The future will focus on thermal power management and is positioned as a national power generation platform. Huadian International is one of the leading thermal power generation companies in China. Renewable energy was split in 2021, and the subsequent operation will mainly focus on thermal power. As of 2023, the Company's holding installed capacity was 58.45 million kilowatts, including 46.89 million kilowatts of coal, 9.09 million kilowatts of gas, and 2.46 million kilowatts of hydropower.
The focus of this report is on two issues: rethinking the long-term positioning orientation and valuation of thermal power. The first question is about changes in the orientation of thermal power positioning: Since the beginning of '24, thermal power has followed a wave of independent markets. Has the thermal power market come to an end? What new logic will follow? We are re-examining thermal power from both short-term and long-term perspectives. The second question relates to discussions on thermal power valuation: We will further discuss the thermal power valuation issue that the market has always been concerned about. How can thermal power be given a planned price based on the PB-ROE logical framework?
In the short term, the excess return on the thermal power index is obvious. This round of short-term restoration is a “correction” of the market's expectations for thermal power EPS. Previously, the market feared that uncertain changes in coal prices and electricity prices in 24 years would damage thermal power profits. Against the backdrop of unanchored profits, thermal power declined significantly in the 3rd quarter of '23. As profits gradually became clear in '24, thermal power concentration began to recover after the beginning of '24, and came out with a strong wave of absolute returns.
Looking at the long term, we think the “second half” of thermal power may officially begin in '24, based on the two catalysts of profit convergence in capacity electricity prices and increased revenue from ancillary services. First, the introduction of capacitive electricity prices will weaken the cyclical nature of thermal power. According to our estimates, the impact of the capacity electricity price mechanism on industrial and commercial electricity prices in most provinces may be concentrated at 0.02 yuan/kilowatt, locking in part of the electricity price revenue ahead of schedule. Second, the new installed capacity of Scenery has far exceeded expectations. Consumption issues may become more prominent in 24, and thermal power may have to be remodeled to take on the problem of wind peak shaving and frequency modulation. Since the beginning of the year, the Development and Reform Commission and the Energy Administration have issued two consecutive articles to promote the construction of the auxiliary service market for thermal power. Thermal power is expected to usher in the first year of role change in 24.
The operating capability highlights the undertone of Huadian International's high-quality operation. 1. Judging from the ROE restoration situation in the past two years, Huadian's restoration pace is superior to that of its peers. 2. Impairment is the cause of changes in the industry and is not a subjective reason for listed company entities. The overall depreciation of the central enterprise Chunghwa Electric remained neutral. 3. Thermal power is relatively pure, in the context of declining capital expenditure. The ability to pay dividends may gradually improve. 4. The expiration of unit depreciation also has a positive impact on profits.
The positive impact of the unit's depreciation expiration in the past two years on profits is expected to increase by a high single digit.
Thinking about valuation models. The inflection point of the thermal power profit cycle may have been reflected in the 3rd quarter of 2023. Traditional cycle valuation methods, such as annualizing high performance points in a single quarter and then multiplying PE, are no longer suitable. Therefore, the logical response to PB-ROE is very important. Seen from two perspectives, if the market wants to price a certain type of asset at 1x PB, then the corresponding expected ROE may be at the level of 7%. In the second part of the discussion on coal prices and electricity prices, it was not very difficult for Huadian International to achieve this level of profit in '24.
Investment advice: In the current context of declining coal prices and basically stable electricity prices, the profit level of thermal power is expected to improve further. It is estimated that net profit from 24 to 26 will reach 73.71/81.28/9.299 billion yuan, respectively, an increase of 63.0%/10.3%/14.4% year-on-year, respectively. Using a segmented valuation of the company, the company's target market value for 24 was 82.6 billion yuan, with 18% room compared to the current market capitalization level. The target price was 8.1 yuan, and for the first time coverage was given a “strong push” rating.
Risk warning: Risk of falling electricity prices, risk of fluctuating coal prices, electricity reform policies may fall short of expectations, measurement errors and other risks.