Rating: OUTPERFORM (maintain) 

With lower costs and rising electricity prices, thermal power companies’ profitability could improve. Coupled with the revaluation of power plant assets, we believe valuations of thermal power companies could increase. We favor Huaneng Power (600011 CH, BUY), Huadian Power (600027 CH, BUY), Jilin Electric Power (000875 CH, BUY) and China Resources Power (0836 HK, BUY). 

Rerating opportunities in new energy sector; high upside potential 

China’s power generation market is currently coal-based. To reduce the energy burden, we believe the only way is to increase the proportion of renewable energy generation and reduce that of coal-fired generation. We predict that to meet China’s carbon peak target, CAGRs in wind power and photovoltaic (PV) installed capacity would have to reach 9% and 15% respectively over 2020-30, with cumulative wind and PV installed capacity CAGRs at 6% and 9% respectively over 2020-50. 

Major power generation companies are taking strides toward new energy. Compared with pure new energy operators, valuations of companies that have both thermal power and new energy installed capacity have much growth headroom, in our view. According to our calculations on the installed capacity and market value of pure new energy operators, the following six companies’ new energy business are relatively higher than their current market values by these amounts/representing the following shortfalls: Jilin Electric Power (RMB27.3bn/158.5%), China Resources Power Holdings (RMB23.1bn/38.2%), Huaneng Power International (RMB18.3bn/29.0%), Huadian Power International (RMB4.8bn/ 14.6%), GD Power Development (RMB2.9bn/6.1%) and Datang International Power Generation (-RMB1.7bn/-3.4%). These companies also hold relatively high thermal power assets, so we see much revaluation upside potential. 

Policies to ensure supply would gradually lead to cuts in coal prices 

Price uptrend: Since the beginning of the year, China’s coal prices have risen sharply, mainly due to the imbalance between supply and demand. As of 13 Aug, the closing price of Qinhuangdao Port coal power (5500K) came to RMB942/ton, up 71.0% yoy. The thermal coal futures settlement price (active contract) is RMB770/ton, up 34.7% yoy. 

Weak supply: The yoy growth rate of China's raw coal production from March to June was significantly lower than in previous years. China's coal and lignite imports in 5M21 were 25.3% lower than in 5M20. With favorable economic conditions and higher temperatures, China's electricity consumption continues to increase. Along with a marginal decline in hydropower, demand for thermal power has increased. Thermal power generation in 1H21 came to 2.8tr kWh, with a CGR of 7.4% yoy over 1H19-21. Currently, the peak period of coal consumption is coming to an end, and demand for coal is showing a downward trend. The National Development and Reform Commission and other bodies have issued the "Notice on Implementing Nuclear Increased Capacity Replacement Commitments to Accelerate the Release of High-Quality Capacity" and other policies to ensure supply. In the future, with the gradual implementation of policies that guarantee supply with successive releases of coal production capacity, the coal supply and demand balance would improve and this would gradually drive down coal prices, in our view. 

Tight power supply and demand has kept electricity prices steady 

China’s electricity prices are lower than those in other countries, with room for increases. In 2019, the average sales price of electricity in China was RMB0.611/kWh, about 59%, 80% and 83% of prices in OECD countries, newly industrialized countries and the US respectively. 

Supply: the pace of total power generation investment has slowed, with the new energy expansion making it difficult to ensure total effective supply. 

Demand: electricity consumption has continued to grow in recent years. China’s electricity consumption CGR is likely to reach 5.5% over 2020-25E and 3.4% over 2020-35E. So, there is a lot of room for improvement. With advancement of electricity market reforms and improvement of electricity commodity attributes, electricity supply is tightening vs demand, implying room for rising electricity prices. 

Currently, electricity prices in many places have increased. In August 2021, the average transaction price of power plants in Yunnan Province increased 9.38% yoy, and that in Inner Mongolia increased 30.50% yoy. The bid spread in Guangdong Province has narrowed significantly from previous years. In August, it is -2.5%/kWh, vs -130%/kWh in 2020. Amid the tight supply and demand balance, the Ningxia Development and Reform Commission issued a notice to limit the monthly trading price of coal power to rise no more than 10% vs the benchmark price. Inner Mongolia also issued a notice in August such that Western Inner Mongolia Electric Power coal-fired electricity trading market transaction prices vs the reference price can go up no more than 10%. 

Valuation and risks 

We believe that there is plenty of room for the rerating of new energy assets, while the fundamentals of the thermal power business have reached an inflection point. The renewable energy business has yet to mature and thermal power still accounts for a high proportion of China’s current installed power generation capacity. Therefore, the replacement of thermal power with wind and solar is not feasible in the short term, in our view, so installed capacity for thermal power remains necessary. With lower costs and rising electricity prices, thermal power companies’ profitability could improve. Coupled with the revaluation of power plant assets, we believe the valuations of thermal power companies could increase. We favor Huaneng Power International (600011 CH, BUY), Huadian Power International Corporation (600027 CH, BUY), Jilin Electric Power (000875 CH, BUY) and China Resources Power Holdings (00836 HK, BUY). 

Other stocks (not rated): GD Power Development and Datang International Power Generation. 

Risks include: sharp decline in macro-economic conditions; policy effects falling below expectations; electricity price slump; and a sharp rise in coal prices. 

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