China Power: Solid Performance Delivered In 2019

Summary

• Net profit up 17%.
• Dividend bumped up 18%, now yielding over 9%.
• Transformation to greener energy on track.

Investment Thesis

In my last article on China Power International (OTCPK:CPWIF) dated 18th September 2019 titled "China Power Int: Get Paid 7.4% Whilst Waiting For Value To Be Unlocked", I asked if the stock offered good value or if it was a value trap.

During this market drawdown, on paper, it should be an even better value proposition.

Based on well-known and often used assessment matrixes such as Price/Earnings, Price/Book Value, and dividend yield, the company is looking very attractive. They could even be categorized as a growth company.

The company has published its 2019 Annual Report, so it is a good time to explore how they are progressing.

Highlights from 2019 Result

The combined total electricity sold by the company for the year ended 31 December 2019 amounted to 83,558,993 MWh which was an increase of 17.7% year on year.

Total electricity sold in 2019 increased by 17.75% compared with the previous year, and the revenue increased by 19.80%.

Net profit attributable to shareholders came in at RMB 1.28 billion, representing an increase of 16.94% from the previous year.

The dividend increased by 18% from RMB 0.11 to RMB 0.13

Source: China Power Int. 2019 Annual Report

We should look at a breakdown of how each different source of energy delivers the net profit.

Source: China Power Int. 2019 Annual Report

I often come across commentators here on SA that fervently criticize companies, such as Royal Dutch Shell (RDS.A) (RDS.B), which are transforming the company from a complete fossil-based source of income to include power generation and distribution, including renewable energy. The critics all are of the opinion that renewable energy is not a profitable business. Maybe some time back, it was not profitable but, clearly, looking at how much profit CPWIF generates (no pun intended) from renewable, such biases are clearly wrong.

Its total debt increased considerably. This is caused by a large investment in new power plants and infrastructure related to the operation of these plants.

Source: China Power Int. 2019 Annual Report

If we look at the Debt/EBITDA, it becomes high. The EBIDTA for 2019 came in at RMB 10.3 billion. With total debt at RMB 78.6 billion, the ratio becomes 7.6.

As a result of this, finance costs (interest and exchange rate losses) increased considerably from RMB 2.58 billion to RMB 3.16 billion. On a more positive note, the weighted average interest rate on borrowings was slightly down from 4.48% to approximately 4.37% per annum.

Green investing

The company is delivering on its promise to switch more of the production of electricity to clean energy. As of the end of 2018, clean energy accounted for 32.88% of the attributable installed capacity of the Group. This increased to 35.57% by the end of 2019. As we have seen from the increase in net profit, such switch does not have to come at the cost of lower profits, which is often the argument many investors have towards renewable energy.

It is still a long way to go to totally phase out coal-powered plants in China, as certain regions still rely on coal. Nevertheless, throughout 2019, they continued to control their capital expenditure of their coal-fired power assets and, at the same time, withheld developing any new coal-fired power project other than what was already under construction.

New for the year is the addition of a 13.9% stake in one gas-powered power plant in Shanghai.

They are also exploring the potential application of hydrogen power actively.

Returning capital to investors

It is good to be socially responsible and to put ESG (Environmental Social & Governance) matters high on the list of priorities for a company to focus on, but at the end of the day, it still needs to return capital to shareholders.

Some may engage in a debate as to whether companies should retain their earnings, as Warren Buffet professes, as it compounds the intrinsic value of the company over time or that it ought to return a decent portion of the earnings to its shareholders. Just a caveat, we are looking more at free cash flow rather than the reported earnings.

CPWIF decided last year that they intend to pay out at least 50% of the company's earnings going forward. The company celebrated their 15 years anniversary last year, and in their 2019 Annual Report, published 26 March 2020, it was interesting to note that their Chairman Tan Jiun stated that:

over these years, the company has always placed the shareholders' interests as its first priority and has been committed to sharing development achievements with its shareholders".

Their track record of returning capital to investors is quite good, as can be seen from this updated graph.

Source: Data from China Power Int, graphs from Tudor Invest

Based on today's closing price in Hong Kong of HKD 1.56, the dividend, which is payable to shareholders on the 30th June, equates to HKD 0.1426 giving a yield of 9.14%.

Not bad for a utility.

In terms of valuation, the company trades at a Price/Net Book Value of 0.45.

Risks associated with the thesis

Utilities all over the world are to a large extent regulated by governments, which want to make sure there are stability and sufficiency in the delivery of the electricity, and it needs to be sold at a price that the consumers can afford to pay.

Hence, there will always be a limit to what kind of return can be considered acceptable. This was also a point raised by Warren Buffet and Greg Able during Berkshire Hathaway's (BRK.B) (BRK.A) recent shareholder meeting. As they concluded, you might not get rich but one can make a "decent return" from the production and distribution of electricity.

One particular risk they have to live with is the cost of the energy source, such as coal. The production of electricity is also dependent on how much rain they get, as hydropower is a large part of their clean energy source.

A high level of debt is normally raising a red flag for me. However, as described earlier, I have less concern about it for two reasons. The first is that low, and as in China even lower, interest rates are here to stay for the foreseeable future. Secondly, the income stream is very secure, as people need electricity, coupled with the fact that, ultimately, the company is controlled by a state-owned company. I believe all future debts will be paid.

Outlook

As we all know, at the beginning of 2020, the outbreak of the coronavirus started in Wuhan which is located in the province of Hubei in China. China Power has two power plants in this province. The fact that electricity is an essential service, it did not disrupt their operation.

It is reported that as much as 80% of factory workers have resumed their work, but it is still not clear what level of production capacity factories are running at.

The Chinese government has implemented a number of measures to kick start the economy; however, there are still considerable uncertainties about how the downturn in the economy will impact the demand for electricity. In view of this development, China Power will continue to closely monitor the impact on its business and take appropriate countermeasures as necessary.

In terms of the balance between electricity supply and demand and against the backdrop of the State's macro-policy of counter-cyclical adjustments, the China Electricity Council predicted that the national total electricity consumption would sustain its steady growth in 2020 with an estimated annual growth of 4% to 5%. They have stated that the national electricity supply and demand remained generally in balance.

Conclusion

In my last article, I raised the question of what could be the catalyst that would unlock the value. There always has to be one. Because without it, the stock can remain "cheap" forever. To sum it up, catalysts which I think could be there are as follows:

First of all, the business they are in has to offer some form of a moat. It does, as it is very capital intensive with new entries into their business being restricted due to licensing from governments.

Secondly, it needs a good management. The present management seems to be doing the right things both in transforming the company towards more sustainable development and the way they treat all the shareholders.

Last, but not least, since price action of any securities is formed as a result of investors' perceptions of what will happen going forward, such market participants must have confidence in both the business model and the way they will be treated as "partners" in the business. This does take time. It does not happen overnight, but I think there is a good chance that investors, especially institutional, will see that it offers good value.

I would like to end this article with a comment from the International Energy Agency, which I think is the big picture in all of this.

Dr, Fatih Biron, the Executive Director of IEA made the following remark on 22 March 2020:

Today, we're witnessing a society that has an even greater reliance on digital technology to get on with day-to-day life, whose energy use is increasing in the form of electricity, and where the power supply is more dependent than ever on wind and solar. In such a society, electricity security is the foundation of prosperity and stability - but ensuring that security requires action from governments.

I have pointed out in my earlier articles on CPWIF that the electrification taking place in China still has lots of growth in it. As the country continues to develop - the need for more electricity will continue to increase

One example of this is the fact that the Chinese government is very proactive and taking swift actions to implement electrification of large parts of their transportation.

I continue being bullish on CPWIF, as I believe they are able to navigate the challenges they face going forward. They do have both the backing and the support they need from the government.

If you are interested in CPWIF I would recommend trading it on the Hong Kong stock exchange, where its code is 2380.HK, as daily trading volume exceeds 22 million shares per day.

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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.

I am long China Power International, Hong Kong