2022, the national unified electricity market system will be basically established by 2025.

In May of this year, the National Development and Reform Commission once again released the basic rules for the operation of the electricity market, which will be officially implemented on July 1st, accelerating the pace towards national unified electricity market system, and it is favorable for power generation enterprises to improve their profitability.

In fact, the electricity prices in the overseas markets continue to rise as the supply and demand is balanced, and the unit price is much higher than in China. For example, the cost of electricity for Chinese residents is only slightly over 0.5 yuan per kilowatt-hour, while in the United States it is over 0.9 yuan per kilowatt-hour, and in OECD countries it is more than 1.35 yuan per kilowatt-hour. All of this is due to the direct and indirect subsidies from local Chinese governments. In the future, with the degree of marketization increasingly rising, electricity prices are expected to increase slightly in the long term.

Rising electricity prices are the big weapon for investment. This not only brings revenue growth, but also improves profitability, drives up gross margin and net margin, and raises the central valuation, making it easy to present good long-term performance.

02

The electrical utilities sector is further divided into sub-sectors such as hydroelectric, thermal power, nuclear power, wind power, solar energy, and other subdivisions. Different investment logics are applied to subsector leaders, such as the huge difference in business models between hydroelectric and solar energy, which leads to differences in capital performance.

There is a big difference in the valuation of capital for each industry, which is mainly reflected in the difference in thresholds (whether it can prevent capital outside the industry from entering the industry) and the size of future industry growth increments.

The hydroelectric power track has an extremely high threshold, and once resources are occupied, long-term benefits can be enjoyed.

China's water conservancy power generation is mainly concentrated in the upstream Yangtze River, Yellow River, Pearl River, Lancang River, and Songhua River, where water resources are abundant, and hydropower stations are mainly concentrated in the southwest region. The hydropower industry is the lifeline of the country, with a franchise operating right, access threshold, and a high scale monopoly advantage.

Furthermore, hydropower generation has low costs because water is a renewable energy source and there are no variable fuel costs during production, ensuring long-term stable returns on capital.

From this perspective, the business model is much better than that of thermal power leaders. Because the latter's biggest cost is coal, but the price has a clear cycle, resulting in a strong performance cycle attribute, making it difficult to run like super bull stocks like hydropower.

Moreover, the operating threshold of photovoltaic power generation enterprises is relatively low. Only the corresponding installation equipment needs to be purchased, and there is no need for a franchise operating license, which means that competition is more intense.

With the substantial increase in photovoltaic installed capacity, policy subsidies have continued to decline, and grid-connected electricity prices have continued to decline, the growth and profitability of relevant leading companies have deteriorated. For example, in 2023, wind power accounted for 70% of Three Gorges Energy's power generation, and photovoltaics accounted for 28%. The profit growth was slow, the stock price continued to decline, and it was depressed.

Looking at the medium and long-term game of solar energy, it is even more unbearable. Due to overcapacity, the prices of various links of photovoltaics have plummeted in recent years. Since 2024, the prices of polysilicon, wafers, solar cells, and components have fallen by as much as 37%, 39%, 14%, and 15%, respectively, among which the price of P-type components has dropped from 1.83 yuan/watt in early 2023 to the current 0.82 yuan/watt, a drop of up to 55%.

The price collapse-type decline has led to a significant deterioration in the profitability of upstream and downstream enterprises of photovoltaics, and performance will also show a clear Waterloo. This is also the most core driving force behind the continuous and substantial decline in photovoltaic sector stock prices.

All of this is due to the low business threshold.

For many years, the photovoltaic industry has been considered a cyclical industry with not too good profits, and capital inside and outside the industry did not care. In December 2020, China officially announced that it will achieve carbon peak in 2030 and carbon neutrality in 2060. After that, capital inside and outside the industry began to crazy gold mining in photovoltaic power generation.

Outside the industry, there are equipment manufacturers, automakers with plastic interior and exterior trinkets, household appliance compressor/temperature controller manufacturers, and even listed companies that make slippers, all of which have announced their entry into the photovoltaic industry. There are also new forces such as Gaojing Solar Energy, which has just been established for more than a year, and has officially announced a $17 billion investment in a 50GW silicon wafer project.

Inside the industry, Tongwei Co., Ltd., which used to be a silicon material manufacturer, began to move downstream to integrate, and Xinjiang Goldwind Science & Technology (002202.SZ) and Trina Solar Co., Ltd. also began to integrate the entire industrial chain, while Longi, who used to make silicon wafers, also began to move downstream.

The technical barriers to polysilicon, silicon wafers, solar cells, and component and parts are not high, and the upstream and downstream can be mutually infiltrated, and external players can also enter the game through capital investment.

Soon, the photovoltaic industry chain experienced serious overcapacity. According to agency predictions, by the end of 2024, the production capacity of polysilicon, silicon wafers, solar cells, and components will reach 1,180 GW, 940 GW, 1,360 GW, and 1,220 GW, respectively, about 2.3 to 3.3 times the newly added installed capacity demand in 2024. Moreover, the cycle of breaking through costs to achieve production capacity clearing will be very long.

Even in the next few years, when the market reaches a relatively balanced state, there is no driving force to drive prices up because once there are good profits and low operating thresholds, production capacity will emerge again.

In summary, hydropower leaders continue to reach new highs, while photovoltaic power generation and upstream leaders continue to decline, and the fundamental logic is also different due to business barriers.

The former can bring continuous and stable investment returns, while the latter may show cyclical properties and may not have a good long-term profit base.

03

Currently, the water conservancy utilities index has a PE ratio of 24.8 times and a PB ratio of 2.76 times, both of which are at the absolute high levels of valuation since 2019. However, with the continuous increase in stock prices, the relative valuation is high compared to historical levels, but it should not have reached the level of a bubble.

Due to the market-oriented reform of electrical utilities and the continued low risk preference of the overall market, the hydropower sector has shown a certain premium compared to the past few years, which is also reasonable.

Currently, from the perspective of business models, potential performance growth, and the grouping of certain internal and external institutions, the rising trend of hydraulic leading companies will not end easily in the short term, and there are still opportunities in the future.

However, it is also necessary to closely monitor the relevant risks of macroeconomic changes leading to market style switching. (Complete article)