CLP Holdings: Expecting A Better 2020

Summary

• The Hong Kong electricity business's permitted rate of return was reduced since October 2018 which depressed earnings, but earnings growth should resume in FY2020 with the new capital investment program.
• There is a mixed picture for other markets, as the outlook for the Australian business remains bleak, while the Mainland China business is expected to maintain steady growth.
• CLP Holdings, currently, trades at 18.1 times consensus forward FY2020 P/E and offers a consensus forward FY2020 dividend yield of 3.8%.
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Elevator Pitch

I maintain my "Neutral" rating on Hong Kong-listed CLP Holdings Limited (CLPHY) (OTCPK:CLPHF) [2:HK].

FY2019 was a challenging year for CLP Holdings, as the company's operating earnings fell by -20.5% YoY. FY2020 is expected to be a better year for the company, with market consensus expecting a mid-single digit core earnings growth for CLP Holdings this year. This is reasonable, considering that the Hong Kong electricity business should see a resumption of earnings growth in FY2020 with an increase in net fixed assets in tandem with the new capital investment program.

On the flip side, CLP Holdings' Australian business is expected to continue being under pressure in FY2020, with intensifying competition in the Australian retail electricity market, and weak wholesale electricity prices due to new renewable energy supply.

Furthermore, CLP Holdings' consensus forward FY2020 dividend yield of 3.8% is not as attractive as most of its Hong Kong utility peers, which warrants a "Neutral" rating.

This is an update of my initiation article on CLP Holdings published on January 23, 2020. CLP Holdings' share price has increased slightly by +2% from HK$82.50 as of January 22, 2020, to HK$84.20 as of March 5, 2020, since my last update. CLP Holdings, currently, trades at 18.1 times consensus forward FY2020 P/E, which represents a premium to its historical five-year and 10-year mean forward P/E multiples of 16.1 times and 15.7 times respectively.

Readers are advised to trade in CLP Holdings shares listed on the Hong Kong Stock Exchange with the ticker 2:HK, where average daily trading value for the past three months exceeds $30 million and market capitalization is above $27 billion. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.

Hong Kong Electricity Business To Resume Growth In FY2020

CLP Holdings had a challenging time last year, as the company's operating earnings fell -20.5% YoY to HK$11,121 million in FY2019. This was primarily attributable to a decline in the permitted rate of return on average net fixed assets for the Hong Kong electricity supply business, and headwinds for its Australian energy business (to be discussed in a subsequent section of the article).

The company's operating earnings for its Hong Kong electricity business declined by -13.0% YoY to HK$7,448 million in FY2019, as the permitted rate of return on average net fixed assets for the Hong Kong electricity business was reduced from 10% to 8% with effect from October 2018. While this might seem negative, it is actually positive for CLP Holdings when one takes a longer-term perspective.

CLP Holdings entered into a new 15-year Scheme of Control or SoC agreement with the HKSAR (Hong Kong Special Administrative Region) government in late-2018; the SoC agreement covers the period from October 1, 2018, to September 30, 2033. Although the Hong Kong electricity business had its permitted rate of return on average net fixed assets cut from 10% to 8%, the new SoC agreement means that CLP Holdings gets to continue operating the electricity supply monopoly for Kowloon and New Territories in Hong Kong.

More importantly, a five-year capital investment program amounting to HK$52.9 billion was approved by the HKSAR government in tandem with the signing of the new SoC agreement. This means that CLP Holdings' Hong Kong electricity business is guaranteed of steady earnings growth for the next couple of years till 2023, given the increase in average net fixed assets (capital investment in electricity generation, transmission and distribution assets) as a result of the approved five-year capital investment program.

The Hong Kong electricity business' FY2019 operating earnings could have been worse, if not for a +3.4% YoY increase in net fixed assets last year. This was attributable to capital expenditures of HK$9.1 billion spent on electricity generation assets and transmission & distribution assets as part of the approved five-year capital investment program.

In the company's FY2019 financial results announcement, CLP Holdings emphasized that "we now have a predictable earnings trajectory (for the Hong Kong electricity business) as we continue with the critical investments under the current Development Plan (HK$52.9 billion capital investment program)."

Furthermore, there is potential upside to the Hong Kong electricity business' permitted rate of return on average net fixed assets of 8% in the next few years. CLP Holdings highlighted at the company's recent FY2019 earnings call on February 24, 2020, that the Hong Kong electricity business' permitted rate of return on average net fixed assets can be increased to a maximum of 8.234%. as part of financial incentives awarded if certain energy savings targets can be met.

A Mixed Picture For Other Markets

As highlighted earlier, the Hong Kong electricity business is the key profit contributor for CLP Holdings, contributing approximately two-thirds of the company's FY2019 operating earnings. Outside of its home market Hong Kong, Mainland China, and Australia are the next largest profit contributors, accounting for 20% and 14% of CLP Holdings' operating earnings in FY2019.

Last year, operating earnings from the company's overseas businesses fell by -28.4% YoY to HK$4,441 million. CLP Holdings' Australian energy business was the biggest drag on the company's overall earnings, as its operating earnings from Australia more than halved from HK$3,302 million in FY2018 to HK$1,566 million in FY2019.

The Australian retail business (the sale and supply of electricity to consumers) was hurt by price caps for retail electricity prices which came to effect in July 2019; while the Australian power generation business was adversely impacted by extended maintenance for Yallourn Power Station in Victoria due to safety issues, and coal supply shortages for Mount Piper Power Station in New South Wales.

The outlook for CLP Holdings' Australian business in FY2020 remains bleak. The Australian retail business will see the full impact of price caps for retail electricity prices (that were introduced in 2H2019) on its earnings in FY2020, and competition is intensifying in the Australian retail market with CLP Holdings' number of Australian retail customers declining by -3% YoY in FY2019.

For the Australian power generation business, a recovery in utilization rates for coal-fired power plants, Mount Piper Power Station and Yallourn Power Station, in FY2020 is expected, as their respective coal supply and safety issues are addressed. However, this could be offset by downward pressure on wholesale electricity prices for the Australian power generation business resulting from increased renewable energy supply in Australia.

In contrast, CLP Holdings' Mainland China business has performed well, with operating earnings up +5.3% YoY from HK$2,163 million in FY2018 to HK$2,277 million in FY2019. The Mainland China business' diversified energy portfolio of nuclear, renewables and thermal power generation assets played a key role in its stable earnings growth.

CLP Holdings' Mainland China Power Generation Portfolio

Source: CLP Holdings February 2020 Investor Presentation Slides

Looking ahead, operating earnings from Mainland China in FY2020 should continue to be supported by full-year contributions from new power generation assets, which includes the commissioning of the 49.5MW CLP Laizhou II wind farm and the acquisition of a 36MW Meizhou Pingyuan solar plant last year.

The key risk for CLP Holdings' Mainland China business is regulatory in nature. With China's economy affected by the current coronavirus outbreak, China's National Development and Reform Commission or NDRC has announced a 5% reduction in electricity rates for businesses in late-February 2020. While the 5% reduction in electricity rates is currently absorbed by the state grid, Independent Power Producers or IPPs could eventually be asked to share part of the burden, and that could be potentially negative for CLP Holdings' Mainland China business' future earnings.

Valuation

CLP Holdings trades at 18.1 times consensus forward FY2020 P/E and 17.0 times consensus forward FY2021 P/E based on its share price of HK$84.20 as of March 5, 2020. As a comparison, the stock's historical five-year and 10-year mean forward P/E multiples were 16.1 times and 15.7 times respectively.

CLP Holdings offers consensus forward FY2020 and FY2021 dividend yields of 3.8% and 4.0% respectively. The stock's historical 10-year average dividend yield was approximately 4.0%. CLP Holdings declared a quarterly dividend per share of HK$1.19 for 4Q2019, which brings full-year FY2019 dividends per share to HK$3.08. This implies a dividend payout of 70% and a YoY growth of +2% in absolute terms.

CLP Holdings' forward P/E valuation is relatively reasonable compared with its peers, but its dividend yield is comparatively less attractive, as per the peer valuation comparison table below.

Valuation Of Hong Kong-listed Utility Peers

Stock	Consensus Forward One-Year P/E	Consensus Forward Two-Year P/E	Consensus Forward One-Year Dividend Yield	Consensus Forward Two-Year Dividend Yield
HK Electric Investments Limited (OTCPK:HKCVF) (OTCPK:HKVTY) [2638:HK]	29.9	28.4	4.0%	4.1%
The Hong Kong and China Gas Company Limited (OTCPK:HOKCY) (OTCPK:HOKCF) [3:HK]	29.3	27.9	2.5%	2.7%
Power Assets Holdings Limited (OTCPK:HGKGY) (OTCPK:HGKGF) [6:HK]	16.3	16.0	5.0%	5.0%
CK Infrastructure Holdings Limited (OTCPK:CKISY) (OTCPK:CKISF) [1038:HK]	12.9	12.8	4.7%	4.8%

Click to enlarge

Source: Author

Risk Factors

The key risk factors for CLP Holdings include lower-than-expected Australian wholesale electricity prices, stiffer-than-expected competition in the Australian retail energy market, regulatory risks in Mainland China, and lower-than-expected dividends in the future.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.