Chindia power

Rajesh Panjwani Contents

Head of Power Research
[email protected] Executive summary ............................................................................ 3
(852) 26008271
Chindia’s power challenges ................................................................ 4
Abhishek Tyagi
(91) 2266505055 China - The bloated dragon .............................................................. 28
Juliet Zhu India - The hungry elephant ............................................................. 52
(86) 2120205913

Charles Yonts Power stocks .................................................................................... 90

Head of Sustainable Research
(852) 26008539 Company profiles

Aditya Bhartia ABB India - SELL ....................... 113 Huaneng Power - SELL ............... 177
(91) 2266505077 Adani Power - O-PF ................... 119 Jindal Steel & Power - O-PF ........ 181
Zac Gill BHEL - BUY .............................. 123 JSW Energy - U-PF .................... 185
(852) 26008725
CESC - O-PF ............................. 131 Lanco Infratech - O-PF ............... 189
China Power Intl - O-PF .............. 135 Longyuan Power - U-PF .............. 195
China Res Power - O-PF ............. 139 NHPC - U-PF ............................. 201
Coal India - O-PF....................... 143 NTPC - BUY .............................. 205
Crompton Greaves - BUY ............ 147 Power Grid - O-PF ..................... 209
Datang Intl Power - U-PF............ 153 Shanghai Electric - O-PF ............. 213
Dongfang Electric - U-PF ............ 159 Suzlon - U-PF............................ 217
GCL-Poly Energy - BUY .............. 163 Tata Power - BUY ...................... 223
Harbin Power Equip - U-PF ......... 169 Thermax - O-PF ........................ 227
Huadian Power - SELL ................ 173 Voltas - BUY ............................. 231

Appendices ............................................................................ 235 - 296

All prices quoted herein are as at close of business 22 June 2011, except for ABB and Tata Power which
are priced as at close of business 23 June 2011.

Energising research

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 Executive summary Chindia power

Hungry elephant, bloated dragon

India’s power generation India, one of the world’s lowest per-capita electricity consumers, is hungry for
set to accelerate, power, with 400 million people lacking access. China, on the other hand, is
China’s growth to slow
bloated after a massive energy binge and will be forced to slow down and
concentrate on a more sustainable mix. While Beijing focuses on improving its
energy efficiency, India’s capacity additions are set to take off, with
consumption growth surpassing that of China over the next few years. We
identify the winners and losers of this trend in this report.

Chindia’s power problems The challenges that India and China’s power sectors face can be traced back
have their roots in to their regulatory regimes. In China, tariffs are government controlled while
regulatory structures
coal prices are market determined. Power-company profits are thus squeezed,
pre-empting them to cut generation, which has caused the current power
crunch. In India, power-generation firms earn healthy returns but distribution
companies make big losses which forces them to back down on purchases
and cut supply, exacerbating chronic shortages. The coal market in India is a
near monopoly which has hampered production growth.

China to focus on tariff China will address power shortages and the low utilisation of existing capacity
reforms, regional grid via tariff reform, expanding inter-regional grid and reducing energy intensity
buildout and power mix
while improving its power mix. We expect power-demand elasticity to contract
from 1.46x in 2010 to 0.85x by 2015. New capacity additions should remain
stagnant. We anticipate solar to enjoy most growth as grid constraints limit wind
power, and nuclear development is reined in after the recent disaster in Japan.

India’s power capacity India’s power-demand growth looks set to accelerate from a low base and
addition set to accelerate, surpass that of China. We expect burgeoning state-utility losses to be
creating coal shortage
contained, as only six provinces have contributed to most of the deterioration
in state-utility finances. Moreover, several states have recently enforced 5-20%
tariff increases. Coal shortages pose a bigger challenge. New projects using
domestic coal may only receive 70% of their needs from domestic mines,
relying on imports to make up the shortfall. We forecast domestic coal demand
to rise from 483 million tonnes in FY12 to 760-780 million tonnes in FY17.

Our top picks In India, we prefer utilities with higher coal security such as NTPC and Tata
Power, transmission utility PowerGrid and equipment suppliers BHEL and
Crompton. In China, China Resources Power is the most efficient utility,
while China Power International is the cheapest. We like Shanghai Electric
for its overseas growth potential and solar stocks GCL Poly and Trina Solar.

Per-capita consumption in Per-capita power consumption across provinces in China and India
top provinces in India is
5,500 (kWh) China India Inner Mongolia
at similar levels to bottom Shanghai

provinces in China 5,000

Tianjin Zhejiang
4,500
Jiangsu
4,000 Chandigarh
Beijing

Heilongjiang Guangdong Shanxi

3,500 Hebei
Guangxi Fujian Liaoning
Chongqing
3,000 Hunan Gansu Shandong
Goa
Henan
2,500 Puducherry Xinjiang
Delhi Jilin Hubei Guizhou
2,000 Shaanxi
Hainan Yunnan
1,500 Punjab
Anhui Sichuan AP Karnataka
Jiangxi Rajasthan
1,000 Haryana HP Meghalaya Andaman & Nicobar
J&K Chattisgarh
Sikkim Lakshadweep Tripura
500 Gujarat
MP Orissa Kerala
Nagaland
Manipur
Tamil Nadu West Bengal UP
0 Uttarakhand
Mizoram Arunachal Jharkhand
Maharashtra Pradesh Assam Bihar

Source: CEC, CEA, CEIC, IMF, CLSA Asia-Pacific Markets

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 Section 1: Chindia’s power challenges Chindia power

Chindia’s power challenges

China and India have China and India are the second- and fifth-largest power generators in the
world’s second- and fifth- world and together account for 12% of global GDP and 24% of global power
largest power capacity
generation. Apart from being big, these countries also have among the
fastest-growing power sectors. In the past decade, around half of the
incremental power generation has happened in Chindia.

Figure 1

Some 24% of global Power-generation capacity across countries (2008)

power generation
happens in Chindia 1,200 (GW)
1,010
1,000
797
800

600

400 281
224
177
200 139 128 118 104 99

0
Russia

Brazil
China

India

Italy
Japan
US

Germany

Canada

France
Source: IEA, CLSA Asia-Pacific Markets

Figure 2

Chindia accounts for c.40- Chindia’s share in global incremental power demand per year over the last decade
60% of incremental
global power demand 70 (%)
59 58
60
54 53

50 47
46
43
42
40 35

30

20

10

0
2001 2002 2003 2004 2005 2006 2007 2008 2010

Source: BP, CLSA Asia-Pacific Markets

China is now facing Both economies are now facing their own power-sector challenges. After,
power shortages seven years of adequate power supply, China started to face shortages from
after seven years
April, which are likely to worsen over coming months and years. For India,
however, power shortages are nothing new. Compared to the 3-5% shortages
China is expected to face in the peak summer months, India has seen a 10-
15% power shortfall for many years. Some experts believe that India’s power
shortages have been underestimated and do not capture much of the
country’s latent power demand.

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 Section 1: Chindia’s power challenges Chindia power

Figure 3

China is likely to face 30- China’s estimated power shortages

70GW in power shortages
over next three years 80 (GW) Power shortage estimated by State Grid (%) 6.0
Shortage as % of capacity (RHS)
70 5.5

60 5.0

50 4.5

40 4.0

30 3.5

20 3.0

10 2.5

0 2.0
2011 2012 2013

Source: State Grid, Media reports, CLSA Asia-Pacific Markets

Figure 4

India has faced much Energy deficit and peak-power deficit in India
higher power shortages
for many years 25 (%) Energy deficit Peak power deficit

20

15

10

0
FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

Source: CEA, CLSA Asia-Pacific Markets FY10

Figure 5

India must rely Coal imports as a percentage of total demand in China and India
on more coal imports
20 (%) India China

15

10

(5)

(10)
CY12CL

CY13CL
CY00

CY01

CY02

CY03

CY04

CY05

CY06

CY07

CY08

CY09

CY10

Source: CEIC, Ministry of Coal, CLSA Asia-Pacific Markets

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India faces coal shortages India has learned to live with shortages by cutting power supply for a few
and huge losses by hours per day in most provinces and hence this is not considered to be a big
distribution companies
issue for the sector. The problem India faces over the next few years is too
much power capacity and too little coal to run that capacity while huge
financial losses made by state-power-distribution companies hang like the
sword of Damocles. India’s power capacity addition has picked up in the past
two years. However, production by Coal India, the country’s largest coal
producer, is not keeping up with the demand. State-distribution-utility losses
were up 64% to Rs506bn in FY09.

Different regulatory structures, different problems

Problems in The problems faced by the two countries can be understood better by
Chindia stem from comparing the regulatory structures for power tariffs and coal prices. In
regulatory structures
China, coal prices are largely market driven while tariffs, both on grid and
retail, are entirely determined by the government.

Figure 6

Tariff and coal supply systems

China India
China’s coal prices are Retail tariffs for end Fixed by government on an Determined by provincial
market driven while customers ad-hoc basis. electricity regulators, but
India’s are not there are local government
pressure to limit tariff
increases.
India’s IPPs can pass On grid tariff (charged by Fixed by government on an Fixed by central and provincial
costs on to distribution generators to transmission ad-hoc basis. regulators without much
firms, in China they can’t and distribution cos.) interference from
government.
Coal prices Mostly market determined Not market determined. Fixed
with some interference/ by Coal India with consent
guidance from the from the government.
In India, IPPs make government.
healthy returns;
distributors incur Impact on IPPs Squeezed between rising Most make healthy returns as
heavy losses (generation companies) coal prices and government- coal costs are passed on to
fixed on-grid tariffs. Making distribution companies.
losses or little profits.
Impact on transmission Grid (T&D combined) firms Distribution companies make
and distribution companies have been profit making heavy losses due to inefficient
although their returns are operations, power theft and
low. subsidies provided to
In China, the grid is agricultural and residential
moderately profitable customers.
while IPPs suffer Coal industry structure Many central and provincial Coal India controls about 80%
SOEs are involved in coal of national coal supply. Little
supply. Largest player competition.
controls 11% of market.
Coal demand-supply Some shortages in recent Massive coal shortages going
past which have been met forward as coal production
through coal imports. lags demand by a wide
margin.
Source: CLSA Asia-Pacific Markets

Currently, some plants In China, coal prices have risen sharply, but power tariffs haven’t kept pace.
see narrow or negative The margins of power generators have been squeezed. Some are losing
margins on additional
money at margin if they buy coal at spot prices and generate power. As a
power generation
result some operate below their optimal capacity utilisation while others have
shut down. This, along with other factors, such as poor hydro-power
generation and a shortage of inter-regional grid capacity, has resulted in
power shortages in some provinces despite adequate capacity.

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 Section 1: Chindia’s power challenges Chindia power

Figure 7

China’s capacity addition Key characteristics of China and India’s power sectors
is stagnant; while its China India
accelerating in India
Growth in annual Stagnant since 2006. Growing and should continue to grow
capacity addition for next many years.
India’s per-capita power Per capita consumption in 3,176 812
use is a quarter of China’s 2010/FY11 (kWh)

Capacity mix trend Share of coal declining; that of Share of coal is rising and a reversal in
hydro, nuclear and wind rising. this trend is likely only after five years.
Share of coal declining in Presence of overseas Almost nonexistent in thermal Substantial presence of Chinese
China, rising in India generation equipment power. Some overseas players equipment suppliers in India.
suppliers present in wind and hydro. Korean, Japanese and European
companies also have presence either
either directly or through JVs with
Indian companies.
China insists on Presence of overseas T&D Substantial presence by global Most of the market controlled by
technology transfer to equipment suppliers majors like ABB, Siemens, Areva domestic suppliers and domestic
local companies T&D through JVs in China - subsidiaries of international majors.
especially in higher voltage But recently witnessing competition
products. from Korean and Chinese equipment
suppliers.
Indian companies get Approach towards Government throws its weight in Government generally not involved.
inferior deals on technology transfers the bargaining process. Focus is Technology transfer is not insisted
technology transfer on technology transfer to local upon. Indian companies get a much
companies and indigenisation of inferior deal on technology transfers
the technology at a quick pace. compared to their Chinese
Companies that refuse to share counterparts.
technology find it difficult to
enter the market.
IPPs are mostly IPP ownership Mostly owned by central and Historically, mostly owned by state
government-owned in state governments. and central governments, but private
China, rising private sector share is increasing sharply.
participation in India Power consumption mix (%)

Industry 75 40

Agriculture 2 21

Services 11 15

Residential 12 24

Power capacity mix

Thermal 73 65

Hydro 22 22

Nuclear 1 3

Wind 3 8
Source: CLSA Asia-Pacific Markets

Indian distribution cos In India, retail tariffs are supposed to be ‘independently’ determined by the
make heavy losses to provincial electricity regulators, but in practice there is heavy political
maintain subsidies
interference. Moreover, historically the tariff structure has included heavy
subsidies for residential and agricultural customers, which are not easy to
eliminate and are politically unpalatable. As a result, distribution utilities are
making heavy losses.

While IPPs in India are On the other hand, on-grid tariffs are determined either by regulators or
able to pass coal costs on through a process of competitive bidding largely independent of political
to distribution companies
interference. For regulated return projects, coal costs are passed through to
distribution utility companies. But for competitively bid projects, coal cost
pass through varies from project to project based on tender conditions as well
as the option taken by the bidder while bidding. Thus, most listed power
utilities have been earning very healthy returns.

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Figure 8

IPPs in India have more ROE of NTPC versus Huaneng

stable returns on equity

20 (%) NTPC Huaneng Power

15

10

(5)

(10)
2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: Companies

Despite poor return ratios in the past few years, IPPs in China have continued
their aggressive capacity addition, which has led to a sharp rise in debt. In
India, power-capacity addition has moved at a slower pace. Moreover, then
private sector has been more active in capacity addition and are therefore
more highly geared than state-owned NTPC.

Figure 9

Net gearing of China IPPs Net gearing of NTPC versus Huaneng Power
has grown substantially

300 (%) NTPC Huaneng Power

250

200

150

100

50

0
2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: Companies, CLSA Asia-Pacific Markets

Despite high ROEs, there The concern for the Indian power sector is that heavy losses being made by
are two fears for Indian state utilities forces them to purchase less power than the demand at end-
utility companies:
customer levels (to limit their losses), which could lead to lower off-take of
power from the generators.

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 Section 1: Chindia’s power challenges Chindia power

First, that state utilities The other big concern is shortage of coal. Coal production in India has lagged
are forced to purchase that in China by a wide margin. With acceleration in power-capacity addition,
less power due to losses
coal shortages are likely to increase at an alarming rate over the next few
years, threatening the utilisation level of coal-power plants in India. We
expect increasing share of India’s coal demand to be met by coal imports,
unlike China which will be largely self sufficient.

Different stages of development cycle

India still lags well While both countries are facing power-sector challenges, they are also at
behind China in terms of different stages of their development cycle. China is much more advanced,
power development
with per-capita consumption more than 4x that of India, while power-
generation capacity is 6x that of India.

Figure 10

China’s power capacity Size of China and India's power sector (2010/FY11)
6x of India and Power capacity (MW)
generation over 4x
Total Coal Gas Diesel Other Nuclear Hydro Renew-
thermal able
India 173,626 93,918 17,706 1,200 na 4,780 37,567 18,455
China 962,190 656,230 26,619 8,230 15,555 10,824 213,397 31,987

Power generation (GWh) Utilisation level (PLF) (%)

Thermal Nuclear Hydro Renew-able Thermal Nuclear Hydro
India 664,914 26,285 114,296 29,763 75.1 68.0 38.0
China 3,414,500 76,800 686,300 50,100 57.4 90.5 39.1
Source: CLSA Asia-Pacific Markets

China’s power sector has The gap between the size of power sectors in China and India has grown
grown much faster substantially over the last decade. In 2000, China’s per-capita power
than India’s . . .
consumption was twice that of India; in 2010, it was around 4x more.

Figure 11

. . . and per-capita Per-capita power consumption

consumption was 4x that
of India in 2010 versus 3,500 China India
(kWh/person)
2x in 2000
3,000
China 10-year growth - 194% (11.4% cagr)
2,500

2,000

1,500

1,000 India 10-year growth - 50% (4.1% cagr)

500

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: CEIC, Central Electricity Authority, CLSA Asia-Pacific Markets

China’s demand has This gap has continued to grow as power-demand growth in China has been
grown at 2x that of India higher than India for every year over the last decade except for 2008 and
2009 when China’s power consumption was severely impacted by the global
financial crisis.

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The gap between China During this period, China’s economic growth has also been faster than India’s
and India’s power growth GDP growth. However, the difference between the rates of power-generation
is large at 6.4ppts . . .
growth between the two countries at 6.4ppt is substantially higher than the
difference in the rates of economic growth at 2.8ppt.

Figure 12

The gap in power demand Power-demand growth

growth between China
and India at 6.4ppts . . . 18 China India
(%)

16

14

12 China average - 11.9%

10

6 India average - 5.5%

2
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Figure 13

. . . while the gap China versus India GDP growth

between economic
growth is 2.8ppts . . . 16 China India
(%)

14

12
China average 9.9%
10

India average 7.1%

6

2
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: CEIC, CLSA Asia-Pacific Markets

China’s power elasticity is 50% higher than that of India

. . . due to China’s high The growth gap is due to higher elasticity of power demand to GDP in China
elasticity of power demand compared to India. In China, power demand has grown faster than GDP. The
to GDP growth . . .
average power demand to GDP growth elasticity in China has been 1.16x. The
same is 0.77x for India over the last decade. Except for the years when
power-demand growth was impacted by the global financial crisis, China’s
power demand to GDP growth ratio has ranged between 1.2-1.5x, and was
1.4x in 2010.

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 Section 1: Chindia’s power challenges Chindia power

Figure 14

. . . which is 50% higher Power demand to GDP growth

India’s elasticity
1.8 (x) China India

1.6

1.4
China average 1.16x
1.2

1.0

0.8

0.6 India average 0.77x

0.4

0.2

0.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: CEIC, CLSA Asia-Pacific Markets

Unlike China, capacity constrains have stifled demand in India

India’s lag has been There were two key factors likely responsible for such a big gap in power-
partly due to lack demand elasticity to GDP growth in the two countries. First is supply. India
of supply
has missed its power capacity-addition targets for many years by a wide
margin and thus supply has constrained power consumption. China, on the
other hand, has actually surpassed its capacity-addition targets for most
periods. Secondly, faster industrial-production growth in China is driving
strong demand growth.

Figure 15

India has consistently Growth in power capacity

missed capacity targets;
China has exceeded them 25 (%) China India

20

15

10

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: CEIC, CLSA Asia-Pacific Markets

Therefore, demand has Strong growth in China’s power capacity has meant that, unlike India,
not been constrained in demand has not been constrained by the lack of capacity since 2005. This is
China like it has in India
evident from Figure 16 which shows that for every year from 2005-09,
power-capacity growth in China was higher than power-demand growth.

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Figure 16

Since 2005, China’s Power-capacity growth in China versus demand growth

capacity growth has been
higher than demand 25 Capacity growth Demand growth
(%)
growth

20

15

10

0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: CEIC, Industry, CLSA Asia-Pacific Markets

India demand has Figure 17 illustrates India’s power-demand growth for most years being
consistently outpaced higher than capacity growth. A capacity shortfall has resulted in frequent
supply addition . . .
power cuts in most cities and villages. For small towns and villages, power
cuts are substantial, which discourages people who live in these locations to
purchase electrical items such as refrigerators, even if they can afford to buy
the electricity to use these capital goods.

Figure 17

. . . which hurts India’s power-capacity growth versus demand growth

development as frequent
power cuts discourage 11 (%) Capacity growth Demand growth
electricity use
10

2
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: CEIC, Industry, CLSA Asia-Pacific Markets

Substantial amount of latent demand in India

Lack of supply is affecting A study by the National Centre for Applied Economic Research looked at the
penetration of electrical key reasons why electricity use for capital goods differed in urban and rural
appliances in India
areas of India. It found that the lack of a regular supply was a bigger reason
for the difference in penetration of electrical appliances between urban and
rural areas than any income gap.

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Figure 18

There is substantial pent- Factors affecting penetration of consumer products in rural India
up demand for electricity
in rural areas of India
Lifestyle
11%
Interaction
between income
and electricity
10%

Electricity
Income 56%
23%

Source: National Council for Applied Economic Research, CLSA Asia-Pacific Markets

Industry has been the key driver of power demand in China

Economic structure is the Another important factor driving faster demand growth in China has been the
second key reason why structure of the two economies as well as the difference in the regulatory
China has outpaced India
policies in the two countries. Indian economic growth has been driven by
services which form 56% of GDP currently. China’s economic growth, on the
other hand, has been primarily driven by industry.

Figure 19 Figure 20

Industry makes up 47% India - GDP China - GDP

of GDP in China versus
Agriculture
26% in India Agriculture Industry 10%
18% 26%

Industry
47%

Services
Services 43%
56%

Source: CEIC, CLSA Asia-Pacific Markets

China has grown GDP The differences in economic structure of the two countries are manifested
primarily through power- more clearly in the break-up of power consumption. While 75% of power
hungry industries
consumption in China is by industry, in India this share is only 40%.

Figure 21 Figure 22

Industry makes up 75% India - Power consumption China - Power consumption

of power demand in China
and only 40% in India Agricultural
Agricultural Services
2%
21% 11%

Industrial
Residential
40%
12%

Services
15% Industrial
Residential 75%
24%

Source: CEIC, CLSA Asia-Pacific Markets

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Figure 23

Strong correlation: power China’s power generation vs industrial GDP growth

generation seems to be a
leading indicator of 25 Industrial GDP growth
industrial growth
Power generation growth (LHS)
20

15

10

0
1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010
Source: CEIC, CLSA Asia-Pacific Markets

Power supply has helped The relationship between power consumption and industrial growth in China is
stimulate industries to a two-way street, with industrial production boosting demand for power and
expand in China
power-generation growth providing an impetus for industrial growth. This is
evident from Figure 23. The growth in power generation is a leading indicator
for growth in industrial production. Availability of power has encouraged
industries to expand capacity. This is also reflected in Figure 24. In the years
when the rate of power-generation growth in industry has been high, the
share of industry in China’s power consumption has also risen.

Figure 24

China’s most energy As growth of power generation rises industry’s share in power use also goes up
intensive sectors have led
industrial growth 20 (%) 78
Power generation growth (LHS)
18 Share of industry in power consumption
77
16
76
14
12 75

10 74
8
73
6
72
4
2 71
1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: CEIC, CLSA Asia-Pacific Markets

Steel production in China Industry’s energy intensive sectors - steel, non-ferrous metals, chemicals and
has grown an average cement - are the largest consumers of power. In China, these four account for
18% for the last 10 years
almost 32% of total industrial-power consumption. Figure 25 illustrates the
rate of steel-consumption growth has been around 18% in China for the last
10 years compared to 10% in India. Figure 26 shows China’s average
aluminium production growth at 20% versus 10% for India. For cement
China’s production growth is 12% against India’s 8%.

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Figure 25

India’s steel production Growth in steel production

has grown 10% annually
over the same period 35 (%) Steel China Steel India

30 China average growth 18%

25

20

15

10

5
India average growth 10%
0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: Wind, CEIC, CRISIL, CLSA Asia-Pacific Markets

Figure 26

China’s aluminium Growth in aluminium production

production has outpaced
at an even greater rate 40 (%) Aluminium China Aluminium India

35

30 China average growth 20%

25

20

15

10

5 India average growth 10%

0

(5)
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: Wind, CEIC, CRISIL, Companies, CLSA Asia-Pacific Markets

Figure 27

Cement is closer but Growth in cement production

China still takes the edge
20 (%) Cement China Cement India

18
China average growth 12%
16

14

12

10

6
India average growth 8%
4
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: Wind, CEIC, CMA, Industry, CLSA Asia-Pacific Markets

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How far behind China is India in power consumption?

Per-capita consumption in Figure 28 shows per-capita power consumption across provinces in China
most Indian provinces and India tells the story. Per-capita consumption in provinces with the
is well below that
highest consumption levels in India equals the per-capita consumption in
in Chinese provinces
the bottom rung of China’s provinces. There are fairly large provinces in
India where per-capita consumption is less than one-fifth of India’s average
and 1/20th of China’s per-capita consumption. There is substantial room for
growth in these provinces.

Figure 28

Provincial per-capita consumption in China and India

5,500 (kWh) China India

Inner Mongolia

5,000 Shanghai

Zhejiang
4,500 Tianjin

Jiangsu

4,000
Beijing

Shanxi
Guangdong
3,500
Liaoning
Hebei
Fujian

Shandong
3,000

Gansu

2,500 Xinjiang
Goa Heilongjiang Henan

Puducherry

Hubei Guizhou
Hunan
Chongqing
2,000 Delhi Shaanxi
Jilin Yunnan
Chandigarh Guangxi
Punjab
Sichuan Haryana

1,500 Hainan Anhui Gujarat

Jiangxi Maharashtra
Tamil Nadu
HP Uttarakhand
1,000 J&K
AP
Karnataka
Rajasthan
Sikkim Meghalaya Chattisgarh
MP Andaman & Nicobar
500 Orissa Kerala Lakshadweep
West Bengal Tripura
UP Nagaland Manipur
Mizoram
Arunachal
Jharkhand
Pradesh Assam
Bihar
0

Source: CEC, CEIC, CEA, CLSA Asia-Pacific Markets

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The roles tariffs play

Tariffs in China favour Power tariffs are another important factor that have shaped both countries’
industry while in India power sectors and had an impact on power consumption by different
they favour residential
segments. The average power tariffs in India are lower than in China due to
and agriculture
big subsidies given by India for both agricultural and residential tariffs.
However, for industry, China tariffs are lower than in India. Additionally, in the
past most provinces have offered discounts on power supply to heavy
industry to promote economic growth. Overall, industrial power tariffs in
China have been around 26% lower than in India.
Figure 29

Industrial tariffs in China Estimated power tariffs (2009)

are around 26% lower
14 (US¢/kWh) China India
than in India 12.3
12
9.3 9.5
10

8 6.8 6.9
5.8
6 5.4

4
2.0
2

0
Residential Agricultural Industrial Commercial
Source: CEA, CEC, CLSA Asia-Pacific Markets

China’s industry is both Lower industrial power tariffs in China have also encouraged much higher
bigger than India and power consumption by industry there. While the size of industrial GDP in
more energy intensive
China is 6.7x that of India, power consumption by industry in China is 8.2x
that in India. For the services sector, the ratio of economic activity and power
consumption between the two economies is similar.

India consumes twice However, in the agriculture sector, China consumes only half as much power
as much power in as India despite having twice the economic output. One of the key reasons for
agriculture, with
India’s higher consumption is due to some large states providing free power
half the output
for agriculture while others provide heavy subsidies. This leads to inefficient
use and power wastage by agricultural customers in India. Interestingly,
agricultural power tariffs in China are only at a slight discount to residential
and industrial power tariffs.
Figure 30

Similar energy intensity Ratio of GDP and power consumption between China and India
for both service sectors
10 (x) 9.4 GDP (China/India)
9 Power consumption (China/India)
8
6.7
7
6
5
4 3.5
2.9
3 2.1
2
1 0.6

0
Industry Services Agriculture
Source: CEIC, CEA, CLSA Asia-Pacific Markets

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Agricultural electricity Meanwhile, accurate measurements of agriculture power consumption are

consumption in India may unavailable and it is often estimated. Since consumption remains unmetered,
be a bit overstated
there is a tendency to overestimate, which helps power utilities hide their
transmission and distribution losses, and pilferage. Many have pointed out
that that consumption is much lower than what is projected. A large part of
the losses could be the result of pilferage by residential, commercial and low-
voltage industrial consumers.

Figure 31

China’s industry Power consumption per unit of GDP

consumes 40% higher
power per unit of GDP 1.2 (kWh/US$) India China
1.09

1.0

0.78
0.8

0.57
0.6

0.4

0.17 0.16
0.2 0.14

0.0
Industry Services Agriculture

Source: CEIC, CEA CLSA Asia-Pacific Markets

Is industrial-power consumption key to China’s energy woes?

Substantial room for High energy consumption by China’s industry could be the key to solving a
improvement in China’s lot of energy challenges China faces. While high energy consumption by
energy intensity
China’s industrial sector is one of the key contributors to global warming
and pollution, it also offers a great opportunity for improving the power
and energy intensity of the economy. Various studies have shown that
there is substantial room for improvement in energy efficiency in industrial
production in China.

Figure 32

China is still well behind Substantial scope for improving energy efficiency in China
world best practice in
energy intensity 1,800 (kgce/tonne of production)
1,600
1,400 2005 average Chinese intensity
Current world best practice
1,200
1,000
800
600
400
200
0
Cement Steel Ethylene Ammonia Alumina
(Rotary kiln) (bof)

Source: LBNL, CLSA Asia-Pacific Markets

18 [email protected] 27 June 2011

 
  
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Some 75% of power is Improving energy efficiency is important as 75% of the power produced in
consumed by industry China is consumed by the industrial sector. China has the highest share of
versus 40% in India
power consumption by industry of any country worldwide and almost double
of that in India at 40%. In some Chinese provinces, industry’s share of power
consumption is higher than 90%.

Figure 33

In some Chinese Power consumption in select Chinese provinces

provinces, power use
is more than 90% of (%) Industry Commercial Residential
electricity demand 3.8
100
13.2 11.3 3.4
90 17.4 14.3 15.8 16.5
9.8
80 11.2 10.0
24.7 16.3
70
60 39.5

50
92.5
40 78.3
71.4 72.4
67.5
30 61.7

20 41.0

10
0
Beijing Shanghai Guangdong Zhejiang Hubei Sichuan Qinghai

Source: CEC, CLSA Asia-Pacific Markets

History suggests that industry’s share in power consumption will fall

Share of industrial power Figure 34 illustrates industrial-power consumption in China versus the USA,
consumption has declined the UK, Japan and Korea. It shows that none of these economies have had
in other countries . . .
such a high share of power consumption in industry over the last 50 years.
Korea is the closest and had 70% of power consumption by industry in the
1950s. Note that all of the countries have shown a significant decline in share
of power consumption by industry, except the UK, where the share of power
consumption by industry was 40%, even in 1950s.

Figure 34

. . . we believe China will Share of industrial electricity consumption in selected countries

follow suit . . .
90 (%) 1950 1960 1970 1980 1990 1995
2000 2005 2007 2008 2010
80

70

60

50

40

30

20

10

0
Korea USA Japan UK China

Source: CEC, CLSA Asia-Pacific Markets

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. . . in line with the We believe that China’s power-consumption growth will slow down given
government’s target to resource constraints and the need to protect the environment. Since China’s
cut energy intensity
power consumption in residential and commercial segments is relatively low by
international standards, most of the savings have to come from power
consumption by industry. The government has already targeted a slowdown in
energy consumption in the 12th Five Year Plan (please see Appendix 1 for
details) which aims to cut energy use per unit of GDP by 16% by 2015 and
limit the overall energy consumption by 2015 to 4bn tonnes of coal equivalent.

Change in economic structure will help reduce energy consumption

Lower growth for energy We have already seen the substantial scope for improvement in Chinese
intensive industry energy efficiency. Another important factor that will drive a slowdown in
energy consumption in China is the reduction in the production growth rate of
high energy intensity goods.

Energy intensive Our commodities team expects a substantial decline in the production growth
industries’ growth will rates of chemical, steel, aluminium, copper and cement in the next five years
slow . . .
compared to the last five years. Even though the overall rate of growth is going
to be reasonably high at 40-50%, it will be substantially lower than the 75-
125% growth rates seen in the last five years. These sectors account for 24%
of the energy and power consumption in China and a slowdown in these sectors
will lead to a slowdown in power consumption as well.

Figure 35

. . . from 75-125% in last Growth of high energy intensive industries in last and next 5-10 years
five years to 40-50% in
next five years 140 (%) 2005-10 2010-15 2015-20
125.6

120

100
82.0 82.6
80 74.8

60 51.9
42.8 45.5
38.7
40
25.2
20.5
20 12.6

0
Steel Aluminium Copper Cement

Source: CEIC, CLSA Asia-Pacific Markets

Power tariffs need to go up

China will likely allow Raising energy prices is a way to enforce energy efficiency. This is evident in
energy prices to rise our studies of energy efficiency and power prices in provinces across China.
In the top quartile provinces in China in terms of energy efficiency, industry
pays the highest premium to residential users for electricity.

In the bottom quartile, industries get power at discount to residential users.

Rising power tariffs are also necessary to ensure that the generators get
enough returns and are incentivised to add more power capacity and thus
keep power shortages under check. If power tariffs are not hiked, shortages
in China may worsen in coming years. Thus raising tariffs serves both
purposes: controlling the rate of growth of power demand and improving
power supply. Recently, the government has imposed tariff hikes in 15
provinces and we should see more hikes in coming months and years.

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Figure 36

Strong correlation Energy prices and energy efficiency are highly correlated
between energy prices 3.5 (ton of SCE/Rmb10,000) 30
(%)
and energy intensity
Premium/(discount) for large industry versus residential users 25
3.0
Energy consumption per unit of GRP (LHS)
20
2.5
15
2.0 10

1.5 5

0
1.0
(5)
0.5
(10)

0.0 (15)
Q1 Q2 Q3 Q4
Source: CEIC, CLSA Asia-Pacific Markets

In addition to tariff hikes, Over and above these tariff hikes, most local governments have taken measures
additional penal tariffs to restrict power to energy intensive industries, to charge extra for power supply
may be imposed
to energy-intensive industries and to impose penal tariffs on inefficient users.
We have listed actions taken by some of the provinces in Figure 37.
Figure 37

Several provinces have Local measures against power shortages

implemented additional Region Measures
measures to
reduce intensity Shanghai Local power authorities will restrict power supply to Baosteel between
June and September.

Jiangsu Since April, the Jiangsu Grid has implemented peak load shifting and power
restrictions in 47 industries such as steel, cement, construction materials and
the hotel sector.
Hunan has imposed Zhejiang The provincial government has imposed an additional Rmb0.1-0.3/kWh tariff
punitive tariffs for energy on companies whose annual power consumption is higher than 5000 tonnes of
intensive industries standard coal or 2.95m kWh.

Hunan On 21 April, the provincial government imposed punitive power tariffs on eight
energy-intensive industries (steel, alloy iron, battery, cement, caustic soda,
electrolytic aluminum, yellow phosphorus and zinc smelting). The punitive
tariffs will be applied to those manufacturers whose power consumption
exceeds an approved standard.

Anhui On 29 May, Anhui government implemented peak load-shifting measures in

energy-intensive sectors and illegal-construction projects.
Chongqing restricts Chongqing On 12 May, Chongqing government imposed restrictions on power consumption
power to intensive in energy-intensive sectors; supply to these sectors will be the first to be cut
sectors during shortages when the shortages worsen.

Jiangxi The provincial planning bureau and power-supply bureau have formulated a
power-rationing plan and set specific power consumption quotas for key
enterprises and projects.

Henan Since May, the provincial government has implemented a

power-rationing plan.

Hubei The authorities will further restrict power supply to energy-intensive sectors.

Beijing Beijing will consider using a staggered rush-hour plan, targeting the steel,
cement, electrolytic aluminum and ceramics industries. Meanwhile, Beijing will
issue a staggered power tariff policy later this year, ie, higher levels of
consumption will trigger a higher tariff.

Hebei Shijiazhuang, the provincial capital, will guarantee power supply for
competitive enterprises such as hi-tech firms while restricting power
consumption in energy-intensive sectors.
Source: CRR, domestic media reports

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We expect China’s power demand growth to slow

Efforts to reduce energy We believe the government’s efforts on reducing energy intensity, along with
intensity, higher tariffs, higher power tariffs, constraints on coal supply and continued power
supply constrains . . .
shortages will help reduce demand growth for power in China. We expect the
elasticity of power demand to GDP growth to gradually come down from an
average 1.46x in 2010 to 0.85 by 2014. As discussed above, economic
structural change, the slowdown in production of energy-intensive goods and
the government’s focus on energy efficiency will help achieve this.

Figure 38

. . . help reduce China’s Elasticity of China’s power-demand growth to GDP growth

power elasticity to go
down from 1.2x to 0.85x 1.6 (x)

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: CEC, CLSA Asia-Pacific Markets

As a result, power-demand growth in China is likely to come down from

around 14.9% in 2010 to 11.9% in 2011, 9.5% in 2012 and 7% by 2014.

Figure 39

Power demand growth Power demand/generation growth in China

is likely to come down
from 15% to 7% 20 (%) Total generation - China Total Thermal - China
18
16
14
12
10
8
6
4
2
0
2006 2008 2010 2012 2014 2016 2018 2020

Source: CEC, CLSA Asia-Pacific Markets

The rate of capacity The rate of power-capacity growth has already slowed considerably from
increase is down from about 20% in 2006 to 10% currently. We expect this to continue to decrease
20% to 10%
gradually. The increase in thermal-power capacity (and thus base-load power
capacity) will be lower than overall capacity growth and this gap will continue
to widen as China adds more nuclear, wind and solar power capacity.

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Figure 40

Thermal-power capacity Growth rate of power capacity in China

growth will be lower than
overall capacity growth
25 (%) Total capacity - China Total thermal - China

20

15

10

0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: CEC, CLSA Asia-Pacific Markets

Meanwhile, India’s power demand growth is set to increase

India will add 87GW of As discussed earlier, one of the key constraints on India’s power-demand
conventional capacity in growth has been slow growth in power capacity. That is about to change with
its 12th Five-Year Plan
a big pick up in capacity addition in India. We expect conventional power-
versus 47GW in the 11th
capacity addition to go up from 47GW in the 11th plan to 87GW in the 12th
plan. We expect the power-capacity addition rate to increase from 7.1% over
the last five years to 9.3% over the next five. The rate of growth of thermal-
power capacity will be even higher.

Figure 41

Rate of capacity growth Growth in power capacity in India

to increase from
7.1% to 9.3%
14 (%) Total capacity - India Total thermal - India

12

10

2
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: CEA, CLSA Asia-Pacific Markets

Power elasticity to With capacity constraints easing, we expect India’s power demand growth to
rise from 0.7x to 1x GDP growth elasticity to increase from an average 0.7x over the last five
years to 1x in the next few years, before declining to 0.8-0.9x again.

27 June 2011 [email protected] 23

 
  
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Figure 42

India’s power generation India’s elasticity of power demand growth to GDP growth
growth to increase from
5.8% to 9.2% 1.2

1.0

0.8

0.6

0.4

0.2

0.0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: CEA, CEIC, CLSA Asia-Pacific Markets

Some concerns whether We expect India’s power generation growth to pick up from 5.8% over the
there will be sufficient past few years to 9.2% over the next five. Some pundits are concerned
demand for power whether there will be enough demand for new power-generation capacity in
India given rising power costs and burgeoning losses of the state power
utilities. We discuss this issue in more detail in Section 3.

Figure 43

Growth in power generation in India

14 (%) Total generation - India Total thermal

12

10

2
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: CEA, CLSA Asia-Pacific Markets

Power consumption It’s worth contrasting the outlook for power generation and demand in China
growth in India is likely and India. While we expect China’s power generation and consumption
to be higher than China
growth to gradually decline, we expect India’s power demand growth to pick
over the next few years
up. This can have an impact on the GDP growth of the two countries as well,
adding a bit of growth to India and shaving off a little growth from China.

Share of thermal power The share of thermal-power generation in total power generation is likely to
generation will fall in gradually decline in China. The trend is already evident in the new capacity
China and rise in India
mix and this will reflect more and more in the power-generation mix.

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 Section 1: Chindia’s power challenges Chindia power

However, for India, the rate of thermal-power capacity addition (mostly coal)
will be higher than overall capacity addition. In fact, an increase in coal-fired
capacity is the key driver of the pick up in power-capacity addition in India.
As a result, the share of thermal-power generation in India’s power mix will
continue to increase over the next few years.

Figure 44

Contrasting power-generation growth

16 (%) Total generation - India Total generation - China

14

12

10

4
2009 2010 2011 2012 2013 2014 2015

Figure 45

Coal-fired plants Share of thermal power in total power generation

are driving most of
India’s capacity 83 India - Thermal as % of total
(%)
China -Thermal as % of total
82

81

80

79

78

77
2008 2009 2010 2011 2012 2013 2014 2015

Source: CEA, CEC, CEIC, CLSA Asia-Pacific Markets

India desperately needs to increase power tariffs

Like China, power tariffs The power tariff hikes in China are being driven by power shortages and poor
in India will go up profitability of the IPPs. In India, the power tariff hikes will be driven by the
huge losses of the power distribution companies. The process of tariff hikes
has begun, and as discussed in Section 3, electricity regulators in many
provinces have already imposed significant tariff hikes. In China, both on-grid
and retail tariffs have been increased. In India, while on-grid tariffs are
adjusted when the fuel prices go up, retail tariff hikes have to be approved by
the regulator. These new tariffs will benefit the energy-distribution firms.

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Tariff hikes in India will Unlike China, where industry is likely to face the highest tariff increases, in
be mostly for agriculture India they are already too high while residential and agricultural tariffs are
and domestic segments
low. One of the tasks given to the regulators is to narrow the discrepancy. As
a result, we do not expect a significant change in industrial tariffs, but
agricultural tariffs could see a sharp increase from a low base while
residential tariffs are also likely to go up.

India is also focusing on energy efficiency

India is implementing Energy efficiency is not the biggest problem for India as supply constraints
new policy to increase and tariff structure have prevented run-away energy consumption as seen in
energy efficiency
China. However, India also recognises the constraints to future capacity
addition as there will be a big shortage of domestic coal going forward and
the cost of power supply will continue to increase. Hence, it is focusing on
energy efficiency as a way to cut down its power demand and dependence on
imported fuel.

PAT programme focuses According to news reports, the Power Ministry plans to impose huge penalties
on industrial of over Rs0.1m a day on industries that fail to achieve energy-efficiency
energy efficiency . . .
targets under the three-year Perform, Achieve and Trade (PAT) programme
from 1 April 2011.

. . . and can help India PAT, which aims to increase industrial-energy efficiency, is expected to reduce
avoid 5,600 MW of energy consumption by 5%, amounting to an avoided capacity of more than
additional capacity
5,600MW over the course of the three-year programme. There are strict
penalties, as well as incentives for industries participating in PAT, starting
from 1 April, 2011. Those entities that fail to achieve the targets must pay
huge penalties. Other entities that perform better will be awarded Energy
Savings Certificates (ESCerts), which can be traded. Entities that are short of
targets can also buy these certificates to make up for the shortfall. Eight
industries - cement, thermal power plants, pulp & paper, textile, fertiliser, iron
& steel, aluminium and chlor-alkali - account for more than half of energy
consumption and are PAT participants.

Agriculture sector too offers a big opportunity in India

Wastage of power in India’s power consumption by agriculture sector is twice that of China, with
agriculture half the agricultural production. Recent studies suggest a big scope of
sector in India
reduction in power consumption by the agricultural sector in India with a
short payback period of these efforts. Impact of agricultural power
consumption in India by K V S Ramachandra Murthy and M. Ramalinga Raju
studies this issue in detail. We discuss the key findings from the report as well
as from www.electricityindia.com here.

Agricultural subsidies benefit a few and create a number of problems

Only 20% of farmers Some 73% of India’s population depends on agriculture. About 50% of the
benefit from population are farmers. About 20% of the farmers have electric pumps.
agricultural subsidies
Hence, only 10% of the population directly benefits from agricultural
electricity use. In most of the states, agricultural consumption is
unmetered. Consumers pay a flat-rate tariff which is also highly
subsidised. However, a large part of the subsidy is cornered by richer,
larger farmers. In Maharastra state, 80% of farmers depend on rain-fed
agriculture. Of the remaining 20%, those with large land-holdings (2%)
capture 20% of the subsidy.

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Free/cheap power leads This situation leads to a cycle of problems. There is no benefit to small or
to over-use and depletion marginal farmers. Improper targeting of agricultural subsidies has led to
of water table . . .
improper crop selection and competitive well deepening. This in turn has led
to overuse of ground water and lowering of the ground water table which has
a severe impact on poor farmers. In some states, the situation is dire. In
Maharastra, the water table is falling by two to six metres each year. In
Punjab, 79% of ground water blocks are either overexploited or critically low.
In Haryana, in 59% of blocks, water tables have dropped from 10-15m to
400-450 metres.

. . . resulting in more As water levels fall, power use increases to pump the same quantity of water
energy consumption out of the ground. The cost of well deepening and replacing pumps by pumps
of a higher rating is paid by those farmers who can afford it. Thus cost
increases but agricultural output does not.

Experts estimate 40% According to a project report prepared by Maharashtra from implementing
saving potential DSM (demand side management) for the agricultural sector, there is the
in electricity use
potential for energy savings of up to 40%, which is almost 10% of the total
by agriculture
power consumed in India.

Separating agricultural power consumption

‘Single phasing’ of power Several measures have been introduced to reduce agricultural consumption.
to separate power Schemes such as ‘single phasing’, (providing power supply on single phase so
for agriculture
that agriculture pumps do not operate, while the household lights can work),
separate feeders for agricultural pumps, metering distribution transformers
supplying pump sets are examples. These help to better understand
agricultural consumption and can also enable restricted supply of electricity
for pumps. Some states including Andhra Pradesh, Madya Pradesh and Uttar
Pradesh have limited the hours of supply (7, 6 and 10 hours/day respectively)
to reduce the water and power use.

Scope for improving energy efficiency of agricultural pumps

30-50% improvement It has been realised that there is scope for improving efficiency of electricity
possible in efficiency of use by pump sets. Current efficiency levels are 20-30%. It is estimated that
agricultural pumps
improvement of 7-10% is possible by the use of efficient motors, installing
capacitors, using plastic pipes instead of iron and using frictionless foot
valves. In addition to reducing consumption, improving efficiency of
agricultural power use has an additional benefit of improved quality of power
supply due to reduced losses and improved voltage levels. Better voltage in
turn improves water discharge and reduces motor burnouts. To qualify for
free power, the state of Andhra Pradesh has made implementation of these
efficiency improvements mandatory.

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China - The bloated dragon

China’s per capita While India is clearly hungry for power given chronic power shortages, is it fair
consumption is to call China bloated as far as power consumption is concerned? Per-capita
much lower than
power consumption is still much lower than most developed economies,
developed world . . .
suggesting substantial room for growth. Also, beginning April 2011, it again
started facing power shortages, indicating its hunger for more power.

. . . but power use per However, when compared with the level of economic activity, China’s power
unit of GDP is among the consumption is certainly at the upper end of the scale on a global basis.
highest in the world
Moreover, with 75% of power generation based on coal, China is by far the
world’s leading coal-power user. As a result China has the highest CO2
emissions in the world on an absolute basis, and the highest per unit of PPP
GDP amongst the top 15 emitting countries. Even when measured by CO2 per
capita, China is now above the world average.

Figure 46

China’s power consumption per unit of PPP GDP versus other countries: 2008

Australia
Brazil
Canada
China
France
Germany
India
Indonesia
Japan
Korea, Rep.
Malaysia
Mexico
Philippines
Russian
Thailand
United
United States
Vietnam (kWh)

0 0.1 0.2 0.3 0.4 0.5

Figure 47

On coal-based power, the China’s coal power consumption per unit of PPP GDP vs other countries: 2008
gap is even higher
Australia
Brazil
Canada
China
France
Germany
India
Indonesia
Japan
Korea, Rep.
Malaysia
Mexico
Philippines
Russian
Thailand
United
United States
Vietnam (Mtoe)

0 20 40 60 80 100 120 140 160 180

Source: CLSA Asia-Pacific Markets, The World Bank

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Figure 48

Which makes China by far CO2 emissions total: 2010

the world’s leading
CO2 emitter . . . China 8.3
USA 6.1

India 1.7
Russia 1.7

Japan 1.3

Germany 0.8

South Korea 0.7

Canada 0.6
UK 0.6
Brazil 0.5

Mexico 0.5

Italy 0.4

France 0.4
Australia 0.4
(bnt)
Spain 0.3

0 1 2 3 4 5 6 7 8 9

Source: BP Statistical Yearbook, CLSA Asia-Pacific Markets

Figure 49

. . . and a leader in CO2 CO2 emissions per unit of PPP GDP - top 15 countries: 2010
emissions per unit of GDP
China 826
Russia 765
South Korea 491
Canada 455
India 421
USA 419
Australia 416
Mexico 304
Japan 285
Germany 282
UK 252 Global average = 445
Italy 248
Spain 244
Brazil 214
(t/US$m)
France 188

0 100 200 300 400 500 600 700 800 900

Source: BP Statistical Yearbook, CIA World Factbook, CLSA Asia-Pacific Markets

The consequences of continued energy binge

We dealt with the scary consequences of China’s high and rising power and
energy consumption - especially coal - in our 2010 report China’s energy
binge. Growing energy consumption has created massive pollution problems
in China. According to some estimates there are over 750,000 pollution-
related deaths in China per year and pollution-related healthcare costs could
account for a double-digit share of China’s GDP by 2020.

If China’s energy consumption does not slow, and if its energy mix fails to
include a much higher proportion of green energy, the consequences will be
disastrous for China and the rest of world: the chances of limiting global
Consequences of warming to less than 2°C would be virtually nil. China’s energy security would
continued energy binge be under serious threat and runaway pollution would continue to poison air
will be disastrous and water in China and neighbouring countries.

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Government has The government and the politburo in China are fully aware of these problems
temporarily lifted its and began serious efforts to adjust the structural imbalances in the economy
focus on energy efficiency
in early 2007 and later in 2H10. In the last five years over 75GW of inefficient
power capacity was shut down by the government. For 2010 the government
targeted closing 25mt of iron smelting, 6mt of steel making and 50mt of
cement capacity. However, in 2011 the government seems to have taken its
foot off the pedal on energy conservation and this has led to strong growth in
power demand causing power shortages.

Power shortages strike again

Power demand has been With the government lifting the restrictions on energy-intensive industries in
stronger then expected 2H10, power demand growth revived and was around 12% YoY in January to
April 2011. This was higher than the China Electricity Council’s earlier forecast
of 10% 2011 power demand growth, which it subsequently revised up to
12%. In April, higher power-demand growth coincided with slowing hydro
generation, triggering power shortages. Note that China has enough thermal-
power capacity to meet the shortage created by low hydro generation, but
thermal utilisation did not rise enough to meet the shortfall.

It is about utilisation, not capacity

Utilisation hours in One of the key differences from China’s 2004 power shortages is that current
previous shortages were power plant utilisation hours are much lower than those seen in 2003-05, as
much higher
Figure 50 shows. Last time around, power shortages became reasonably
serious in 2003, at which point thermal-power capacity utilisation was 5,700
hours. In 2004 and 2005, utilisation hours were around 5,900 hours. In
contrast, the thermal-power utilisation run rate has been 5,233 hours in
January to May 2011, just about 1.5% higher than the same period last year.

Figure 50

Power capacity utilisation - then and now

6,200 (hours) Total utilisation Thermal power utilisation

6,000
5,800
5,600
5,400
5,200
5,000
4,800
4,600 Utilisation
4,400 Utilisation declining
bottomed
after massive
4,200 in 1999
capacity buildouts
4,000
11CL
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

Source: CEC, CEIC, CLSA Asia-Pacific Markets

Utilisation is lower than Thermal-power capacity utilisation in 2010 is lower than 2004 in almost every
2004 in almost province, and in most provinces there is a double-digit percentage difference
every province
between power utilisation in 2004 and in 2010. Utilisation in 2011 will be a bit
better than in 2010, but still substantially lower than levels seen in 2004.

30 [email protected] 27 June 2011

 
  
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Figure 51

Thermal-power capacity utilisation by province in 2004 and 2010

90 (%) 2004 2010

80

70

60

50

40

30
Jilin

Ningxia
Tianjin

Inner Mongolia

Heilongjiang
Beijing

Liaoning

Qinghai
Fujian

Xinjiang
Jiangxi

Sichuan
Hainan

Guizhou
Shanxi

Jiangsu
Shanghai

Zhejiang

Shaanxi
Hebei

Anhui

Chongqing
Henan

Hubei

Guangxi

Yunnan
Hunan

Gansu
Shandong

Guangdong

Source: CEC, CEIC, State Electricity Regulatory Commission, CLSA Asia-Pacific Markets

In 11 provinces, In 11 provinces across China, 2004 utilisation hours were at least 15% higher
utilisation levels were than 2010. This clearly highlights that it is not a capacity shortage this time
15% higher in 2004 . . .
around: the issue is existing capacity operating at lower utilisation levels.

Figure 52

. . . indicating substantial Difference in thermal capacity utilisation levels: 2004 versus 2010
under-utilisation of
capacity currently 30 (%)
25
20
15
10
5
0
(5)
(10)
Inner

Shandong
Henan

Hunan

Gansu
Guangdong

Guizhou
Yunnan
Hebei
Shanxi

Shanghai
Jiangsu

Anhui
Zhejiang

Fujian

Hubei

Guangxi

Sichuan

Shaanxi
Hainan
Chongqing
Jiangxi

Ningxia
Beijing
Tianjin

Liaoning

Qinghai

Xinjiang
Jilin
Heilongjiang

Source: CEC, CEIC, SERC, CLSA Asia-Pacific Markets

Growth in power capacity Another way to look at whether the current shortage is a capacity or a
has been higher than utilisation problem is to look at the growth of both electricity consumption
power consumption
and thermal capacity in recent years. Figure 53 shows power consumption
and capacity growth in various regions over the last five years. Most regions
have seen higher growth in capacity than in power consumption. This
highlights again that this shortage is more about utilisation than capacity.

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Figure 53

Except for Beijing, Cagr in power capacity and power consumption, 2005-10
capacity growth is higher
than consumption 30 (%) Power consumption Cagr Power capacity Cagr

25

20

15

10

0
Beijing

Liaoning
Jilin

Fujian
Jiangsu

Henan

Hunan

Hainan

Sichuan

Yunnan

Gansu

Xinjiang
Tianjin

Zhejiang

Shandong

Guangdong

Chongqing

Guizhou
Shanxi

Heilongjiang
Shanghai

Guangxi
Hebei

Anhui

Jiangxi

Hubei

Shaanxi

Qinghai
Ningxia
Inner Mongolia

Source: CEC, CEIC, SERC, CLSA Asia-Pacific Markets

Why is utilisation not going up to meet power demand?

Low hydro-power One of the key supply-side triggers for the current power shortages is lower-
generation was the than-expected hydro generation. In 1Q11, hydro was strong and shortages
trigger for shortages
were not significant. However, in April 2011 hydro-power generation was up
only 1% while capacity had grown by 11% YoY. In May hydro generation
dropped 8.5% YoY. Thus inadequate hydro played an important role in
triggering the shortages.

Thermal power utilisation The gap created by lower hydro-power could have been filled by higher
in April 2011 was up only thermal generation, but that did not happen. In May 2011 utilisation hours for
1.5ppt YoY to 61%
thermal plants were around 58%, up 1.9ppt YoY but still substantially lower
than the levels seen at the time of previous shortages. Even in 2006, in most
months utilisation levels for thermal plants were substantially higher than
seen in April 2011.

Figure 54

Power generation in China

(TWh) May 10 May 11 % YoY Jan-May 2010 Jan-May 2011 % YoY
Thermal 270.9 308.7 13.9 1,374.6 1,527.8 11.1
Hydro 55.9 51.1 (8.5) 188.4 207.7 10.2
Nuclear 5.3 6.9 30.4 28.3 34.9 23.3
Wind 4.6 7.3 58.7 20.9 33.3 59.3
Others 3.8 3.5 (7.4) 15.4 12.5 (18.8)
Total 340.5 377.5 10.9 1,627.6 1,816.2 11.6

Figure 55

China power generation capacity - installed and added

(MW) Capacity added Capacity installed
Jan-May 2010 Jan-May 2011 % YoY May 2010 May 2011 % YoY
Thermal 21,340 16,380 (23.2) 660,560 721,190 9.2
Hydro 3,730 3,930 5.4 167,960 186,700 11.2
Wind 3,070 4,090 33.2 21,620 36,370 68.2
Total 28,140 24,400 (13.3) 859,560 955,690 11.2
Source: CEC, CLSA Asia-Pacific Markets

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High coal prices and grid We believe the two main reasons for thermal utilisation hours not rising to
constraints were the two meet demand are: higher coal prices making it uneconomical for coal power
key reasons
plants to operate; and lack of physical infrastructure and government policies
to facilitate inter-regional transfers from provinces with extra power to power-
short areas.

Lack of incentive for IPPs to boost generation

Additional power So far in 2011 power demand has been higher than expected and hydro
generation has to depend generation has been lower, putting the entire burden to meet the shortfall on
on spot-coal purchases
coal-fired plants. Since the amount of coal to be supplied under contract rates
was fixed at the beginning of the year, any extra power generation has to be
done using coal purchased on the spot market.

Some provinces make As highlighted in Figures 56-59, in some provinces the average marginal cost
little or negative margin of coal is almost the same or higher than on-grid power tariffs, making it
on incremental power
uneconomical for the power plants to run using coal bought at spot rates.
Plants in provinces with below-average efficiency levels are losing money on
every extra unit of power they generate. These charts do not take into
account the impact of recent tariff hikes on profit margins, which we will
discuss later.

Figure 56 Figure 57

Before recent tariff hikes Power tariff versus coal cost - Hunan Power tariff versus coal cost - Jiangxi
some plants in some
provinces… 430 (Rmb/MWh) 450 (Rmb/MWh)
410
390 400
370
350
350
330
300
310
290 Hunan average on-grid power tariff Jiangxi average on-grid power tariff
250
270 Coal cost per MWh Coal cost per MWh

250 200
2006 2007 2008 2009 2010 2011 2006 2007 2008 2009 2010 2011

Figure 58 Figure 59

…were losing money on Power tariff versus coal cost - Hebei Power tariff versus coal cost - Guizhou
any additional power
generation 400 (Rmb/MWh) 330 (Rmb/MWh)
310
350 290
270
300
250
230
250
210
Hebei average on-grid power tariff
200 190 Guizhou average on-grid power tariff
Coal cost per MWh
170 Coal cost per MWh
150 150
2006 2007 2008 2009 2010 2011 2006 2007 2008 2009 2010 2011

Source: CEIC, CLSA Asia-Pacific Markets

Coal shortage, stretched Even for plants that are making a small contribution, it may not be worth
balance sheets and cash running the power plants given the low margins, the difficulty in sourcing coal
crunch also have impact
and a severe cash crunch. The gearing levels of IPPs have continued to go up
over the last few years given low levels of profitability or losses. At the end of
2010, around 20% of the IPPs in China had negative net worth and over half
made losses in the year.

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Figure 60

With wide variations in On-grid tariff prices (Rmb, fen) after recent hikes
on-grid tariffs,
profitability varies a lot
by province

37

37

38

25 30
47

36
35
45
22
28

39 45
35
1919
19 19

41 48
39
33
48
37

16-20 41 41

21-25 32 41

26-30

31-35 26
34 51
36-40

41-45

46 & up

45

Source: CEC, CEIC, CLSA Asia-Pacific Markets

Recent surveys from our CRR team also reveal that high coal prices are
among the key reasons for power shortages. This is evident from the
following excerpts:

Eight out of ten power Managers at eight of the ten coal-fired power plants we spoke to (including
plants operating at less several subsidiaries of the top-five IPPs) admit that they are operating below
than full capacity
full capacity at present mainly due to high coal prices. “Coal prices are far
higher than we can afford. The more power we generate, the deeper our
losses,” says a manager at a Jiangsu-based subsidiary of Shenhua Group
(1088 HK). Thus, to reduce operational losses this plant has closed down
some of its generating units, he says.

Some plants lose The manager of a private power plant in Ningbo, Zhejiang province said
money on incremental ‘We’re paying above Rmb900/tonne for thermal coal at the moment and so
power generated
losing around Rmb300 for every 1,000 kWh of power generated.’

Big producers not buying Since 2005 Jiangsu province has been encouraging local power producers
generation quota from with small-capacity generating units (≥300MW) to transfer their power
small plants
generation quota to larger/more efficient producers and share the profit from
the related power generation. However, a local power plant manager in the
province tells CRR that several big producers are now rejecting his plant’s
quota for power generation. “The business is no longer profitable for them at
current coal prices,” he says. This implies a loss in total power generation.

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Figure 61

Power plants operators Is your plant operating at full capacity at the moment?
admit not running plants
at full capacity . . . Yes
20%

No
80% % of power plants

Figure 62

. . . due to low tariffs and Based on your forecast coal price, over next three months your plant will:
rising coal prices
Shut down some
generating units to
reduce losses
10%

Generate as much Depends on

power as possible whether Beijing raises
despite losses power tariffs
30% 60%

% of power plants

Source: CRR

The challenge of transmitting power

Infrastructure and The other big factor impacting power shortages is a lack of inter-regional
administrative constraints transmission of power. This is caused by a shortage of inter-regional
on inter-regional
transmission capacity, conflicting provincial interests and a lack of policies to
power transfer
incentivise the transfer of power from power-surplus to power-short regions.

The problem starts with the geographic imbalance between the availability of
natural resources (coal, oil, gas, wind and sunlight) and areas with maximum
demand for energy.

Geographic imbalance Roughly 66% of China’s coal, wind and solar power resources are located in its
with 66% of power north and northwest regions. An even higher 80% of hydro resources lie in the
resources in the north
southwest. However, two thirds of demand is in the east, the region with the
and northwest
largest population, but far away from energy supplies. China has been trying to
meet this imbalance by transporting coal through rail and road, transmitting
gas through pipelines and sending power through transmission lines.

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Figure 63

China’s mismatch of power generation and consumption

Wind

Solar + Wind

Coal + Wind

Wind Coal

Wind
Coal
Nuclear

Hydro
Hydro

Total capacity added by 2020 (GW)

Hydro 157
Coal 561 Hydro

Nuclear 45
Wind 196 Demand
centre
Solar 54
Nuclear

Source: CLSA Asia-Pacific Markets, State Grid Corporation of China

Some provinces suffer However, the development of the grid has not kept pace with the extremely
shortages while others rapid development of power generation capacity. This is evident from the fact
have surplus
that in the peak demand season there are regions which, despite running at
high utilisation hours, are short of power, while there are other regions with
excess capacity operating at low utilisation hours but without the ability to
transmit power to power-short areas.

30GW of shortage in Bai Jianhua, economist from Energy Research Institute at State Grids says
North, East and Central the power shortage in north, east and central China amounts to 30GW, but
China. 27GW surplus in
northeast and northwest China has a 27GW surplus. However, due to grid
North and Northwest
constraints, the surplus power cannot be transmitted to areas suffering from
power shortages. In fact, in Inner Mongolia about one third of thermal units
have been suspended and 42% of wind power has been abandoned.

36 [email protected] 27 June 2011

 
  
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Figure 64

Thermal power utilisation hours by region in 2010

70 (%)

65

60

55

50

45

40
Shandong

Henan

Hunan
Guangdong

Guizhou

Yunnan

Gansu
Jiangsu

Hebei

Zhejiang

Shanghai

Hainan

Fujian

Anhui

Shanxi

Hubei

Sichuan

Guangxi

Shaanxi
Chongqing

Inner Mongolia
Liaoning

Tianjin

Jiangxi

Ningxia
Beijing

Qinghai
Jilin

Heilongjiang

Northeast East Central West

Figure 65

Thermal power utilisation hours by region - % variation from the national average

15 (%)

10

(5)

(10)

(15)
Shandong

Henan

Hunan
Guangdong

Guizhou

Yunnan

Gansu
Jiangsu

Hebei

Shaanxi
Zhejiang

Shanghai

Guangxi
Hainan

Fujian

Anhui

Shanxi

Hubei

Sichuan
Chongqing

Inner Mongolia
Liaoning

Tianjin

Jiangxi

Ningxia
Beijing

Qinghai
Jilin

Heilongjiang

Northeast East Central West

Source: CEC, SERC CLSA Asia-Pacific Markets

Demand-supply mismatch The demand-supply mismatch situation has worsened in recent years with the
has worsened with strong rapid development of wind power (often without adequate consultation with
growth in wind power
the grid companies) and will continue to pose a serious challenge, with an
increasing share of renewables in the power-generation mix. Unlike coal and
gas, natural resources needed for generating wind and solar power cannot be
transported in trucks or pipelines.

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Regional demand- Going forward more and more capacity addition (both coal and wind) is likely
supply mismatch will to happen away from demand centres and this will put more and more
increase further
pressure on the grid infrastructure.

Thermal-power capacity Xue Jing of China Electricity Council presented at our China Forum this year
addition will move to and commented that additional power capacity is shifting towards the
western and central China
middle/west regions while demand in the eastern part of the country remains
high. However, the power deficit caused cannot be bridged effectively by the
West-East Electricity Transmission project and the effective additional capacity
is limited. Construction of an ultra-high voltage grid and the growth in inter-
regional transmission needs to be accelerated to optimise resource
distribution on a larger scale.

As is evident from Figures 66-67, over the last few years additional capacity
has been shifting from east to west China. However development of the grid
has not kept pace with capacity growth. This shift in new capacity will
continue and intensify in the coming years.

Figure 66

Capacity growth is China capacity growth

stronger in the West

Northeast
Northeast
2000-2005
2000-2005 16%
16%
2005-2010
2005-2010 80%
80%

East
East
West
West 2000-2005
2000-2005 67%
67%
2000-2005
2000-2005 83%
83% 2005-2010
2005-2010 59%
59%
2005-2010
2005-2010 146%
146%

Central
Central
2000-2005
2000-2005 60%
60%
2005-2010
2005-2010 90%
90%

Source: CEC, CEIC, CLSA Asia-Pacific Markets

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Figure 67

A third of new capacity Share of new capacity

was in the west over
2005-10

Northeast
Northeast
2000-2005
2000-2005 3%
3%
2005-2010
2005-2010 7%
7%

East
East
West
West 2000-2005
2000-2005 49%
49%
2000-2005
2000-2005 22%
22% 2005-2010
2005-2010 31%
31%
2005-2010
2005-2010 33%
33%

Central
Central
2000-2005
2000-2005 27%
27%
2005-2010
2005-2010 29%
29%

Source: CEC, CEIC, CLSA Asia-Pacific Markets

The transmission challenge - physical infrastructure

Most grid investment has One of the key reasons for the inadequate regional power transfer is a lack of
been for capacity within infrastructure to transmit it. Investment in the inter-regional grid has not kept
provinces/regions
pace with the shift in power capacity: most of the grid development has been
within the provinces and regions.

Government plans to In order to develop a grid on a countrywide scale, the government is

increase UHV lines over undertaking a massive buildout of ultra-high voltage (UHV) transmission
three times in next
lines. This will enable China to better meet its electricity needs by connecting
five years
supply centers (including renewable energy and thermal power assets) with
demand centers along the southern and eastern coast. In January, State Grid
said it would invest Rmb500bn to implement a UHV electricity transmission
system, and expand the network to 40,000 kilometers, up from 12,750km at
the end of 2010. The backbone of this endeavor is a plan to create three
vertical UHV grids and three horizontal UHV grids by the end of the 12th Five-
year Plan (2015).

Target to build five Taking an even longer view, the government will aim for five horizontal and
horizontal and six vertical six vertical grid networks which will centre on northern China, eastern China
grid networks
and central China, with north-eastern China and north-western China the
transmission points. The network will link the major thermal, hydro, nuclear
and renewable energy bases.

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Figure 68

Proposed grid lines by 2015

15
19

23

18

14 11

23
19

21 24
20
26
12

25
20
21

13

17

Under construction
Planned

City Province KV Line length (km) Capacity (MW)

Completed
1 Jindongnan-Jinmen Shanxi-Hubei 1,000 640 6,000
2 Jinsha river downstream Yunnan-Guangdong +/-800 1,375 2,500
3 Lanzhou-Xianju Gansu-Shaanxi 750 1,074 2,100
4 Xibei-Huazhong Shaanxi-Sichuan +/-500 574 1,500
5 Cangdong-Banqiao Hebei-Tianjin 500 202 2,400
6 Houcun-Shibei Shanxi-Hubei 500 191
7 Datong-Fangshan Shanxi-Beijing 500 599
8 Hubei-Jiangxi 500 198
9 Innger Mongolia-Liaoning 500 705 1,500
10 Guangdong-Hainan 500 140 750
11 Xibeiningdong-Huabeishandong Ningxia-Shandong +/-600 1,335 4,000
Under construction
12 Shanghai-Sichuan +/-800 1,907 6,400
13 Yunnan-Guangdong +/-800 1,375 2,500
14 Xining-Yongneng Qinghai 750 346
15 Hulunbuir-Liaoning Inner Mongolia-Liaoning +/-500 952 3,000
16 Three gorges-Shanghai Hubei-Shanghai +/-500 1,890 3,000
17 Yunnan-Guanxi 500 750
18 Xilinguole-Jiangsu Inner Mongolia-Jiangsu 1,000 1,435
Planned
19 Kumul-Zhenghou Xinjiang-Henan 800 1,100
20 Huainan-Shanghai Anhui-Shanghai UHV
21 Zhangbei-Nanchang Hebei-Jiangxi UHV
22 North Shaanxi-Changsha Shaanxi-Hunan UHV
23 West Innter Mongolia-Weifang Inner Mongolia-Jiangsu UHV
24 Central Shanxi-Xuzhou Shanxi-Jiangsu UHV
25 Yaan-southern Anhui Sichuan-Anhui UHV
26 Jinping-Sunan Sichuan-Jiangsu 800
Source: CLSA Asia-Pacific Markets

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Figure 69

Proposed horizontal and Proposed ultra-high voltage transmission lines in China

vertical transmission lines

Source: CCTD, CLSA Asia-Pacific Markets

The transmission challenge - Administrative issues

China does not have a The other big issue with transmitting power between various regions is
unified national grid and administrative. China does not have a unified national electricity grid (we
provinces pursue their
discuss this in more detail later). Different provinces in China pursue their
own interests
own interests and are not keen to sell power to other regions unless they
benefit in some way. There is no strong ministry for energy in China under
central government control and no clear policies to encourage inter-provincial
and inter-regional power sales - especially when coal prices are high. The
CLSA Asia-Pacific Markets callout box below shows excerpts from our recent CRR Power shortages
report (7 June 2011) which highlight the problem.

Reluctance to supply power to other provinces

‘Amid high prices, some provinces with a power surplus Grid has rejected their requests, our contacts doubt
are becoming reluctant to supply those provinces facing the sustainability of the rapid growth in their power
shortages. Fujian is one of the few coastal provinces supply to the Yangtze River-delta area given their
that still enjoy a power surplus. But with high input growing operational losses. “Our power contribution to
costs, power plants are cutting back. Contacts we other provinces will definitely come down,” says a
spoke to at local power plants agree that it makes little manager at a Guodian (600795 CH) subsidiary in
economic sense for local IPPs to buy expensive coal to Fujian. It is a similar story in Anhui province, where
generate power for other provinces. some local power plants are also unwilling to supply
more power to Zhejiang and Jiangsu provinces. Under
‘These contacts admit that they have been using the the current scenario (ie, rising coal prices but
provincial government and other authorities to lobby artificially low power tariffs), transferring more power
the State Grid to reduce the amount of power they means Anhui is subsidising other provinces, says an
have to generate for other provinces. While the State industry source.’

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Provincial governments As the above excerpts suggest, power plants generate and sell the minimum
often incentivise power required volumes to other provinces, but when coal prices are high they are
supplies within province
reluctant to sell anything beyond this. Quite often provincial governments
provide additional subsidies to power plants in their province to make sure
they remain operational. Hence these plants continue to supply power to their
own province but are reluctant to sell to other regions.

Conflicting interests also One of the listed IPPs we spoke to recently said that conflicting provincial
impact construction of interests also hamper construction of enough inter-regional grid capacity.
grid capacity
While the local arms of the State Grid report to State Grid Head Office, which
is a national body, they also report to the respective provincial governments.
Most of the capex of these State Grid provincial arms has been focused on
creating transmission capacity within the province, with little emphasis given
to the inter-provincial and inter-regional grid.

China’s grid system A recent IEA report on China’s grid systems clearly lays out these problems.
fragmented into six China is currently fragmented into six regional power grid clusters, all of
regional clusters
which operate rather independently. The State Grid Corporation of China
(SGCC) manages four of these (the east, central, northwest, northeast grids)
as well as part of the north grid (specifically, the eastern part of the Inner
Mongolia grid).

Inter-regional trade This network covers 26 provinces and municipalities. The western part of
was only 4% of the Inner Mongolia grid is managed by an independent company. The
power generated
south grid is managed by the China Southern Grid Company (CSGC). As
discussed in the previous section, inter-regional interconnections are weak.
Cross-regional trade of electricity amounted to 158TWh in 2009: only 4%
of total electricity production.

Figure 70

China’s power grid is Regional power grid clusters in China

divided into six
regional clusters

Source: IEA, Wang 2009

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 Section 2: China - The bloated dragon Chindia power

Load balancing takes According to the IEA, in each of China’s six regional grid clusters, balancing of
place essentially at supply and demand takes place essentially at the provincial level. One
provincial level
province represents one balancing area. Thus, the SGCC’s jurisdiction of 26
provinces and municipalities covers 26 balancing areas. Trading of power
takes place both among provinces and among grid regions. While cross-
regional electricity trade remains extremely limited, inter-provincial power
imports and exports within a grid cluster show more dynamism. In 2009,
total electricity traded stood at 532TWh, 13% more than the previous year
and 14% of the total generation in China. Of that total traded amount, cross-
regional trade was only 158TWh.

Figure 71

Power traded between Electricity trading between provinces and grid clusters
provinces was 14%, but
between regions only 4%

Regional grid cluster Regional grid cluster

Provincial
Provincial grid
grid
(Balancing
(Balancing area)
area)

Source: IEA, CLSA Asia-Pacific Markets

Lack of flexibility in the Another hurdle the government needs to overcome is reforming the market in
market is another which inter-grid electricity transfers are negotiated. Of electricity traded
constraint . . .
between grids, 80% is based on long-term contracts which mandate the price
and quantity of the transfers as much as one year in advance. In 2009, only
14% of all inter-regional trades were based on market-oriented prices, with
the remaining set by the government via long-term contracts.

. . . no incentive for This feeds into the problem mentioned above, as there is no market incentive
provinces to export power for would-be power exporters to send surplus generation to another region,
even if the infrastructure to do this is in place. In fact, due to the rigidity of
the market, it is possible that a province which has a power surplus will still
have to import power due to a previously-agreed contract and be forced to
export its own surplus at lower prices. Until a responsive market that reacts
to supply and demand is created, regional grids will prefer to be self-
sustainable for as much of their power demand as possible.

Grid reforms necessary Thus as well as adding the transmission grid, Beijing also needs to sort out
apart from increasing the these softer administrative issues arising from the structure of the national
grid capacity
grid and the vested interests of various provinces. Creating a strong national
body on power/energy management and developing policies supporting inter-
regional power transfer would help.

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Will power shortages worsen in the coming months?

Figure 72

July and August are the Monthly power consumption trend

peak months for
power consumption 13.0 (TWh/day) 12.8 2010
12.5 12.6 12.6 2011
12.5
12.5

11.9
12.0
11.7 11.7
11.6
11.5
11.5 11.3 11.3

11.1 11.0
11.0
10.6

10.5

10.0
Jan-Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Source: CEC, CLSA Asia-Pacific Markets

But hydro generation China's power demand peaks in July and August, with demand around 15-
should also pick up if 19% higher than April levels. However, hydro-power generation is also
rainfall normalises
highest in July and August and most of the gap between the levels in April
and July-August will be covered by higher hydro if the rainfall pattern is
normal. However, if hydro generation continues to be below normal, power
shortages could be much worse in the coming months. According to CEC and
State Grid, shortages could be in the range of 30-40GW (3-4% of installed
capacity) in the summer months.

Figure 73

Hydro peak generation Monthly hydro-power generation trend

overlaps with
peak consumption 3.0 2010
(TWh/day)
2.7 2.7
2.5
2011
2.5 2.3

2.0
2.0 1.8
1.7
1.7
1.3 1.4 1.4 1.4
1.5
1.2 1.1
1.0
1.0

0.5

0.0
Jan-Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Source: CEC, CLSA Asia-Pacific Markets

Will shortages worsen in coming years?

Power demand elasticity Two factors will play an important role in the future power demand supply
and renewables are balance. First is the elasticity of power demand to GDP growth. Second is the
two key factors for
rising share of hydro and wind power, which introduces additional variability
future shortages
to the grid.

44 [email protected] 27 June 2011

 
  
 Section 2: China - The bloated dragon Chindia power

Elasticity of power demand to GDP growth

Figure 74

We expect China’s power China’s power demand to GDP elasticity

demand to GDP elasticity
to decrease
1.6 (x) 1.5 1.5
1.4 1.4
1.4 1.3
1.2 1.2
1.2
1.2
1.0 1.0
Average = 0.98x
1.0 0.9 0.9
0.8 0.9
0.8
0.8 0.7 0.7
0.6
0.5
0.6
0.4
0.4

0.2

0.0

11CL

12CL

13CL

14CL

15CL
1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010
Source: CEIC, CEC, CLSA Asia-Pacific Markets

If elasticity remains high, Except for 2008 and 2009, when power demand in China was impacted by the
China will face more financial crisis, power demand to GDP growth in China has been between 1.2x
shortages
and 1.5x since 2002. However, we believe the elasticity of power demand to
GDP growth is likely to come down to 0.85-1.0x post-2011, as we discuss in
the first section of this report. If the power elasticity continues to be high (ie,
over 1x) in the coming years, China will face severe shortages.

Could see 40GW As per news reports, the State Grid forecasts that China will see a power
shortage this year shortage of 30GW in 2011, which could reach 40GW in the peak season if
hydro generation remains poor. The State Grid believes that the regions that
will face high shortages during the summer peak include Beijing, Tianjin
Tangshan, Hebei, Shanghai, Jiangsu, Zhejiang, Anhui, Hunan, Henan, Jiangxi
and Chongqing. State Grid expects the power shortage to increase to 50GW
in 2012 and 70GW in 2013.

Trans-regional supply To address the power shortages, State Grid is planning to reduce
is key to filling the consumption at energy-intensive and polluting users, while further increasing
power gap
inter-provincial supply. Currently a maximum of 31.67GW is available for
trans-regional supply. State Grid added that northern provinces may receive a
maximum 13.65GW, while in eastern China this will be 13.47GW, and central
China 7.83GW.

Near, medium and long-term solution to power shortages

In short term, not much In the near term the government has very little option but to increase power
option but to hike tariffs, tariffs and focus on power rationing and energy conservation in order to
curb power demand
address the shortages. This has already happened in 15 provinces, with the
government raising tariffs by an average of 6.9% and increases ranging by
region from 4% to 15%.

Highest tariff hikes for The highest tariff hikes have been in the provinces with lowest tariffs. For
regions with lowest instance Qinghai, which had the highest 15% tariff hike, is the province with
absolute tariffs
the lowest on-grid tariffs in China. Gansu, which had the second highest
increase at 11%, is also among the provinces with the lowest tariffs. Shanxi,
with a 10% jump, also has tariffs substantially below the national average.

27 June 2011 [email protected] 45

 
  
 Section 2: China - The bloated dragon Chindia power

Tariff hikes should bring As some of the power plants in these regions were making losses or negligible
some loss making plants profits for each additional unit of power generation, these hikes will help bring
back on stream
some of their power plants back on stream.

Figure 75

Significant tariff hikes Tariff hikes announced in May 2011, now implemented
for select provinces in Province Tariff change (Rmb/kWh) % change
May 2011
Shanxi 3.1 9.7
Qinghai 3.0 15.4
Gansu 2.7 10.7
Jiangxi 2.6 6.4
Hainan 2.5 6.1
Shaanxi 2.5 7.9
Shandong 2.5 5.8
Hunan 2.4 6.2
Chongqing 2.3 6.6
Anhui 2.0 5.1
Henan 2.0 5.4
Hubei 2.0 5.4
Sichuan 1.5 4.9
Hebei 1.5 3.9
Guizhou 1.2 4.0
Average 2.3 6.9
Source: NDRC, News reports, CLSA Asia-Pacific Markets

Economics of marginal In Figures 76-77 we highlight two provinces: Hunan and Guizhou. We
power generation estimate that the gross margins for producing an additional unit of power
have improved
from coal purchased on the spot market were negative in Hunan before the
tariff hike and crossed breakeven after the tariff hike. For Guizhou, the gross
margins were negligible before the tariff hike: after the increase, the power
plants in the province should make some margins - though they will remain
substantially lower than in past periods.

Figure 76 Figure 77

Recent tariff hikes have Marginal tariff and coal cost Marginal tariff and coal cost
helped improve power
430 (Rmb/MWh) 330 (Rmb/MWh)
plant finances in 410 310
some provinces 390 290
370 270
350 250
330 230
310 210
Guizhou average on-grid power tariff
290 Hunan average on-grid power tariff 190
270 Coal cost per MWh 170 Coal cost per MWh
250 150
2006 2007 2008 2009 2010 2011 2011- 2006 2007 2008 2009 2010 2011 2011-
after hike after hike

Source: NDRC, CEC, CRR, CLSA Asia-Pacific Markets

The measures on power rationing and energy conservation have already

begun in various provinces, as discussed in the first section of the report.

Medium and long-term measures

China should focus on The key medium and long-term measures to address the power shortages
demand management, have to be: demand management through energy efficiency and China’s
grid buildout and tariffs
reduced dependence on energy intensive industries; aggressive buildout of
grid capacity; and introducing tariff reforms to encourage IPPs to add more
capacity. We discuss each of these in more detail.

46 [email protected] 27 June 2011

 
  
 Section 2: China - The bloated dragon Chindia power

Demand management will play a crucial role

China must slow down its We believe the most important measures over medium to long term are on
power-demand growth demand side. China’s power demand has been growing at an unsustainable
pace over the last decade: this has to slow down due to constraints on energy
resources as well as the environment. We have already discussed the demand
management issue in detail in the first section of the report.

Grid buildout
Inter-regional grid As discussed earlier in this section, given the geographical disparity between
capacity may grow by the resources for power generation (coal, hydro, wind) and the demand
200% over 2010-15
regions, and given the rising proportion of renewable capacity addition in
China, there is a need to step up the expenditure on building China’s inter-
regional power grid. China Electric Council believes that inter-regional
transmission capacity needs to go up from estimated 79GW in 2010 to
238GW in 2015 - a 200% increase.

Figure 78

Much of the new power Breakup of new gross power capacity additions in China
addition is far away from
demand centres 120,000 (MW) Net base load Shut down Renewables Hydro

100,000

80,000

60,000

40,000

20,000

0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: CEIC, CLSA Asia-Pacific Markets

Figure 79

This means trans-regional Inter-regional transmission capacity in China

power transmission must GW 2010 2015 2020
pick up Trans-regional power transmission from large thermal-power base 57 171 271
Trans-regional power transmission from large hydro-power base 22 67 83
Total 79 238 354
Source: CEC, CLSA Asia-Pacific Markets

CEC forecasts 81% CEC also forecasts 81% growth in substation capacity by 2015 and a 51%
growth in substation growth in transmission line kilometres by 2015. Another important difference
capacity by 2015
between capex the over last five years and the next is that, while capex over
2006-10 was primarily focused on intra-province and intra-region
infrastructure, the main target of the next five will be to increase inter-
regional capacity.

Figure 80

And 51% growth in Likely increase in physical grid infrastructure

transmission line km by 2010 2015 % chg 2020 % chg
2015 as well Transmission lines (>110kV) (km) 880,000 1,330,000 51.1 1,760,000 32.3
Substation capacity (bn kVA) 3.1 5.6 80.6 7.9 41.1
Source: CEC, CLSA Asia-Pacific Markets

27 June 2011 [email protected] 47

 
  
 Section 2: China - The bloated dragon Chindia power

Figure 81

We estimate 14% cagr in Estimated annual grid capex based on CEC’s grid capex target for 12th plan
grid capex; share of high
voltage will rise 700 (Rmbbn)

600

500

400

300

200

100

0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: IEA, SGERI 2010a.

The 12th FYP plan will see In terms of amount spent, CEC expects over Rmb2.5tn to be spent on the
a big jump in renewables power grid in the 12th plan, 73% growth over the 11th and a greater
coming onto the grid
increase than the 60% boost to the power capacity spend. The main reason
for the power capacity spend boost is that most of the new capacity added
in the 11th plan was coal-based. In the 12th plan the share of wind power
and nuclear will increase substantially and on a per MW basis there is a
substantial difference between coal and wind/nuclear. Even for coal plants
the input costs have gone up sharply and more stringent environment
norms have pushed up the per MW cost.

Figure 82

T&D spending will rise Power sector spend in 11th, 12th and 13th plan periods
along with renewables to
(Rmbbn) 2006-10 2011-15 Change from last 2016-20 Change from last
deliver power to
five years (%) five years (%)
end-users
Power investment 3,202 5,300 66 5,800 9
Power supply 1,727 2,756 60 2,958 7
Power grids 1,475 2,544 73 2,842 12
Source: CLSA Asia-Pacific Markets

Power tariff reforms

Healthy pace of capacity To keep power shortages under control China needs to add base-load
addition needed to avoid capacity at a healthy pace, but the current financial situation of China’s IPPs
increase in shortage
threatens this. Unless steps are taken to rectify this, the shortages could
worsen in the coming years.

Increase in tariffs has Over the last four years contract coal prices have risen 43% and spot coal
lagged coal prices by prices are up over 60%. However, over the same period power tariffs are up
a big margin
only 18%, squeezing the IPPs’ profit margins. However they did not slow
down the pace of their capacity growth and as a result, their balance sheets
are now severely strained: two of the listed IPPs have net gearing of near
400% and another two are at 210-250%.

48 [email protected] 27 June 2011

 
  
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Figure 83

Over four years, power Index of power tariffs and coal prices
tariffs up 18% versus
43-61% rise in coal prices 160 (2006 = 100)

150 Power tariffs

Contract coal prices
140 Spot coal prices

130

120

110

100
2006 2007 2008 2009 2010

Source: Companies, CLSA Asia-Pacific Markets

Nearly half of China IPPs According to an NDRC media briefing, 43% of coal-fired power plants were
lost money in 2010. loss making in 2010. In ten provinces in China, all thermal power plants
Situation worsened in
made losses in 2010. The situation has worsened in 2011. For Datang, loss-
2011
making power plants reached 46% of the total in 1Q compared with a third in
2010.

Figure 84

In 10 provinces, all Thermal power plants are loss-making in half of the regions in China
thermal power plants
made losses in 2010

Heilongjiang

Jilin

Liaoning
Xinjiang

Inner Mongolia Beijing

Tianjin

Hebei
Shanxi
Ningxia Shandong
Qinghai
Gansu
Jiangsu
Shaanxi Henan
Xizang
(Tibet)
Anhui Shanghai

Sichuan Hubei
Chongqing
Zhejiang

Hunan Jiangxi
Guizhou
Fujian
Provinces that all thermal power
plants are loss-making
Yunnan Taiwan
Guangxi Guangdong

Hong Kong

Hainan

Source: CEC, CLSA Asia-Pacific Markets

27 June 2011 [email protected] 49

 
  
 Section 2: China - The bloated dragon Chindia power

Figure 85

Sharp decline in returns Huaneng Power – Net profit margin

due to tariff mismatch
25 (%)

20

15

10

(5)

(10)
FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10

Source: Bloomberg, CLSA Asia-Pacific Markets

Figure 86

Most IPPs in China are Net gearing of China IPPs at end-2010

highly geared
450 (%)
406
400 381

350

300 249

250 212

200
136
150

100

50

0
Huadian Datang CPI Huaneng CRP

Source: Companies, CLSA Asia-Pacific Markets

Earlier, increasing To keep power shortages under control, IPPs need to add a healthy level of
size was the key capacity each year. This is becoming increasingly unlikely due to two reasons:
target for IPPs

New assessment criteria for IPPs

New assessment criteria One noticeable change for IPPs is that the assessment of the SOE’s
will force IPPs to focus on management performance is no longer driven by the scale of its operations
profits, not size
but rather is based on net profit, EVA®, return on capital employed and
accretion in net worth (discussed in CLSA’s ROE/EVA report, see Appendix 14
for more details). Under these criteria, without a clear long-term tariff pricing
mechanism, strategic planning for IPPs will be difficult and current capacity
expansion plans are likely to be missed rather than exceeded. We have
learned that some projects that were approved years ago have now been
suspended due to lack of capital and also a lack of confidence that they will
generate healthy returns.

50 [email protected] 27 June 2011

 
  
 Section 2: China - The bloated dragon Chindia power

Difficulty in getting bank financing

IPPs finding it difficult to The balance sheets and cashflow of these IPPs have been worsening over last
get new loans, rollover few years and have now reached the point where some of the plants are
old loans
finding it difficult to roll over debt or to source debt for new plants. One
example is Datang’s Shanxi Yuncheng power plant. It has been loss-making
since its commissioning four years ago and current debt-to-asset ratio is over
70%. To keep it running Datang has to provide a guarantee with joint liability
for the financing of the Yuncheng plant. Our CRR team also found in its
survey that some of the local governments have been providing funds to
power plants to keep them running given the cash crunch and difficulties in
securing bank financing.

Unless tariff reforms are Given these two issues, the government needs to rationalise the tariff
put in place, power structure in China to encourage a healthy level of base-load capacity addition.
shortages could worsen
Raising power tariffs will also help government in its goal of reducing the
energy intensity of the economy. As discussed in Section 1, power tariffs in
China are substantially lower for industry than those of India, and as we
showed in this section, power consumption per unit of GDP is far higher in
Rising power tariffs will
also help achieve China than in other countries. Increasing power tariffs will help to encourage
efficiency targets power conservation. As discussed earlier a number of states have already
started this move, with penal tariffs for power consumption beyond a certain
standard rate as well as higher tariffs for heavy industry.

We believe over a period of time China will move towards a more rational
tariff system and allow IPPs to earn better returns.

27 June 2011 [email protected] 51

 
  
 Section 3: India - The hungry elephant Chindia power

India - The hungry elephant

State utilities back out of Like many things in India, the power sector is riddled with paradox. On one
power purchases even hand, it is is among the world’s lowest per-capita power consumers and faces
with power shortage
massive power shortages. On the other, state utilities often back out of power
purchases (ie, refuse to buy available power from generators).

Coal supply is a challenge India has one of the best regulatory systems for power generators across
with capacity additions Asia, which ensures healthy profitability for sensible suppliers. Conversely
its distribution sector is possibly the world’s worst, with high aggregate
technical and commercial (AT&C) losses and ballooning financial shortfalls.
For decades, the power sector was blamed for not building sufficient
capacity. Now, as capacity additions pick up, there’s worry about whether
new plants can buy enough coal to operate and whether power demand
will meet supply.

Understanding the roots of these paradoxes is important for investors to

identify the winners and losers in the Indian power space. The most
important questions investors need answers to are:

1. Will there be enough demand to absorb all the new capacity?

2. Will rising SEB losses sink Indian’s power ship before it takes off?

3. How will India meet its coal shortage problem?

4. Which companies can best handle these challenges?

All these issues are closely interrelated. Coal shortages elevate power-
generation costs, which influences state utility finances and, in turn, impacts
power demand. We start our analysis with India’s demand-supply situation for
coal and then look at the nature of state utility losses and prospects; and
finally we examine the power-demand outlook.

How severe will the coal shortages be?

Coal-fired capacity jumps We expect a big pick up in power-capacity additions over the next five years.
from 26GW to 66GW Most will be coal fired, which we expect to climb from 26GW in the past five
years to 66GW in the next five. As result the power sector’s domestic coal
demand is likely to rise from 483mt in FY12 to 784mt in FY17 (assuming 80%
utilisation of incremental capacity; we believe overall utilisations will range
between 75-80%). That’s an increase of over 300mt.

Demand rises by 300mt, In the same period, hikes in domestic coal supplies are only likely to reach
supply only by 160mt about 160mt, assuming 4-5% production growth from Coal India and a big
pick up in captive coal production by government and private players. The
gap between coal demand and domestic supply is likely to increase from close
to 60mt in FY12 to about 200mt by FY17, a 28% Cagr. Given the higher
calorific value of imported coal, the differential implies a need to import
135mt per annum in FY17 for power sector up from 40mt in FY12.

52 [email protected] 27 June 2011

 
  
 Section 3: India - The hungry elephant Chindia power

Figure 87

Coal-based capacity adds India’s coal-fired power-capacity additions

66GW over FY12-17
18,000 (GW)

16,000

14,000

12,000

10,000

8,000

6,000

4,000

2,000

0
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

Source: CEA, CLSA Asia Pacific Markets

Figure 88

At 80% utilisation, import Different scenarios for India’s coal demand vs supply
requirements reach
(mt) FY12 FY13 FY14 FY15 FY16 FY17
135mt in FY17
Demand

Coal requirement for existing capacity 439 483 537 596 655 718

Incremental coal requirement 44 54 59 59 64 66

Total demand @ 80% utilisation 483 537 596 655 718 784
for new capacity

Supply

Coal India (FSA and Loas) 347 364 379 398 414 430

Coal India (e-auctions) 20 21 22 22 23 24

SCCL 31 32 33 34 35 36

Captive mines 27 35 48 64 80 96

Total supply 425 452 481 518 552 586

Gap 58 85 114 137 167 198

Imports required to fill the gap 40 57 78 93 113 135

Scenario - Coal DD-SS GAP at 75% utilisation

Total demand @ 75% utilisation 480 531 586 641 701 763
for new capacity

Imports required to fill the gap 38 53 71 84 101 120

Scenario - Coal DD-SS GAP at 85% utilisation

Total demand @ 85% utilisation for 486 543 606 668 736 806
new capacity

Imports required to fill the gap 41 62 84 102 125 149

Source: Ministry of Coal, CLSA Asia-Pacific Markets

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Some 70mt of coal is Of India’s 300mt incremental coal demand, around 70mt is for projects based
required for imported on imported coal (project list in Figure 90) and 230mt is for domestic-coal
coal
projects. However, domestic supply is only likely to grow by 161mt, implying
based projects
only 70% of the 230mt incremental demand can be met by local production;
the rest will have to be imported.

Figure 89

Some 70% of the Incremental coal demand in the 12th plan and how it’s met
incremental demand over
(m tonnes) @ 80% PLF @75% PLF
FY12-17 can be met by
domestic sources of coal Increase in coal DD for power sector in 12th plan 301 282
@80% PLF for new plants
Increase in coal DD for imported coal-based capacity 70 70
(in domestic coal tons)
Incremental DD for domestic coal-based projects 231 213
Increase in domestic coal supply 161 161
Incremental coal imports for domestic-coal based capacity 70 51
(in domestic-coal tonnes)
Incremental coal DD for domestic-coal based projects 69.7 75.9
met by domestic sources (%)
Incremental coal DD for domestic coal based projects 30.3 24.1
to be met through coal imports (%)
Percent of total new coal DD through domestic coal (%) 53.6 57.1
Percent of total new coal DD through imported coal (%) 46.4 42.9
Source: Infraline, CLSA Asia-Pacific Markets

Figure 90

Imported coal based Power projects based on imported coal

projects will need
Project Developer Capacity Imported coal requirement
additional 47mt of coal
(MW) (mt)
Mundra Adani Power 4,620 10.5¹
Trombay Tata Power 750 2.8
Dahanu Reliance Infra 500 1.9
Vijaynagar JSW Energy 600 2.2
Udupi Lanco 1,200 4.5
Mundra UMPP Tata Power 4,000 11.8
Krishnapatnam UMPP Reliance Power 3,960 14.7
Sikka GSEC 500 1.9
Meenakshi Meenakshi Energy 300 1.1
Simhapuri Simhapuri Energy 300 1.1
Saliya Essar 1,200 4.5
Ratnagiri JSW Energy 1,200 4.5
Pipavav Videocon 1,200 4.5
Coastal Energen Coastal Energen 1,200 3.1²
IND Barath IND Barath 660 1.7²
Krishnapatnam APGENCO 1,600 4.2²
Meenakshi Meenakshi Energy 600 1.6²
Bhavanpadu East Coast Energy 1,320 3.4²
¹ 70% requirements of Mundra I-III and 50% requirements of Mundra IV would be imported. ² 70% of
the requirements would be imported. Source: Infraline, CLSA Asia-Pacific Markets

54 [email protected] 27 June 2011

 
  
 Section 3: India - The hungry elephant Chindia power

Actual imports differ from The following factors impact coal-import levels:
situational miss-matches
‰ Willingness of state utilities to buy expensive power using imported coal;
the cost difference between the two is significant.

‰ Equipment constraints to use imported higher calorific-value (CV) coal;

most older coal-based power plants are unable to use more than 15% of
the higher CV coal. For new projects, the government stipulates
equipment should be able to use 30% imported CV coal.

‰ PPA (power purchase agreement) terms; terms at individual

companies may or may not allow imported coal in the event of
domestic shortfalls. Projects with likely impacts are regulated return
and Case 1 projects where bidders use an escapable-component-of-
energy charge while bidding.

‰ Logistics infrastructure to handle high volume; Indian ports capacity

has grown substantially with a major boost coming from the private
sector at ports like Mundra, Dhamra, Krishnapatnam and Gangawaram.
However, a key constraint is the evacuation facilities from ports,
especially by railway.

‰ Domestic production; output from Coal India itself is a considerable

factor, which was recently beset by substantial problems.

Coal India’s production - A critical shortage factor

Coal India’s production Coal India’s production growth has been below expectations. The situation is
was flat YoY in FY11 exacerbated by railways that are unable to supply wagons for coal
evacuation. Coal India ended the past year (FY11) at 430mt of production,
which was flat YoY as compared to its initial plan of 460.5mt and reduced
target of 440.2mt. As result of the shortfall and growth in power capacity,
India’s coal imports increased to 93mt in FY11; non-coking coal made up
67mt of the total. The import Cagr over the past four years was 21% and for
noncoking coal it was 28%.

Figure 91 Figure 92

Coal based power India’s coal production, the past decade India’s coal based power capacity
capacity has increased
at a faster rate
than increase in 550 (mt) Increase in the year 105,000 (MW) Increase in the year
Last year's production Last year's capacity
coal production 500 95,000

450 85,000

400 75,000

350 65,000

300 55,000
FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11
FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

Source: CEA, Ministry of Coal, CLSA Asia-Pacific Markets

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Figure 93

Coal India scales back Coal India’s production

production targets
500 (mt) Reduced production from
earlier envisaged

450

400

350

300

250
FY07 FY08 FY09 FY10 FY11 FY12

Source: Coal India, CLSA Asia-Pacific Markets

Figure 94

Ramping coal imports India’s coal imports over the past decade

100 (mt) Total imports Non coking coal imports

80

60

40

20

0
FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11E

Source: Ministry of Coal, CLSA Asia-Pacific Markets

Coal India’s FY12 The company signed a memorandum of understanding (MoU) with the
target is 452mt government for 452mt of production in FY12, which implies 5% growth for
the year. Coal India offered 347mt of coal to the power sector in FY12. It
already has fuel supply agreements (FSA) for power projects commissioned
before March 2009, totalling 306mt. This leaves only 41mt of coal for power
projects commissioned in FY10 (6,055MW), FY11 (9,725MW) and ones
coming on in FY12.

Out of the total coal-based power capacity commissioned over FY10-11,

2,580MW is based on imported coal. At 80% utilisation, the remaining
13,200MW of domestic coal-based capacity would require about 61mt.
Capacity commissioned over FY12 adds to the supply pressure.

Coal India willing to sign In a recent standard-linkage-committee meeting for the power sector, Coal
FSAs with 50% domestic India said it is willing to sign fuel supply agreements (FSA) with utilities if
coal commitment
power companies agree to the model FSA circulated by Coal India, which
provides for supply of 50% indigenous and 50% imported coal, if available.

56 [email protected] 27 June 2011

 
  
 Section 3: India - The hungry elephant Chindia power

Environmental clearance has been the key hurdle

MoEF’s demarcation of The Ministry of Environment and Forest (MoEF) has demarcated the coal
forest areas into “go” bearing areas into ‘go’ and ‘no-go’ areas, depending on the intensity of
and “no go“ areas
forest cover. The result is a large part of coal bearing areas are outside the
has impacted the
production of coal purview of future expansion. Out of nine coal fields, which cover about
650,000 hectares, more than 50% (396 coal blocks) were demarcated as
no-go areas.

Figure 95

More than 50% of the No-go areas of various coal fields

area under nine coal
fields was restricted 90,000 100
(ha) (%)
No go area % no go (RHS)
75,000 80
60,000
60
45,000
40
30,000

15,000 20

0 0

Karanpura
Wardha

Hasdeo

Bokaro
Sohagpur

Mandraigarh

Talcher

IB Valley
Singrauli

West
North

Source: MoEF, CLSA Asia-Pacific Markets

MoEF curbed industrial MoEF also put a moratorium on environmental clearance consideration till
activity in critically September 2011 for projects lying in critically polluted areas. Restrictions on
polluted areas
mining in critically polluted zones has impacted coal production targets by
39mt for FY12 according to Coal India.

CEPI index formed to For identifying ‘critically polluted’ industrial clusters, the Central Pollution
identify pollution Control Board (CPCB) and Indian Institute of Technology (IIT) Delhi studied
pollution levels in 88 industrial clusters and formulated a Comprehensive
Environmental Pollution Index (CEPI) in December 2009.

Areas with CEPI scores of According to their study, areas with CEPI scores of 70 and above should be
70 or more are classified considered critically polluted and need further detailed investigation in terms
as critically polluted
of the extent of damage and appropriate remedial action. Out of 88 industrial
clusters studied by the CPCB 43 were identified as critically polluted.

MoEF, after considering the study, issued circulars regarding evaluation of

projects for granting environmental clearance in critically polluted areas.

Recent dilution in norms by MoEF should boost production

PMO actively involved in The Prime Minister’s Office (PMO) has tried to resolve coal-production issues -
diluting MoEF norms especially when it’s widely believed that future projects are constrained
because of the tough MoEF stance. The ministry relaxed some norms but a
final solution is still in the works, with PMO participation. (After the PMO
intervention, the number of ‘go’ blocks increased from 396 to 467).

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Figure 96

No-go areas identified by Old definition of go and no-go areas

forest cover; GFC > 30% Coal field Total no. of coal No-go blocks
WFC > 10% blocks with area (10% WFC¹ & 30% GFC²)
Blocks Area (ha) Blocks Area (ha)
Talcher 82 80,400 68 64,000
IB Valley 49 51,600 26 23,600
Mandi Raigarh 80 118,200 29 37,400
Sohagpur 110 127,550 88 98,800
Wardha 113 82,900 98 45,000
Singrauli 46 66,800 20 31,600
North Karanpura 63 60,600 39 33,500
West Bokaro 39 14,800 28 10,900
Hasdeo Arand 20 45,900 - -
Total 602 648,750 396 344,800 (53%)
¹ WFC-Weighted Forest Cover; ² GFC - Gross Forest Cover; Source: MoEF, CLSA Asia-Pacific Markets

The earlier definition of The relaxations of norms, which lead to go-areas increases, are as follows:
no-go was relaxed
‰ A cluster approach was adopted, under which isolated no-go forest
patches in the midst of go areas were also added to the go area.
‰ A total of 24 coal blocks, already approved by the MoEF but found to fall
within no-go areas, were added to the go list
‰ Additionally, 28 large no-go coal blocks, identified jointly with the
Ministry of Coal, were recommended for boundary modification to allow a
few more areas to be reclassified

Figure 97

Only 29% of the area in Post PMO intervention, go blocks increased

nine coal fields is still Coal field As per cluster Including ones Coal blocks
considered no-go approach (A blocks with earlier requiring boundary
grouped with B blocks) clearance modification
Blocks Area (ha) Blocks Area (ha) Blocks Area (ha)
Talcher 73 69,000 75 70,200 3 6,984
IB Valley 32 28,000 33 30,300 2 4,642
Mandi Raigarh 32 40,300 32 40,300 7 7,274
Sohagpur 94 102,600 98 105,000 1 7,203
Wardha 101 45,800 104 48,000 4 34,986
Singrauli 20 31,600 26 35,800 4 11,526
North Karanpura 44 35,500 51 39,300 4 8,819
West Bokaro 29 11,100 30 11,500 3 1,105
Total 425 363,900 449 380,400 28 82,539
56% 59% 462,939 ha or 71%
Source: MoEF, CLSA Asia-Pacific Markets

CEPI Relaxation
‰ A moratorium was already lifted in the Angul-Talcher coal field.
‰ A technical assessment of remediation plans in Chandrapur, Singrauli,
Jharia, lb Valley and Raniganj is in progress. Korba will take longer
because the state has not submitted any remediation plan.

Merchant power capacity based on coal linkage will be hit hard

Companies with higher We expect companies highly dependent on Coal India’s linkages would be
Coal India dependence most impacted by a coal production shortfall. Companies will need to source
suffer most from
some coal from e-auctions (10-11% of Coal India’s production) or buy
production shortfalls
washery rejects and blend it with high-CV imported coal.

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Figure 98

NTPC, CESC, Adani Power Utility capacity expansion plans and their dependence on coal linkages
and Sterlite Energy have
the highest dependence 25,000 (MW) Capacity (LHS) (%) 120
on coal linkages Dependence on linkage
20,000 100

80
15,000
60
10,000
40

5,000 20

0 0
Energy

Energy
GVK Power

Power

Tata Power

Power
Jaiprakash

CESC
Reliance

Sterlite
Indiabulls

Energy
Adani
Essar

JSPL

Lanco
Power

GMR
JSW

Power
Power
Source: Companies, CLSA Asia-Pacific Markets

Merchant plant coal There is an Empowered Group of Ministers (EGoM), formed to look into the
allocations may be curbed crisis situation regarding coal supplies for new power generation capacity.
One of most talked about measures is to cut coal supplies to merchant-power
projects (power projects selling power in the short term market and not
through long term power purchase agreements) and divert that coal to
projects with long-term power purchase agreements. We think this is a likely
policy change but it is not enough to resolve the problem; more drastic
changes are required.

Figure 99

Of capacity planned by Merchant capacities and dependence on coal linkages from Coal India
the private sector, 23% is Company Capacity PPA/ Merchant Merchant Dependence on
merchant capacity (MW) Regulated (%) linkage (%)
Adani Power 9,240 7,269 1,971 21.3 69.3
JSW Energy 3,650 1,620 2,030 55.6 0
JSPL 5,380 3,216 2,164 40.2 44.6
Reliance Power 20,040 17,532 2,508 12.5 9.0
Lanco 7,140 5,388 1,752 24.5 48.2
Jaiprakash Power 7,480 5,569 1,911 25.6 59.6
Tata Power 8,167 7,917 250 3.1 14.3
CESC 2,425 1,975 450 18.6 72.2
Indiabulls Power 2,700 2,080 620 23.0 100.0
GMR Energy 6,331 3,611 2,720 43.0 41.9
GVK Power 1,771 1,771 0 0 0
Essar Power 4,880 4,242 638 13.1 0
Sterlite Energy 4,380 2,580 1,800 41.1 100.0
Total 83,584 64,769 18,814 22.5 37.3
Source: Companies, CLSA Asia-Pacific Markets

Diverting e-auction coal Another measure suggested was diverting some e-auction volume to the
to power production as a power sector. Coal India maintains e-auction coal is mainly for industries
solution to coal shortage
without linkages, which are located close to mines. Thus it’s not usable for
power projects located far from mines. However, it is known that many power
companies have bought e-auction coal consistently for some time now. Lanco
and Sterlite Energy are examples. The issue will surely crop up again when
the EGoM makes its decision.

27 June 2011 [email protected] 59

 
  
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Coal prices on an uptrend

International thermal- While domestic coal production growth was lacklustre, coal prices rose, both
coal prices climb internationally and in India. International spot-thermal-coal prices climbed
over the past year (with a 30% increase over 12 months) thus making some
power projects uneconomical with variable power-generation costs in a Rs2.8-
3/kWh range. Our resources team expects thermal-coal prices to remain
strong, pressuring costs for power projects operating exclusively on imported
coal or using it to blend with domestic coal.

Figure 100

The year to date average Thermal coal prices

coal price is US$125/t
160 (US$/tonne)

140 129
125

120
99
100

80 72

60

40

20

0
2008A 2009A 2010A 2011 YTD

Source: Bloomberg, CLSA Asia-Pacific Markets

Indian domestic coal Similarly, on the domestic front, coal prices trended up. In the recent price
prices also rising hike imposed by Coal India in February 2011, prices to power consumers
were not changed, except for consumers who bought from Mahanadi
Coalfields (a subsidiary of Coal India). The coal sold via e-auction (up to 11%
of Coal India’s sales volume) fetched close to a 100% premium as developers
rushed to buy in an effort to utilise assets. Rising petrol and diesel prices also
increased coal transportation costs.

Figure 101

Frequent Price hikes in Coal India’s price hikes since FY01

the domestic market
18 (%)
16.2
16 15.0

14

12 11.0
10.0
10
8.5

2
0.0 0.0 0.0 0.0 0.0 0.0
0
FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11

Source: Coal India, CLSA Asia-Pacific Markets

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Figure 102

Despite hikes Indian coal Coal India prices for different grades of coal for power utilities
still sells at a steep Rs/t A B C D E F G
discount to global prices
ECL 3,690 3,590 1,395 1,140 930 740 537
BCCL 3,690 3,590 1,250 1,040 830 660 470
CCL 3,690 3,590 1,220 1,000 790 530 450
NCL 3,690 3,590 1,100 920 740 580 430
SECL 3,690 3,590 1,050 880 730 570 430
MCL 3,690 3,590 1,050 880 730 570 430
Source: Coal India, CLSA Asia-Pacific Markets

Figure 103 Figure 104

E-auction coal commands Coal India average realisation and its Volume of coal sold via e-auctions and
60-80% premium realisation for sales versus e-auctions its price premium over FSA coal

2,000 (Rs/t) Avg realisation 60 (mt) Volume (LHS) (%) 100

Realisation in e-auction % premium
1,600 50 80
40
1,200 60
30
800 40
20
400 20
10

0 0 0
FY07 FY08 FY09 FY10 FY11F FY07 FY08 FY09 FY10 FY11F

Source: Coal India, CLSA Asia-Pacific Markets

Figure 105

Coal India’s February 11 Coal prices of different grades sold from several Coal India mines
price hike was aimed at ECL (for ECL/Mugma ECL/Rajmahal field BCCL CCL NCL SECL MCL
non-power consumers 12 units ) (for 19 units) (for two units)
A grade - exceeding 6,401 (kCal/kg)
Revised 3,690 3,690 3,690 3,690 3,690 3,690 3,690
Old 1,710 1,970 - 1,660 1,620 1,490 1,310 1,280
% 115.8 87.3 122.3 127.8 147.7 181.7 188.3
B grade - exceeding 5,800 but not exceeding 6,401 (kCal/kg)
Revised 3,590 3,590 3,590 3,590 3,590 3,590 3,590
Old 1,540 1,750 - 1,510 1,460 1,340 1,220 1,130
% 133.1 105.1 137.7 145.9 167.9 194.3 217.7
C grade - exceeding 5,400 but not exceeding 5,801 (kCal/kg)
Revised 1,290 1,500 1,250 1,220 1,100 1,050 1,050
Old 1,290 1,500 - 1,250 1,220 1,100 1,050 950
% 0.0 0.0 0.0 0.0 0.0 0.0 10.5
D grade - exceeding 4,800 but not Exceeding 5,401 (kCal/kg)
Revised 1,040 1,240 1,040 1,000 920 880 880
Old 1,040 1,240 - 1,040 1,000 920 880 790
% 0.0 0.0 0.0 0.0 0.0 0.0 11.4
E grade - exceeding 4,200 but not exceeding 4,801 (kCal/kg)
Revised 780 990 1,020 830 790 740 730 730
Old 780 990 1,020 830 790 740 730 620
% 0.0 0.0 0.0 0.0 0.0 0.0 0.0 17.7
F grade - exceeding 3,600 but not exceeding 4,201 (kCal/kg)
Revised 610 740 870 660 630 580 570 570
Old 610 740 870 660 630 580 570 480
% 0.0 0.0 0.0 0.0 0.0 0.0 0.0 18.8
G grade - exceeding 3,200 but not exceeding 3,601 (kCal/kg)
Revised 430 480 700 470 450 430 430 430
Old 430 480 700 470 450 430 430 350
% 0.0 0.0 0.0 0.0 0.0 0.0 0.0 22.9
Source: Coal India, CLSA Asia-Pacific Markets

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Coal transport is another bottleneck

Coal despatches from Apart from constraint on production, coal supplies suffer from a lack of
mines also suffer due to logistics infrastructure – mainly with railways. Coal India received 162 rakes
lack of wagons
in FY11 from Indian Railways. The company requires 184 rakes to meet its
target of 454mt in FY12. Coal India had an inventory of 70mt of coal at the
end of FY11 and actually added about 7mt to its stocks during the year. With
increased transportation, more could be liquidated. An additional 20 railway
rakes per day could help liquidate 25mt of coal, which can cater to about
5GW power capacity.

Railways promise Coal constitutes about 45% of the tonnage carried by Indian Railways but its
additional rakes to revenue share is lower at 40%, which implies it’s not the most lucrative
ease shortages
business for the railway, though it is the largest.

Figure 106

Coal constitutes 45% of Indian railways - Freight mix

Indian Railway’s tonnage

Source: Indian Railways FY10 annual report, CLSA Asia-Pacific Markets

Figure 107

Road despatches are Coal despatches for Coal India by mode

about 25% of the total
FY10 FY11
Mode Raw-coal despatch % of total Raw-coal despatch % of total
Rail 194 47 200 47
MGR¹ 87 21 84 20
Road 104 25 110 26
Others 31 7 30 7
Total 415 100 424 100
¹ MGR - merry go round rail facility Source: Coal India, CLSA Asia-Pacific Markets

Distance from the mine head to the nearest port also determines whether
coal imports make sense economically. In Figure 108 we map the distance of
power projects from the nearest port. Import levels depend on state policy
allowing developers to show availability based on imported coal and what
proportion of higher CV imported coal their equipment (boilers, turbines
generators) can take.

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 Section 3: India - The hungry elephant Chindia power

Figure 108

Many new power projects are located far from ports

Company Project Capacity Location
(MW)
Adani Power Mundra I -IV 4,620 Coastal, Gujarat
Tiroda 3,300 880km from Mumbai; 1,356km from Mundra; 727km from Vizag; 1,027km from Paradip; Maha
Kawai 1,320 944km from Mundra; 909km from Mumbai; Rajasthan
JSW Energy Vijaynagar 860 482km from Mumbai;147km from Murmagao; Karnataka
Ratnagiri 1,200 Coastal; Maha
Barmer 1,080 476km from Mundra; Rajasthan
JSPL Tamnar I & II 3,400 1853km from Mundra;492km form Paradip; pit head coal mine for part of the requirements
Godda 660 Pit head project; Jharkhand
Dumka 1,320 Pit head project; Jharkhand
R Power Rosa -I- II 1,200 1,351km from Mundra;1,216km from Mumbai;1,043km from Haldia; UP
Butibori 600 880km from Mumbai;1,356km from Mundra; 727km from Vizag; 1027km from Paradip;
752km from Visakhapatnam; Maha
Sasan 3,960 Pit head plant; MP
Chitrangi 3,960 Pit head plant; MP
Krishnapatnam 3,960 Coastal; AP
Tilaiya 3,960 Pit head plant; Jharkhand
Lanco Amarkantak I&II 600 1,444km from Mundra;1,258km from Mumbai;759km from Paradip;
752km from Visakhapatnam
Uduppi 1,200 Coastal; TN
Anpara C 1,200 1,104km form Vizag;833km from Paradip;682km from Haldia; UP
Babandh 1,320 129km from Paradip; Orissa
Vidharba 1,320 880km from Mumbai;1,356km from Mundra; 727km from Vizag; 1027km from Paradip; Maha
JP Power Nigrie 1,320 1,222km from Mundra;915km from Visakhapatnam;955km from Paradip
Bina - I 500 1,198km from Paradip;1,072km from Mundra; 917km from Mumbai
Karchana - I& II 1,980 1,157km from Vishakapatnam; 1,027km from Paradip; 1,579km from Mundra;
1,475km from Mumbai;876km from Haldia
Bara - I 1,980 1,416km from Haldia; 1,393km from Mundra; 1,680km from Vishakapatnam;
1,508km from Mumbai
Tata Power Mundra 4,000 Coastal
Maithon 1,050 386km from Haldia; 532km from Paradip
CESC Haldia 600 Coastal
Chandrapur 600 965km from Paradip; 706km from Vizag; 923km from Mumbai
Indiabulls Power Amravati I 1,350 692km from Mumbai; 924km from Vizag; 1,069km from Paradip; 1,160km from Mundra
Nashik 1,350 798km from Mundra; 172km from Mumbai
GMR Kamalanga 1,400 Pit head plant
Raipur 1,370 1,132km from Mumabi; 629km from Paradip;
Varora (Emco) 600 965km from Paradip; 706km from Vizag; 923km from Mumbai; 543km from Vishakapatnam
Shahdol (SJK) 1,370 853km from Vizag; 835km from Paradip; 973km from Haldia; 1,325km from Mumbai
GVK Goindwal Sahib 540 Captive mine in Jharkhand
Essar Salaya I 1,200 Coastal
Mahan I 1,200 Pit head plant
Vadinar PII 510 Coastal
Paradip 120 Coastal
Tori I 1,200 Pit head plant
Sterlite Energy Jharsugda 2,400 403km from Paradip; 547km from Haldia
Talwandi Sabo 1,980 1,899km from Haldia; 1,169km from Gujarat; 1,487km from Mumbai
Source: Companies, CLSA Asia-Pacific Markets

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SEB losses - the Achilles’ heel of India’s power sector?

Worsening SEB finances Worsening SEB finances are among the biggest challenges for growth in the
are a major concern power sector. Between FY07-09 state utility losses nearly doubled and were
up 64% from the previous year in FY09. Most state utility balance sheets are
in tatters. Since they control over 90% of India’s power distribution and are
the end customers of the almost all power utilties, their financial health and
ballooning losses are a matter of grave concern for banks, coal suppliers and
the power utilities themselves. Some people believe this is the Achilles’ heel
of India’s power sector and could cause the country’s next big crisis.

Figure 109

Losses jumped in 2009, State distribution companies’ financial losses (without subsidy)
which was a general
election year 600,000 (Rsm)
505,850
500,000

400,000
342,370

278,930
300,000
234,240
209,140
200,000

100,000

0
FY05 FY06 FY07 FY08 FY09

Source: PFC, CLSA Asia-Pacific Markets

Finance Commission The 13th Finance Commission projected that losses will more than double by
estimates exclude loss FY14 to Rs1,161bn. The forecast assumes no tariff increase or reduction in
reductions and tariff hikes
losses. The recent deterioration in state utility finances is a concern.

Poor performance by few However, a closer analysis shows that while state utility losses are serious,
states largely influences rays of hope exist. First, the aggregate loss trend hides the fact that in most
aggregate loss figures
states finances stabilised or even improved over the last few years. However,
a few states have shown massive deterioration, which pulls down the entire
country’s performance. Hence, the malaise is easier to control with
concentration in a few states.

High merchant tariffs The second important takeaway is higher merchant power tariffs had an
impacted losses in FY09 important role in the worsening of state utility losses over the last few years.
In 2009 India had general elections, a time when states buy power no matter
what the price. As a result, average merchant tariffs were more than
Rs7.25/kWh in FY09. Short-term prices subsequently corrected to Rs5.2/kwh
in FY10 and Rs4.5/kWh in FY11; we expect further corrections to Rs3.5/kWh
by next year. We believe this, along with the gradual reduction in AT&C losses
and tariff hikes, will help keep losses under control.

States have taken tariff After studying a number of recent tariff orders we believe most states
hikes in their most recent have taken hikes (ranging between 5-20%). Thus in our base case we
tariff orders
assume an annual tariff increase of 3-5% and a reduction in transmission
& distribution (T&D) losses by 1ppt per annum. This implies overall losses

64 [email protected] 27 June 2011

 
  
 Section 3: India - The hungry elephant Chindia power

at distribution companies will not deteriorate significantly from here. There

is hope losses can be cut substantially if tariffs hikes are higher than 5%
or the AT&C loss reduction is greater than 1ppt per annum. Recent
indications show both are possible.

Figure 110

Aggregate P&L for state distribution companies

(Rsm) FY09 FY10E FY11E FY12E FY13E FY14E FY15E
Revenue from power sales 1,554,070 1,747,604 1,915,375 2,156,433 2,543,560 3,027,011 3,547,902
Other revenue 149,740 145,248 148,153 152,597 157,175 161,891 166,747
Income - distribution 1,703,810 1,892,851 2,063,528 2,309,030 2,700,735 3,188,902 3,714,649
Total expenditure 2,212,670 2,341,849 2,578,536 2,836,645 3,267,464 3,763,659 4,261,392
Recovery of cost (%) 77 81 80 81 83 85 87
Book losses without subsidy 505,850 448,998 515,008 527,615 566,729 574,758 546,743
Net energy input (mkwh) for utilities 606,036 657,047 694,331 734,371 813,894 904,274 989,890
selling directly to customers
Energy sold (mkwh) 467,690 505,926 534,635 572,809 642,976 723,419 801,811
Energy realised (mkwh) 433,666 473,468 503,807 540,203 606,839 687,791 767,759
AT&C losses (%) 28.4 27.9 27.4 26.4 25.4 23.9 22.4
Average tariff (Rs/kwh) on 3.58 3.69 3.80 3.99 4.19 4.40 4.62
units realised
Average supply cost on units 5.10 4.95 5.12 5.25 5.38 5.47 5.55
realised (Rs/kwh)
Gap (Rs/kwh) on every unit realised 1.52 1.26 1.32 1.26 1.19 1.07 0.93
Source: PFC, CLSA Asia-Pacific Markets

Figure 111

Finance Commission SEB losses under different scenarios

estimates are close to our
(Rsbn) FY11CL FY12CL FY13CL FY14CL
worst-case scenario
Base case (3-5% tariff hike, 1ppt reduction 515 528 567 575
in AT&C losses)
Scenarios
No reduction in AT&C losses 515 557 635 714
AT&C loss reduction at 1.5ppt pa 515 513 533 535
AT&C loss reduction at 3ppt pa 515 469 430 356
No increase in tariff 515 630 803 987
Tariff hike at 7% instead of 3-5% 515 487 469 398
No improvement in T&D losses and no 515 658 865 1,107
increase in tariff
Estimates for the 13th finance commission 686 803 987 1,161
Source: CLSA Asia-Pacific Markets

A few bad eggs . . .

Three states contributed Figure 112 shows the trend in SEB losses from FY08 to FY09. Three states -
to the 70% of losses Rajasthan, Andhra Pradesh and Tamil Nadu accounted for about 70% of
(before state subsides)
increased T&D losses in FY09. If we include three more states - Uttar
Pradesh, Madhya Pradesh and Karnataka - these explain 93% of India’s
increased T&D loess. Around 20 states or union territories (UT) either
reported no deterioration in finances or an increase in financial losses. It is
clearly a case of few bad eggs spoiling the basket.

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Figure 112

Increase of Rs205bn in SEB losses for FY08-09 by state

aggregate losses for State FY08 FY09 Change FY09/FY08 % of total
FY09; six states account Andhra Pradesh (25,260) (76,280) (51,020) 24.8
for 93% Rajasthan (38,050) (88,850) (50,800) 24.7
Tamil Nadu (49,690) (89,640) (39,950) 19.4
Uttar Pradesh (63,430) (81,220) (17,790) 8.7
Madhya Pradesh (23,960) (40,680) (16,720) 8.1
Karnataka (14,330) (28,340) (14,010) 6.8
Maharashtra 6,750 (6,800) (13,550) 6.6
Haryana (29,010) (40,560) (11,550) 5.6
Orissa 7,380 1,250 (6,130) 3.0
Bihar (13,050) (17,250) (4,200) 2.0
Puducherry 340 (700) (1,040) 0.5
Jharkhand (12,350) (13,200) (850) 0.4
Mizoram (440) (740) (300) 0.1
Manipur (1,170) (1,410) (240) 0.1
West Bengal 3,640 3,450 (190) 0.1
Kerala 2,170 2,170 0 0.0
Nagaland (810) (680) 130 (0.1)
Goa 1,390 1,580 190 (0.1)
Gujarat (9,980) (9,750) 230 (0.1)
Meghalaya (310) (20) 290 (0.1)
Arunachal Pradesh (830) (480) 350 (0.2)
Uttarakhand (5,040) (4,650) 390 (0.2)
Sikkim (300) 100 400 (0.2)
Assam (1,280) (740) 540 (0.3)
Tripura (290) 280 570 (0.3)
Himachal Pradesh (250) 320 570 (0.3)
Jammu & Kashmir (13,720) (12,790) 930 (0.5)
Chattisgarh 4,640 7,740 3,100 (1.5)
Delhi (1,040) 4,040 5,080 (2.5)
Punjab (42,380) (32,420) 9,960 (4.8)
Total (320,660) (526,270) (205,610) 100.0

Figure 113

Increase in SEB losses in FY09 over FY08 (without state subsidies)

20,000 (Rsm)

10,000

(10,000)

(20,000)

(30,000)

(40,000)

(50,000)

(60,000)
Tamil Nadu
Himachal Pradesh
Sikkim

Delhi
Arunachal Pradesh

Nagaland

Jammu & Kashmir

Mizoram

Chattisgarh
Meghalaya

Rajasthan

Kerala

Madhya Pradesh
Bihar

West Bengal

Manipur
Assam

Tripura

Uttar Pradesh

Andhra Pradesh
Orissa

Gujarat
Uttarakhand

Maharashtra
Karnataka

Puducherry
Jharkhand

Haryana

Punjab

Goa

Source: PFC, CLSA Asia-Pacific Markets

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Bad eggs also default on subsidies . . .

The state utility losses discussed in the previous section did not take state-
government subsidies into account. The subsidies undertaken by state utilities
are called subsidies booked and those actually paid are called subsidies
realised. Once we take subsidies into account, the per unit revenue gap is
lower. In FY07 and FY08 the gap between subsidy booked and subsidy
realised was Rs0.1-0.12/kwh. This jumped to a new high, Rs0.27/kwh in FY09
- a significant deterioration.
Figure 114

A widening gap between Revenue gap for state utilities - Rs/kWh

subsidies booked and Region Gap without Gap with Gap (with revenue/
realized in FY09 subsidy subsidy subsidy realised)
06-07 07-08 08-09 06-07 07-08 08-09 06-07 07-08 08-09
East 1.21 0.47 0.51 1.04 0.30 0.21 1.07 0.45 0.20
North East 0.78 0.54 0.39 0.69 0.44 0.36 0.80 0.51 0.55
North 0.73 0.95 1.07 0.41 0.42 0.38 0.53 0.58 0.80
South 0.34 0.51 1.05 0.04 0.17 0.45 0.10 0.21 0.66
West 0.13 0.15 0.28 0.03 0.06 0.17 0.14 0.20 0.45
National 0.48 0.54 0.78 0.25 0.23 0.33 0.34 0.35 0.60
Source: PFC, CLSA Asia-Pacific Markets

Andhra Pradesh and Interestingly, Rajasthan and Andhra Pradesh, the biggest contributors to
Rajasthan accounted for incremental losses in FY09 (accounting for 50% of the increase in losses in
the 88% of the gap
FY09) are also the two states with the largest gap between subsidies booked
and realised. These two states account for 88% of the gap.
Figure 115

Only 60% of FY09 booked Subsidy booked and received by state utilities
subsidy was realised
350 (Rsbn) Subsidy booked (%) 130
Subsidy received 120
300
% received (RHS)
110
250
100
200 90
150 80
70
100
60
50 50
0 40
FY02 FY03 FY04 FY05 FY07 FY08 FY09

Figure 116

The largest gap was for Difference between subsidies received and booked
Andhra Pradesh, FY07 FY08 FY09
Rajasthan and Jharkhand Bihar 0 0 0
Jharkhand 0 (1,320) (10,000)
Meghalaya 0 0 0
Tripura 0 0 0
Haryana 0 0 0
Himachal Pradesh 0 0 0
Punjab 0 0 0
Rajasthan (5,980) (23,760) (66,040)
Uttar Pradesh 0 (450) 0
Andhra Pradesh (1,170) (4,580) (33,650)
Karnataka 0 (350) (590)
Tamil Nadu 0 0 (2,500)
Gujarat (320) 0 0
Madhya Pradesh (80) 0 0
Total (7,550) (30,460) (112,780)
Source: PFC, CLSA Asia-Pacific Markets

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Five states contributed For state utility losses, after subsidies, the bad performance of a few states
to 85% of post significantly impacted overall performance of the state electricity boards. For
subsidy losses
example, the states of Tamil Nadu, Uttar Pradesh, Madhya Pradesh, Haryana
and Karnataka contributed to the 85% of post-subsidy losses in FY09.

Figure 117

Loss contribution for key states after subsidies

Rsm FY07 FY08 FY09
All states except Tamilnadu, Uttar Pradesh, Madhya Pradesh, Haryana and Karnataka
PAT (66,370) (23,900) (34,020)
Cash profit (9,290) (560) (84,690)
Tamilnadu, Uttar Pradesh, Madhya Pradesh, Haryana and Karnataka
PAT (64,710) (101,520) (195,390)
Cash profit (55,900) (75,180) (199,300)
All states
PAT (131,080) (125,420) (229,410)
Cash profit (65,190) (75,740) (283,990)

Figure 118

Chattisgarh is the most Top five most profitable states

profitable state State Profits in FY09 (Rsm) State Cash profit in FY09 (Rsm)
Chhattisgarh 7,740 Delhi 13,170
Delhi 4,040 Chhattisgarh 8,900
Andhra Pradesh 3,520 Gujarat 8,840
West Bengal 3,450 West Bengal 8,380
Kerala 2,170 Kerala 6,810
Goa 1,580 Orissa 5,230

Figure 119

Losses increased Losses at states

significanltly in FY09
20,000 (Rsm)

(20,000)

(40,000)

Tamil Nadu
(60,000) Karnataka
Uttar Pradesh
(80,000) Haryana
Madhya Pradesh
(100,000)
FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09

Source: PFC, CLSA Asia-Pacific Markets

State utility balance sheet - Dire straits

Outstanding debt for The net worth of state power utilities at the end of FY09 was US$6.5bn and
state power utilities in the total outstanding debt was US$53bn. Of that, 17.5% was loaned from
FY09 was US$53bn
state governments and the balance was in the form of loans from banks,
financial institutions and bonds.

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State power utilities meet cash needs (apart from what they collect in tariffs)
by raising working capital debt or issue bonds, which are usually guaranteed
by the respective state governments.

Figure 120

State utilities Capital employed by state utilities

incrementally borrowed Rsm FY07 FY08 FY09 Change in Change in
Rs433bn in FY09 FY08/FY07 FY09/FY08
Net worth 164,600 362,420 296,540 197,820 (65,880)
State government loans 509,120 409,010 425,900 (100,110) 16,890
Loans from FI/Banks/Bonds 1,286,670 1,545,750 1,979,170 259,080 433,420
Other loans 36,130 28,200 26,590 (7,930) (1,610)
Grants towards capital assets 111,840 129,350 169,710 17,510 40,360
Consumer contribution 169,690 183,750 212,400 14,060 28,650
Total capital employed 2,278,090 2,658,420 3,110,250 380,330 451,830
Source: PFC, CLSA Asia-Pacific Markets

Figure 121

Loans make up 78% of Total SEB capital employed in FY09

employed capital

Grants towards Consumer

contribution Networth
capital assets
7% 10%
5%

Other loans State govt loans

1% 14%

Loans from
FI/Banks/Bonds
63%

Source: PFC, CLSA Asia-Pacific Markets

Figure 122

Debtors increased from SEB balance-sheet assets

109 days of sales in FY08 FY07 FY08 FY09 Change in Change in
to 1,133 days in FY09 FY08/FY07 FY09/FY08
Net fixed assets 1,491,070 1,778,420 2,028,430 287,350 250,010
Work in progress 598,950 637,800 787,810 38,850 150,010
Capital expenditure 382,780 447,620 522,400 64,840 74,780
Debtors (distribution companies) 456,950 499,140 563,810 42,190 64,670
Debtors (gencos/transcos/ 269,580 337,710 417,000 68,130 79,290
trading companies)
Creditors (distribution companies) 469,870 654,540 651,220 184,670 (3,320)
- for purchase of power
Source: PFC, CLSA Asia-Pacific Markets

Merchant power has played an important role . . .

High fuel prices have Power purchases are the most dominant costs in SEB profit & loss
lead to higher power statements. With increases in capital costs at new power projects and rising
purchase costs
fuel prices (both coal and gas) expenses are on a rising trend.

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Figure 123

Power purchase cost is Expenses break-up of SEBs

the key cost for the power Rsm FY07 FY08 FY09
utilities -62% of the total Power purchased 1,477,450 1,684,810 1,975,560
Generation cost 324,520 355,050 444,750
Employees cost 198,090 227,610 311,820
O&M cost 50,610 58,110 65,410
Interest cost 137,080 153,230 190,550
Depreciation 115,790 115,480 125,710
Admin and gen exp. 28,070 29,850 34,830
Other exp 63,120 44,560 38,410
Total expenses 2,394,750 2,668,770 3,186,940
Source: PFC, CLSA Asia-Pacific Markets

During FY07-09, while costs increased by 8%, the average selling price only
rose by 4.5%. Some states instituted tariff decreases in FY09 as populist
measures.

Figure 124

Employee costs are 10% SEB expenses for FY09

of the total
Admin and
Depreciation
Genexp
4%
1% Other exp
Interest cost 1%
6%

O&M cost
2%

Employees cost
10%

Generation cost Power purchase

14% 62%

Source: PFC, CLSA Asia-Pacific Markets

The 13th Finance Commission identified high ‘merchant power prices’ as one
of the reasons losses climbed at state utilities in recent years. It’s no surprise
that states spending the most on merchant power are also the ones topping
the table in term of losses. Six of the top seven merchant power buyers in the
country are also among the top seven loss making states.

Figure 125

States buying more Top merchant power buyers are also the top loss making state utilities
merchant power have Top seven merchant power buyers Top seven loss making state utilities
maximum losses
mkWh Percent of total Rsm Incremental
merchant power bought loss in FY09
by the state (%) (%)
Rajasthan 3,158 25 Andhra Pradesh 51,020 25
Maharashtra 2,667 21 Rajasthan 50,800 25
Andhra Pradesh 2,098 17 Tamil Nadu 39,950 19
Madhya Pradesh 1,233 10 Uttar Pradesh 17,790 9
Tamil Nadu 973 8 Madhya Pradesh 16,720 8
Uttar Pradesh 955 8 Karnataka 14,010 7
J&K 603 Maharashtra 13,550 7
Source: CERC, CLSA Asia-Pacific Markets

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Figure 126

Top 10 states for the past three years in terms of buying merchant power (mkWh)
State 8mFY09 State FY10 State FY11
Rajasthan 3,158 Rajasthan 6,771 Tamil Nadu 8,314
Maharashtra 2,667 Tamil Nadu 5,181 Punjab 4,370
Andhra Pradesh 2,098 Haryana 3,376 Maharashtra 4,317
Madhya Pradesh 1,233 Maharashtra 3,293 Rajasthan 3,900
Tamil Nadu 973 Punjab 2,027 Uttar Pradesh 3,264
Uttar Pradesh 955 Uttar Pradesh 1,848 Haryana 1,677
J&K 603 Delhi 1,793 Delhi 1,632
DNH 379 Andhra Pradesh 804 Jharkhand 909
Uttarakhand 310 DNH 357 Andhra Pradesh 656
Haryana 246 Uttarakhand 271 Karnataka 507
Source: CERC, CLSA Asia-Pacific Markets

Insufficient tariff hikes is another key reason

Some states have not While the cost of power generation and procurement steadily rose, many
increased tariffs for years states did not hike distribution tariffs for many years - many have not even
filed a tariff petition with the regulator. The best (or worst) example of this is
Tamil Nadu, where the SEB did not file a tariff petition from FY03-09 and
ended up with an accumulated loss of Rs168bn.
Figure 127

States responsible for Average realisation of power in different states over FY07-09 (Rs/kwh)
70% of increased losses State FY07 FY08 FY09 FY08/FY07 FY09/FY08
cut tariffs in FY09 % chg % chg
Sikkim 1.75 1.88 1.91 8 2
Jammu & Kashmir 1.47 2.55 2.35 73 (8)
Andhra Pradesh 2.28 2.55 2.51 12 (1)
Puducherry 2.35 2.53 2.55 8 1
Uttar Pradesh 2.48 2.43 2.57 (2) 6
Arunachal Pradesh 2.17 2.76 2.66 28 (4)
Punjab 2.44 2.39 2.69 (2) 13
Uttarakhand 2.29 2.46 2.70 7 9
Rajasthan 2.92 2.83 2.79 (3) (1)
Tamil Nadu 2.84 2.91 2.81 3 (3)
Orissa 2.94 2.96 2.99 0 1
Karnataka 2.86 3.04 3.02 6 (1)
Bihar 2.75 2.96 3.12 8 5
Jharkhand 3.16 3.25 3.19 3 (2)
Mizoram 2.00 2.90 3.24 45 12
Madhya Pradesh 3.11 3.09 3.26 (1) 5
Haryana 2.53 2.75 3.27 9 19
Chattisgarh 3.02 3.39 3.30 12 (3)
Goa 2.90 2.98 3.33 3 12
Nagaland 2.46 2.70 3.33 10 23
Meghalaya 2.77 2.99 3.72 8 25
Kerala 3.24 3.51 3.80 8 8
Tripura 3.04 2.91 3.82 (4) 31
West Bengal 3.52 3.55 3.88 1 9
Maharashtra 3.71 3.51 3.93 (5) 12
Gujarat 3.12 3.22 4.01 3 24
Manipur 2.95 3.07 4.04 4 31
Himachal Pradesh 3.38 3.57 4.06 6 14
Delhi 4.26 4.35 4.36 2 0
Assam 4.51 5.08 4.95 13 (3)
Country 2.94 3.02 3.21 3 6
Source: PFC, CLSA Asia-Pacific Markets

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Big tariff mismatch

High degree of cross The National Tariff Policy aims for rationalisation, linking fees with the cost of
subsidy in consumer supply, with an eventual reduction of cross subsidies to +/- 20% of average
categories
costs by 2010-11. However, the states of Punjab, Karnataka, Tamil Nadu and
Andhra Pradesh still provide free power to agricultural consumers and many
others sell to farming operations at a huge discount, which runs against
national policy. States with high under-recovery from agricultural customers
are among the biggest loss makers in the country.

Figure 128

Cross subsidy
State Agriculture Agriculture % under Industrial Industrial % over
(% of total Energy (% of total recovery from (% of total energy (% of total recovery
sold - mkwh) revenue Rsm) agriculture sold - mkwh) revenue Rsm) from industry
Haryana 36 4 32.0 27 35 8.0
Karnataka 36 7 29.0 31 35 4.0
Rajasthan 37 17 20.0 29 43 14.0
Punjab 29 - 29.0 33 49 16.0
Andhra Pradesh 31 1 30.0 35 47 12.0
Maharashtra 22 11 11.0 46 56 10.0
Gujarat 32 15 17.0 43 58 15.0
Tamil Nadu 22 - 22.0 37 54 17.0
Madhya Pradesh 30 13 17.0 28 41 13.0
Source: PFC, CLSA Asia-Pacific Markets

Figure 129

Tariff policy talks of Tariff design and subsidy

linking charges to the
cost of supply

Source: Forum of Regulators; CLSA Asia-Pacific Markets

Figure 130

Policy aims to reduce Provisions for reducing cross subsidy in the National Tariff Policy
cross subsidy by the end
of FY11 across all states

Source: National tariff policy, CLSA Asia-Pacific Markets

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Towards rationalisation of tariffs and payment of subsidies

Tariff hikes and reduced Future state utility finances depend on the amount of power sold, the percent
AT&C losses is the future of power wasted in AT&C losses and the revenue gap on each power unit sold.
The amount of power sold should rise substantially, given capacity additions.
Hence, the loss levels could only be reduced by shrinking the revenue gap on
each unit of power and curbing AT&C losses.

The government formed the Shunglu Committee to delve deeper into state
utilities’ losses. The committee is headed by Mr V K Shunglu who is the
former chairman of Comptroller Auditor General (CAG). The committee has
yet to submit the complete report to the government.

State utilities willing As previously discussed, we believe aggregate losses can be largely contained
to hike tariffs if AT&C losses are cut by 1ppt per annum and we take a 5% per annum tariff
hike in coming years. Are states willing to take tariff hikes? We think the
answer is a resounding ‘yes’ if we look at the trend of states adjusting tariffs.
In 2010, 16 issued revisions, a big pick up from past levels.

Figure 131

Tariff revised in Year wise tariff revisions

16 states in 2010 Last year of revision Number of states States
2002 1 Goa
2005 1 Rajasthan
2006 3 Haryana
Nagaland
Tripura
2008 1 Bihar
2009 5 Assam
Chattisgarh
Karnataka
Sikkim
Delhi
2010 16 Andhra Pradesh
Arunanchal Pradesh
Gujarat
Himachal Pradesh
J&K
Jharkhand
Kerala
Madhya Pradesh
Maharashtra
Meghalaya
Orissa
Punjab
Tamil Nadu
Uttar Pradesh
Uttrakhand
West Bengal
2011 2 Manipur
Mizoram
Source: Infraline, CLSA Asia-Pacific Markets

States are looking to To dig deeper into the SEB-losses issue, we analysed recent regulatory filings
take tariff hikes from nine state utilities. The findings are encouraging. The states are not only
looking at tariff hikes to recover current revenue gaps but also accumulated
shortfalls from past periods. Many states are considering 5-20% tariff hikes
while some states proposed bolder moves - like 51% for Jharkhand. Some
states, with huge accumulated losses, are not willing to implement big
increases but they seem willing to pay subsidies, which state utilities are
supposed to get as per the Electricity Act.

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Figure 132

Tariff hikes have ranged Tariff hikes approved by regulators in certain states
between 6-20% across
most states 25 (%)

15-20
20

15 13
12
11
10 9

6 6
5

1
0
Bihar Madhya Uttar Uttrakhand Tamil Maharashtra Punjab Himacahal
Pradash Pradesh Nadu Pradesh

Source: CLSA Asia-Pacific Markets

While state utilities and electricity regulators are taking bold steps there is a
risks politicians could oppose efforts - especially in years before elections.
However, our 5% tariff-hike assumptions appear quite resasonable and they
could be even higher.

Tariff petitions and orders

Following is a highlighting of various tariff petitions and orders from selected
Indian states.

Madhya Pradesh
Madhya Pardesh reduced In determining tariffs, the Madhya Pradesh Regulatory Commission gave due
cross subsidies in its consideration to the requirement of the Electricity Act, 2003, which states
latest tariff order
that consumer tariffs should reflect the cost of supply. The National Tariff
Policy provides that by FY11, tariffs should be within +/- 20% of the Average
Cost of Supply. The average cost for 2010-11 works out to Rs4.22/kWh. As
shown in Figure 133, the regulatory commission has tried to reduce cross-
subsidies in FY11 as compared to FY10.

Figure 133

Reduction in cross Average realisation as a percent of the average supply cost

subsidy as per Tariff FY10 (as per tariff order FY11 (as per new Change
policy guidelines dated 29th July 2009 (%) tariff order) (%) (ppt)
Domestic 93.0 94.9 1.9
Non-domestic 144.0 138.8 (5.2)
Public water works 92.0 90.1 (1.9)
Street Light 101.0 92.0 (9.0)
Agriculture 67.0 74.6 7.6
Railways 128.0 125.3 (2.7)
Coal Mines 143.0 129.3 (13.7)
Industrial 127.0 121.2 (5.8)
Non-industrial 136.0 125.6 (10.4)
Irrigation, PWW and other than agriculture 95.0 95.6 0.6
Bulk residential users 103.0 100.2 (2.8)
Bulk supply to exemptees 93.0 88.4 (4.6)
Source: MPERC, CLSA Asia-Pacific Markets

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An increase in tariffs alone was targeted to close the revenue gap (about an
11% hike) - which is good news. No increases in subsidies were proposed to
recover part of the cost.

Figure 134

Tariff hike of 11% Madhya Pradesh’s annual revenue requirement (ARR) for FY11
(Rsm) State
Total ARR for FY 2010-11 102,553
True-up for FY08(distribution company) 2,231
Total FY 2010-11 ARR as approved 104,784
Revenue at Current Tariffs 94,691
Gap at Current Tariffs (10,093)
Revenue at New Tariffs 104,778
Final Gap/Surplus (6)
Source: MPERC, CLSA Asia-Pacific Markets

Figure 135

Avg tariff for Low Tension Tariff for LT and HT customers in Madhya Pradesh as per FY11 tariff order
(LT) consumers is fixed Low Tension (LT) Sales (MU) Revenue (Rsm) Tariff
at Rs3.81/kWh . . .
Domestic Consumers 6,183 24,730 4.00
Non Domestic 1,395 8,170 5.86
Public Water Works and Street Light 580 2,230 3.84
Industrial 770 4,030 5.23
Irrigation Pumps for Agriculture 7,225 22,460 3.11
Agriculture related use in Rural Areas 29 100 3.45
LT Units Sold (MU) 16,182 61,720 3.81
. . . while it is Rs4.97/ High Tension (HT)
kWh for High Tension Railway Traction 1,559 8,230 5.28
(HT) consumers Coal Mines 557 3,040 5.46
Industrial 4,262 21,790 5.11
Non-Industrial 708 3,760 5.31
Seasonal 20 130 6.50
Irrigation 326 1,310 4.02
Public Water Works 31 130 4.19
Bulk Residential Users 434 1,840 4.24
Bulk Supply to Exemptees 765 2,850 3.73
HT Units Sold (MU) 8,662 43,080 4.97
Total LT + HT Units Sold (MU) 24,844 104,800 4.22
Source: MPERC, CLSA Asia-Pacific Markets

Uttar Pradesh
13% hike in tariff Uttar Pradesh has a larger revenue gap, compared to Madhya Pradesh, as its
overall tariff levels are much lower. However, the state plans to bridge part of
the gap with hikes with the balance funded by state subsidy or loans. The
regulator has approved a tariff hike of 13% in the FY10 order; the average
cost of supply is Rs4.17/kWh.

Figure 136

Uttar Pradesh SEB revenue gap for FY10 and its proposed funding
Rsm
Consolidated revenue gap for FY10 97,270
Govt of UP subsidy 18,320
Revenue gap after considering subsidy 78,950
Proposed sources to meet revenue gap
a) revenue from proposed tariff increase 25,490
b) additional subsidy from govt of UP/Loan from banks and financial institutions 53,460
Source: UPERC, CLSA Asia-Pacific Markets

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Maharashtra
Maharashtra regulators Maharashtra State Electricity Distribution Company Ltd (MSEDCL) is not
approved a 1% hike dependent on state subsidies for recovering costs. According to its FY11 tariff
order, all costs and returns are only recovered via tariffs and there is no
major regulatory asset creation or demand for more subsidies, which is an
encouraging sign. MSEDCL, in its petition, claimed a revenue gap of Rs36bn
at existing tariff levels, which requires a 12% hike. However, Maharashtra
regulators calculated the revenue gap as only Rs2bn, which requires less than
a 1% increase to cover.

Haryana
Haryana’s tariffs were Haryana is another case where distribution tariffs have remained static for
static for years years. In the FY11 petition both distribution utilities did not give any
indication on how they plan to recover huge revenue gaps, which they
themselves forecast. Thus, the Haryana regulator took it upon itself to resolve
the situation.

The law allows the regulator to take up the job of tariff determination under
the following circumstances:

If the Commission is satisfied that the expected revenue of a distribution

licensee (s) differs significantly from the revenue it is permitted to recover, it
may order the distribution licensee(s) to file an application within the time
specified by the Commission to amend its tariff appropriately failing which the
Commission shall suo moto start the proceeding for determination of tariff.

The regulator three options to bridge the gap.

1. To suitably adjust the tariff to generate additional revenue.
2. To request the government provide subvention to compensate for
financial losses at the utilities, which are fully government owned.
3. Licensees improving, on their own, so as to generate sufficient revenue.

Haryana regulators chose The Haryana regulators choose the first option, but kept in mind that
to resolve losses consumers should not suffer a tariff shock. State distribution companies had
carried forward losses of Rs26.6bn in September 2010. The Haryana regulator
converted the revenue gap in FY09-10 into a regulatory asset, which
accounted for Rs7.3bn - against which utilities are allowed to borrow from
approved lending institutions; the regulatory asset must be recovered from
consumers in the form of higher tariffs over a period of three years.

The past revenue gap, after regulator actions, was Rs19bn. The tariff revision
in FY11 recovered Rs12bn. Thus, there is positive movement, not only
towards recovering current dues but also past dues. The accomplishment is a
welcome sign from a state that was one of worst performers.

Jharkhand
Jharkhand proposed a The Jharkhand SEB expects a cumulative revenue gap of Rs101bn (US$2.2b)
51% tariff hike . . . for FY03-12 if it does not hike tariffs. This includes losses from past periods.
Its proposal is to convert to a regulatory asset, recovering costs over five
years with a 51% tariff increase.

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Figure 137

Tariff hikes required to close the revenue gap for Jharkhand’s SEB
Projected revenue from Increase in Projected cumulative gap
power sales (Rsm) tariff (%) from FY03-12 (Rsm)
Revenue at existing tariff 20,460 0 101,410
Revenue (tariff) at which gap 121,870 496 0
from FY03-12 is met
Tariff at cumulative gap from 37,990 86 83,880
FY11-12 is met
At proposed tariff 30,940 51 90,930

Figure 138

. . . and writing off past Proposed phasing of the regulatory asset

dues over five years Year Regulatory asset Amount passed on
allowed (%) in ARR (Rsm)
2012-13 15 13,640
2013-14 15 13,640
2014-15 20 18,190
2015-16 25 22,730
2016-17 25 22,730
Total 100 90,930
Source: JERC, CLSA Asia-Pacific Markets

Uttrakhand
Uttrakhand had a 5.74% In Uttarakhand the regulator allowed a tariff hike of 5.74%. This, however,
tariff hike in its last order was much lower than the petitioner’s demand of a 31% hike. As per the
average revenue requirement (ARR), there was a revenue gap of Rs21.5bn.
The state asked for a 31% hike to meet its minimum cash requirement and to
recognise the balance as a regulatory asset. According to the regulator the
revenue gap was only Rs1.6bn, which only required a 5.26% hike with the
average cost of supply at Rs3.69/kWh.

Bihar
Bihar issued a 15-20% In Bihar a 15-20% tariff hike was approved by the regulator, though the increase
hike in tariffs is lower than that proposed by the state board (Source: Business Line). The
Bihar’s SEB incurs a loss of about RS14bn annually and has outstanding dues of
nearly Rs100bn, of which Rs70bn is owed by government departments.

Andhra Pradesh
State subsidies will cover Andhra Pradesh state government provides one of the highest subsidies to its
FY12’s revenue gap in agricultural consumers. However, the subsidy amount is already known to the
Andhra Pradesh
regulator while deciding upon the year’s tariff. This is in line with Section 65
of the Electricity Act. Consultation between the regulator and state
government helps reduce the occurrences when there is a huge gap between
‘subsidy booked’ and ‘subsidy received’ as has been the case for many states.

For Andhra Pradesh, the difference between the subsidy booked and subsidy
received was Rs33bn in FY09. The state government gave assurances it would
provide a Rs41.5bn subsidy for FY12. The Andhra Pradesh regulator fixed the
power tariff for FY12 to recover the full ARR with no under recoveries. The
state subsidy of Rs41.5bn fills the revenue gap left from the collection of
power tariffs and other operating income from distribution companies.

Tamil Nadu
No tariff petition was filed Tamil Nadu’s SEB is perhaps the best example of how not to run a state utility
from FY03-09 business. The board never filed a tariff petition from FY03-09, which basically
means there were no tariff revisions over that period. The accumulated losses

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were Rs168bn (US$3.7bn). While the SEB eventually filed a petition there is
no road map as to how past dues would be recovered. The new proposed
tariff structure still leads to incremental losses of Rs64-74bn every year for
the next three years.

Tariff orders lack past Tamil Nadu’s electricity regulators also have the view that a tariff hike to
dues recovery plans recover past dues is not pragmatic and would be a shock to consumers. The
revenue gap, as per their estimate, would be lower going ahead as compared
to the SEB’s assessment. The regulator has converted the past dues into a
regulatory asset. However, the tariff order does not give an indication of how
to recover it.

Figure 139

Revenue gap before and after proposed tariff hikes

(Rsm) SEB Regulators
FY11 FY12 FY13 FY11 FY12 FY13
Revenue with new tariff 212,600 228,414 247,174 200,410 213,929 228,545
Revenue with existing tariff 193,318 207,281 225,095 183,906 196,127 209,314
Increase in revenue 19,282 21,133 22,078 16,505 17,801 19,230
Revenue required from electricity sales 287,496 293,366 321,275 279,464 274,551 263,436
Revenue gap 74,896 64,952 74,102 79,054 60,622 34,892

Figure 140

Past dues converted Creation of a regulatory asset to bridge losses carried forward
into regulatory assets

Source: TNERC, CLSA Asia-Pacific Markets

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The Tamil Nadu government also approved a subsidy of Rs21bn for FY12, to
Tamil Nadu Generation and Distribution Corporation Limited (TANGEDCO), in
accordance with the Electricity Act, 2003, to cover the revenue shortfall,
subject to the extension of free electricity supply or tariff reductions.

Automatic tariff hikes

Losses may reduce We saw how many states took tariff hikes to eliminate or reduce revenue
merely by the rising share gaps and to recover the past shortfalls from customers. Interestingly, even if
of paying consumers
utilities do not impose any increases in coming years, the average utility
realisation will go on rising every year. This is because the share of segments
paying relatively higher tariffs (commercial, industry and residential) will rise
and the share of agricultural power consumption will decline. Even over the
past few years the rate of growth in power consumption by commercial
sectors has been the highest followed by residential and industrial.
Agricultural power consumption grew 1.5% over the past decade, far lower
than the other segments. As a result, the share of agriculture in overall power
consumption will continue to decline, pushing up average realisations.

Figure 141

Consumption growth has Electricity consumption growth by segment

been highest for
commercial and industrial 20 (%) Industry Agriculture Domestic Commercial
consumers
15

10

(5)

(10)
FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08

Figure 142

Agriculture demand Average annual power demand growth over the past decade
growth was only 1.5%
over the last decade . . . 10 (%) 9.3

9
8 7.2
7 6.2
6 5.4

5
4
3
2 1.5

1
0
Total Industry Agriculture Domestic Commercial

Source: CEIC, CMIE, CLSA Asia-Pacific Markets

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Figure 143

. . . if the trend continues, Average FY09 power tariffs across segments

average tariffs
automatically rise 4.5 (Rs/kWh) 4.3 4.2

4.0
3.3
3.5

3.0
2.4
2.5

2.0

1.5
0.9
1.0

0.5

0.0
Domestic Commercial Agricultural Industrial HT Industrial LT

Source: PFC Report, CLSA Asia-Pacific Markets

Reduction in AT&C losses

The R-APDRP scheme In our base case we assume a 1ppt reduction in AT&C losses per annum. In
aims to reduce losses by the government’s Revised - Accelerated Power Development Program (R-
15% over five years
APDRP) a 15% reduction in AT&C losses is targeted over 5 five years or a
3ppt reduction per year in towns with populations over 30,000. For towns
with losses of less than 30%, the target is 1.5ppt every year.

The total outlay of the scheme is Rs515bn (US$11bn). There are two parts of
the Scheme, Part A for setting baseline data and Part B for implementing
improvements.

Part A sets baseline data Part A of the scheme intends to establish baseline data via automatic meter
reading (AMR), geographical information system (GIS) mapping, SCADA
(supervisory control and data acquisition) adoption of IT facilities and other
tactics. Loans will be given to SEBs and distribution companies and the
government proposes to invest Rs100bn under Part A. Initially funds will be
issued as loans but they may be converted into grants, subject to conditions.

Involvement of India’s top IT companies raised hopes for quality work in

building the systems. A total of 11 IT implementation agencies (ITIA) were
appointed in states so far. States have also hired IT consultants to help guide
the process.

Figure 144

Top Indian IT companies IT implementation agencies

are involved in Part A Contractor State
TCS Madhya Pradesh
Spanco Punjab
TCS West Bengal
Infosys Karnataka
Infinite Uttrakhand
HCL Rajasthan
TCS Gujarat
Wipro J&K
HCL Jharkhand
HCL Himachal Pradesh
TCS Andhra Pradesh
Source: Media articles, CLSA Asia-Pacific Markets

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Part B handles actual Part B of the Scheme is for system improvement projects and India’s
infrastructure government proposes investing Rs400bn, which includes renovation,
improvement
modernisation and strengthening of 11kV-level substations, transformers,
transformer centres, reconductoring lines at 11kV levels and below, load
bifurcation, feeder separation, load balancing, high voltage distribution
system (HVDS) (11 kV), aerial bunched conductoring in dense areas,
replacement of electromagnetic energy meters with tamper proof electronic
meters, installation of capacitor banks and mobile service centres, etc. In
exceptional cases, where sub-transmission systems are weak, strengthening
to 33kV or 66kV levels is also considered.

Power theft is a non- Apart from R-APDRP, the government is taking other initiatives to reduce
bailable offence AT&C losses. As theft is one cause of high AT&C losses, legal provisions in the
Electricity Act, 2003, for dealing with electricity theft, were further
strengthened by the Electricity (Amendment) Act, 2007, making the offence
detectable and non-bailable.

We believe our estimate of 1ppt reduction in AT&C losses is conservative and

could be surpassed.

Figure 145

Some states showed AT&C loss trend in some states in FY10

meaningful improvement State name Distribution AT&C losses (%)
in AT&C losses in FY10 companies FY09 FY10 Change
Andhra Pradesh 4 16.2 13.0 (3.2)
Arunachal Pradesh 1 61.6 60.2 (1.4)
Assam 4 35.2 20.3 (14.9)
Bihar 1 47.4 34.4 (13.0)
Chhattisgarh 1 30.9 32.5 1.6
Goa 1 13.1 17.2 4.1
Gujarat 4 22.8 22.1 (0.8)
Haryana 2 33.0 33.3 0.3
Himachal Pradesh 1 17.2 12.9 (4.3)
Jammu and Kashmir 1 71.9 69.1 (2.9)
Jharkhand 1 58.2 59.0 0.8
Karnataka 5 32.1 25.7 (6.5)
Kerala 1 21.5 21.6 0.1
Madhya Pradesh 3 46.8 61.1 14.3
Maharashtra 2 31.3 31.2 (0.1)
Punjab 1 19.1 19.0 (0.1)
Rajasthan 3 33.0 29.5 (3.5)
Tamil Nadu 1 16.2 15.3 (0.9)
Uttar Pradesh 5 37.1 40.3 3.2
Uttaranchal 1 38.3 35.4 (3.0)
West Bengal 1 22.7 22.7 0.0
Source: Ministry of Power, CLSA Asia-Pacific Markets

Can states support SEB losses?

State guarantees diminish In the event of default by borrowing entities (ie state utilities), the respective
state governments are required to meet debt-service obligations. In order to
contain fiscal risks associated with guarantees, 18 states put ceilings in place
(statutory or administrative) on the guarantees (outstanding or incremental).
Over last few years state guarantees given to other entities for loans have
fallen in absolute value, as well as a percent of GDP. It’s down from 8% of
GDP in FY04 to under 3% in FY09. For example, in the state of Gujarat,
guarantees given to power distribution company, Gujarat Urja Vikas Nigam
Limited (GUVNL) over the past five years, halved.

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Figure 146

State guarantees have Total state guarantees (beyond power utilities)

been reducing over the
years 2,500 State guarantees % of GDP (RHS) 9
(Rsbn) (%)
8
2,000 7
6
1,500
5
4
1,000
3

500 2
1
0 0
FY92

FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09
Source: RBI, CLSA Asia-Pacific Markets

Figure 147

Guarantees halved State guarantees to GUVNL

50 (Rsbn) Guarantees for GUVNL (LHS) (%) 35

45 GUVNL as % of total state guarantees
30
40
35 25

30
20
25
15
20
15 10
10
5
5
0 0
FY06 FY07 FY08 FY09 FY10

Source: Gujarat Budget documents; CLSA Asia-Pacific Markets

Will there be enough demand for power generated in India?

A total of 400m Indians India has an estimated 400m people (more than the entire population of
are still without power United States) without access to power. Shortages consistently run at close to
or above double digit percentage levels. There are frequent power cuts across
most states and in some smaller cities and villages, power cuts may last eight
to 12 hours. As seen in the first section, per capita power consumption in
some of India’s larger states is one-twentieth of average per capita power
consumption in China. There is no doubt that demand exists at the end user
level to absorb current capacity as well as new additions.

In a bid to contain losses Despite this, state utilities backed out of power purchases from generators in
state utilities back down recent quarters. With no major elections pending, states were under no
on power procurement
pressure to procure power for most of FY11. A focus on loss containment
meant states started to back down on long term PPAs and preferred power
cuts over further expenditure. This was something most developers did not

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 Section 3: India - The hungry elephant Chindia power

expect. Loss of generation, due to backing down units on low schedules from
beneficiary states during the year 2010-11, has been reported as 9.7bn kWh
(1.5% of total power sold) by the generating utilities, which could be worth
Rs30bn (US$650m) assuming an average selling price of Rs3/kwh.

Figure 148

About a quarter of power Reasons for generation shortfalls in FY11

was lost due to a lack of
demand
Transmission
constrains
3% Coal shortage
Lack of demand 17%
23%

Poor quality coal

18%
Water shortage
6%
Project delays
33%

Source: CEA, CLSA Asia-Pacific Markets

Backing down could lead This is good news and bad news. The good is it shows state utilities are
to lower assets utilisation conscious of profitability and are willing to avoid buying power (especially
expensive power) to limit losses. It is bad because India is adding capacity at
an unprecedented pace. If the state utilities keep on backing down, the new
capacity may operate at low utilisation hours, which will be negative for
power generation utilities.

And negative political We believe the problem will continue, as there is more pressure on utilities to
repercussions control losses. However, infrastructure (power, roads, water) is becoming
important in national and local elections and governments will find it difficult
to justify rising power cuts. Hence state utilities will have to find a fine
balance between backing down and buying power.

Increased buying power As shown earlier, most states have done well in limiting utility losses and
for distribution companies some are taking serious actions on tariffs, which will help close the revenue
gap. Thus the ability of states to buy more power will also increase. In our
base case assumptions we take a moderate 1ppt per annum reduction in
AT&C losses and a 5% per annum increase in national power tariffs.

Taking these assumptions we believe power supply from Indian state utilities
can increase by an 11% Cagr during FY11-14 (with power purchase from
generators increasing at a 9% Cagr) without increasing losses substantially.
We also believe our assumption of AT&C loss reduction at 1ppt per annum
(versus the government target of 3ppt) and the tariff hike of 5% per annum
can be surpassed.

Merchant power plants However, this leaves power generators with high costs, and those which do
vulnerable not have firm supply commitments, vulnerable. Thus a lot of merchant power
capacity in the country will be at risk of insufficient demand and low
utilisation levels.

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Sensitivity of short-term purchases on power costs

Total power purchase Karnataka state regulators studied the impact of buying more short term
costs are sensitive to power on overall utility-distribution costs. The exercise was carried out with
merchant tariffs
two basic scenarios:
‰ Normal monsoon rains (June to September period when there is rainfall
and thus there is higher hydro power generation) - in which the total
short-term power purchased was 7,286mkWh.
‰ Monsoon rains 20% lower - in which the total short-term power
purchased was 9,634mkWh - an increase of 2,348mkWh or 32%.

Figure 149

Tariff increase by 6% in Karnataka power costs

hydro generation is lower
Source Normal monsoon Lower monsoon
due to 20% less rains
mkWh Cost (Rsm) mkWh Cost (Rsm)
KPC-Hydro 11,876 6,833 9,528 5,482
KPC-Thermal 12,114 37,826 12,114 37,826
CGS 11,507 26,522 11,507 26,522
IPPs 716 6,025 716 6,025
NCE 4,082 14,842 4,082 14,842
Lanco 1,930 6,025 1,930 6,025
Short term 7,286 29,144 9,634 38,535
Total 49,511 127,216 49,511 135,257
Increase over FY10 5,135 17,451 5,135 25,491
Increase (%) 11.6 15.9 11.6 23.2
Avg power purchase cost (Rs/kWh) 2.57 2.73
Increase in avg cost (Rs/kWh) 0.10 0.26
Increase (%) 3.9 10.4
Source: KPCL, CLSA Asia-Pacific Markets

In the normal monsoon scenario, average power purchase costs increased by

3.9% YoY. However, in the lower monsoon scenario, about 5% of power is
purchased on a short-term basis instead of from existing hydro power
projects. Hence power tariffs increase 10.4% YoY and the overall power cost
goes up by 6% which is a significant increase for a loss making utility.

Figure 150

Sensitivity of power costs Percent of increase in power purchase costs

to merchant tariffs (%) Normal monsoon Lower monsoon
Short term tariff of Rs3/kWh (2.1) 2.6
Short term tariff of Rs4/kWh 3.9 10.4
Short term tariff of Rs5/kWh 9.8 18.3
Source: KPCL, CLSA Asia-Pacific Markets

Short term tariffs corrected 37% over the past two years
Merchant tariffs on a two- State utilities are sensitive to high power costs (except in election months).
year downtrend As a result merchant power tariffs, - which many thought was the lever to
higher returns (and will remain high for extended periods), have corrected in
recent quarters.

The sales volume of short-term power (excluding Uninterrupted Interchange -

UI) in FY11 increased by 33% YoY while the money spent on buying this
power increased by only 15% implying a sharp correction in tariffs.

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 Section 3: India - The hungry elephant Chindia power

Figure 151

The average merchant Merchant power tariffs

tariff for FY11 was
Rs4.5/kWh 10 (Rs/kWh) Merchant tariff Peak deficit (RHS) (%) 15
9 14
7.7
8 13
6.8
7 6.1
5.9 12
6 5.5
5.2
4.8
5.0 5.0 4.8
4.7 4.8
4.7 5.0
4.7 4.1 11
4.6
5 4.5 4.1 4.3
3.6 3.4 3.8 10
4 3.5
9
3
2 8
1 7
0 6
Jul 09

Nov 09
Dec 09

Jul 10

Nov 10
Dec 10
May 09
Apr 09

Jun 09

Aug 09
Sep 09
Oct 09

Feb 10
Mar 10

May 10

Sep 10
Jan 10

Apr 10

Jun 10

Aug 10

Oct 10

Feb 11
Mar 11
Jan 11
Source: CERC, CLSA Asia-Pacific Markets

Figure 152

Short term power sales Short-term market in FY10-FY11

increased by 33% in FY11 mkWh FY10 FY11 % YoY
Short term power- excluding UI (mkWh) 40,095 53,479 33.4
Total short term power 65,901 81,557 23.8
UI sales 25,806 28,078 8.8
Rsm
Money spent on short term power 209,266 239,757 14.6
Money spent including UI 328,446 349,550 6.4
UI sales 119,180 109,793 (7.9)
Rs/kWh
Avg realisation 5.2 4.5 (14.1)
Avg realisation - including UI 5.0 4.3 (14.0)
UI realisation 4.6 3.9 (15.3)
Source: CEA, CERC, CLSA Asia-Pacific Markets

Figure 153 Figure 154

Share of short term sale Short term sales in FY10-FY11 Proportion of different modes
through exchanges
90,000 (mkWh) Bilateral Exchanges UI (%) Bilateral Exchanges UI
has risen 100
80,000
70,000
80
60,000
50,000 60
40,000
30,000 40
20,000
20
10,000
0 0
FY10 FY11 FY10 FY11

Source: CERC, CLSA Asia-Pacific Markets

Merchant tariffs and utilisation levels at risk

Merchant tariff under With a substantial amount of long term PPA based on installed-power capacity
pressure in the future over the next few years, a large part of incremental demand will be fulfilled
by long-term capacity. Moreover, the government’s decision to prioritise coal
supply for the plants with long- term supply agreements would mean that
most of the merchant power capacity may not get domestic coal and will have
to depend on imported coal, increasing their expenses.

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Plants with long-term Even if our assumption of strong demand and supply growth in the country
PPAs in a better position does not materialise, the impact on power plants having long-term PPAs will
not be significant as most can recover fixed costs as long as they make plants
available for generation. They may have to take a hit on incentives but that
will not have a significant impact on earnings. Merchant power plants on the
other hand could face low demand, which pressures tariffs.

Sustainable tariffs for the sector

We expect sustainable We expect generator’s tariffs to settle in the range of Rs3.25-3.50/kWh on a
tariffs of Rs3.25-3.5/kWh steady basis. Most state regulators have not approved higher bids. Our
calculations also show companies make decent ROE at that level (except ones
fully dependent on imported-thermal coal).
Figure 155

Fixed and variable tariffs for a coal-based plant under different scenarios

(Rs/kWh) Fixed cost Variable cost

5 200km 800km 1,250km

0
100% domestic

100% domestic

100% domestic
100% imported

70% domestic +

30% domestic +

100% imported

70% domestic +

30% domestic +

100% imported
e-auction; 65% linkage)

e-auction; 65% linkage)

e-auction; 65% linkage)

70% domestic +

30% domestic +
30% imported

70% imported

30% imported

70% imported

30% imported

70% imported
100% domestic (35%

100% domestic (35%

100% domestic (35%

Figure 156

This is sufficient to Power tariff for coal-based power projects with 20% ROE
ensure 20% equity IRR Rs/kWh Fixed cost Variable cost Total tariff
in most cases At 200km from the mine head/port
100% domestic 1.61 0.80 2.42
100% domestic (35% e-auction; 65% linkage) 1.61 0.96 2.57
100% imported 1.61 2.35 3.97
70% domestic + 30% imported 1.61 1.50 3.11
30% domestic + 70% imported 1.61 2.06 3.68
At 800km from the mine head/port
100% domestic 1.61 1.26 2.87
100% domestic (35% e-auction; 65% linkage) 1.61 1.42 3.03
100% imported 1.61 2.60 4.21
70% domestic + 30% imported 1.61 1.86 3.48
30% domestic + 70% imported 1.61 2.35 3.97
At 1,250km from the mine head/port
100% domestic 1.61 1.60 3.21
100% domestic (35% e-auction; 65% linkage) 1.61 1.76 3.38
100% imported 1.61 2.79 4.40
70% domestic + 30% imported 1.61 2.14 3.75
30% domestic + 70% imported 1.61 2.57 4.18
Source: CLSA Asia-Pacific Markets

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Figure 157

The recent Case 1 bids Case-1 bid trends

have been in the range of State Date Quantum Developer Levelised tariff PPA signed
Rs3.5-5.5/kWh (MW) (Rs/kWh) (Yes/No)
GUVNL -1 Dec 06 1,000 Adani 2.890 Yes
GUVNL -2 Jan 07 200 Aryan 2.250 Yes
1,000 Adani 2.350 Yes
GUVNL -3 Jan 07 1,000 Essar 2.401 Yes
HPPGCL Dec 07 300 PTC- GMR 2.906 Yes
1,424 Adani 2.940 Yes
MPPTC Dec 07 150 Essar 2.450 Yes
1,250 Reliance 2.700 Yes
MSEDCL- 1 Mar 08 1,320 Adani 2.642 Yes
684 Lanco 2.720 Yes
300 JSW 2.729 Yes
MSEDCL- 4 Sep 09 200 Emco (GMR) 2.880 Yes
1,200 India Bulls 3.270 Yes
1,325 Adani 3.294 Yes
RRVPNL Dec 09 1,200 Adani 3.248 Yes
KPTCL Mar 10 150 PTC - Monnet Ispat 3.757 Yes
400 PTC - Thermal Powertech 3.771 Yes
200 PTC - Meenakshi Energy 3.801 Yes
600 JSW 3.812 Yes
400 PTC - NCC 3.889 Yes
200 PTC - East Coast 3.889 Yes
GUVNL Mar 10 1,010 KSK 2.345 Yes
800 Shapoorji Pallonji 2.800 Yes
1,000 Essar 3.135 Yes
BSEB Mar 10 450 Essar 3.050 Yes
UPPCL -1 Feb 11 300 Adani 4.727 No
120 Lanco 5.563 No
400 RKM Power Gen 4.586 No
100 Vandana 4.683 No
UPPCL -2 Feb 11 300 PTC - Athena 3.324 No
2,456 Reliance 3.700 No
200 Jaypee 3.900 No
680 Lanco 4.283 No
160 PTC - KVK 4.413 No
200 PTC - Indbharat 4.810 No
APCC Feb 11 500 NCC 3.688 No
200 PTC - Athena 3.667 No
580 PTC - Hinduja 3.448 No
620 PTC - East Coast 3.478 No
500 Thermal Power Tech 3.688 No
NPCL Feb 11 240 Essar 4.090 No
200 Visa 4.190 No
50 Jaypee 4.230 No
200 Videocon 4.310 No
200 Adani 4.490 No
50 Dans 5.410 No
Source: Infraline, CLSA Asia-Pacific Markets

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Power projects based on Power generators dependent solely on domestic coal from Coal India would
domestic coal would have have to source 25-30% of their requirements from other sources. One option
to source 25-30% of coal
is to source some from e-auction, which is held by Coal India for 10-11% of
from other sources
its production. However e-auction coal sells at a premium to normal Coal
India prices - for FY11 the premium was 80%. The effective premium reduces
the further a plant is from the mine head.

Figure 158

Premium of e-auction coal Landed price of linkage and e-auction coal at various distances from mines
reduces as distance from
the mine increases 3,500 (Rs/t) Landed price of linkage coal (%) 80
Landed price of e-auction coal
3,000 Premium of e-auction coal (RHS) 70

60
2,500
50
2,000
40
1,500
30
1,000
20
500 10

0 0
(km) 200 350 500 650 800 950 1,100 1,250 1,400

Source: Ministry of Coal, CLSA Asia-Pacific Markets

The tariff for earning a 20% ROE (on invested equity) is about Rs3/kWh for
Adani and Lanco at their current cost structures. However, for JSW Energy,
which sources most of its coal from the spot market, the tariff should be
about Rs4/kWh to make 20% ROE.

Figure 159

Adani and Lanco require a Tariff required for earning 20% ROE (on invested equity)
tariff of about Rs3/kWh
Adani Power Lanco Infratech JSW Energy
to make a 20% ROE
Units available for sale (mkWh) 22,729 23,702 18,889
Fuel cost (Rsm) (27,659) (40,743) (52,305)
Operation and maintenance cost (Rsm) (3,594) (3,974) (3,504)
Depreciation (Rsm) (6,294) (6,676) (4,098)
Interest (Rsm) (16,572) (10,246) (7,699)
Taxes (Rsm) (2,576) (2,028) (1,663)
Equity invested (Rsm) 51,520 40,552 33,252
ROE (assuming 20%) - Rsm 10,304 8,110 6,650
Total revenue (Rsm) 66,998 71,778 75,920
Tariff (Rs/kWh) 2.95 3.03 4.02
Source: CLSA Asia-Pacific Markets

Painful PPAs
Aggressive PPAs could Some power developers have signed PPAs with very aggressive terms (no
hurt in the future escalation; capped overall tariff, etc) over the past two to three years. With
changes in sector dynamics, many companies are trying to wriggle out of the
agreements or trying to re-negotiate the terms (see Figure 160). However,
that may not be easy and some units may make losses.

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 Section 3: India - The hungry elephant Chindia power

Figure 160

Painful PPAs
Company Project PPA quantum PPA terms Current status
(MW)
Lanco Amarkantak II 300 ‰ Regulated return project subject to an overall ‰ The company is currently selling power from this
limit equal to the levelled tariff for the first 12 plant in the UI market.
years at the rate of Rs2.25/kWh and ‰ The company is also trying to remove the two
Rs2.34/kWh over 25 years. cap conditions on overall tariff and fuel cost
‰ Annual fuel-cost escalation of capped at 5%. escalations in the PPA.
‰ HERC (Haryana regulator), in its Feb 2011
order, directed Lanco to adhere to the original
PPA and restrained the company from selling
power to third parties.
Adani Mundra III 1,000 ‰ Adani signed a PPA for this project with ‰ Adani Power has unilaterally cancelled the PPA
Power GUVNL at a Rs2.35/kWh tariff for 25 years with GUVNL citing the company has not been
with no escalation for any component. provided with a coal block for the project, which
was part of the original understanding.
‰ The regulator clarified that in a Case- 1
competitive bidding process, fuel supply is the
responsibility of the power supplier (Adani
Power) and not the buyer (GUVNL). Hence, non
availability of fuel cannot be used as an excuse
to break the contract.
JSW Ratnagiri 300 ‰ MSEDCL and JSW signed the PPA for 300MW ‰ JSW Energy approached Maharashtra’s power
Energy supply of power on 15 January 2009. regulator for permission to increase power
‰ The 25-year normalised tariff is tariffs after the state government’s distribution
Rs2.72/kWh.The fuel cost will be escalated as utility Mahavitaran refused its request to
per the CERC determined inflation formula. increase the tariff because of the increase in fuel
costs.
Source: CLSA Asia-Pacific Markets

PPAs with passthrough

CERC gives the escalation Some companies have used escapable and nonescapable tariff components
rates on a six monthly while bidding for Case-1 and Case-2 power projects. Central Electricity
basis Regulatory Commission (CERC), on a six monthly basis, provides the
escalation rates for the purpose of bid evaluation and payments. However, the
actual expense incurred by the company could be different from the ‘allowed
expenses,’ based on rates specified as per CERC.
Figure 161

Escalation rates for Escalation rate for bid evaluation and payments for April - September 2011
competitive bidding S. no Description Annual escalation rates Annual escalation
based power plants for bid evaluation rates for payment
(%) (%)
1 Escalation rate for domestic coal 6.66 0.00
2 Escalation rate for domestic gas 2.42 187.59
3 Escalation rates for different escapable sub-components for plants based on imported coal
3.1 ‰ Escalation rate for coal sub-components¹ 14.02 34.43
3.2 ‰ Escalation rate for transportation sub-components 15.99 24.30
3.3 ‰ Escalation rate for inland-handling sub-components 5.21 9.09
4 Escalation rate for coal inland-transportation charges
4.1 ‰ Up to 100 Km distance 2.38 0.00
4.2 ‰ Up to 500 Km distance 2.05 0.21
4.3 ‰ Up to 1000 Km distance 1.88 0.21
4.4 ‰ Up to 2000 Km distance 2.44 0.22
4.5 ‰ Beyond 2000 Km distance 2.55 0.22
5 Escalation rate for gas inland-transportation charges 2.97 11.81
6 Escalation rates for different escapable sub-components for plants based on imported gas
6.1 ‰ Escalation rate for gas sub-components 12.55 6.12
6.2 ‰ Escalation rate for transportation of gas sub-components 15.99 24.30
6.3 ‰ Escalation rate for inland-handling sub-components 5.21 9.09
7 Inflation rate to be applied to indexed-capacity charge 5.21 9.09
components
8 Inflation rate to be applied to indexed-energy charge 5.57 9.55
components in the case of captive fuel sources
¹ Composite series using weight of 50% to API4 (Price of South African Coal), 25% to BJI/Coalfax (Price of
Australian Coal) and 25% to Global Coal (Price of Australian Coal); Source: CERC, CLSA Asia-Pacific Markets

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Power stocks
China top picks: CRP, CPI Our top utility picks are NTPC, Power Grid and Tata Power in India and
CRP and CPI in China. Investors with higher risk appetite could also consider
India top picks: NTPC,
Adani Power, CESC and Lanco Infratech.
Power Grid, Tata Power

While the Indian power sector is experiencing growth acceleration, China’s is

slowing down. Thus, India is a better market for investors looking for growth.
However, coal supply will be a major risk. Hence, we prefer utilities with low
coal supply risk which are NTPC, Power Grid and Tata Power. CRP in China
offers return ratios similar to NTPC and Power Grid in India, although with
higher volatility. This is reflected in its valuations which are at discount 20-
30% to comparable Indian peers on a PE and PB basis. We believe
Longyuan’s growth will be negatively impacted by grid constrains in China.

Figure 162
Power utilities’ outlook
Coal cost in India should China India
increase by more than Coal prices ‰ Contract coal prices likely to continue ‰ We expect domestic coal prices to rise by
5% per year due to to go up by about 5% per annum around 5% per annum.
driven by coal shortage and cost push.
higher imports ‰ International coal prices should decline
‰ We expect spot prices to marginally which helps Indian power generators to
decline from current high levels as some extent.
international coal prices decline and ‰ However, the proportion of higher-cost
government also applies pressure. imported coal will rise and thus, overall
Overall coal cost increase
for IPPs should be much ‰ Coal price to increase but will not be rise in coal prices will be more than 5%
significant. per year.
less in China
Growth in ‰ Overall capacity addition in the ‰ Power capacity has picked up in past couple
power country likely to remain flat. of years and should continue to grow.
capacity ‰ Most utilities are planning to go slow ‰ For many private utilities, growth in
Capacity addition by in power-capacity addition due to low capacity is quite high from a low base.
China IPPs to be flat; profitability and stretched balance
strong growth for Indian sheets. Government may inject
power companies capital into IPPs to ensure ongoing
projects are built.
‰ We do not expect any major pick up
in capacity addition due to power
shortages.

Utilisation ‰ Power-capacity utilisation hours are ‰ Utilisation hours in India are much higher
Utilisation levels to levels likely to go up in the near term and than in China and are likely to remain flat.
increase in China; flat stabilise at reasonably high levels They may go down a little due to
to down in India longer term given power shortages. insufficient coal supply. We expect 75-80%
utilisation for most new coal capacity under
long term PPAs. Utilisation levels for
merchant power capacity could be 60-75%.

Tariffs rise for residences Power tariffs ‰ The government has recently hiked ‰ Retail power tariffs will go up as states
and agriculture in India power tariffs in 15 provinces. Power try to reform the power sector and
and for industry in China shortages should remain a pressure reduce state-utilities losses. However,
point and we expect more tariff hikes. expect merchant power tariffs to be
under pressure and continue to decline.
Profitability of China IPPs Profitability ‰ We believe power utilities have seen ‰ Most power generators have been earning
to increase from low base the worst on the profit side over the healthy returns while merchant power
past few years. With coal prices plants have been earning super-normal
unlikely to go up substantially, the returns. We expect some dip in
tariff hike required for efficient IPPs to profitability of plants with long-term PPAs
earn reasonable returns should not be due to coal constrains and a big decline in
high. We believe the government will merchant power profitability due to lower
In India, profits for
be able to take the required tariff hikes merchant tariffs and higher coal price.
long-term PPAs to see a and IPP profitability will improve.
small dip; big dip for
merchant power Net gearing ‰ The balance sheets of China IPPs are ‰ NTPC has relatively low gearing but most
in bad shape. A slowdown in capacity private IPPs have high net gearing.
addition and improved profitability
will help gradual improvement in
balance sheet.

Source: CLSA Asia-Pacific Markets

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 Section 4: Power stocks Chindia power

BHEL and Crompton We prefer Indian equipment suppliers over Chinese suppliers due to better
Greaves are our top picks. growth and higher return ratios. Our top picks are BHEL and Crompton
Shanghai Electric should
Greaves. We also like Voltas and Thermax in India, although both
outperform peers in China
companies could face near-term head winds.

GCL-Poly and Trina In China, we prefer Shanghai Electric which is better positioned to catch a
are our top picks for higher share of the market versus peers. The strong growth in China’s high-
solar equipment
voltage T&D market can be played via global majors such as ABB, Siemens
or A-share listed T&D firms. For solar equipment, our top picks are GCL Poly
and Trina Solar. The tables below outine the outlook for power-equipment
suppliers and utilities.
Figure 163

Power-equipment suppliers’ outlook

Strong growth in both China India
power generation and Market size ‰ Power-capacity addition has stagnated ‰ Power capacity addition will continue to
T&D in India over the past few years and will remain go up and the market for both
at current levels. However, high voltage generation and T&D equipment should
T&D spend should expand rapidly. grow at a healthy pace.
China moving to more Mix of new ‰ Mix is rapidly changing with stagnant ‰ Unlike China, India’s wind-power
non-fossil fuel power; in capacity thermal power capacity additions and potential is limited. Nuclear will take
rise in wind, solar and nuclear power. time to develop. Therefore, over the
India coal’s share will rise
Annual wind power installation has next few years coal will remain the
grown substantially and future growth dominant technology. We expect a
will be low. Growth in solar and nuclear major pick up in solar-power capacity
installations will remain strong, though addition in a few years.
nuclear installation will be slower than
earlier expectations. We also expect
more gas capacity addition.
Competition in thermal Competition ‰ Three players are likely to dominate the ‰ BHEL should dominate the thermal-
power heats up in India thermal-power equipment market . power market but several new
domestic and foreign competitors have
‰ These three players will also dominate
emerged.
the nuclear market although there is
likely to be competition for some ‰ Nuclear power is likely to be dominated
components from the likes of CFHI and by BHEL and L&T.
China Erzhong.
‰ Suzlon is the leading player in wind
‰ Significantly higher competition for wind power. Competition is increasing.
with Sinovel and Goldwind holding No. 1
‰ Solar is in its nascent stage. BHEL
and No. 2 positions.
undertakes small solar PV and solar
‰ GCL Poly is the most competitive thermal projects. It is planning a
polysilicon producer globally. Trina is a bigger presence in a joint venture with
leading integrated panel maker. Bharat Electronics. Tata Power has a
presence in solar through its JV Tata-
‰ Global majors have a strong presence in
BP solar.
high voltage T&D market through JVs.
‰ High voltage T&D market dominated
by two domestic and three global
majors.
New orders could fall Order ‰ Orderflow over the last couple of years was ‰ New orderflow has been strong for
sharply in China due to outlook boosted by nuclear power and large generation companies and weak for
overseas orders. Both are expected to T&D companies. We expect generation
lower nuclear and
decline sharply and new orders should fall. orders to be stable while a sharp pick
overseas orders is expected in T&D orders.
Revenue ‰ Revenue Cagr over next few years likely ‰ Revenue growth likely to be around
Chinese suppliers: 5-10%
growth to be in the range of 5-10% for listed 15% for power generators as well as
revenue Cagr; Indian players, mainly driven by nuclear power T&D equipment suppliers given strong
suppliers: 15% Cagr and expansion into overseas markets. industry growth.
Margin ‰ Margins may be helped slightly by wider ‰ Ebitda margins for BHEL should
Net profit margins outlook margins on nuclear-power related revenue. increase helped by falling employee
flat in China; should costs as a percentage of sales.
‰ However, rising staff and admin
improve in India
expenses also put pressure on margins. ‰ For T&D equipment suppliers margins
Overall, margins likely to remain flat. should be flat to marginally up.
‰ Net profit margins may not widen due to ‰ Net profit margins should improve
higher tax rates. marginally.
Balance ‰ Strong balance sheets with substantial ‰ Strong balance sheets with substantial
sheet cash from customer advances. cash from customer advances except
for Suzlon.
Source: CLSA Asia-Pacific Markets

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Figure 164
Investment strategy
China India
In China, stick with Power ‰ Government tariff hike will allow most ‰ Avoid companies with too much coal
efficient IPPs; in India to utilities efficient companies to earn healthy supply risk and too much merchant
those with less coal and returns. power.
merchant power risk ‰ Stick with the most efficient companies ‰ Stick to players which have most of
and companies which have captive their capacity tied up in long-term
coal assets and exposure to non- contracts and have less risk on coal
thermal power assets. supplies.
In India, stick with Equipment ‰ Growth unlikely to be strong and ‰ Growth should be strong in the next few
market leaders; in China suppliers dependent on overseas markets. We years although competition will rise.
choose those better prefer companies with track
‰ Stick with players with proven track
records/capability in overseas markets.
placed to export records and reasonable valuations.
Source: CLSA Asia-Pacific Markets

Valuations - Power utilities

In all our valuations we have used financials for year ending 31 March 2011
for 2010, and 31 March 2012 for 2011 and so on for Indian companies with a
March year end. For CESC in India, we have not included the impact of retail
subsidiaries in the financials.
Figure 165

Indian power utilities Power utilities - PE multiples 2012

trade at slightly higher
PE multiples (x) 58.9
16 13.8
13.6 13.6 13.2
14 12.8 13.0 12.7
12 10.2
CRP is among the cheaper 10.0 10.0
utilities in the region 10 9.3

8 7.3 6.8
on PE basis 6.6
6
4
Jindal Steel & Power
China Power Intl
Datang Intl Power
China Res Power
Huadian Power

Adani Power
Longyuan Power

Huaneng Power

Power Grid

Tata Power
JSW Energy

Lanco Infratech
NHPC

NTPC

CESC

Figure 166

Except for Longyuan and Power utilities - PB multiples (2011)

CRP all Chinese utilities
trade under 1x PB 3.5 (x) 3.1 3.0
3.0
2.5
2.0 2.0
2.0 1.8
1.7 1.6
Ex-CESC, Indian utilities 1.5
trade at over 1x PB 1.5 1.1 1.1
0.9 0.8
1.0 0.7
0.6 0.5
0.5
0.0
Jindal Steel & Power
Datang Intl Power

China Power Intl

China Res Power

Huadian Power

Adani Power
Longyuan Power

Huaneng Power

Power Grid

Tata Power

JSW Energy

Lanco Infratech
NTPC

NHPC

CESC

Source: CLSA Asia-Pacific Markets

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 Section 4: Power stocks Chindia power

Figure 167

Higher PB multiples of Power utilities - ROE (2012)

Indian companies are
30 (%) 29.3
justified by higher RoEs 26.9
25
20 18.9

CRP’s ROE is higher than 13.8 14.6 14.6 13.9

15 12.4 11.4
Longyuan. Adani Power’s 11.1
9.3
ROE is c.3x that of JSW 10 8.5 7.8
5.8
Energy 5
0.8
0

Jindal Steel & Power

China Power Intl
Datang Intl Power
China Res Power

Huadian Power

Adani Power
Longyuan Power

Huaneng Power

Power Grid

Tata Power
Lanco Infratech

JSW Energy
NTPC

CESC

NHPC
Figure 168

On EV/Ebitda Indian Power utilities - EV/Ebitda multiples (2012)

companies are
cheaper than Chinese (%)
counterparts . . . 10 9.5
9.0 8.7
9 8.4
7.7 7.7 7.6
8 6.9
6.6 6.4
7 6.4 6.3 5.9
6 5.2
5
4
3
2
Jindal Steel & Power
China Power Intl

Datang Intl Power

China Res Power

Huadian Power

Adani Power
Longyuan Power

Tata Power
Huaneng Power

Power Grid
JSW Energy

Lanco Infratech
NTPC

NHPC

Figure 169

. . . due to lower Ebit Power utilities - Ebit margins (2012)

margins of China IPPs
60 (%) 56.0
52.6
50 44.9
36.1 37.6
40
Adani Power and JSPL’s
Ebit margins are higher 30 23.9
20.8 20.1 19.5
than Longyuan - which is 20
18.5 17.2 15.9 15.6
a wind power company! 8.3 7.7
10
0
Jindal Steel & Power
China Power Intl

Datang Intl Power

China Res Power

Huadian Power

Adani Power
Longyuan Power

Tata Power
Huaneng Power

Power Grid

JSW Energy

Lanco Infratech
NHPC

NTPC

CESC

Source: CLSA Asia-Pacific Markets

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Figure 170

… and higher net gearing Power utilities - Net gearing (2012)

of the Chinese utilities
(%)
600
500
500 417
400 325
311
300 259
226
199
200 149 149 139 130
CRP has the lowest 89 76
gearing among China 100 45 42
IPPs and NTPC, NHPC 0
among Indian power cos

Jindal Steel & Power

Datang Intl Power

China Power Intl

China Res Power

Huadian Power

Adani Power
Huaneng Power

Longyuan Power

Power Grid

Tata Power
Lanco Infratech

JSW Energy

CESC

NTPC

NHPC
Figure 171

Despite low profitability, Power utilities - Dividend yield (2011)

high gearing China IPPs
pay decent dividends . . . 3.5 (%)
3.0 2.8 2.7 2.7 2.6 2.6 2.5 2.4
2.5 2.3
2.0 1.8
1.7
1.5 1.0
1.0 0.5
0.5 0.3
0.0 0.0
. . . and do frequent
0.0
equity issuances on the

Jindal Steel & Power

China Power Intl

Datang Intl Power

China Res Power

Huadian Power

Adani Power
Huaneng Power

Longyuan Power

Power Grid

JSW Energy

Tata Power

Lanco Infratech
NHPC

NTPC

CESC
other hand

Figure 172

A very high correlation ROAE versus PB

between PB and ROEs
3.5 11CL PB (x)
JSPL
Adani

3.0

2.5
Indian players with
Power Grid
captive mines offer NTPC
2.0 CLP
highest RoEs Tata Power
Longyuan
1.5 JSW Energy
NHPC
CRP Lanco

1.0 Huaneng
CESC
CRP’s offers far higher
Huadian
returns than other 0.5 Datang
CPI
China IPPs Three-year ROAE (%)
0.0
(2) 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32

Source: CLSA Asia-Pacific Markets

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Figure 173

Relation between PEs PE versus EPS Cagr

and earnings growth
is weaker . . . 30 10CL PE (x)

25 Longyuan

20
China Everbright Int'l
. . . due to risks
NHPC NTPC
to growth JSPL
15 CLP Huaneng Power Grid

Tata Power
CRP Lanco
JSW CPI
10 Datang

CESC Earnings Cagr 2010-12 (%)

5
(10) 0 10 20 30 40 50

Figure 174

Among China IPPs, CRP Power utilities’ current PE multiples versus history
and CPI trading at a
1 yr fwd PE (x) Peak cycle
discount to history Mid cycle
Current
30
Trough cycle
25
20

Most India IPPs trading 15

at discount to history 10
reflecting concern on
coal supply, SEB losses 5
0

Longyuan
Power Grid
CESC

Datang

Huadian

Huaneng
JSPL

NTPC

NHPC

CLP
JSW

Tata Power

CRP
Adani

Lanco

CPI

China Everbright
Int'l

Figure 175

On PB, all China IPPs Power utilities’ current PB multiples versus history
trading at discount to
1 yr fwd PB (x) Peak cycle
history given low returns Mid cycle
7 Current
Trough cycle
6
5
Adani, JSW Energy and 4
NHPC are trading near
all-time lows 3
2
1
0
Longyuan
Power Grid
CESC

JSPL

NTPC

NHPC

Datang

Huadian

Huaneng
JSW

Tata Power

CLP

CRP
Adani

Lanco

China Everbright
CPI

Int'l

Source: CLSA Asia-Pacific Markets

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Power utilities - Our top picks

Top picks China: CRP, CPI Our top utility picks are NTPC, Power Grid and Tata Power in India and
CRP and CPI in China. Investors with higher risk appetite could also consider
Top picks India: NTPC,
Adani Power, Lanco and CESC. CRP in China offers return ratios similar to
Power Grid, Tata Power
NTPC and Power Grid in India, although with higher volatility, as coal costs
are not passed through. This is reflected in valuations which are at 20-30%
discount to comparable Indian peers on both a PE and PB basis.

Current shortages will Ongoing power shortages should help CRP’s coastal plant operate at better
boost CRP’s utilisation utilisation rates. Some of the company’s proposed coastal projects have been
rate
awaiting government approval for a long while. Shortages make it more likely
that it will gain these approvals, boosting future growth. With rising captive
coal production, its dependence on external coal will decline and earnings
should be more predictable.

CPI is has high hydro We like CPI because of its hydro-power exposure which allows it to earn
exposure and cheap reasonable returns. Valuations are also near all-time lows. At 7.3x 2012 EPS
valuations
and 0.5x PB, CPI is the cheapest power utility in Chindia.

Only the most efficient We have SELL ratings on Huadian and Huaneng and an Underperform on
players are likely to earn Datang. While that the Chinese government will likely inforce more tariff
ROE higher than CoE
hikes, they are likely allow the most efficient players to earn returns higher
than their cost of equity. While government would like to use tariff hikes as a
tool to enforce energy efficiency, high inflation remains a concern. The
government would also like to keep the pressure on IPPs to improve their
efficiency. We believe financial performance of Huadian, Huaneng and Datang
will improve substantially, but they will continue to earn return on equity
lower than the cost of equity, which is reflected in their valuations and we do
not see significant upside.

Longyuan is China’s largest wind-power generator and offers decent return

ratios and high growth. However, a lot of this is already reflected in the
valuations at 18x 2011 earnings. We believe the grid constrains in China will
continue to curtail its power generation. The grid situation in China is likely to
worsen before it improves. Hence we are negative on both wind-power
generators and equipment suppliers. A better way to play the wind-power
sector in China is through T&D equipment suppliers.

Indian power companies Top picks in Indian power companies

offer much higher growth Indian power companies offer far higher growth than Chinese IPPs. Some of
the private power companies are set to grow their capacities multifold over
the next few years. However, they are also likely to face risk of massive coal
shortages, which we believe will be the biggest constraint faced by the Indian
power sector over the next few years.

We prefer NTPC and We prefer companies with relatively slower but almost certain growth such as
Power grid as their profits NTPC and Power Grid. Both state-owned companies earn almost all of their
are driven by regulated
profits from regulated return projects. The companies have a big project
return projects
pipeline which can take care of the capex over the next five to 10 years.

NTPC is better placed According to the government’s policy on coal linkages, the first preference for
than private players for coal linkages is Central, State and Case 2 projects. These projects will get
coal supply
60% of the coal, with 35% going to other projects. We believe NTPC will get a
preference over private companies in coal supply. Moreover, NTPC has also
been allotted six captive coal mines with total reserves of 6bn tonnes. The
first of these mines, Pakri Barwadih, is expected to start production in FY13.
This will also help alleviate the coal shortages faced by NTPC.

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Strong capex on Power Grid owns almost all the interstate-transmission capacity in India.
transmission capacity Unlike power generators, it does not face coal shortages. However, if
will drive growth
generation projects are substantially delayed, it may have to delay its
for Power Grid
transmission projects. We have already built these delays into our estimates.
Strong capex on inter-state transmission and build out of national corridors
should drive strong capex and earnings Cagr for Power Grid.

Tata Power is the only Tata Power is the only power utility in Chindia that is net long on coal
utility in Chinda that is through its ownership of a 30% stake in coal mines of Bumi Resources of
net long on coal
Indonesia. These mines will also supply coal for its 4GW Mundra power
project. Tata Power has one FSA (1.7mtpa) for its Maithon power projects and
another Letter of Award (2mtpa) from Coal India. It also has a backup coal
supply arrangement with Tata Steel (Group Company) for up to 1mtpa of coal
middlings for its Maithon project in case there is a shortage of coal supply
from Coal India. Expansion of coal mines and progress on its project pipeline
will provide the key catalysts for Tata Power.

Facing coal shortages In terms of coal shortages, JSW Energy is entirely dependent on imported
coal for 2GW of its installed capacity. Its efforts to source cheaper coal from
Indonesia and its bid to acquire CIC Energy have failed. High-cost imported
coal is putting substantial strain on its earnings and we expect continued
pressure on the company’s financial performance. We would continue to avoid
JSW Energy despite its reasonable 2012 PE given no credible plans to
control coal costs.

Adani Power is Adani Power is one of the best-placed companies among Indian private
best placed to source power companies to source imported coal given the group’s long experience
imported coal
in coal trading and ownership of Bunyu mines in Indonesia. Hence, we prefer
it to most other private-power companies. However, there is a risk that it may
get less coal from the domestic market. Given the shortage of coal, the
government may reverse its earlier decision to offer 30% domestic coal to
even projects based on imported coal (like Mundra I-III).

There is risk of a shortfall There is also a risk that Adani will not get sufficient coal from domestic
in domestic coal supply linkages for its Mundra IV and Tiroda projects in which it has domestic coal
linkages. While the valuation is not demanding, investors may like to wait for
more clarity from the upcoming meeting of the Group of Ministers on coal
supply and whether Adani Power gets the domestic coal it needs. We are also
concerned about the price of imported imported from Indonesia increasing
due to Indonesian government imposing a minimum export price for coal it
exports. The company denies any impact on its coal price due to this because
of low calorific value coal that it imports. However, uncertainty on this issue
will remain an overhang.

Investors with higher risk appetite could consider investing in the stock. If
coal issues are resolved in favour of the company, there would be good
upside. However, if it faces coal shortages in the domestic market and an
escalation in coal costs from overseas, the stock price will struggle.

Lanco is cheap, Lanco is one of the cheapest power stocks in India on a PE and EV/Ebitda
but vulnerable to basis. However, it also is likely to face coal shortages and is vulnerable to
coal shortage,
a drop in merchant-power tariffs. Thus despite a high target price upside
merchant power
we have it on Outperform instead of BUY. CESC too is trading on very
attractive valuations. However, given the uncertainty on the outlook of its
loss-making retail business and likely coal shortage for new power plants
we rate it an Outperform.

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Figure 176

Valuation methodology for power utilities

China IPPs Valuation basis Rationale

China Res Power Theoretical P/B based on (COE-g)/(ROE-g) Due to volatile earning, PB offers a better measure

Huaneng Power Theoretical P/B based on (COE-g)/(ROE-g) Due to volatile earning, PB offers a better measure

Datang Intl Power Theoretical P/B based on (COE-g)/(ROE-g) Due to volatile earning, PB offers a better measure

Huadian Power Theoretical P/B based on (COE-g)/(ROE-g) Due to volatile earning, PB offers a better measure

China Power Intl Theoretical P/B based on (COE-g)/(ROE-g) Due to volatile earning, PB offers a better measure

India power companies

Adani Power DCF Earnings largely predictable with key risks from
merchant tariffs, utilisation rates and coal prices

CESC SOTP with power business valued using DCF PB is good measure for the existing regulated business;
and P/B. Retail business on EV/Sales future non- regulated projects are valued on DCF

Jindal Steel & Power SOTP with power business valued at DCF Earnings largely predictable with risk from merchant
tariffs and utilisation

JSW Energy DCF Earnings largely predictable with risk from merchant
tariffs, utilisation rate and coal prices

Lanco Infratech SOTP with power business valued at DCF Earnings largely predictable with risk from merchant
tariffs, utilisation rates and coal prices

NTPC DCF Regulated, predictable earnings

NHPC DCF Regulated, predictable earnings

Tata Power SOTP with power business valued at PE/DCF Substantial earnings from coal business and other
and coal business at PE investments earnings make it difficult to use DCF for
the whole business

Power Grid Theoretical P/B based on (COE-g)/(ROE-g) Negative cashflow for many years makes DCF
difficult to use
Source: CLSA Asia-Pacific Markets

Indian IPPs are valued We value all China IPPs on PB given the uncertainty and high volatility in
using DCF as they are earnings and cashflows. We value most of the Indian power companies using
more predictable
DCF as earnings are more predictable. With CRP being the only utility which
has ROE higher than cost of equity, it has a target PB of higher than 1x. Given
CRP’s higher ROE, it is also likely to grow faster. We have used a lower long-
term growth rate for Huadian and Huaneng given their lower ROEs.

Figure 177

CRP demands the highest Valuation multiples for China IPPs

target PB valuation
China IPPs Risk free Market risk Beta Cost of LT growth Target
rate (%) premium (%) equity (%) rate (%) PB (x)
China Res Power 4.0 6.0 0.80 8.8 4 1.75

Huaneng Power 4.0 6.0 0.77 8.6 2 0.75

Datang Intl Power 4.0 6.0 1.00 10.0 3 0.90

Huadian Power 4.0 6.0 0.86 9.2 2 0.42

China Power Intl 4.0 6.0 0.75 8.5 3 0.70

Source: CLSA Asia-Pacific Markets

Given the current uncertain economic environment, we have done a

sensitivity analysis to our target price multiples for China IPPs for any
changes in the cost of equity. Target prices can go down by 12-17% for 1ppt
increase in cost of equity.

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Figure 178

Target prices could go TP multiple to 1% change of COE

down by 12-17% for 1ppt CoE -1% Current CoE +1%
increase in cost of equity
China Res Power 2.21 1.75 1.45
Huaneng Power 0.85 0.73 0.63
Datang Intl Power 1.07 0.91 0.80
Huadian Power 0.49 0.42 0.37
China Power Intl 0.90 0.73 0.62
Change (%)
China Res Power 26 0 (17)
Huaneng Power 18 0 (13)
Datang Intl Power 17 0 (13)
Huadian Power 16 0 (12)
China Power Intl 22 0 (15)

Figure 179

Power utilities’ valuation matrix

Company Code Country Last Mkt cap 3M avg Ebit margin 5Y avg Net PE
price (US$m) daily (%) Ebit gearing (x)
(US$m) 11CL 12CL margin (%) 11CL 12CL
(%) 11CL
Power utilities
China Res Power 836 HK China 14.16 8,610 15.0 18.6 18.5 17.9 148.8 11.6 10.2
Huaneng Power 902 HK China 4.08 9,327 9.6 6.7 7.7 6.6 225.9 22.0 12.8
Datang Intl Power 991 HK China 2.59 9,531 6.4 14.1 15.9 13.4 310.7 13.5 10.0
Huadian Power 1071 HK China 1.52 2,948 1.9 7.0 8.3 5.8 500.0 (23.8) 56.3
China Power Intl 2380 HK China 1.87 1,226 1.9 16.2 17.2 12.6 258.9 10.9 7.3
CESC CESC IB India 262.65 732 0.1 16.9 15.6 16.4 75.8 6.8 6.6
Adani Power ADANI IB India 106.95 5,200 0.2 53.2 44.9 48.9 325.2 11.3 9.3
Jindal Steel & Power JSP IB India 612.85 12,730 1.3 38.2 37.6 39.7 88.9 11.5 10.0
JSW Energy JSW IB India 64.75 2,360 1.1 26.1 23.9 30.4 129.8 9.6 13.8
Lanco Infratech LANCI IN India 26.1 1,400 1.1 21.7 20.8 17.6 417.5 8.7 6.8
NTPC NATP IB India 175.15 33,977 0.7 19.4 20.1 19.9 44.8 14.8 13.0
NHPC NHPC IB India 23 6,288 0.7 55.9 56.0 52.6 41.7 15.2 13.6
Tata Power TPWR IB India 1228.1 6,500 0.5 21.7 19.5 18.1 138.8 11.2 12.7
Power Grid PWGR IB India 101.95 10,491 0.9 53.2 52.6 56.1 198.7 15.7 13.2
Renewable utilities
Longyuan Power 916 HK China 7.15 6,852 13.1 33.0 36.1 28.8 149.4 17.9 13.6

Company PB Div ROE 5Y avg EV/Ebitda 10-12CL Rec Upside

(x) yield (%) ROE (x) EPS Cagr (%)
11CL 12CL 11CL 11CL 12CL (%) 11CL 12CL (%)
Power utilities
China Res Power 1.5 1.3 2.7 13.2 13.8 12.4 8.8 7.7 14.9 O-PF 32.1
Huaneng Power 0.9 0.8 2.7 3.6 5.8 3.1 9.3 8.4 2.7 SELL (11.8)
Datang Intl Power 0.7 0.7 2.3 7.7 9.3 8.0 9.8 8.7 (1.9) U-PF 8.1
Huadian Power 0.5 0.5 (1.9) 0.8 (2.0) 8.0 6.6 (8.2) SELL (21.1)
China Power Intl 0.6 0.6 2.8 6.3 8.5 3.6 10.4 9.0 24.1 O-PF 23.0
CESC 0.8 0.7 1.7 12.3 11.4 13.3 3.3 2.7 0.9 O-PF 25.6
Adani Power 3.0 2.5 2.6 29.0 29.3 17.5 6.7 5.9 113.6 O-PF 16.9
Jindal Steel & Power 3.1 2.4 0.5 30.6 26.9 36.9 7.0 6.4 23.4 O-PF 14.2
JSW Energy 1.6 1.5 1.8 17.9 11.1 18.1 6.9 7.6 (4.3) U-PF 11.2
Lanco Infratech 1.1 1.0 19.0 18.9 19.1 4.8 5.2 44.3 O-PF 30.3
NTPC 2.0 1.8 2.5 13.9 14.6 14.3 8.5 7.7 12.2 BUY 19.9
NHPC 1.1 1.0 2.6 7.4 7.8 7.3 6.7 6.4 8.0 U-PF 8.7
Tata Power 1.8 1.6 1.0 17.8 13.9 16.3 6.4 6.9 5.0 BUY 18.6
Power Grid 2.0 1.8 2.4 13.4 14.6 13.6 6.6 6.3 12.6 O-PF 14.8
Renewable utilities
Longyuan Power 1.7 1.5 0.3 11.2 12.4 10.8 10.8 9.5 23.5 U-PF 15.8
Source: CLSA Asia-Pacific Markets

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Equipment suppliers - Picking the winners

Indian power equipment Power-equipment suppliers are a second derivative play on power demand
suppliers offer higher and power-capacity growth. Hence, their performance depends on the rate of
growth . . .
increase of capacity. In China, the rate of increase is coming down, while it is
going up in India. Thus we prefer Indian power-equipment players over
Chinese equipment suppliers.

. . . and better The growth outlook is not the only difference. All Indian power equipment
return ratios suppliers make better margins and have higher returns than their Chinese
counterparts. While Indian equipment suppliers have expanded margins over
last few years, for Chinese suppliers the costs (staff, administrative, R&D, bad
debts) have grown faster than sales and Ebit margins have been coming
down over last few yeas. Going forward, with slowing revenue growth cost
control will be very important for Chinese equipment suppliers. For Indian
suppliers we see flat to marginally rising margins.

Our top picks are BHEL Our top picks are BHEL and Crompton Greaves in India. BHEL, the largest
and Crompton Greaves has been derated over the past couple of years on concerns of rising
competition. We believe BHEL has significant competitive advantages and it
will be able to sustain a 20% earnings cagr over next three years.
Crompton Greaves is the leading T&D equipment maker in India and is
well placed to capitalise on the pick-up in T&D expense. Its orders have
slowed over the last two years but we believe this is temporary and a pick
up in orders is imminent. Meanwhile, it continues to do well in its consumer
and industry divisions.

We also like Thermax and We also like Thermax though it may face headwinds near term due to a
Voltas but they may face slowdown in orders. It remains a good long-term play on Indian power and
near term headwinds
environment-related spend. Another Indian play on rising power
penetration is Voltas, a leading air-conditioner manufacturer in India.
Rising power penetration in India will boost sales of air cons in India and
benefit Voltas.

We do not expect a pick As discussed earlier, we do not expect a major pick up in power-capacity
up in power capacity additions in China due to the current power shortages. We expect the
addition in China
capacity additions to remain close to 2010 levels. The power shortages
will have to be dealt with via higher power prices, grid build out and
demand-side management. We also expect nuclear-power additions to
slowdown substantially from the earlier plans and expect 2020 capacity
addition to be 56GW or lower compared to a government target of 90GW.
Please see Appendices for our views on nuclear power and Chindia’s
power mix.

We prefer Shanghai Among Chinese equipment suppliers, our relative preference is for companies
Electric as it is better that can expand in overseas markets and have good technology access. We
placed to grow overseas
believe Shanghai Electric is better positioned compared with its peers. Its
recent JV with Alstom for the boiler business could be a game changer in the
longer term. This JV combines the low cost of Shanghai Electric and the
technology of Alstom. We believe Shanghai Electric’s earnings growth will pick
up after three years of stagnant earnings. We expect Shanghai Electric to
close its valuation gap versus Dongfang.

100 [email protected] 27 June 2011

 
  
 Section 4: Power stocks Chindia power

Dongfang’s growth is For Dongfang Electric, we expect revenue and operating profit growth to
likely to slow slow down. Over the last few years, the company has been a beneficiary of
rapid growth in the wind and nuclear-power segments - both of which
Dongfang was an early entrant. However, with the slowdown in wind-power
installations and China halting approvals for new nuclear power projects, the
growth is likely to decline. Dongfang’s gross margins are also likely to come
down from their 2010 highs.

Harbin’s return ratios are We also continue to maintain our Underperform rating on Harbin Power due to
poor; use of cash is a its low growth and poor return ratios. While the company has a high cash
concern
balance, its use of that cash is a concern. The company’s recent decision to
invest Rmb1.35bn in A-shares of Datang highlights that risk.

Figure 180

Indian power companies Return ratios for Chinese and Indian power equipment suppliers in 2011
have consistently earned
higher returns . . . 45 (%) ROAE ROCE
40.0
40
35.5
35
30 27.8 27.1
24.1 24.4
25 23.2
21.3

20
15 12.6

8.0 8.7
10 6.4

5
0
Harbin Power Shanghai Dongfang Crompton Thermax BHEL
Electric Electric

Figure 181

. . . supported by higher Gross margins of equipment suppliers

gross margins
45 (%) 41.9

40 37.3

35 31.7

30
25
18.9
20 16.3
14.4
15
10
5
0
Harbin Power Shanghai Dongfang Thermax Crompton BHEL
Electric Electric

Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 101

 
  
 Section 4: Power stocks Chindia power

Figure 182

. . . as well as wider Ebit margins of power-equipment suppliers

Ebit margins
18 (%) 16.8

16
14
11.5
12
10.3
10
8.0
8 6.5
5.4
6
4
2
0
Harbin Power Shanghai Dongfang Thermax Crompton BHEL
Electric Electric

Figure 183

More room for wages to Staff costs as a percentage of sales

rise in Chinese companies
14 (%) 13.0
11.8
12

10

8 7.3 7.4

5.5 5.6
6

0
Harbin Power Shanghai Dongfang Thermax Crompton BHEL
Electric Electric

Figure 184

Chinese firms get much Non-operating income as % of pre-tax profit

higher proportion of
profit from non- 60 (%)
operating income . . . 49.2
50
. . . part of this is
financial income and a
40
part of these are 33.0
government subsidies
30
23.5

20 17.3

9.8
8.4
10

0
Crompton Thermax BHEL Dongfang Shanghai Harbin Power
Electric Electric

Source: CLSA Asia-Pacific Markets

102 [email protected] 27 June 2011

 
  
 Section 4: Power stocks Chindia power

Figure 185

Chinese companies also Tax rate

pay a lower tax rates.
Rising tax rates could 35 (%) 33.2 33.3

impact EPS growth

30
25.4
25
19.3
20

15

10
5.7 6.2

0
Shanghai Dongfang Harbin Power Crompton Thermax BHEL
Electric Electric

Figure 186

BHEL, and other Indian Revenue and operating profit growth comparison
companies, have reported
much higher revenue and 30 2006-10 Cagr (%) BHEL Dongfang Electric
profit growth . . . Shanghai Electric Harbin Power
25

20

15

10

(5)
Revenue Gross profit Ebit

Figure 187

. . .which should continue Revenue and operating profit growth expectations

30 2010-13 Cagr (%)

25 BHEL Dongfang Electric

Shanghai Electric Harbin Power
20

15

10

0
Revenue Gross profit Ebit
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 103

 
  
 Section 4: Power stocks Chindia power

Valuations - Power-equipment suppliers

Figure 188

All Indian equipment Power-equipment suppliers - PE (2012)

makers, except ABB are 31.4
16 (x)
trading at a discount to
14.6
Dongfang Electric 13.8
14 13.3

11.6
12 11.4

BHEL offers higher 9.8

growth and returns and 10
trades at discount to
Chinese peers 8

4
Dongfang Shanghai Harbin ABB India Thermax Crompton BHEL
Electric Electric Power Equip Greaves

Figure 189

Except the outliers, Power-equipment suppliers - EV/Ebitda multiples (2012)

Indian and Chinese peers
11 (x) 19.5
are trading at similar
EV/Ebitda multiples 10
9
8.1 8.0
8
6.8 7.0
6.7
7
6
5
4 3.7

3
2
Dongfang Shanghai Harbin ABB India Crompton BHEL Thermax
Electric Electric Power Equip Greaves

Figure 190

Chinese companies Power-equipment suppliers - Net gearing (2012)

have higher net cash
as % of equity (%)
0

(10)

(20) (16)
(20)
(30)

(40)

(50) (46) (43)

(60)
(61)
(70) (67)
(71)
(80)
Shanghai Harbin Dongfang Crompton ABB India BHEL Thermax
Electric Power Equip Electric Greaves

Source: CLSA Asia-Pacific Markets

104 [email protected] 27 June 2011

 
  
 Section 4: Power stocks Chindia power

Figure 191

Indian companies trade at Power-equipment suppliers - PB multiples (2011)

much higher PB multiples
and make better returns 7 (x) 6.4

5
4.0 3.9
3.8
4 3.4

2 1.4
0.9
1

0
Dongfang Shanghai Harbin ABB India Thermax Crompton BHEL
Electric Electric Power Equip Greaves

Figure 192

Chinese companies offer Power-equipment suppliers - Dividend yield (2012)

higher dividends yields
3.0 (%)

2.5 2.2
2.0
2.0

1.5 1.2
1.0
0.9 1.0
1.0

0.5 0.3

0.0
Shanghai Harbin Dongfang BHEL Thermax Crompton ABB India
Electric Power Equip Electric Greaves

Figure 193

Strong correlation PE versus earnings Cagr for power-equipment suppliers

between PE multiples and
expected earnings Cagr 20 10CL PE (x)
Dongfang Electrical
Crompton
18 Thermax

16 BHEL
Shanghai Electric

14 Voltas

12
Harbin Power Equip
10
Earnings Cagr 2010-12 (%)
8
(5) 0 5 10 15 20

Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 105

 
  
 Section 4: Power stocks Chindia power

Figure 194

Firms with higher ROEs PB versus ROAE for power-equipment suppliers

enjoy higher return ratios
7 11CL PB (x)
ABB
6

5
Crompton
Thermax
4
Dongfang Electrical
BHEL
3
Voltas

2 Shanghai Electric
Suzlon

1
Harbin Power Equip Three-year ROAE (%)
0
(10) (5) 0 5 10 15 20 25 30 35

Source: CLSA Asia-Pacific Markets

We use PE to value most We use PE multiples to set our target price for power-equipment suppliers, as
equipment manufacturers they are generally net-cash companies with big variations in return ratios. We
apply 14-16x earnings multiples for the companies depending on their growth
outlook, except for Harbin where we apply a 10x multiple given little growth
in earnings and poor return ratios.

Indian firms command Our earnings multiples for most companies are at 10-25% discount to last
higher PEs due to five-year average multiples. The discount depends on the growth outlook. In
faster growth
general, PE multiples for Indian companies are higher because of their faster
growth, better earnings composition and higher return ratios.

Figure 195

Valuation basis for power-equipment suppliers

Valuation basis Target PE multiple
China Equipment suppliers
Dongfang Electric PE 14x 2012 EPS
Harbin Power PE 10x 2012 EPS
Shanghai Electric PE 14x 2012 EPS
India equipment suppliers
ABB PE 25x 2012 EPS; likely buy back by the
parent supports a higher multiple
BHEL PE 15x FY13 EPS
Crompton Greaves PE 16x FY13 EPS
Thermax PE 15x FY13 EPS
Voltas PE 14x FY13 EPS
Source: CLSA Asia-Pacific Markets

Figure 196 shows sensitivity to our target prices if the earnings yield demand
by investors from these companies increases. Target prices can go down by
9% to 20% for 1ppt increase in the earnings yield.

106 [email protected] 27 June 2011

 
  
 Section 4: Power stocks Chindia power

Figure 196

Target prices can go down Target PE multiple to 1% change of CoE

by 9%-20% for a 1ppt (x) Current CoE +1% CoE +2%
rise in earnings yield
Dongfang Electric 14.0 12.3 10.9
Shanghai Electric 14.0 12.3 10.9
Harbin Power Equipment 10.0 9.1 8.3
ABB India 25.0 20.0 16.7
BHEL 15.0 13.0 11.5
Crompton Greaves 16.0 13.8 12.1
Thermax 15.0 13.0 11.5
Voltas 14.0 12.3 10.9
Change to target price (%)
Dongfang Electric (12) (22)
Shanghai Electric (12) (22)
Harbin Power Equipment (9) (17)
ABB India (20) (33)
BHEL (13) (23)
Crompton Greaves (14) (24)
Thermax (13) (23)
Voltas (12) (22)

Figure 197

Power equipment valuation matrix

Company Code Country Last Mkt cap 3M avg Ebit margin 5Y avg Net PE
price (US$m) daily (%) Ebit gearing (x)
(US$m) 11CL 12CL margin (%) 11CL 12CL
(%) 11CL
Power equipment suppliers
Dongfang Electric 1072 HK China 27.7 7,309 14.2 5.6 6.0 5.1 (70.5) 17.0 14.6
Shanghai Electric 2727 HK China 4.1 11,610 13.0 3.7 3.9 3.7 (46.0) 13.5 11.6
Harbin Power Equip 1133 HK China 8.7 1,540 8.9 1.9 2.1 2.5 (61.3) 10.7 9.8
ABB India ABB IB India 830.5 3,925 0.3 6.6 8.9 6.1 (19.6) 46.4 31.1
BHEL BHEL IB India 1,921.7 20,981 4.1 17.1 17.9 15.9 (43.4) 13.9 11.4
Crompton Greaves CRG IB India 251.3 3,582 0.9 10.6 11.4 11.2 (16.0) 16.4 13.3
Thermax TMX IB India 584.8 1,549 0.3 9.5 9.7 10.2 (66.9) 16.4 13.8
Suzlon SUEL IB India 45.2 1,784 4.7 4.2 6.0 3.9 137.3 na 19.8
Solar power
GCL-Poly Energy 3800 HK Hong Kong 3.8 7,652 99.8 30.6 29.4 36.5 90.5 8.5 6.8
Suntech Power STP US China 7.8 1,434 5.1 9.7 7.6 8.8 39.9 6.4 9.4
Trina Solar TSL US China 20.5 1,561 17.5 17.9 12.0 16.1 (6.6) 3.9 6.0
Trony 2468 HK China 3.5 711 3.3 39.7 34.5 37.3 (27.6) 6.2 5.8

Company PB Div ROE 5Y avg EV/Ebitda 10-12CL Rec Upside

(x) yield (%) ROE (x) EPS Cagr (%)
11CL 12CL 11CL 11CL 12CL (%) 11CL 12CL (%)
Power equipment suppliers
Dongfang Electric 3.4 2.7 0.9 21.3 20.0 22.5 10.1 8.1 7.0 U-PF (2.4)
Shanghai Electric 1.4 1.3 2.2 11.8 11.9 12.2 8.4 6.8 11.7 O-PF 20.7
Harbin Power Equip 0.9 0.8 2.0 8.9 8.7 10.0 2.7 3.7 (3.1) U-PF 2.2
ABB India 6.4 5.4 0.3 14.7 18.8 13.5 19.5 29.3 199.2 SELL (15.7)
BHEL 3.8 3.0 1.2 30.1 29.3 29.6 8.8 7.0 17.1 BUY 30.1
Crompton Greaves 3.9 3.1 1.0 26.5 26.1 31.7 10.2 8.0 16.8 BUY 19.4
Thermax 4.0 3.2 1.0 26.7 25.7 26.3 8.5 6.7 11.6 O-PF 16.3
Suzlon 1.3 1.2 (0.9) 6.6 (4.8) 10.0 7.0 na U-PF 10.7
Solar power
GCL-Poly Energy 2.5 1.8 na 33.4 29.2 68.0 7.1 5.0 42.2 BUY 33.4
Suntech Power 0.7 0.6 na 10.9 6.7 8.4 4.0 4.0 (26.3) U-PF 6.6
Trina Solar 1.3 1.1 na 31.1 19.1 22.8 2.5 3.5 (8.4) BUY 102.6
Trony 1.5 1.1 na 30.0 21.7 31.7 4.2 2.8 0.3 BUY 86.8
Source: CLSA Asia-Pacific Markets

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Solar power plays in China

We expect over- Despite our long-term positive outlook for solar, we do not see any way out of
supply in 2012 . . . acute oversupply situation in 2012. We expect demand to remain relatively
flat at around 20GW as sharp falls in Germany and Italy - the world’s two
largest solar markets - are offset by growth predominantly in Chindia, the
USA and Japan. Meanwhile, potential supply will expand to at least 35GW,
based on First Solar (FSLR US - US$125.02 - U-PF) and first-tier polysilicon
producers. The gap may prove smaller, but even under our most wildly
optimistic bull-case scenario, demand can only grow to 28GW in 2012.
Panelmakers, and their suppliers, will thus face a period of compressed
margins and, ultimately, consolidation.

. . . and prefer the From a China perspective, our two top picks are leading, low-cost wafer
low-cost leaders: maker GCL Poly and leading low-cost panel brand Trina Solar.
GCL and Trima

The investment thesis for GCL is relatively straightforward. The company is

one of the world’s lowest cost producers of polysilicon and wafers. None of its
competitors on the polysilicon side have anywhere near as low a production
cost for wafers, while its major wafer competitors either purchase polysilicon
at much higher prices or produce at uncompetitive costs. In an oversupplied
situation, it is conceivable that prices will fall to the cost of marginal
production. However, even if both polysilicon and wafer prices fall to the cost
of marginal production in 2012 (US$25 per KG, and US$0.44 per Watt,
respectively) and remain there for the entire year, GCL would maintain a 30%
gross margin. GCL is the last man standing.

Even at the cost of The investment case for Trina is less clear, given that production costs
marginal production, downstream are flatter (at least comparing to other Chinese companies).
GCL still makes 30%
However, we believe that Trina still stands out through proven management,
gross margins
strong brand and low cost. In an oversupply situation, there is a much more
pronounced preference for top-tier panel makers that have been vetted by
the banks providing project finance on solar projects. This has been
demonstrated in the mini-crash of 2Q11, with top-tier Chinese panel makers
running at more than 85% utilisation rates and selling at US$1.5 per Watt,
while second-tier producers have struggled to exceed 60% utilization rates
despite ASPs under US$1.4 per Watt. Overall, while we expect Trina to suffer
lower margins into 2012, it will emerge with a bigger piece of the solar
market just as it enters a period of long-term sustainable growth.

Other plays on Chindia’s power sector

Coal companies offer an Alternative plays on Chindia’s power sector include coal companies in both
alternative play on the countries, nuclear-fuel and component suppliers as well as the waste-to-
Chindia story
energy company China Everbright in China.

We prefer Coal India We maintain our Outperform rating on Coal India which should benefit from
which benefits from the rising coal-fired capacity addition. The company has displayed flexibility by
rise in coal-fired power
taking differential price hikes for different types of coal and categories of
capacity in India
consumers. With its average realisations still at a 50% discount to
international coal prices, there is enough headroom to absorb price hikes. We
view Coal India as a good defensive play, with potential for positive earnings
surprises. Key risks for the stock are lower availability of railway rakes that
would impact its despatches and the change in e-auction policy which could
reduce the size of its most lucrative business segment.

108 [email protected] 27 June 2011

 
  
 Section 4: Power stocks Chindia power

We also like China Coal and Shenhua Energy as they are likely tobenefit
from rising coal demand in China, which should keep coal prices at a
reasonably high levels going forward.

Figure 198

Other plays on Chindia’s power sector - Valuation matrix

Company Code Country Last Mkt cap 3M avg Ebit margin 5Y avg Net PE
price (US$m) daily (%) Ebit gearing (x)
(US$m) 11CL 12CL margin (%) 11CL 12CL
(%) 11CL
Renewable utilities
China Everbright 257 HK China 3.0 1,383 3.4 32.9 32.0 32.8 72.9 16.6 12.0
Coal companies
Shenhua Energy 1088 HK China 35.8 89,050 95.1 36.1 35.2 36.9 (9.6) 13.1 12.1
China Coal Energy 1898 HK China 10.2 18,983 53.4 16.1 16.8 17.5 (10.1) 12.5 10.0
Yanzhou Coal 1171 HK China 29.5 23,263 63.5 32.5 30.5 30.8 12.9 10.8 10.9
Hidili Industry 1393 HK China 6.2 1,657 7.9 49.5 48.0 43.6 49.9 9.3 7.2
Fushan Intl Energy 639 HK China 4.3 2,984 19.9 60.4 57.1 57.1 (25.4) 9.2 8.6
Coal India COAL IS India 378.7 53,147 27.6 28.9 28.1 20.4 (130.8) 15.3 15.3
Nuclear fuel & components
CFHI 601106 CH China 4.3 4,308 31.5 9.6 10.1 13.5 8.8 28.2 23.0
China Erzhong 601268 CH China 9.0 2,353 11.4 9.6 10.7 9.1 49.1 30.7 20.0
Shentong Valve 002438 CH China 20.2 320 2.9 19.6 22.4 17.9 (44.8) 26.9 19.5
ERA ERA AU Australia 4.3 864 5.1 (29.2) 15.3 17.0 (1.8) (8.9) 22.8
Toshiba 6502 JP Japan 400.0 20,541 203.5 3.8 4.4 1.9 175.2 11.3 12.3

Company PB Div ROE 5Y avg EV/Ebitda 10-12CL Rec Upside

(x) yield (%) ROE (x) EPS Cagr (%)
11CL 12CL 11CL 11CL 12CL (%) 11CL 12CL (%)
Renewable utilities
China Everbright 1.9 1.7 0.5 12.1 14.5 12.2 7.6 5.3 30.4 O-PF 59.1
Coal companies
Shenhua Energy 2.6 2.2 3.1 20.9 19.4 19.8 7.0 6.1 10.1 O-PF 18.9
China Coal Energy 1.4 1.2 2.0 10.8 11.8 11.8 6.2 5.1 21.0 O-PF 22.5
Yanzhou Coal 2.6 2.2 2.8 26.7 21.4 23.5 6.6 5.8 6.0 SELL 5.6
Hidili Industry 1.1 0.9 2.7 14.8 16.2 13.2 7.2 5.6 44.3 O-PF 32.3
Fushan Intl Energy 1.1 1.0 4.2 14.4 13.5 12.5 3.5 3.2 16.0 O-PF 45.5
Coal India 5.3 4.1 1.5 39.6 33.6 32.8 9.0 7.5 26.2 O-PF 21.5
Nuclear fuel & components
CFHI 1.6 1.5 0.4 5.9 6.8 18.4 19.0 16.3 21.7 SELL (17.8)
China Erzhong 2.5 2.3 1.0 8.5 12.0 11.1 12.9 10.4 65.9 SELL (6.9)
Shentong Valve 2.6 2.4 0.9 10.1 12.7 17.4 17.3 12.2 46.5 SELL 13.2
ERA 1.0 1.0 (10.2) 5.0 8.6 (8.0) 6.5 (17.6) SELL (16.1)
Toshiba 1.6 1.5 1.3 14.3 12.0 1.0 4.3 3.6 n.a. BUY 42.5
Source: CLSA Asia-Pacific Markets

China Everbright has We have an Outperform rating on China Everbright which earns better return
above-average ROEs and ratios than China IPPs and is now trading at reasonable earnings multiples.
undemanding valuations
We have underperform or sell ratings on most nuclear fuel and component
companies except Toshiba which we believe will benefit from faster gas-
business development, higher nuclear-power-plant maintenance. Toshiba’s
AP1000 technology is also now more likely to be used as a technology by the
Chinese when China resumes its nuclear-power build out.

Some unrated companies affected by Chindia’s power sector developments

are listed below. Global T&D players and A-share listed Chinese power T&D
companies should benefit from China’s T&D network build out.

27 June 2011 [email protected] 109

 
  
110
Figure 199

Non-covered plays on Chindia’s power sector - Valuation matrix

Name Code Country Year Last Mkt cap 3M avg Ebit margin 5Y avg Net PE PB Div. ROE 5Y EV/Ebitda 09-11
end price (US$m) daily (%) Ebit gearing (x) (x) yield (%) avg (x) EPS
(US$m) margin (%) ROE Cagr
2010 2011 (%) 2008 2010 2011 2010 2011 09A 2010 2011 (%) 2010 2011 (%)

Power generation and T&D equipment

ABB Ltd-Reg ABBN VX Switzerland Dec 10 21.24 58,308 162.3 13.6 14.5 13.4 (41.6) 16.6 14.2 3.4 3.4 2.38 21.8 22.6 22.7 9.5 8.2 26.2

Siemens AG-Reg SIE GR Germany Sep 10 92.75 121,389 389.1 12.8 12.5 8.6 19.1 11.6 11.6 2.5 2.5 2.76 22.0 20.3 17.1 7.4 7.2 33.7

Schneider Electric SA SU FP France Dec 10 110.75 43,157 149.4 15.0 15.5 14.3 18.3 12.9 11.4 1.9 1.9 2.68 14.7 15.6 13.3 8.2 7.4 21.3

Alstom ALO FP France Mar 11 42.05 17,723 87.9 6.5 7.3 7.7 41.3 12.5 10.9 2.5 2.5 2.91 20.7 21.0 26.4 7.2 6.5 56.9

Eaton Corp ETN US United States Dec 10 48.38 16,507 157.3 12.2 13.0 9.1 30.9 12.3 10.4 1.9 1.9 2.23 17.0 17.8 14.4 8.3 7.2 29.7

Nuclear equipment
[email protected]

Section 4: Power stocks

Areva AREVA FP France Dec 10 25.35 13,907 1.9 6.9 9.0 2.5 38.3 18.4 12.8 1.1 1.1 5.7 7.5 8.4 11.2 9.0 (10.7)

Shaw Group Inc SHAW US United States Aug 10 33.07 2,689 49.8 3.2 5.0 4.2 (57.1) 19.5 12.1 1.7 1.7 7.4 12.5 7.5 7.1 5.0 57.5

Flowserve Corp FLS US United States Dec 10 109.02 6,086 72.4 12.9 15.5 (1.4) 13.9 11.8 2.4 2.4 1.06 20.1 19.5 23.9 8.7 7.5 15.0

Wind equipment

Vestas Wind Systems A/S VWS DC Denmark Dec 10 123.10 4,814 66.0 6.9 7.4 7.4 21.0 11.3 9.4 1.1 1.1 10.2 11.1 12.4 5.2 4.6 50.8

Gamesa Corp Tecnologica SA GAM SM Spain Dec 10 5.48 1,928 46.1 4.5 5.1 5.0 (13.3) 19.4 14.8 0.8 0.8 4.3 5.4 8.7 3.5 3.0 33.3

Xinjiang Goldwind Sci&Tech-A 002202 CH China Dec 10 14.43 5,425 63.8 16.9 16.3 15.6 (21.1) 13.6 11.1 2.6 2.6 2.25 21.8 20.8 26.8 9.9 8.2 14.4

China High Speed Transmissio 658 HK Hong Kong Dec 10 8.06 1,410 12.2 19.7 18.4 20.1 41.2 6.6 6.2 1.1 1.1 4.00 18.7 17.3 20.7 5.8 5.5 (0.1)

Sinovel Wind Group Co Ltd-A 601558 CH China Dec 10 27.54 8,566 13.9 69.4 14.8 11.7 3.1 3.1 1.73 19.9 20.5 68.2 13.4 9.7 22.0

Solar equipment

Yingli Green Energy Hold-ADR YGE US China Dec 10 8.71 1,293 34.1 14.6 14.2 14.5 35.0 6.7 6.4 0.9 0.9 14.0 12.2 10.3 4.7 4.3 (1.2)

Ja Solar Holdings Co Ltd-ADR JASO US China Dec 10 5.49 922 42.2 11.0 9.5 10.5 3.1 4.9 5.0 0.8 0.8 17.1 14.4 13.7 3.3 3.0 (16.7)

Canadian Solar Inc CSIQ US Canada Dec 10 10.77 462 10.5 6.4 6.8 62.1 7.9 7.0 0.8 0.8 11.2 10.5 6.8 7.9 6.8 13.8

Hanwha Solarone Co -Spon ADR HSOL US China Dec 10 5.89 496 6.1 9.2 (1.8) 6.4 5.8 0.4 0.4 9.2 6.8 2.9 3.0 2.7 (25.5)

Renesola Ltd-ADR SOL US China Dec 10 4.96 428 28.0 16.8 14.3 5.3 38.9 3.0 3.1 0.6 0.6 23.7 19.7 7.5 2.6 2.5 (9.1)

T&D

Baoding Tianwei Baobian-A 600550 CH China Dec 10 17.24 3,662 25.6 14.6 17.4 13.2 119.5 23.0 17.2 2.2 2.2 11.08 11.0 13.9 16.8 17.2 12.6 37.6

Tbea Co Ltd-A 600089 CH China Dec 10 12.22 4,983 74.6 9.5 8.1 9.9 (32.3) 15.8 12.6 2.3 2.3 0.60 13.8 15.4 19.3 12.7 10.1 21.1

Henan Pinggao Electric Co-A 600312 CH China Dec 10 10.22 1,295 33.0 5.2 7.0 4.3 13.6 54.9 27.5 2.8 2.8 5.3 10.6 7.6 33.3 21.4

Nari Technology Developmen-A 600406 CH China Dec 10 35.23 5,726 28.9 19.8 20.2 15.0 (52.0) 48.9 34.0 11.6 11.6 0.14 25.3 27.3 23.9 49.2 34.6 49.3

Shanghai Zhixin Electric C-A 600517 CH China Dec 10 11.01 1,054 10.8 (20.7) 19.4 16.1 4.8 4.8 3.47 25.5 27.9 25.7 12.6 10.4 14.6

Chindia power
Shanghai Siyuan Electric -A 002028 CH China Dec 10 12.74 867 16.9 12.3 (60.6) 14.6 12.1 6.00 24.8 (8.7)

Renewable operators
27 June 2011

China Windpower Group Ltd 182 HK Hong Kong Dec 10 0.71 674 1.1 27.8 29.2 25.7 8.4 8.9 6.8 1.2 1.2 14.0 15.9 12.1 9.0 6.6 33.3

China Power New Energy Devel 735 HK Hong Kong Dec 10 0.48 486 1.4 27.5 31.5 26.4 87.4 10.2 8.1 0.6 0.6 5.9 7.0 5.4 7.8 6.0 26.8

Source: Bloomberg, CLSA Asia-Pacific Market

 
  
 Chindia power

Company profiles

ABB India - SELL .................... 113 Huaneng Power - SELL ........... 177

Adani Power - O-PF ................ 119 Jindal Steel & Power - O-PF.... 181

BHEL - BUY ............................. 123 JSW Energy - U-PF.................. 185

CESC - O-PF ............................ 131 Lanco Infratech - O-PF ........... 189

China Power Intl - O-PF.......... 135 Longyuan Power - U-PF .......... 195

China Res Power - O-PF.......... 139 NHPC - U-PF ........................... 201

Coal India - O-PF .................... 143 NTPC - BUY............................. 205

Crompton Greaves - BUY ........ 147 Power Grid - O-PF................... 209

Datang Intl Power - U-PF ....... 153 Shanghai Electric - O-PF ......... 213

Dongfang Electric - U-PF ........ 159 Suzlon - U-PF.......................... 217

GCL-Poly Energy - BUY ........... 163 Tata Power - BUY ................... 223

Harbin Power Equip - U-PF ..... 169 Thermax - O-PF ...................... 227

Huadian Power - SELL ............ 173 Voltas - BUY ........................... 231

All prices quoted herein are as at close of business 22 June 2011, except for ABB and Tata Power which
are priced as at close of business 23 June 2011.

27 June 2011 [email protected] 111

 
  
 Chindia power

Notes

112 [email protected] 27 June 2011

 
  
 ABB India
Rs817.20 - SELL

Rajesh Panjwani Turnaround priced in

[email protected] ABB has performed dismally in the past two years, with revenue and PAT
(852) 26008271
falling by 8% and 88%. We now expect a pick up in orders, which should
Aditya Bhartia translate to a 20% revenue Cagr over 2010-12. We also forecast Ebitda
(91) 22 66505077 margins recovering from 1.3% in 2010 to 7% in 2011 and 10% by 2012,
assuming the company extracts operational efficiencies with no further
Abhishek Tyagi losses in rural electrification business. However, the valuation looks rich
(91) 22 66505055
at 46x 11CL and 31x 12CL PE. We downgrade to SELL (from U-PF earlier).

Disappointing performance
ABB’s revenue has fallen 8% in the past two years, to Rs63bn in 2010.
27 June 2011 Moreover, the Ebitda margin has plummeted by 10ppts, from 11.3% in 2008
to 1.3% in 2010. This has seen ABB’s profit after tax (PAT) fall by 88%, from
India Rs5.5bn two years ago to Rs632m now. Such dismal performance has, in
Industrials part, been the result of thin-margin projects won during the economic
downturn, losses and exit costs in its rural electrification business, royalty
Reuters ABB.BO
Bloomberg ABB IB
costs (0.1% of revenue in 2006 to 1.8% by 2010) and project cost overruns.
Order inflows also disappointed in 2010, falling 27% YoY to Rs63.5bn.
Priced on 23 June 2011
India Sensex @ 17,727.5
Orderflow revival and revenue profit growth
12M hi/lo Rs974.90/595.80 From 2H11, we expect order inflows to revive coming off a low base, both in
the power and automation segments. PowerGrid ordering for substations and
12M price target Rs700.00
±% potential -14% transformers should increase in 2011, having dropped by 42% YoY in 2010.
Target set on 1 Nov 10 This, along with a pick up in execution, should help ABB post a 20% revenue
Cagr over 2010-12. With the bulk of rural-electrification projects executed,
Shares in issue 211.9m
25.0%
there is potential for Ebitda margins to widen to 7% in 2011 and 10% by
Free float (est.)
2012, should the company manage to extract the operating efficiencies that
Market cap US$3,858m management is aiming for. We have built in these margins into our model,
3M average daily volume and consequently, forecast Ebitda to increase 10x to Rs8.7bn by 2012. PAT
Rs82.1m (US$1.8m) should also rise at a similar rate, from Rs632m in 2010 to Rs5.7bn by 2012.
Foreign s'holding 78.2%
Valuation remains rich
Major shareholders While we recognise the potential turnaround in ABB’s business
ABB Inc. 75.0%
performance, valuations look rich at 46x 2011 and 31x 2012 PE. This
FIIs 3.1%
captures all the positives, while ignoring the associated risks. We
therefore, downgrade our rating from Underperform to SELL. In the Indian
transmission & distribution (T&D) space, we continue to prefer Crompton
Greaves, which is trading at a 50% discount to ABB and has historically
Stock performance (%) delivered better revenue and profit growth.
1M 3M 12M
Absolute (3.8) 8.9 (6.3)
Relative (2.4) 11.9 (6.2) Financials
Abs (US$) (3.1) 8.7 (3.7) Year to 31 Dec 09A 10A 11CL 12CL 13CL
1,050 (Rs) (%) 110 Revenue (Rsm) 62,372 62,871 77,990 89,194 102,235
ABB India (LHS) 105
1,000 Ebitda (Rsm) 5,824 838 5,796 8,672 10,855
Rel to Sensex 100
950 Net profit (Rsm) 4,096 632 3,789 5,662 7,110
95
900
90 EPS (Rs) 19.3 3.0 17.9 26.7 33.6
850
85 CL/consensus (0) (EPS%) - - 94 101 123
800
80
750
EPS growth (% YoY) (18.1) (84.6) 499.3 49.4 25.6
75
700 70
ROE (%) 18.0 2.6 14.7 18.8 19.8
650 65 Net debt/equity (%) (21.6) (24.2) (18.6) (19.6) (23.5)
600 60 PE (x) 42.3 273.9 45.7 30.6 24.4
Jun 09 Feb 10 Oct 10 Jun 11
PB (x) 7.1 7.1 6.3 5.3 4.4
Source: Bloomberg
EV/Ebitda (x) 28.6 198.8 28.9 19.1 15.0
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 ABB India - SELL Chindia power

Disappointing performance
Revenue fell by 9% YoY in ABB’s revenue and revenue growth
2009 and grew by a
modest 1% YoY in 2010 80 (Rsbn) Revenue (LHS) (% YoY) 60
Revenue growth
70 50
60
40
50
30
40
20
30
10
20

10 0

0 (10)
CY01 CY02 CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10

Ebitda margin plummeted ABB’s Ebitda and Ebitda margins

to 1% in 2010 . . .
9 (Rsbn) Ebitda (LHS) Ebitda margins (%) 14

8
12
. . . on the back of 7
narrow-margin projects, 10
rural electrification losses 6
and cost overruns 8
5

4 6
3
4
2
2
1

0 0
CY01 CY02 CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10

Order backlog stayed flat Order inflows and backlog

YoY in 2010. . .
100 (Rsbn) Orderflow Order backlog
90
. . . while order inflows
fell by 27% YoY 80
70
60
50
40
30
20
10
0
C Y04 C Y05 C Y06 C Y07 C Y08 C Y09 C Y10

Source: ABB, CLSA Asia-Pacific Markets

114 [email protected] 27 June 2011

 
  
 ABB India - SELL Chindia power

Capacity utilisation has fallen sharply

As a result capacity Capacity utilisation over the last six years
utilisation has fallen . . .
120 (%) CY05 CY06 CY07 CY08 CY09 CY10

100

80

60

40

20

0
Switchgears Transformers Motors and other Electronic control
machines and supply units

. . . and return Return on capital employed

ratios dived
50 (%)

40

30

20

RoE RoCE (pre-tax)

10

0
CY04 CY05 CY06 CY07 CY08 CY09 CY10

We expect an improvement in performance . . .

We forecast a 20% Revenue and Ebitda margins
revenue Cagr over
2010-12 . . . 100 (Rsbn) Revenue (LHS) Ebitda margins (%) 14
90
12
80
70 10
. . . and Ebitda margins to
recover to 10% by 2012 60 8
50
40 6

30 4
20
2
10
0 0
CY11CL

CY12CL
CY01

CY02

CY03

CY04

CY05

CY06

CY07

CY08

CY09

CY10

Source: ABB, CLSA Asia-Pacific Markets

27 June 2011 [email protected] 115

 
  
 ABB India - SELL Chindia power

PAT can, therefore, PAT and PAT growth

increase 10x to
Rs5.7bn by 2012 6 (Rsbn) PAT (LHS) PAT growth (% YoY) 600

500
5
400
4
300

3 200

100
2
0
1
(100)

0 (200)
CY01 CY02 CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10 11CL 12CL

. . . but valuations look rich

ABB’s valuation looks rich ABB’s 12-month forward PE ratio
at 48x 11CL and
32x 12CL PE 300

250

200

150

100 +1sd102.4x

avg58.8x
50

-1sd15.3x
0
Jun 06 Apr 07 Feb 08 Dec 08 Oct 09 Aug 10 Jun 11

ABB is trading at a ABB’s 12-month forward PE ratio comparison with Crompton

significant premium to
Crompton Greaves 255 ABB India
ABB India
Crompton Greaves
205
Crompton Greaves

155

105

avg58.8x
55

avg16.9x
5
Jun 06 Apr 07 Feb 08 Dec 08 Oct 09 Aug 10 Jun 11

Source: ABB, CLSA Asia-Pacific Markets

116 [email protected] 27 June 2011

 
  
 ABB India - SELL Chindia power

Summary financials
Year to 31 December 09A 10A 11CL 12CL 13CL
Summary P&L forecast (Rsm)
Revenue 62,372 62,871 77,990 89,194 102,235
Op Ebitda 5,824 838 5,796 8,672 10,855
Op Ebit 5,339 321 5,160 7,929 10,007
Interest income 0 0 0 0 0
Interest expense (241) (174) (200) (200) (200)
Other items 726 855 712 747 837
Profit before tax 5,824 1,002 5,673 8,476 10,643
Taxation (1,728) (370) (1,883) (2,814) (3,534)
Minorities/Pref divs 0 0 0 0 0
Net profit 4,096 632 3,789 5,662 7,110
Summary cashflow forecast (Rsm)
Operating profit 5,339 321 5,160 7,929 10,007
Operating adjustments (550) 0 0 0 0
Depreciation/amortisation 485 517 635 743 848
Working capital changes (631) 1,017 (2,450) (2,588) (2,597)
Net interest/taxes/other (1,968) (499) (2,083) (3,014) (3,734)
Net operating cashflow 2,675 1,356 1,262 3,070 4,525
Capital expenditure (1,546) (860) (2,200) (2,000) (2,000)
Free cashflow 1,129 496 (938) 1,070 2,525
Acq/inv/disposals 442 0 0 0 0
Int, invt & associate div 726 843 700 735 825
Net investing cashflow (378) (16) (1,500) (1,265) (1,175)
Increase in loans 0 0 0 0 0
Dividends (466) (466) (513) (513) (513)
Net equity raised/other (19) (243) (19) (19) (19)
Net financing cashflow (485) (710) (532) (532) (532)
Incr/(decr) in net cash 1,812 630 (769) 1,274 2,818
Exch rate movements (53) 0 0 0 0
Opening cash 3,482 5,241 5,871 5,102 6,375
Closing cash 5,241 5,871 5,102 6,375 9,193
Summary balance sheet forecast (Rsm)
Cash & equivalents 5,241 5,871 5,102 6,375 9,193
Debtors 28,577 29,260 36,015 41,178 47,187
Inventories 7,294 6,979 8,660 9,902 11,347
Other current assets 6,380 7,153 8,876 10,149 11,630
Fixed assets 7,895 8,238 9,803 11,060 12,212
Intangible assets 0 0 0 0 0
Other term assets 0 0 0 0 0
Total assets 55,556 57,668 68,624 78,832 91,737
Short-term debt 0 0 0 0 0
Creditors 14,784 16,402 20,354 23,272 26,669
Other current liabs 16,536 17,075 20,833 23,005 25,947
Long-term debt/CBs 0 0 0 0 0
Provisions/other LT liabs (1) (46) (46) (46) (46)
Minorities/other equity 0 0 0 0 0
Shareholder funds 24,237 24,237 27,483 32,601 39,167
Total liabs & equity 55,556 57,668 68,624 78,832 91,737
Ratio analysis
Revenue growth (% YoY) (8.8) 0.8 24.0 14.4 14.6
Ebitda growth (% YoY) (24.8) (85.6) 591.9 49.6 25.2
Ebitda margin (%) 9.3 1.3 7.4 9.7 10.6
Net profit margin (%) 6.6 1.0 4.9 6.3 7.0
Dividend payout (%) 10.3 67.0 12.3 8.2 6.6
Effective tax rate (%) 29.7 36.9 33.2 33.2 33.2
Ebitda/net int exp (x) 24.2 4.8 29.0 43.4 54.3
Net debt/equity (%) (21.6) (24.2) (18.6) (19.6) (23.5)
ROE (%) 18.0 2.6 14.7 18.8 19.8
ROIC (%) 20.9 1.1 17.1 22.0 24.0
EVA®/IC (%) 8.5 (11.3) 4.7 9.6 11.6
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 117

 
  
 ABB India - SELL Chindia power

Recommendation history - ABB India Ltd (ABB IB)

Date Rec level Closing price Target
23 June 2011 SELL 817.20 700.00
01 November 2010 U-PF 822.50 700.00
02 August 2010 U-PF 812.05 720.00
25 May 2010 U-PF 829.10 810.00
31 October 2009 U-PF 767.85 600.00
02 August 2009 U-PF 699.00 490.00
Source: CLSA Asia-Pacific Markets

118 [email protected] 27 June 2011

 
  
 Adani Power
Rs106.95 - OUTPERFORM

Abhishek Tyagi Volume step up

[email protected] Adani Power should see strong volume and earnings growth as projects
(91) 2266505055
under construction complete. The company tied up 80% of its capacity in
Rajesh Panjwani long-term PPAs and took steps to fix short-term contracts at decent
(852) 26008271 prices. The company can meet part of its coal requirement from its parent
but it depends on Coal India for the balance, which could be a risk. We
maintain our Outperform call with a target price of Rs125 factoring in low
utilisation rates for the Tiroda power project.

Strong volume growth

Adani Power has an aggressive commissioning schedule and we expect its
27 June 2011 installed capacity to increase from 1,980MW at the end of FY11 to 4,620MW
by the end of FY12 and 6,600MW by FY13. Generation should increase 7.5x
India over the same period. Existing and under-construction capacity is all coal
Power based, thus coal requirements also increase to 24m tonnes by FY13.

Reuters ADAN.BO
Bloomberg ADANI IB
Long-term PPAs tie up about 80% of power
The company sold about 80% of its power via long-term PPAs. It signed
Priced on 22 June 2011
contracts for 7,269MW with the states of Gujarat (2,000MW), Haryana
India Sensex @ 17,550.6
(1,424MW), Rajasthan (1,200MW) and Maharashtra (2,645MW). One Gujarat
12M hi/lo Rs144.55/106.10 PPA has a Rs2.35/kWh tariff (fixed for 25 years), which the company is
disputing with Gujarat’s state utility.
12M price target Rs125.00
±% potential +17%
Target set on 22 Jun 11 Steps taken to tie-up short-term power
Adani Power took steps to sell off short-term power as well. The company has
Shares in issue 2,180.0m
a letter of award (LOA) with Uttar Pradesh (UP) to sell 600MW at Rs4.7/kWh
Free float (est.) 26.5%
(at UP bus bar) for one year starting in June 2011. Similarly it tied up 800MW,
Market cap US$5,200m at Rs4.1kWh, (at Maharashtra bus bar) with Maharashtra for a period of one
3M average daily volume year and a day.
Rs81.7m (US$1.8m)

Major shareholders
Coal is the key risk
Promoters 73.5% We cut our earnings estimates for the company to factor in lower utilisation
FIIs 9.6% rates for its Tiroda power project, which depends on domestic coal. In the
future the company may receive a coal-block allocation (not in our numbers),
which would improve the project’s value. Furthermore, we are concerned
about the sustainability of buying Indonesian coal at the current low rate.
Given the risks, we only rate the stock as Outperform, despite attractive
valuations compared to other Indian power companies. Our DCF-based target
Stock performance (%) price is Rs125.
1M 3M 12M
Absolute (5.1) (3.6) (12.3)
Relative (0.9) (1.2) (11.3) Financials
Abs (US$) (4.8) (3.5) (10.0) Year to 31 Mar 10A 11CL 12CL 13CL 14CL
160 (Rs) (%) 125 Revenue (Rsm) 4,349 18,963 78,774 126,890 158,989
Adani Power (LHS) 120
150 Rel to Sensex Net profit (Rsm) 1,700 5,494 20,720 25,058 29,492
115
140
EPS (Rs) 0.8 2.5 9.5 11.5 13.5
110
105 CL/consensus (26) (EPS%) - 107 95 82 88
130
100 EPS growth (% YoY) - 223.1 277.2 20.9 17.7
120 95 PE (x) 137.1 42.4 11.3 9.3 7.9
110 90
Dividend yield (%) 0.0 0.4 2.6 3.3 3.9
85
100 FCF yield (%) (32.3) (32.8) (32.8) (3.9) 2.0
80
90 75 PB (x) 4.0 3.7 3.0 2.5 2.0
Aug 09 Mar 10 Nov 10 Jun 11 ROE (%) 2.9 9.0 29.0 29.3 28.9
Source: Bloomberg
Net debt/equity (%) 159.9 270.1 325.2 283.2 237.3
www.clsa.com Source: CLSA Asia-Pacific Markets

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 Adani Power - O-PF Chindia power

Aggressive Capacity ramp-up schedule

commissioning
7,000 (MW) Capacity Addition 660 6,600
660
6,000
660

5,000 660
660
4,000 660

660
3,000
660
2,000 330
330
330
1,000 330

Jul 11

Dec 11

Jul 11
Sep 09

Mar 10

Jun 10

Aug 10

Jun 11
Jan 11

Apr 11

Apr 12

Apr 12

Apr 12
Coal requirements to Coal requirement
jump to 24mt by FY13
40 (mt) Mundra I& II Mundra III Mundra IV Tiroda I
Tiroda II Kawai Tiroda III
35

30

25

20

15

10

0
FY10 FY11 FY12 FY13 FY14 FY15

Domestic coal needs Sources of coal for the power project

rising as Tiroda and
Kawai are commissioned (%) Spot thermal coal Indonesian Domestic
100
90
80
70
60
50
40
30
20
10
0
FY10 FY11 FY12 FY13 FY14 FY15

Source: CLSA Asia-Pacific Markets

120 [email protected] 27 June 2011

 
  
 Adani Power - O-PF Chindia power

By FY14, 9.2GW of new Operational data

capacity comes on line FY12CL FY13CL FY14
Generation capacity (MW) 4,620 6,600 9,240
Effective annual capacity (MW) 3,300 6,435 7,700
Generation (mkWh) 24,042 45,241 57,334
Sales (mkWh) 22,239 41,848 53,034
Merchant sales (mkWh) 14,063 14,958 11,402
PPA sales (mkWh) 8,176 26,889 41,633
Overall Tariff (Rs/kWh) 3.54 3.03 3.00
Merchant tariff (Rs/kWh) 4.00 3.50 3.55
Fuel cost (Rs/kWh) 1.12 1.16 1.14
O&M cost (Rs/kWh) 0.16 0.17 0.20
Fixed cost (Rs/kWh) 1.19 1.03 1.03

Over FY12-14 we expect a P&L statement

19% earnings Cagr
(Rsm) FY12CL FY13CL FY14
Revenue 78,774 126,890 158,989
Fuel costs (27,006) (52,281) (65,553)
O&M costs (3,594) (7,280) (10,443)
Total costs (30,599) (59,561) (75,995)
Ebidta 48,175 67,329 82,994
Ebidta margin (%) 61.2 53.1 52.2
Other income 301 185 187
Depreciation (6,294) (10,321) (16,702)
Interest (16,549) (25,408) (27,601)
PBT 25,633 31,785 38,878
Taxes (5,124) (6,354) (8,370)
Eff tax rate (%) 20.0 20.0 21.5
PAT 20,509 25,431 30,507
Minority interest (MI) 211 (373) (1,016)
PAT after MI 20,720 25,058 29,492

Recommendation history - Adani Power (ADANI IB)

Date Rec level Closing price Target
22 June 2011 O-PF 107.35 125.00
09 February 2011 O-PF 122.70 131.00
06 September 2010 O-PF 133.85 140.00
30 August 2010 O-PF 135.70 146.00
28 March 2010 U-PF 116.55 111.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 121

 
  
 Adani Power - O-PF Chindia power

Summary financials
Year to 31 March 10A 11CL 12CL 13CL 14CL
Strong earnings growth Summary P&L forecast (Rsm)
Revenue 4,349 18,963 78,774 126,890 158,989
Op Ebitda 2,438 11,126 48,175 67,329 82,994
Op Ebit 2,085 9,379 41,881 57,008 66,292
Interest income 319 303 301 185 187
Interest expense (377) (2,496) (16,549) (25,408) (27,601)
Other items 0 0 0 0 0
Profit before tax 2,027 7,186 25,633 31,785 38,878
Taxation (327) (1,692) (5,124) (6,354) (8,370)
Minorities/Pref divs 0 0 211 (373) (1,016)
Net profit 1,700 5,494 20,720 25,058 29,492
FCF turns positive in FY14 Summary cashflow forecast (Rsm)
Operating profit 2,085 9,379 41,881 57,008 66,292
Operating adjustments 0 0 211 (373) (1,016)
Depreciation/amortisation 353 1,747 6,294 10,321 16,702
Working capital changes (831) (5,942) (9,467) (7,647) (4,745)
Net interest/taxes/other 2,677 (4,188) (21,673) (31,762) (35,971)
Net operating cashflow 4,284 996 17,246 27,547 41,262
Capital expenditure (79,679) (77,356) (93,776) (36,693) (36,693)
Free cashflow (75,394) (76,359) (76,529) (9,146) 4,569
Acq/inv/disposals (500) (500) 0 0 0
Int, invt & associate div 319 303 301 185 187
Net investing cashflow (79,859) (77,553) (93,474) (36,508) (36,506)
Increase in loans 55,808 70,387 81,668 13,995 7,033
Dividends 0 (824) (6,153) (7,629) (9,152)
Net equity raised/other 25,836 0 0 0 0
Net financing cashflow 81,644 69,563 75,515 6,366 (2,120)
Incr/(decr) in net cash 6,069 (6,994) (713) (2,595) 2,637
Exch rate movements 0 0 0 0 0
Opening cash 5,585 11,654 4,660 3,946 1,352
Closing cash 11,654 4,660 3,946 1,352 3,988
Capex would ease Summary balance sheet forecast (Rsm)
post FY14 Cash & equivalents 11,654 4,660 3,946 1,352 3,988
Fixed assets 155,562 231,171 318,652 345,024 365,014
Other term assets (2,587) 3,354 12,821 20,468 25,213
Total assets 164,628 239,685 335,920 367,344 394,716
Long-term debt/CBs 105,705 176,092 257,760 271,755 278,787
Provisions/other LT liabs 120 120 120 120 120
Minorities/other equity 1,023 1,023 1,234 861 (154)
Shareholder funds 57,780 62,450 76,806 94,608 115,963
Total liabs & equity 164,628 239,685 335,920 367,344 394,716
Healthy return ratios Ratio analysis
Revenue growth (% YoY) - 336.1 315.4 61.1 25.3
Ebitda growth (% YoY) - 356.3 333.0 39.8 23.3
Ebitda margin (%) 56.1 58.7 61.2 53.1 52.2
Net profit margin (%) 39.1 29.0 26.3 19.7 18.5
Dividend payout (%) 0.0 15.0 29.7 30.4 31.0
Effective tax rate (%) 16.1 23.5 20.0 20.0 21.5
Ebitda/net int exp (x) 42.5 5.1 3.0 2.7 3.0
Net debt/equity (%) 159.9 270.1 325.2 283.2 237.3
ROE (%) 2.9 9.0 29.0 29.3 28.9
ROIC (%) 1.1 3.7 11.8 13.1 13.8
EVA®/IC (%) (9.8) (6.8) 1.1 2.4 3.1
Source: CLSA Asia-Pacific Markets

122 [email protected] 27 June 2011

 
  
 BHEL
Rs1,921.65 - BUY

Rajesh Panjwani Incumbent benefits

[email protected] Bharat Heavy Electricals (BHEL) holds compelling competitive advantages
(852) 26008271
over new entrants. Its position, combined with an order backlog, should
Aditya Bhartia translate to a 17% revenue Cagr over FY11-14. We expect Ebitda margins
(91) 2266505077 to expand as employee and overhead costs decline, helping the firm post
a 19% EPS Cagr. Despite better growth and return ratios, the stock
Abhishek Tyagi trades at a discount to its five-year average PE, PB and EV/Ebitda
(91) 2266505055
multiples as well as to Chinese peers. We maintain our BUY call.

Compelling competitive advantages

BHEL enjoys strong incumbent advantages. It has a significantly higher
27 June 2011 degree of backward integration versus competitors (reflected in greater capex
per megawatt of installed capacity), which allows it to generate wider
India margins. Moreover, its large order backlog and steady order flow means
Power assured volume for vendors; the company can negotiate three-year contracts,
allowing it to lock in scarce vendor capacity at better terms than smaller
Reuters BHEL.BO companies. BHEL also has a solid balance sheet and technology transfer
Bloomberg BHEL IB
agreements in place. Thus it does not face qualifying problems in bidding for
Priced on 22 June 2011 projects, unlike some peers.
India Sensex @ 17,550.6
Orders should stay strong in FY12-13
12M hi/lo Rs2,695.00/1,872.50
In FY11, BHEL met its order guidance of Rs600bn, despite delays in utility
12M price target Rs2,500.00 orders from Rajasthan and NTPC’s 11 x 660MW bulk tender. For FY12,
±% potential +30% management guides for a further 10% increase, which we believe is
Target set on 25 Apr 11
achievable. Over the next two years, two National Thermal Power Corporation
Shares in issue 489.5m (NTPC) bulk tenders (11 x 660MW and 9 x 800MW projects) and orders from
Free float (est.) 32.3% SEBs (with whom BHEL has JVs) will drive orders. The company’s current
backlog provides revenue visibility until FY14. We believe the backlog-to-
Market cap US$20,981m
revenue ratio will remain healthy, at about 3x, even at the end of FY14.
3M average daily volume
Rs1,629.1m (US$36.5m) A 19% EPS Cagr over FY11-14; maintain BUY
Foreign s'holding 12.9% BHEL’s order backlog and anticipation of robust order inflows should translate
into a 17% revenue Cagr over FY11-14. We estimate Ebitda margins will
Major shareholders
improve by about 150bps in this period, with employee and overhead costs
Government of India 67.7%
FIIs 12.9% dropping as a percentage of revenue. This should help the firm post a three-
year 19% EPS Cagr. Historically, BHEL’s earnings growth is stronger than at
Chinese peers and the trend should continue (we estimate 4-8% EPS Cagr for
Dongfang and SEG). But despite this, BHEL trades at a discount to Chinese
companies as well as to its five year average PE, PB and EV/Ebitda multiples.
Stock performance (%) We maintain a BUY recommendation on the stock.
1M 3M 12M
Absolute (7.4) (1.3) (21.0)
Relative (3.3) 1.1 (20.2) Financials
Abs (US$) (7.1) (1.3) (19.0) Year to 31 Mar 09A 10A 11CL 12CL 13CL
2,900 (Rs) (%) 110 Revenue (Rsm) 281,329 342,316 434,510 498,108 590,962
105 Ebitda (Rsm) 38,043 55,045 80,460 92,418 113,934
2,700
100
Net profit (Rsm) 30,492 42,642 60,112 67,889 82,470
95
2,500
90 EPS (Rs) 62.3 87.1 122.8 138.7 168.5
2,300 85 CL/consensus (17) (EPS%) - - 99 99 108
80 EPS growth (% YoY) 6.2 39.8 41.0 12.9 21.5
2,100
75
ROE (%) 25.7 29.6 33.3 30.1 29.3
70
1,900 BHEL (LHS)
65 Net debt/equity (%) (78.6) (60.7) (47.0) (43.4) (42.5)
Rel to Sensex
1,700 60 PE (x) 30.9 22.1 15.6 13.9 11.4
Jun 09 Feb 10 Oct 10 Jun 11 PB (x) 7.3 5.9 4.7 3.8 3.0
Source: Bloomberg
EV/Ebitda (x) 21.7 15.0 10.2 8.8 7.0
www.clsa.com Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com

 
  
 BHEL - BUY Chindia power

Compelling competitive advantages

Compelling competitive BHEL has significantly more backward integration versus newer entrants
advantages (reflected in a higher installed-capacity capex per megawatt), which allows it
to generate greater margins. Moreover, its large order backlog and steady
order flow means the company can place three-year contracts with its
vendors, assuring volumes and allowing it to lock in scarce vendor capacity. It
also affords better supply and pricing terms than for smaller competitors.

BHEL has a strong balance sheet and secure technology transfer agreements
in place. Thus, it avoids problems in qualifying for projects, unlike some
smaller peers. Our industry conversations suggest that all these factors
influence banks, which have started to favour projects that buy BHEL
equipment in the last few quarters.

BHEL has more backward BHEL’s competitive advantages

integration versus Category Description
newer entrants
Backward  BHEL has achieved a far higher degree of backward integration and
integration domestic manufacturing than any new entrant. The fact is evident from
the company’s gross block/MW of capacity being far higher than any
competitor. This is despite the fact that most of the company’s capex is
brownfield and for competitors it’s Greenfield. Plus, BHEL has
advantages of scale (more than twice the capacity of competitors).
 A high proportion of new entrants use imported components from
Western or Japanese JV partners, which deters aggressive pricing.

Long-term  BHEL has established a robust supply chain and it will take time for
vendor others to replicate it.
arrangements
 Ansaldo management highlighted that all domestic players try to use
the same vendors as BHEL. However, none are able to offer long-term
commitments, while BHEL typically enters into three-year contracts.
This helps the firm secure component supplies at favourable prices.

Ease of  Because Cethar Vessels had not entered into a JV agreement with its
qualification technology provider (Riley), it was disqualified from NTPV-DVC bulk
tenders. Cethar’s management said state government tenders are
similar to NTPC, thus the company will find it difficult to qualify for
state government projects as well. It will focus only on private sector
orders, which we believe significantly reduces its addressable market.
 Lack of balance sheet strength could also make it difficult for some
players to qualify for tenders.

Reputation  Our conversations suggest that banks are more comfortable lending to
projects using components sourced form BHEL.

Scale  BHEL’s capacity is 3-8x the size of most new players, providing it with
substantial economies of scale.
 We expect BHEL to enjoy operating-leverage benefits over FY11-14.
Coupled with a decline in employee costs as a percent of sales, this
should help expand margins, despite rising material costs.

Source: CLSA Asia-Pacific Markets

124 [email protected] 27 June 2011

 
  
 BHEL - BUY Chindia power

Strong orders over the next few years

BHEL met order guidance Order flow over quarters
and is confident of
strength into FY12 (Rsbn)
300
FY07 FY08 FY09 FY10 FY11
250
Rs362bn Rs494bn Rs584bn Rs588bn Rs605bn

200

150

100

50

0
1QFY07

2QFY07

3QFY07

4QFY07

1QFY08

2QFY08

3QFY08

4QFY08

1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11
Source: CLSA Asia-Pacific Markets

Strong order inflows in In the last four years BHEL had robust order inflows, in a range of Rs500-
the last four years 600bn. Despite bulk-tender-award delays from NTPC, the company met its
FY11 order guidance.

For FY12, management guides for about a 10% increase in order booking to
Rs650bn. We believe inflows will remain strong over FY12-13, about Rs635bn,
though our project-by-project analysis suggests it could be even higher. Two
NTPC bulk tenders and orders from SEBs (with whom BHEL has signed JV
agreements) provide order visibility. We note the company is also in
discussions with West Bengal, Jharkhand and Orissa state governments to
form additional JVs.

State JVs should produce JVs and Memorandums of understanding (MoU) with state governments
4,700MW of order flow
State Capacity Comments
(MW)
Karnataka 2,400 Awarded in 1HFY11
Maharashtra 1,500 Management expects award in FY13
Tamil Nadu 1,600 Management expects award in FY12; tie up for coal done
Madhya Pradesh 1,600 Management expects award in FY13
Total 7,100 Most of the project awards happen on an EPC¹ basis
Already awarded 2,400 Karnataka
Yet to be awarded 4,700 Maharashtra, Tamil Nadu and Madhya Pradesh
¹ Engineering procurement construction. Source: CLSA Asia-Pacific Markets

BHEL’s current backlog provides revenue visibility until FY14 and we expect a
17% revenue Cagr over FY11-14. Even at the end of FY14, the firm should
have a healthy 3x backlog-to-revenue ratio.

27 June 2011 [email protected] 125

 
  
 BHEL - BUY Chindia power

A backlog of Rs1,640bn Forward order backlog and revenue

provides revenue visibility
1,800 (Rsbn)
through to FY14

1,500

1,200

900

600

300

0
FY11 order backlog FY12 revenues FY13 revenues FY14 revenues

Even on conservative Revenue and order backlog/revenue

order estimates, we
800 (Rsbn) Industrial revenues (LHS) (x) 5.0
expect a 17% revenue
Cagr over FY10-14 Power revenues (LHS)
700
Order backlog/revenues 4.5
600
4.0
500

400 3.5

300
3.0
200
2.5
100

0 2.0
FY08 FY09 FY10 11CL 12CL 13CL 14CL

Source: CLSA Asia-Pacific Markets

A 19% EPS Cagr over FY11-14

We believe that BHEL will Despite commodity costs increasing, we believe BHEL can expand margins
expand margins over the over the next two years. This is because it has settled wage costs until FY17
next few years . . .
and consequently its employee expenses, as a percentage of revenue, will
decline. The company will also enjoy operating leverage benefits. This should
more than offset material cost increases.

. . . as employee costs and Employee costs as a percent of revenue and Ebitda margin
overhead expenses fall as
22 (% of revenue) Employee costs Ebitda
a % of sales

20

18

16

14

12

10
FY05 FY06 FY07 FY08 FY09 FY10 11CL 12CL 13CL 14CL

Source: CLSA Asia-Pacific Markets

126 [email protected] 27 June 2011

 
  
 BHEL - BUY Chindia power

17% revenue Cagr Income statement summary

over FY11-14 FY08 FY09 FY10 FY11CL FY12CL FY13CL FY14CL

Net revenue 193,111 262,432 328,445 415,788 475,215 563,806 672,333

% YoY 12.3 35.9 25.2 26.6 14.3 18.6 19.2

Material costs (106,622) (160,300) (194,283) (225,434) (283,004) (338,715) (407,428)

As a % of revenue 55.2 61.1 59.2 54.2 59.6 60.1 60.6

Employee costs (31,459) (41,128) (50,998) (54,104) (61,630) (67,912) (74,074)

As a % of revenue 16.3 15.7 15.5 13.0 13.0 12.0 11.0

Provisions (2,400) (1,519) (4,152) (25,954) (5,182) (5,441) (5,713)

As a % of revenue 1.2 0.6 1.3 6.2 1.1 1.0 0.8

Other costs (17,991) (21,443) (23,967) (29,836) (32,981) (37,805) (44,852)

As a % of revenue 9.3 8.2 7.3 7.2 6.9 6.7 6.7

Total costs (158,473) (224,389) (273,400) (335,328) (382,797) (449,872) (532,067)

We expect Ebitda margins As a % of revenue 82.1 85.5 83.2 80.6 80.6 79.8 79.1
to expand despite an
Ebitda 34,638 38,043 55,045 80,460 92,418 113,934 140,266
increase in material costs
As a % of revenue 17.9 14.5 16.8 19.4 19.4 20.2 20.9

Depreciation (2,972) (3,343) (4,580) (5,441) (7,485) (8,254) (8,761)

Ebit 31,666 34,701 50,465 75,019 84,933 105,680 131,505

As a % of revenue 16.4 13.2 15.4 18.0 17.9 18.7 19.6

Other income 13,002 13,976 15,704 15,585 15,778 16,615 17,087

Interest (354) (307) (335) (547) (217) (217) (217)

PBT, pre exceptional 44,313 48,370 65,834 90,057 100,494 122,078 148,374

As a % of revenue 22.9 18.4 20.0 21.7 21.1 21.7 22.1

Exceptional income (127) 891 465 0 0 0 0

Reported PBT 44,186 49,260 66,299 90,057 100,494 122,078 148,374

Tax (15,593) (17,878) (23,192) (29,945) (32,605) (39,608) (48,140)

Effective tax rate (%) 35.3 36.3 35.0 33.3 32.4 32.4 32.4

PAT 28,593 31,382 43,106 60,112 67,889 82,470 100,234

Source: CLSA Asia-Pacific Markets

Attractive valuations
Trades at a sharp Share price and 12M forward PE bands
discount to historical
PE multiples 50

45

40

35

30
+1sd28.7x

25
avg22.1x
20

15 -1sd15.6x

10
Jun 06 Apr 07 Feb 08 Dec 08 Oct 09 Aug 10 Jun 11

Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 127

 
  
 BHEL - BUY Chindia power

Stronger Growth than at Cagr in revenue, gross profit and Ebitda for FY07-11
Chinese counterparts . . .
30 (%) BHEL Dongfang Electric
Shanghai Electric Harbin Power
25

20

15

10

(5)
Revenue Gross profit Ebit

. . . which is likely to Cagr in revenue, gross profit and Ebitda for FY11-14
remain the case to FY14
30 (%) BHEL Dongfang Electric
Shanghai Electric Harbin Power
25

20

15

10

0
Revenue Gross profit Ebit

But BHEL still trades at a BHEL versus Dongfang 12m forward PE

discount to Dongfang . . .
120 BHEL BHEL
Dongfang Electric Dongfang Electric
100

80

60

40

avg21.3x
20 avg22.1x

0
Jun 06 Apr 07 Feb 08 Dec 08 Oct 09 Aug 10 Jun 11

Source: CLSA Asia-Pacific Markets

128 [email protected] 27 June 2011

 
  
 BHEL - BUY Chindia power

…and almost at oar with BHEL versus Shanghai Electric 12m forward PE
Shanghai Electric
50 BHEL BHEL
45 Shanghai Electric Shanghai Electric

40
35
30
25
avg22.1x
20
15 avg15.4x

10
5
0
Jun 06 Apr 07 Feb 08 Dec 08 Oct 09 Aug 10 Jun 11

BHEL’s revenue per BHEL compared to global equipment suppliers

employee should increase BHEL Siemens ABB SEC Dongfang Harbin
over the next few years
Revenue (US$m) 9,446 103,072 31,589 9,444 5,641 4,322
Number of employees 47,774 402,700 116,500 28,836 19,990 18,485
Revenue per employee (US$) 197,720 255,952 271,150 327,494 282,170 233,826
Ebit (US$m) 1,631 7,912 3,872 392 335 85
Ebit margin (%) 17.3 7.7 12.3 4.2 5.9 2.0
Number of employees 47,774 402,700 116,500 28,836 19,990 18,485
Ebit per employee (US$) 34,137 19,647 33,236 13,602 16,757 4,611
R&D expense (US$m) 217 5,219 1,082 232 147 98
R&D as a percent of revenue (%) 2.3 5.1 3.4 2.5 2.6 2.3
Past five-year Cagr (%)
Revenue 24 1 7 12 65 9
Ebit 28 14 17 (15) 35 4
PAT 29 13 28 (4) 37 17

Recommendation history - Bharat Heavy Electricals (BHEL IB)

Date Rec level Closing price Target
25 April 2011 BUY 2,057.50 2,500.00
24 January 2011 BUY 2,217.50 2,700.00
13 December 2010 BUY 2,278.00 2,800.00
05 April 2010 O-PF 2,419.10 2,800.00
03 February 2010 O-PF 2,379.35 2,850.00
22 January 2010 O-PF 2,297.40 2,700.00
04 October 2009 U-PF 2,349.95 2,200.00
31 August 2009 U-PF 2,330.20 2,030.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 129

 
  
 BHEL - BUY Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
Summary P&L forecast (Rsm)
Revenue 281,329 342,316 434,510 498,108 590,962
Op Ebitda 38,043 55,045 80,460 92,418 113,934
Op Ebit 34,701 50,465 75,019 84,933 105,680
Interest income 9,829 11,549 10,283 9,804 9,745
Interest expense (307) (335) (547) (217) (217)
Other items 4,147 4,156 5,303 5,974 6,870
Profit before tax 48,370 65,834 90,057 100,494 122,078
Taxation (17,878) (23,192) (29,945) (32,605) (39,608)
Minorities/Pref divs 0 0 0 0 0
Net profit 30,492 42,642 60,112 67,889 82,470
Summary cashflow forecast (Rsm)
Operating profit 34,701 50,465 75,019 84,933 105,680
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 3,343 4,580 5,441 7,485 8,254
Working capital changes 12,444 (24,495) (22,182) (19,455) (39,325)
Net interest/taxes/other (18,755) (15,906) (24,642) (26,632) (32,739)
Net operating cashflow 31,732 14,644 33,636 46,331 41,870
Capital expenditure (12,983) (17,549) (17,623) (17,000) (6,000)
Free cashflow 18,750 (2,905) 16,013 29,331 35,870
Acq/inv/disposals (441) (275) (3,593) (5,700) (700)
Int, invt & associate div 10,720 12,013 10,283 9,804 9,745
Net investing cashflow (2,704) (5,810) (10,933) (12,896) 3,045
Increase in loans 542 (216) 356 0 0
Dividends (9,736) (11,406) (17,747) (19,275) (20,652)
Net equity raised/other (548) (2,458) (6,910) (217) (217)
Net financing cashflow (9,742) (14,080) (24,302) (19,492) (20,869)
Incr/(decr) in net cash 19,287 (5,246) (1,599) 13,943 24,047
Exch rate movements 0 0 0 0 0
Opening cash 83,860 103,147 97,901 96,302 110,245
Closing cash 103,147 97,901 96,302 110,245 134,292
Summary balance sheet forecast (Rsm)
Cash & equivalents 103,147 97,901 96,302 110,245 134,292
Debtors 159,755 206,888 273,546 286,041 339,409
Inventories 78,370 92,355 109,630 114,348 141,582
Other current assets 27,739 32,205 35,469 36,484 37,674
Fixed assets 26,274 39,450 51,631 61,146 58,892
Intangible assets 0 0 0 0 0
Other term assets 18,403 15,272 21,636 21,636 21,636
Total assets 414,211 484,868 592,606 639,991 744,276
Short-term debt 0 0 0 0 0
Creditors 58,529 75,798 96,832 97,015 115,100
Other current liabs 224,801 248,619 292,602 291,190 315,572
Long-term debt/CBs 1,494 1,278 1,634 1,634 1,634
Provisions/other LT liabs 0 0 0 0 0
Minorities/other equity 0 0 0 0 0
Shareholder funds 129,388 159,174 201,538 250,152 311,970
Total liabs & equity 414,211 484,868 592,606 639,991 744,276
Ratio analysis
Revenue growth (% YoY) 30.6 21.7 26.9 14.6 18.6
Ebitda growth (% YoY) 9.8 44.7 46.2 14.9 23.3
Ebitda margin (%) 13.5 16.1 18.5 18.6 19.3
Net profit margin (%) 10.8 12.5 13.8 13.6 14.0
Dividend payout (%) 28.1 23.0 19.5 17.3 14.2
Effective tax rate (%) 37.0 35.2 33.3 32.4 32.4
Ebitda/net int exp (x) 0.0 0.0 0.0 0.0 0.0
Net debt/equity (%) (78.6) (60.7) (47.0) (43.4) (42.5)
ROE (%) 25.7 29.6 33.3 30.1 29.3
ROIC (%) 84.2 73.5 61.0 49.1 47.6
EVA®/IC (%) 70.0 59.3 46.8 34.9 33.4
Source: CLSA Asia-Pacific Markets

130 [email protected] 27 June 2011

 
  
 CESC
Rs262.65 - OUTPERFORM

Abhishek Tyagi Back-ended capacity addition

[email protected] CESC has 1.2GW of fully-operational generation capacity and plans to
(91) 2266505055
increase this to 7.2GW over the next seven years. Construction on the
Rajesh Panjwani Chandrapur project (600MW) is in full swing, while Haldia (600MW)
(852) 26008271 still needs one regulatory approval, after which work can also start.
However, CESC’s retail business continues to lose money at the
Ebitda level and remains a drag on profits. Selling a strategic stake in
retail could be a key trigger. We keep our Outperform call with a
reduced sum-of-the-parts Rs330 target price.

Regulatory business - cash cow

27 June 2011 CESC has an integrated business model - from generation to distribution of
power - in its Kolkata licence area. All costs are “passed through” in the tariff
India and the company earns a steady stream of cash every year. It is also quite
Power well placed on the fuel side, with over 50% of its coal requirements met via
an associate company and the balance sourced from Coal India and imports.
Reuters CESC.BO
Bloomberg CESC IB
Big pipeline of expansion projects
Priced on 22 June 2011
CESC plans to add c.6GW of new power generation capacity by 2018. Nearly
India Sensex @ 17,550.6
all of this is based on domestic coal sources - coal linkages or captive coal
12M hi/lo Rs432.85/261.10 blocks. As of now, only Chandrapur project (600MW) is moving ahead, with
construction in full swing. Most of the other projects still have unresolved
12M price target Rs330.00
±% potential +26% issues with respect to regulatory clearances, land acquisition, environmental
Target set on 22 Jun 11 clearances, coal linkages, etc.

Shares in issue 124.9m

Free float (est.) 47.5%
Retail business remains a drag
CESC’s retail business, via its subsidiary Spencer Retail (220+ stores all over
Market cap US$732m India), continues to lose money at the Ebitda level and we expect this to
3M average daily volume continue over the next couple of years. The company plans to more than
Rs32.3m (US$.7m) double its current retail space by March 2013.
Foreign s'holding 30.5%
Reasonable valuations
Major shareholders We like CESC’s existing power business, and with Chandrapur (already under
Promoters 52.5%
construction) and Haldia (only the regulatory approval pending) getting
FIIs 18.7%
commissioned over the next three to four years, the company’s capacity is
going to nearly double. Retail-business losses will continue to be an
overhang, but we believe there is decent upside for the stock at current
levels. We maintain our Outperform call.
Stock performance (%)
1M 3M 12M
Absolute (6.1) (12.4) (31.9)
Relative (1.9) (10.2) (31.1) Financials
Abs (US$) (5.8) (12.3) (30.1) Year to 31 Mar 09A 10A 11CL 12CL 13CL
460 (Rs) (%) 130 Revenue (Rsm) 30,313 32,928 39,370 39,043 42,244
440 Rev forecast change (%) - - 3.1 (3.0) (2.8)
120
420
Net profit (Rsm) 4,097 4,333 4,870 4,828 4,962
400
110
380 NP forecast change (%) - - 7.5 3.2 5.5
360 100 EPS (Rs) 32.6 34.5 38.8 38.4 39.5
340 CL/consensus (4) (EPS%) - - 99 95 94
90
320
EPS growth (% YoY) 24.4 5.8 12.4 (0.9) 2.8
300
CESC (LHS) 80
280 Rel to Sensex
PE (x) 8.1 7.6 6.8 6.8 6.6
260 70 ROE (%) 14.9 13.9 13.9 12.3 11.4
Jun 09 Feb 10 Oct 10 Jun 11 Net debt/equity (%) 50.8 64.9 76.1 75.8 70.6
Source: Bloomberg
PB (x) 1.1 1.0 0.9 0.8 0.7
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 CESC - O-PF Chindia power

Big pipeline of Long-term capacity expansion plans of CESC

expansion projects
8,000 (MW) Capacity Addition 1,320 7,294

7,000
300
600
6,000
1,320
5,000
1,320
4,000
3,000 600
600
2,000 1,225 9
1,000
0
Existing

Balagarh
Orissa Ph 1

Orissa Ph 2
Gujarat

Total
Jharkhand
Chandrapur

Phase 1

Phase 2
Haldia

Haldia
Solar

Small solar and Projects with more visibility in the medium term
Chandrapur projects
Project Capacity (MW) Comments
currently under
construction Current capacity 1,225 Fully operational
Haldia Phase 1 600 Under implementation
Chandrapur 600 All approvals except the final regulatory approval in place
Orissa Phase 1 1,320 Land in possession, awaiting long term coal linkage
Solar (Gujarat) 9 PPA signed, project under execution
Total 3,754
Source: Company, CLSA Asia-Pacific Markets

Our target price is based Target-price calculation

on sum of the parts
Rs/share Comments
Value of licence area business 270 @1.5x FY12 regulated equity
Chandrapur project 48 One-year forward NPV
Haldia project 50 1.5x PB discounted back to FY12
Value of power business 369
Value of retail business (39) 25% discount to EV/sales of Pantaloon’s
Total 330

Recommendation history - CESC Ltd (CESC IB)

Date Rec level Closing price Target
22 June 2011 O-PF 267.35 330.00
30 March 2010 O-PF 380.50 430.00
23 January 2010 O-PF 420.75 410.00
Source: CLSA Asia-Pacific Markets

132 [email protected] 27 June 2011

 
  
 CESC - O-PF Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
Earnings growth to Summary P&L forecast (Rsm)
remain muted, with no Revenue 30,313 32,928 39,370 39,043 42,244
new capacity Op Ebitda 6,125 7,497 9,950 10,883 11,012
commissioned over next Op Ebit 4,376 5,441 7,280 6,588 6,595
two years Interest income 953 806 605 1,008 884
Interest expense (1,410) (1,782) (2,710) (2,857) (2,610)
Other items 729 756 915 775 798
Profit before tax 4,649 5,221 6,090 5,514 5,667
Taxation (552) (888) (1,220) (686) (705)
Minorities/Pref divs 0 0 0 0 0
Net profit 4,097 4,333 4,870 4,828 4,962
Operating cashflow will Summary cashflow forecast (Rsm)
remain strong, with Operating profit 4,376 5,441 7,280 6,588 6,595
steady regulatory Operating adjustments 0 0 0 0 0
business income Depreciation/amortisation 1,749 2,056 2,670 4,295 4,417
Working capital changes (2,266) (471) 1,228 (520) 831
Net interest/taxes/other (552) (888) (1,220) (686) (705)
Net operating cashflow 3,307 6,138 9,958 9,677 11,139
Capital expenditure (9,320) (11,897) (12,935) (12,935) (10,500)
Free cashflow (6,013) (5,759) (2,978) (3,259) 639
Acq/inv/disposals 2,593 (3,682) (2,000) 0 0
Int, invt & associate div 1,753 1,090 (1,398) 840 (763)
Net investing cashflow (4,975) (14,489) (16,334) (12,095) (11,263)
Increase in loans 9,090 5,227 5,857 5,572 2,956
Dividends (585) (583) (588) (647) (705)
Net equity raised/other (4,192) 2,394 0 0 0
Net financing cashflow 4,313 7,038 5,269 4,926 2,251
Incr/(decr) in net cash 2,646 (1,312) (1,107) 2,507 2,128
Exch rate movements 0 0 0 0 0
Opening cash 9,864 12,510 11,198 10,091 12,598
Closing cash 12,510 11,198 10,091 12,598 14,726
Summary balance sheet forecast (Rsm)
Cash & equivalents 12,510 11,198 10,091 12,598 14,726
Debtors 3,889 4,999 5,977 5,927 6,413
Inventories 2,120 2,383 2,849 2,825 3,057
Other current assets 10,749 10,260 10,291 10,328 10,372
Fixed assets 53,919 61,373 71,638 80,279 86,361
Intangible assets 0 0 0 0 0
Other term assets 79 71 71 71 71
Total assets 86,369 97,069 109,703 120,814 129,787
Short-term debt 0 0 0 0 0
Creditors 15,645 16,063 18,811 18,264 19,762
Other current liabs 1,231 1,227 1,181 1,171 1,267
Long-term debt/CBs 27,357 32,584 38,441 44,013 46,970
Provisions/other LT liabs 12,910 14,220 14,012 15,926 16,091
Minorities/other equity 0 0 0 0 0
Shareholder funds 29,226 32,976 37,258 41,440 45,697
Total liabs & equity 86,369 97,069 109,703 120,814 129,787
ROE is low due to Ratio analysis
high CWIP Revenue growth (% YoY) 9.2 8.6 19.6 (0.8) 8.2
Ebitda growth (% YoY) 10.9 22.4 32.7 9.4 1.2
Ebitda margin (%) 20.2 22.8 25.3 27.9 26.1
Net profit margin (%) 13.5 13.2 12.4 12.4 11.7
Dividend payout (%) 12.2 11.6 10.3 11.4 12.1
Effective tax rate (%) 11.9 17.0 20.0 12.4 12.4
Ebitda/net int exp (x) 13.4 7.7 4.7 5.9 6.4
Net debt/equity (%) 50.8 64.9 76.1 75.8 70.6
ROE (%) 14.9 13.9 13.9 12.3 11.4
ROIC (%) 8.2 7.8 8.8 7.6 7.0
EVA®/IC (%) (3.0) (3.1) (2.0) (3.5) (4.2)
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 133

 
  
 CESC - O-PF Chindia power

Notes

134 [email protected] 27 June 2011

 
  
 China Power Intl
HK$1.87 - OUTPERFORM

Juliet Zhu Hydro play

[email protected] After buying 63% of Wuling Power in 2009, CPI now has the largest
(86) 2120205913
exposure to hydro power of the Chinese IPPs, with hydro 22% of total
Rajesh Panjwani attributable capacity and 64% of operating profit in 2010. With tariff
(852) 26008271 hikes, greater profitability in its hydro business and improved utilisation
at all its consolidated thermal-power plants, we see CPI better positioned
and expect ROE to continue to rise. We rate CPI Outperform, with a
HK$2.30 target price based on 0.7x 12CL PB.

Biggest hydro play

CPI’s hydro-power exposure is the largest among IPPs following its acquisition
27 June 2011 of a 63% stake in Wuling Power. Currently 22% of its attributable capacity is
hydro power, compared with second-largest player Datang’s 10%. With coal
China prices edging higher but tariff adjustments lagging, its hydro business
Power outperformed its thermal operations in 2010: we expect that trend to
continue in 2011. CPI plans to continue expanding its hydro capacity through
Reuters 2380.HK
Bloomberg 2380 HK
acquisitions and construction. We expect hydro power to account for 25% of
total attributable capacity by 2012.
Priced on 22 June 2011
HS CEI @ 12,148.9
Utilisation improvement and best cost management
12M hi/lo HK$1.98/1.50 CPI recorded strong power generation in 1Q 2011. Utilisation hours for its
thermal plants increased 9% while utilisation for hydro more than doubled.
12M price target HK$2.30
±% potential +23% Despite the recent drought hitting hydro in April, management has said that
Target set on 22 Jun 11 1H growth of its hydro power generation is still achievable even under a
worst-case scenario. We do not see our current 16% growth estimate for
Shares in issue 5,107.1m
31.0%
hydro generation in 2011 as too aggressive given the recent heavy rain in
Free float (est.)
China. We also factor in a 5% utilisation improvement for CPI’s thermal
Market cap US$1,226m plants. In addition, the company is controlling its fuel cost quite well thanks
3M average daily volume to its small asset base, the highest contract-coal ratio of its peers and better
HK$14.5m (US$1.9m) fulfilment. We expect its average coal cost to increase 5% in 2011 and 4%
Major shareholders
in 2012.
CPI Holding 69.0%
Attractive valuations. Outperform
At 0.6x 12CL PB and 7x earnings, the stock trades at the lowest 12CL
multiples of its peers, while delivering faster earnings growth. We think it is
better positioned thanks to its hydro business and deserves higher multiples.
Strong power demand and potential acquisitions are positive catalysts. We
base our HK$2.30 target price on 0.7x forward PB. We maintain our
Stock performance (%) Outperform call.
1M 3M 12M
Absolute 6.9 19.1 11.3
Relative 13.9 25.3 10.5 Financials
Abs (US$) 6.6 19.2 11.2 Year to 31 Dec 09A 10A 11CL 12CL 13CL
3.00 (HK$) (%) 120 Revenue (Rmbm) 10,937 14,437 16,588 20,243 22,389
2.80 China Power Int 110 Net profit (Rmbm) 519 667 721 1,030 1,266
2.60 Rel to CEI (RHS)
100
EPS (fen) 14.2 13.1 14.1 20.1 24.7
2.40
CL/consensus (14) (EPS%) - - 107 131 148
2.20 90
EPS growth (% YoY) nm (7.7) 7.8 43.0 22.9
2.00 80
1.80
PE (x) 11.6 12.5 10.9 7.3 5.7
70
1.60 Dividend yield (%) 2.7 2.8 2.8 4.1 5.3
60 FCF yield (%) 1.4 (41.7) (42.0) (40.4) (20.2)
1.40
1.20 50 PB (x) 0.7 0.7 0.6 0.6 0.5
Jun 09 Feb 10 Oct 10 Jun 11 ROE (%) 4.8 5.8 6.3 8.5 9.7
Source: Bloomberg
Net debt/equity (%) 216.8 249.0 258.9 261.8 252.4
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 China Power Intl - O-PF Chindia power

Utilisation improved in 1Q Utilisation hours change

for both thermal and
hydro business 7,000 (hours) 1Q10 1Q11 2010
5,847
6,000 5,382 5,329

5,000

4,000
3,190
2,897
3,000

2,000
1,300

1,000

0
Thermal Hydro

Source: Company, CLSA Asia-Pacific Markets

Best fuel cost Fuel cost management in 2010

management in 2010 Company Increase in fuel cost in 2010 (% change in Rmb/kwh)
CPI 10.3
CRP 23.2
Datang 14.8
Huadian 20.5
Huaneng 15.4
Source: Company

Capacity growth will be CPI - Attributable capacity split

driven by both thermal
and hydro 16 (GW) Thermal Hydro 15
14
14 13
12
12 11

10
8
6
4
2
0
2009 2010 11CL 12CL 13CL

Power generation growth CPI - Net power generation

driven by commissioning
of new capacity 80 (bn kWh) Thermal Hydro
and utilization 67
improvement in 2011 60
60
51
46

40 35

20

0
2009 2010 11CL 12CL 13CL
Source: Company, CLSA Asia-Pacific Markets

136 [email protected] 27 June 2011

 
  
 China Power Intl - O-PF Chindia power

ROE continues to improve CPI - ROE

in forecast periods
11 (%)

10

4
2009 2010 11CL 12CL 13CL

Source: CLSA Asia-Pacific Markets

Valuations are Share price and 12M forward PE bands Share price and 12M forward PB bands
undemanding
60 (x) 2.0 (x)
1.8
50
+1sd44.2x 1.6
40
1.4
+1sd1.31x
30 1.2
1.0
20 avg0.93x
avg16.5x 0.8
10
0.6 -1sd0.56x
0 0.4
Jun 06 Feb 08 Oct 09 Jun 11 Jun 06 Feb 08 Oct 09 Jun 11

Source: Evaluator

Recommendation history - China Power International (2380 HK)

Date Rec level Closing price Target
22 June 2011 O-PF 1.88 2.30
31 May 2011 O-PF 1.84 2.10
19 April 2011 O-PF 1.76 2.00
01 April 2011 U-PF 1.66 1.60
26 November 2010 U-PF 1.65 1.50
14 January 2010 U-PF 2.03 1.80
25 November 2009 U-PF 2.17 2.19
21 September 2009 O-PF 2.26 2.67
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 137

 
  
 China Power Intl - O-PF Chindia power

Summary financials
Year to 31 December 09A 10A 11CL 12CL 13CL
Revenue growth driven Summary P&L forecast (Rmbm)
by utilisation Revenue 10,937 14,437 16,588 20,243 22,389
improvement and Op Ebitda 2,211 3,956 4,583 5,630 6,370
capacity addition in 2011 Op Ebit 1,165 2,244 2,693 3,489 3,991
Interest income 35 104 27 29 40
Interest expense (704) (1,514) (1,736) (2,000) (2,110)
Other items 78 413 297 314 330
Profit before tax 574 1,246 1,281 1,832 2,251
Taxation (22) (380) (320) (458) (563)
Minorities/Pref divs (33) (199) (240) (343) (422)
Net profit 519 667 721 1,030 1,266
Capex remain heavy for Summary cashflow forecast (Rmbm)
new capacity build-out Operating profit 1,165 2,244 2,693 3,489 3,991
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 1,046 1,712 1,890 2,141 2,379
Working capital changes 1,692 (1,463) 59 (278) (131)
Net interest/taxes/other (1,051) (955) (2,094) (2,496) (2,702)
Net operating cashflow 2,852 1,538 2,548 2,857 3,537
Capital expenditure (2,767) (5,009) (5,834) (5,890) (4,990)
Free cashflow 85 (3,470) (3,286) (3,033) (1,453)
Acq/inv/disposals 1,296 (1,213) 100 100 100
Int, invt & associate div 6 106 0 0 0
Net investing cashflow (1,465) (6,116) (5,734) (5,790) (4,890)
Increase in loans (789) 3,835 3,639 3,168 2,621
Dividends 0 (315) (216) (309) (380)
Net equity raised/other (14) 125 0 0 0
Net financing cashflow (802) 3,644 3,423 2,859 2,241
Incr/(decr) in net cash 584 (933) 237 (75) 888
Exch rate movements 0 0 0 0 0
Opening cash 1,327 1,911 977 1,214 1,140
Closing cash 1,911 977 1,214 1,140 2,027
Summary balance sheet forecast (Rmbm)
Cash & equivalents 1,911 977 1,214 1,140 2,027
Debtors 1,430 1,717 1,808 2,206 2,440
Inventories 265 336 342 418 458
Other current assets 915 745 782 821 862
Fixed assets 41,754 44,950 48,898 52,647 55,258
Intangible assets 885 1,226 1,222 1,222 1,222
Other term assets 2,573 3,382 3,476 3,575 3,679
Total assets 54,207 56,790 61,397 65,897 70,044
Short-term debt 6,230 9,097 10,087 12,134 14,639
Creditors 498 461 546 667 731
Other current liabs 3,694 2,505 2,614 2,728 2,848
Long-term debt/CBs 27,943 28,973 31,623 32,743 32,859
Provisions/other LT liabs 960 860 889 921 956
Minorities/other equity 2,443 2,656 2,896 3,239 3,661
Shareholder funds 12,438 12,238 12,743 13,464 14,351
Total liabs & equity 54,207 56,790 61,397 65,897 70,044
RoE will continue to Ratio analysis
improve thanks for higher Revenue growth (% YoY) 13.5 32.0 14.9 22.0 10.6
profitability of hydro Ebitda growth (% YoY) 95.4 79.0 15.9 22.8 13.1
business and easing Ebitda margin (%) 20.2 27.4 27.6 27.8 28.5
cost pressure Net profit margin (%) 4.7 4.6 4.3 5.1 5.7
in 2013 Dividend payout (%) 31.8 34.4 30.0 30.0 30.0
Effective tax rate (%) 3.9 30.5 25.0 25.0 25.0
Ebitda/net int exp (x) 3.3 2.8 2.7 2.9 3.1
Net debt/equity (%) 216.8 249.0 258.9 261.8 252.4
ROE (%) 4.8 5.8 6.3 8.5 9.7
ROIC (%) 3.7 3.4 3.9 4.7 5.1
EVA®/IC (%) (3.1) (2.3) (1.9) (1.2) (0.8)
Source: CLSA Asia-Pacific Markets

138 [email protected] 27 June 2011

 
  
 China Res Power
HK$14.16 - OUTPERFORM

Juliet Zhu Geared to coastal regions

[email protected] China Resources Power has consistently outperformed peers in utilisation
(86) 2120205913
hours and margins, with 63% of its capacity in eastern and southern
Rajesh Panjwani China where power demand is more resilient and tariffs are higher. Power
(852) 26008271 shortages and slower capacity growth in eastern regions will help CRP
maintain a high utilisation ratio. Delays in coal production and ramp-up
are now resolved, with production volume in the five months on track. We
recently upgraded CRP to a O-PF with a revised HK$18.70 target.

Well placed to tap power demand in the coastal regions

CRP has had a clear strategy to develop its power-generation capacity in
27 June 2011 coastal regions where there is strong demand and less capacity addition.
Affordability and tariffs are also higher, which have helped it achieve wider
China margins than other IPPs. With 63% of attributable capacity in China’s
Power southern and eastern regions, utilisation hours of its coal-fired plants have
consistently outperformed the national average and peers. With existing
Reuters 0836.HK
Bloomberg 836 HK
capacity shortages in eastern China, little capacity addition in the pipeline and
infrastructure and regulatory constraints on transmitting power from other
Priced on 22 June 2011
regions, the utilisation of CRP’s plants will remain high. Some of the company’
HS CEI @ 12,148.9
applications for new power plants in eastern China could also gain approval.
12M hi/lo HK$17.92/12.40
Coal business - Another lever
12M price target HK$18.70
±% potential +32% CRP’s upstream coal business will help mitigate fuel-cost risks and diversify
Target set on 23 Jun 11 its revenue streams. In 2010, the coal business contributed 17% of total
operating profit. With higher coal prices and production ramp-up, we estimate
Shares in issue 4,719.5m
25.0%
Ebit contribution from coal business to increase to 22% in 2011. Problems
Free float (est.)
with production ramp-up have been resolved with coal production in the first
Market cap US$8,610m five months up threefold, accounting for 37% of our full-year estimates.
3M average daily volume
HK$116.8m (US$15m) Valuation undemanding, O-PF
Major shareholders
CRP is currently trading at 10x 2012 PE and 1.3x 2012 PB multiple, both of
China Res Holding 64.6% which are at three-year lows. With a projected long-term average ROE of
12% (including 2008 when others were loss-making) and a forecast long-
term growth rate of 4%, we believe the company deserves to trade at a
target 1 year forward PB ratio of 1.7x based on our theoretical PB formula
(RoE-g)/(CoE-g). We maintain O-PF rating on its best fundamentals. Our
target price of HK$18.70 is based on 1.7x 12CL PB.

Stock performance (%)

1M 3M 12M
Absolute (7.9) 1.3 (14.6)
Relative (1.9) 6.6 (15.2) Financials
Abs (US$) (8.1) 1.4 (14.7) Year to 31 Dec 09A 10A 11CL 12CL 13CL
21 (HK$) (%) 106 Revenue (HK$m) 33,214 48,578 61,290 74,832 82,250
20 China Res Power 101 Net profit (HK$m) 5,317 4,904 5,717 6,470 7,218
19 Rel to CEI (RHS) 96
EPS (HK¢) 119.0 105.0 122.4 138.5 154.5
91
18
86 CL/consensus (23) (EPS%) - - 103 96 103
17
81 EPS growth (% YoY) 188.1 (11.8) 16.6 13.2 11.6
16
76 PE (x) 11.9 13.5 11.6 10.2 9.2
15
71
14 Dividend yield (%) 2.6 2.3 2.7 3.0 3.4
66
13 61 FCF yield (%) (14.7) (9.0) (20.9) (9.9) (6.1)
12 56 PB (x) 1.8 1.6 1.5 1.3 1.2
Jun 09 Feb 10 Oct 10 Jun 11 ROE (%) 16.0 12.1 13.2 13.8 13.9
Source: Bloomberg
Net debt/equity (%) 111.2 135.5 148.8 146.3 138.0
www.clsa.com Source: CLSA Asia-Pacific Markets

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 China Res Power - O-PF Chindia power

Tapping strong power demand in coastal areas

CRP has the largest CRP has a clear strategy of developing its power-generation capacity in coastal
exposure in Eastern and regions, mainly in the eastern and southern provinces, as power plants there
Southern China
operate at higher utilisation hours. Affordability and tariffs are also higher in
these areas, which have helped the company achieve wider margins compared
with other IPPs. With 63% of its attributable capacity in China’s southern and
eastern regions, utilisation hours of its coal-fired power plants (on a same plant
basis) have consistently outperformed the national average.

CRP has the highest Geographic exposure of 2010 attributable capacity

capacity concentration Provinces (%) CPI CRP Datang Huadian Huaneng
in Jiangsu and Northern 7 12 55 13 10
Guangdong Provinces Beijing 2 1
Tianjin 0 4 1
Hebei 9 26 11 6
Shanxi 7 10 1
Inner Mongolia 3 13 2 0
Northeast 0 5 3 0 10
Liaoning 5 3 10
Heilongjiang
Jilin
Eastern 38 45 18 57 43
Shanghai 11
Jiangsu 6 39 6 0 12
Zhejiang 1 5 4 9
Anhui 22 4 10
Fujian 5 4
Shandong 1 43 14
Jiangxi 2 4
Central 49 19 0 7 5
Henan 21 13 7 3
Hubei 10 3
Hunan 17 3 2
Southwest 6 1 12 11 6
Chongqing 6 3
Sichuan 0 0 11 2
Yunnan 1 6
Guizhou 6
Tibet
Southern 0 18 9 3 11
Guangdong 0 18 9 3 11
Guangxi 0
Hainan
Northwest 0 0 4 10 3
Gansu 1 3
Ningxia 2 10
Shaanxi
Qinghai 1
Xinjiang
Source: CLSA Asia-Pacific Markets

Utilisation continue Coal-fired power plants utilisation hours: CRP vs national average
to outperform
national average 7,000 (hours) CRP¹ National

6,000

5,000

4,000

3,000

2,000

1,000

0
2006 2007 2008 2009 2010

¹ On the same plant basis, Source: Company, CLSA Asia-Pacific Markets

140 [email protected] 27 June 2011

 
  
 China Res Power - O-PF Chindia power

Coal business - Another lever

Acquisitions of coal CRP has acquired 1.1bn tonnes of coal reserves (on a consolidated basis) in
resources provide Shanxi province over the past two years and has attributable coal reserves of
another lever . . .
about 461m tonnes. Involvement in the upstream coal business is an
important initiative taken by management to mitigate fuel cost risks and
diversify revenue streams. In 2010, CRP’s coal business contributed 17% of
total operating profit. With estimated rising coal prices and production ramp-
up, we estimate Ebit contribution from the coal business will increase to 22%
in 2011. The company encountered difficulties getting government approval
for production to resume and complete the technical upgrades of its acquired
mines last year. The problem has been solved this year, with consolidated coal
production in the first five months well on track, up threefold and accounting
for 37% of our full-year estimates.

. . . given coal price Spot coal price movement

continue to trend up
1,100 (Rmb/tonne)

1,000 Datong premium blend 5,800 kcal/kg

900 Shanxi premium blend 5,500 kcal/kg

800

700

600

500

400

300
Jan 04 Apr 05 Jun 06 Sep 07 Dec 08 Mar 10 Jun 11

Source: CLSA Asia-Pacific Markets

Current valuations are at Forward PE bands Forward PB bands

three-year lows
73 (log) max62.1x 49 (log) max4.47x
34.7x 3.27x
35 28
avg19.3x avg2.08x
13.5x
1.59x
17 17
min7.6x min1.10x

8 10

4 6
Jun 06 Feb 08 Oct 09 Jun 11 Jun 06 Feb 08 Oct 09 Jun 11

Source: Evaluator, CLSA Asia-Pacific Markets

Recommendation history - China Resources Power Holdings (836 HK)

Date Rec level Closing price Target
23 June 2011 O-PF 14.16 18.70
31 May 2011 O-PF 15.48 17.30
18 March 2011 BUY 13.48 17.70
09 January 2011 BUY 13.58 19.20
26 November 2010 BUY 13.34 19.40
23 March 2010 BUY 16.92 22.00
14 January 2010 BUY 15.02 20.50
07 January 2010 BUY 15.74 20.60
25 November 2009 BUY 15.68 20.20
25 August 2009 BUY 19.82 23.50
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 141

 
  
 China Res Power - O-PF Chindia power

Summary financials
Year to 31 December 09A 10A 11CL 12CL 13CL
Earnings growth driven by Summary P&L forecast (HK$m)
coal-production ramp-up Revenue 33,214 48,578 61,290 74,832 82,250
and higher utilisation Op Ebitda 10,694 12,527 16,438 19,958 22,492
in 2011 Op Ebit 7,450 8,253 11,392 13,807 15,476
Interest income 0 0 0 0 0
Interest expense (1,932) (2,527) (4,050) (5,239) (5,566)
Other items 890 791 957 1,000 948
Profit before tax 6,408 6,517 8,300 9,568 10,858
Taxation (370) (755) (1,328) (1,481) (1,836)
Minorities/Pref divs (720) (858) (1,255) (1,617) (1,804)
Net profit 5,317 4,904 5,717 6,470 7,218
Summary cashflow forecast (HK$m)
Operating profit 7,450 8,253 11,392 13,807 15,476
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 3,244 4,275 5,046 6,151 7,016
Working capital changes 1,749 (1,043) (924) 305 (351)
Net interest/taxes/other (2,698) (664) (5,571) (6,952) (8,812)
Net operating cashflow 9,745 10,820 9,943 13,311 13,329
Capital expenditure (19,067) (16,770) (23,737) (19,840) (17,360)
Free cashflow (9,322) (5,950) (13,793) (6,529) (4,031)
Acq/inv/disposals (1,843) 671 957 1,000 948
Int, invt & associate div (2,420) (4,300) 0 0 0
Net investing cashflow (23,330) (20,399) (22,780) (18,840) (16,412)
Increase in loans 13,460 17,756 14,378 5,559 4,591
Dividends (1,085) (1,085) (1,795) (2,032) (2,266)
Net equity raised/other 2,050 (6,748) 230 82 1,176
Net financing cashflow 14,424 9,922 12,813 3,609 3,501
Incr/(decr) in net cash 839 344 (23) (1,919) 418
Exch rate movements (44) 196 0 0 0
Opening cash 5,467 6,262 6,802 6,779 4,859
Closing cash 6,262 6,802 6,779 4,859 5,277
Capital expenditure in Summary balance sheet forecast (HK$m)
2011 is planned to split Cash & equivalents 6,262 6,802 6,779 4,859 5,277
among coal, thermal and Debtors 8,288 10,763 13,580 16,580 18,224
wind businesses Inventories 1,432 2,006 2,304 2,826 3,029
Other current assets 3,016 4,763 4,763 4,763 4,763
Fixed assets 71,553 84,274 99,580 112,435 122,027
Intangible assets 4,301 13,885 17,039 17,791 18,501
Other term assets 14,968 7,302 7,586 7,913 8,288
Total assets 118,926 143,011 164,847 180,383 193,324
Short-term debt 23,494 20,668 23,577 25,245 26,622
Creditors 12,763 14,682 16,866 20,686 22,173
Other current liabs 3,498 1,359 1,366 1,374 1,382
Long-term debt/CBs 32,990 54,243 65,713 69,604 72,818
Provisions/other LT liabs 1,024 1,798 1,888 1,983 2,082
Minorities/other equity 7,561 8,096 9,351 10,968 12,773
Shareholder funds 37,594 42,164 46,086 50,524 55,476
Total liabs & equity 118,926 143,011 164,847 180,383 193,324
CRP generates highest Ratio analysis
RoE among peers Revenue growth (% YoY) 24.1 46.3 26.2 22.1 9.9
Ebitda growth (% YoY) 69.8 17.1 31.2 21.4 12.7
Ebitda margin (%) 32.2 25.8 26.8 26.7 27.3
Net profit margin (%) 16.0 10.1 9.3 8.6 8.8
Dividend payout (%) 31.4 31.1 31.1 31.1 31.1
Effective tax rate (%) 5.8 11.6 16.0 15.5 16.9
Ebitda/net int exp (x) 5.5 5.0 4.1 3.8 4.0
Net debt/equity (%) 111.2 135.5 148.8 146.3 138.0
ROE (%) 16.0 12.1 13.2 13.8 13.9
ROIC (%) 9.7 7.5 8.2 8.7 8.8
EVA®/IC (%) 2.5 0.5 1.4 1.9 2.0
Source: CLSA Asia-Pacific Markets

142 [email protected] 27 June 2011

 
  
 Coal India
Rs378.65 - OUTPERFORM

Abhijeet Naik Coal baron

[email protected] Coal India is targeting 5% production growth in FY12 after a weak FY11.
(91) 2266505060
The recent dilution of norms by the MoEF will also help Coal India’s future
Abhishek Tyagi growth plans. The company depends on Indian Railways for 47% of its
(91) 2266505055 despatches: there has been some improvement in the availability of rakes
lately. We see Coal India as a good defensive play and maintain our
Nitij Mangal Outperform call. Higher-than-expected wage hikes, a change in policy for
(91) 2266505064
e-auction coal and lower wagon availability are near-term risks.

Targeting 5% production growth in FY12

Coal India is targeting 452mt in FY12 after a disappointing FY11, when there
27 June 2011 was no growth in production. The company blamed the Ministry of
Environment & Forest (MoEF) for the FY11 shortfall, as it was unable to mine
India in areas that were declared “critically polluted”. Our estimates factor in 3%
Materials production growth in FY12.

Reuters COAL.NS Despatch growth could be higher

Bloomberg COAL IS Despite huge shortages of coal in the country in FY11, Coal India added c.7mt
Priced on 22 June 2011 coal to its stocks due to a lack of railway wagons. The availability of rakes
India Sensex @ 17,550.6 from Indian Railways (IR) for moving coal has improved in FY12. We factor in
12M hi/lo Rs422.35/289.00
449mt despatches in FY12 (6% growth) and 471mt in FY13 (5% growth).
Coal India’s official FY12 target is higher at 454mt and internally
12M price target Rs460.00 management is even more aggressive, aiming for 479mt, which assumes a
±% potential +21%
25mt inventory reduction.
Target set on 2 Jun 11

Shares in issue 6,316.4m Wage revision in FY12

Free float (est.) 10.0% Coal India is currently negotiating a wage settlement with its trade unions.
Market cap US$53,147m
The company will start providing for this from 2QFY12 onwards. We have built
a 10% hike in overall employee expenses into our models for FY12 and are
3M average daily volume not factoring in any coal price hikes to compensate for the additional
Rs1,226.2m (US$27.5m)
expense.
Major shareholders
Govt. of India 90.0% Maintain Outperform
FIIs 6.1%
Coal India has recently displayed flexibility in taking differential price hikes for
different types of coal and categories of consumers. With its average realisations
still at a 50% discount to international coal prices, there is enough headroom to
take future price hikes. We view Coal India as a good defensive stock with
potential for positive earnings surprises. Key risks are lower availability of
railway rakes, which would impact its despatches, and a change in e-auction
Stock performance (%) policy which could reduce the size of its most lucrative business segment.
1M 3M 12M
Absolute 3.8 5.2 0.0
Relative 8.3 7.7 0.0 Financials
Abs (US$) 4.0 5.2 0.0 Year to 31 Mar 09A 10A 11CL 12CL 13CL
430 (Rs) (%) 145 Revenue (Rsm) 387,888 446,153 502,336 609,635 674,015
Coal India (LHS) 140 Net profit (Rsm) 20,477 96,761 109,276 156,710 173,928
410
Rel to Sensex 135
390
EPS (Rs) 3.2 15.3 17.3 24.8 27.5
130
125 CL/consensus (27) (EPS%) - - 102 116 111
370
120 EPS growth (% YoY) (55.5) 372.5 12.9 43.4 11.0
350 115 PE (x) 116.8 24.7 21.9 15.3 13.8
330 110
Dividend yield (%) 0.7 0.9 1.0 1.5 1.6
105
310 PB (x) 12.6 9.3 7.1 5.3 4.1
100
290 95 ROE (%) 11.3 43.1 36.6 39.6 33.6
Dec 10 Feb 11 Apr 11 Jun 11 Net debt/equity (%) (144.9) (143.0) (135.6) (130.8) (128.5)
Source: Bloomberg
EV/Ebitda (x) 85.6 19.5 14.0 9.0 7.5
www.clsa.com Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com

 
  
 Coal India - O-PF Chindia power

Coal production was Coal India: Key assumptions

flat in FY11 FY08 FY09 FY10 FY11 FY12CL FY13CL
Volumes (mt)
Coal production 379 404 431 431 444 462
Coal despatches 375 401 415 423 449 471
E-auction volume as % of raw coal 8.1 12.9 10.9 11.8 11.8 11.8
Beneficiated volume as % of dispatch 3.8 3.7 3.5 3.7 3.5 3.3
Realisations (Rs/t)
Coal sold on FSA 793 844 947 1,003 1,153 1,211
Auction pricing premium (%) 69.8 75.5 62.6 84.1 80.0 80.0
Beneficiated coal premium (%) 141.1 167.9 125.3 119.7 100.0 100.0
Blended realisations 871 968 1,074 1,187 1,359 1,430

Despatches are expected We expect CIL’s coal despatches to grow at 5.5% Cagr over FY11-13
to grow with availability
of railway rakes
500 (mt) Despatch vol YoY growth (RHS) (%) 8
471
7
449
450 6
423
415 5
401
400 4
375
3

350 2

300 0
FY08 FY09 FY10 FY11 FY12CL FY13CL

Production volumes to grow at 3.5% Cagr over FY12-13 We assume inventory liquidation of 14mt over FY12-13

500 (mt) Production vol YoY growth (RHS) (%) 8 80 (mt)

70
462 7 70 66
62
444
450 6 60 56
431 431

5 50 46 47
404
400 4 40
379
3 30

350 2 20

1 10

300 0 0
FY08 FY09 FY10 FY11 FY12CL FY13CL FY08 FY09 FY10 FY11 FY12CL FY13CL

Source: Company, CLSA Asia-Pacific Markets

144 [email protected] 27 June 2011

 
  
 Coal India - O-PF Chindia power

We build no further price hike in FY12 and 5% in FY13 Blended ASPs will increase at 10% Cagr over FY12-13

1,300 (Rs/t) FSA realizations (%) 16 1,600 (Rs/t) Overall blended realizations (%) 18
YoY growth (RHS) 1,211 YoY growth (RHS)
14 1,500 1,430
16
1,200
1,400 14
12
1,153
1,100 1,300 12
10 1,359
1,003 1,200 10
1,000 8 1,074 1,187
947
1,100 8
6 968
900 1,000 6
844
4 871
793 900 4
800
2 800 2

700 0 700 0
FY08 FY09 FY10 FY11 FY12CL FY13CL FY08 FY09 FY10 FY11 FY12CL FY13CL

Recent price hikes more Coal India price hikes

frequent than before for
Coal India (%)
18
16
16 15

14

12 11
10
10
9

2
0 0 0 0 0 0
0
FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11

Source: Company, CLSA Asia-Pacific Markets

Recommendation history - Coal India Ltd (COAL IS)

Date Rec level Closing price Target
02 June 2011 O-PF 414.45 460.00
21 February 2011 O-PF 302.35 330.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 145

 
  
 Coal India - O-PF Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
26% earnings growth Summary P&L forecast (Rsm)
over FY11-13 Revenue 387,888 446,153 502,336 609,635 674,015
Op Ebitda 24,313 101,662 134,790 193,789 208,249
Op Ebit 7,404 88,368 118,061 176,058 189,301
Interest income 0 0 0 0 0
Interest expense (1,789) (1,560) (791) (932) (932)
Other items 51,495 53,378 47,963 58,770 71,225
Profit before tax 57,110 140,186 165,233 233,896 259,594
Taxation (36,632) (43,425) (55,957) (77,186) (85,666)
Minorities/Pref divs 0 0 0 0 0
Net profit 20,477 96,761 109,276 156,710 173,928
Strong operating Summary cashflow forecast (Rsm)
cashflows Operating profit 7,404 88,368 118,061 176,058 189,301
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 16,909 13,295 16,729 17,731 18,947
Working capital changes 59,667 62,728 12,742 45,938 44,714
Net interest/taxes/other (727) (20,226) (30,871) (50,074) (54,009)
Net operating cashflow 83,252 144,164 116,662 189,653 198,953
Capital expenditure (26,121) (26,428) (24,738) (46,500) (40,000)
Free cashflow 57,131 117,736 91,924 143,153 158,953
Acq/inv/disposals 2,127 2,228 2,187 2,230 2,230
Int, invt & associate div 13,087 27,712 23,011 30,726 38,636
Net investing cashflow (10,907) 3,512 460 (13,543) 866
Increase in loans 2,646 (616) (5,333) 0 0
Dividends (22,548) (29,871) (28,799) (41,529) (46,092)
Net equity raised/other 34,892 (23,361) 928 0 0
Net financing cashflow 14,990 (53,849) (33,205) (41,529) (46,092)
Incr/(decr) in net cash 87,335 93,828 83,917 134,581 153,728
Exch rate movements 0 0 0 0 0
Opening cash 209,615 296,950 390,778 474,695 609,275
Closing cash 296,950 390,778 474,695 609,275 763,003
Huge cash reserves Summary balance sheet forecast (Rsm)
Cash & equivalents 296,950 390,778 474,695 609,275 763,003
Debtors 18,475 21,686 30,256 35,201 38,879
Inventories 36,669 44,018 55,785 64,904 71,685
Other current assets 117,271 86,762 99,225 99,225 99,225
Fixed assets 129,283 142,416 150,425 179,194 200,247
Intangible assets 0 0 0 0 0
Other term assets 9,548 9,658 8,732 8,732 8,732
Total assets 623,247 708,141 829,755 1,004,939 1,187,948
Short-term debt 0 0 0 0 0
Creditors 8,663 7,725 8,717 10,142 11,201
Other current liabs 390,761 406,100 450,650 509,228 563,341
Long-term debt/CBs 21,485 20,869 15,536 15,536 15,536
Provisions/other LT liabs 12,238 14,774 16,214 16,214 16,214
Minorities/other equity 19 236 326 326 326
Shareholder funds 190,081 258,437 338,312 453,494 581,330
Total liabs & equity 623,247 708,141 829,755 1,004,939 1,187,948
Healthy return ratios Ratio analysis
Revenue growth (% YoY) 18.9 15.0 12.6 21.4 10.6
Ebitda growth (% YoY) (59.6) 318.1 32.6 43.8 7.5
Ebitda margin (%) 6.3 22.8 26.8 31.8 30.9
Net profit margin (%) 5.3 21.7 21.8 25.7 25.8
Dividend payout (%) 83.3 22.8 22.5 22.7 22.7
Effective tax rate (%) 64.1 31.0 33.9 33.0 33.0
Ebitda/net int exp (x) 13.6 65.2 170.5 207.9 223.4
Net debt/equity (%) (144.9) (143.0) (135.6) (130.8) (128.5)
ROE (%) 11.3 43.1 36.6 39.6 33.6
Source: CLSA Asia-Pacific Markets

146 [email protected] 27 June 2011

 
  
 Crompton Greaves
Rs251.25 - BUY

Rajesh Panjwani Bridging technology gaps

[email protected] Crompton Greaves has steadily grown its revenue and expanded
(852) 26008271
operating margins despite pressure from rising material prices and
Aditya Bhartia growing competition, while the rest of the industry has faltered. Focused
(91) 2266505077 acquisitions have helped it to improve its product offerings and grow
internationally. As domestic power-order inflows improve in 2HFY12, the
Abhishek Tyagi business should return to a strong revenue growth trajectory from FY13.
(91) 2266505055
We expect a 17% EPS Cagr over FY11-13. Maintain BUY.

Stellar performance in last five years

Crompton enjoyed a 19% revenue Cagr over FY06-11 through a combination
27 June 2011 of organic and inorganic growth. Further, the company has expanded its
Ebitda margin from 8.6% to 13.4% through strict cost control, increased
India standardisation, global sourcing and acquisition synergies. As a result, Ebitda
Power and EPS registered a Cagr of 30% and 31% respectively.

Reuters CROM.BO Strengthening business profile through inorganic growth

Bloomberg CRG IB
Crompton has made nine acquisitions in the past six years, two of which were
Priced on 22 June 2011 concluded in May this year. All but the the Nelco business were based outside
India Sensex @ 17,550.6 India. In addition to giving the company international exposure, acquisitions
12M hi/lo Rs349.00/228.00 have bridged its service offering gap vis-à-vis its multinational competitors.
HVDC is now the only area where Crompton lags its international peers.
12M price target Rs300.00
±% potential +19%
Diversified business model helps; power orders should pick up
Target set on 2 May 11
In FY11, Crompton’s domestic power business disappointed, with revenue
Shares in issue 641.5m increasing by a modest 2% YoY. However, the impact was largely offset by
Free float (est.) 59.1% strong revenue growth in consumer (25% YoY) and industrial (20% YoY)
Market cap US$3,595m businesses, helping the company deliver results in line with expectations. We
believe that order inflows in the power business should pick up in 2HFY12,
3M average daily volume
Rs357.6m (US$8m)
which should translate into strong power revenue growth from FY13 onwards.

Major shareholders Maintain BUY

Promoters 40.9% The next two quarters could be challenging, with power inflows remaining
FIIs 21.7%
weak and margin pressure intensifying. However, we expect domestic power
business to return to double-digit revenue growth from FY13 onwards, while
industrial and consumer businesses should continue to grow strongly (we
forecast 16-21% revenue Cagr). Crompton should consequently deliver 15%
revenue Cagr and 19% EPS Cagr over FY11-13. Valuations look reasonable at
16.4 FY12 and 13.3x FY13 PE, close to five-year average multiples. We
Stock performance (%) maintain BUY with a 12-month forward target of Rs300.
1M 3M 12M
Absolute 1.4 (5.6) (0.7)
Relative 5.9 (3.3) 0.4 Financials
Abs (US$) 1.7 (5.6) 1.9 Year to 31 Mar 09A 10A 11CL 12CL 13CL
400 (Rs) (%) 180 Revenue (Rsm) 87,373 91,409 100,051 116,069 131,511
Crompton Greaves
Rel to Sensex (RHS)
170 Ebitda (Rsm) 9,956 12,770 13,438 14,488 17,339
350 160 Net profit (Rsm) 5,590 8,630 8,887 9,822 12,123
150
300 EPS (Rs) 8.7 13.5 13.9 15.3 18.9
140
CL/consensus (29) (EPS%) - - 96 97 104
130
250 EPS growth (% YoY) 38.0 54.4 3.0 10.5 23.4
120
110 ROE (%) 35.6 39.6 30.7 26.5 26.1
200
100 Net debt/equity (%) 8.3 (6.7) 5.2 (16.0) (31.3)
150 90 PE (x) 28.8 18.7 18.1 16.4 13.3
Jun 09 Feb 10 Oct 10 Jun 11 PB (x) 8.8 6.4 4.9 3.9 3.1
Source: Bloomberg
EV/Ebitda (x) 16.1 12.0 11.5 10.2 8.0
www.clsa.com Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com

 
  
 Crompton Greaves - BUY Chindia power

Stellar performance in last five years

Crompton today enjoys a Crompton’s domestic ranking and competitive scenario across business segments
dominant position in most Division Products Competitors CG’s domestic rank International mkt share
of its businesses
Power Electricity ABB,BHEL, Alstom 1 After numerous acquisitions,
transformers Crompton now enjoys a
strong market share
Distribution BHEL, Alstom, KEC, Voltamp 2
internationally as well.
transformers
Switchgears ABB, BHEL, Siemens, Alstom 1 Low
Industrial LT Motors ABB, Siemens, KEC 1 Low
FHP Motors GE 2
HT Motors BHEL, KEC, ABB, Alstom 2
Consumer Fans Orient, Usha, Khaitan, Polar 1 Hardly any presence
internationally. LED
Lighting Phillips, Surya, Bajaj, Wipro 2
technology might help it
Pumps Phillips, Bajaj, Wipro 1 penetrate new markets.
Source: Company, CLSA Asia-Pacific Markets

Stronger revenue growth Revenue of Crompton and its competitors

than competitors through
a combination of organic 120 ABB
(Rsbn)
and inorganic growth
Areva
100 Crompton (standalone)
Crompton (consol)
80

60

40

20

0
CY04 CY05 CY06 CY07 CY08 CY09 CY10

Crompton’s Ebitda Ebitda margins of Crompton and its competitors

margins have been
much more stable 18 (%)
than competitors
16

14

12

10

8
ABB
6 Areva
4 Crompton (standalone)
Crompton (consol)
2

0
FY05 FY06 FY07 FY08 FY09 FY10 FY11

Source: CLSA Asia-Pacific Markets

148 [email protected] 27 June 2011

 
  
 Crompton Greaves - BUY Chindia power

Focused acquisitions
Crompton’s acquisitions Crompton’s acquisitions over the years
were aimed at providing Company Date Value Comments
scale as well as improving (Rsm)
its product offering Pauwels May 05 1,800  Made Crompton amongst the top 10 transformer manufacturers
 New products acquired from this acquisition:
 Up to 525kV transformers
 compact windmill transformers
 mobile sub-stations and transformers
Ganz Oct 06 2,000  Engaged in the manufacturing of
 EHV Transformers
 Switchgear
 Gas Insulated Switchgear (GIS)
Microsol May 07 570  Engaged in the business of providing substation and
distribution automation for the utility industry, including MV
and HV sub-stations, new sub-stations and retro-fitting
solutions for existing substations.

Sonomatra May 08 92  Engaged in the servicing of power systems such as providing

on-site maintenance, repairing of power transformers & on-
load tap changers, oil analysis, oil treatment and retro-filling
solutions.

MSE Power Sep 08 733  Engaged in engineering, procurement and construction (EPC)
Systems of high voltage electrical power transformer systems.
 This acquisition will increase the Company's strength as a
systems integrator in the EPC arena, particularly in
renewable energy with a focus on the wind segment.

Power Technology Mar 10 2,000  Provides consulting as well as technical and engineering
Systems (PTS) support to regional electricity companies in the UK.
 Service offering includes conceptual engineering and system
studies and complete EPC solutions for sub-stations that
cover electrical, civil and structural aspects.

Nelco businesses Apr 10 920  Will enable Crompton become a stronger player in its
railways business and build capabilities in drives.

Emtron Group May 11 3,700  Emotron manufactures variable frequency drives, soft
starters, shaft power monitors etc.
 The acquisition is aimed at improving Crompton’s
automations solutions in its industrial business.

QEI May 11 1,350  Provider of SCADA and sub-station automation systems.

PowerGrid substation/transformer orders should pick up

PowerGrid’s orders for PowerGrid ordering for substations and transformers over years
substations and
30 (Rsbn) FY09 FY10 FY11
transformers fell by 42%
YoY in FY11 Rs35bn Rs45bn Rs26bn
25

20

15

10

0
1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11

Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 149

 
  
 Crompton Greaves - BUY Chindia power

Trading at a discount to five-year average multiple

Crompton is trading close Crompton’s PE multiple over the last five years
to its average five-year
PE multiple . . . 35

30

25
+1sd22.4x
20
avg16.9x
15
-1sd11.5x
10

0
Jun 06 Apr 07 Feb 08 Dec 08 Oct 09 Aug 10 Jun 11

. . . as well as Crompton’s EV/Ebitda multiple over the last five years

EV/Ebitda multiple
20
18
16
14
+1sd13.3x
12
10 avg10.1x

8
-1sd6.9x
6
4
2
0
Jun 06 Apr 07 Feb 08 Dec 08 Oct 09 Aug 10 Jun 11

However, it is at a Crompton’s PB multiple over the last five years

discount to PB multiple
12

10
A pick up in project
awards will help
the stock rerate 8

+1sd6.53x
6
avg4.95x

4
-1sd3.36x

0
Jun 06 Apr 07 Feb 08 Dec 08 Oct 09 Aug 10 Jun 11

Source: CLSA Asia-Pacific Markets

150 [email protected] 27 June 2011

 
  
 Crompton Greaves - BUY Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
31% EPS Cagr over the Summary P&L forecast (Rsm)
last five years Revenue 87,373 91,409 100,051 116,069 131,511
Op Ebitda 9,956 12,770 13,438 14,488 17,339
Op Ebit 8,740 11,219 11,502 12,341 15,028
Interest income 0 0 0 0 0
Interest expense (808) (428) (209) (203) (192)
Other items 731 1,483 698 984 1,357
Profit before tax 8,663 12,274 11,990 13,122 16,193
We forecast 17% EPS
Taxation (3,047) (3,650) (3,100) (3,295) (4,065)
Cagr over FY11-13
Minorities/Pref divs (26) 6 (4) (4) (5)
Net profit 5,590 8,630 8,887 9,822 12,123
Robust cashflow Summary cashflow forecast (Rsm)
generation . . . Operating profit 8,740 11,219 11,502 12,341 15,028
Operating adjustments 740 1,100 999 904 1,277
Depreciation/amortisation 1,216 1,551 1,936 2,148 2,311
Working capital changes 1,113 (125) (4,459) 2,685 (561)
Net interest/taxes/other (3,600) (3,788) (3,364) (3,722) (4,480)
Net operating cashflow 8,209 9,956 6,615 14,355 13,575
. . . which Crompton
Capital expenditure (2,557) (1,350) (7,593) (4,500) (2,500)
could utilise to
Free cashflow 5,652 8,606 (978) 9,855 11,075
grow inorganically
Acq/inv/disposals (738) (3,864) (1,211) 0 0
Int, invt & associate div 0 0 0 0 0
Net investing cashflow (3,295) (5,213) (8,804) (4,500) (2,500)
Increase in loans (1,238) (2,173) (307) (533) (610)
Dividends (733) (1,540) (1,540) (1,540) (1,540)
Net equity raised/other 268 (2) 332 0 0
Net financing cashflow (1,703) (3,714) (1,515) (2,072) (2,150)
Incr/(decr) in net cash 3,212 1,029 (3,704) 7,783 8,925
Exch rate movements 0 3 0 0 0
Opening cash 2,445 5,656 6,688 2,984 10,767
Closing cash 5,656 6,688 2,984 10,767 19,692
Strong balance sheet Summary balance sheet forecast (Rsm)
Cash & equivalents 5,656 6,688 2,984 10,767 19,692
Debtors 20,556 21,463 25,427 28,498 32,193
Inventories 10,949 10,412 11,893 14,432 15,940
Other current assets 0 0 0 0 0
Fixed assets 13,785 13,760 19,417 22,171 22,376
Intangible assets 0 0 0 0 0
Other term assets 5,019 3,351 6,276 4,670 5,137
Total assets 57,639 61,210 72,744 87,284 102,086
Short-term debt 0 0 0 0 0
Creditors 15,884 14,865 16,138 21,065 23,804
Other current liabs 16,124 15,305 17,755 19,515 21,888
Long-term debt/CBs 7,182 5,010 4,703 4,170 3,560
Provisions/other LT liabs 0 945 1,244 1,244 1,244
Minorities/other equity 139 43 157 161 166
Shareholder funds 18,311 25,043 32,747 41,128 51,425
Total liabs & equity 57,639 61,210 72,744 87,284 102,086
Impressive return ratios Ratio analysis
Revenue growth (% YoY) 27.9 4.6 9.5 16.0 13.3
Ebitda growth (% YoY) 33.8 28.3 5.2 7.8 19.7
Ebitda margin (%) 11.4 14.0 13.4 12.5 13.2
Net profit margin (%) 6.4 9.4 8.9 8.5 9.2
Dividend payout (%) 15.7 17.8 17.3 15.7 12.7
Effective tax rate (%) 35.2 29.7 25.9 25.1 25.1
Ebitda/net int exp (x) 12.3 29.8 64.2 71.2 90.4
Net debt/equity (%) 8.3 (6.7) 5.2 (16.0) (31.3)
ROE (%) 35.6 39.6 30.7 26.5 26.1
ROIC (%) 31.1 42.5 35.6 31.7 38.1
EVA®/IC (%) 18.6 30.0 23.0 19.1 25.5
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 151

 
  
 Crompton Greaves - BUY Chindia power

Recommendation history - Crompton Greaves (CRG IB)

Date Rec level Closing price Target
02 May 2011 BUY 252.35 300.00
01 February 2011 BUY 279.25 340.00
15 September 2010 O-PF 306.20 330.00
09 March 2010 O-PF 249.85 275.00
30 January 2010 O-PF 248.00 271.43
29 October 2009 O-PF 206.20 228.57
04 October 2009 O-PF 183.31 205.71
03 July 2009 O-PF 171.40 191.43
Source: CLSA Asia-Pacific Markets

152 [email protected] 27 June 2011

 
  
 Datang Intl Power
HK$2.59 - UNDERPERFORM

Juliet Zhu Diversification ambition

[email protected] Changes in depreciation policy helped Datang achieve profit growth in
(86) 2120205913
2010 but a 2011 repeat is unlikely given the sharp increase in coal costs
Rajesh Panjwani and rising interest charges. The company started its diversification efforts
(852) 26008271 early, tapping into upstream coal mining and coal-to-chemical/gas.
Datang has an ambitious five-year target of ramping up its non-power
business, but given its track record we see a near-term risk. Our 0.9x
target PB implies a HK$2.80 price: we keep our Underperform call.

Cost drag
Datang focuses its power business development in the “Beijing-Tianjin-
27 June 2011 Tangshang” area and currently has 55% of its attributable capacity in
northern China. Its Tuoketuo plant in Inner Mongolia is one of the most
China profitable power plants in Datang, supplying power generated in the western
Power region to eastern areas and enjoying low costs from a mine-mouth supply.
Like other IPPs, Datang is under pressure from rising coal costs and
Reuters 0991.HK
Bloomberg 991 HK
tightening liquidity. The company’s 1Q net profit under PRC GAAP fell 90%
QoQ, indicating that the operating environment is deteriorating on higher
Priced on 22 June 2011
costs. The ratio of its thermal plants losing money increased to 46% in 1Q
HS CEI @ 12,148.9
from a third in 2010.
12M hi/lo HK$3.50/2.57
Thermal power no longer the focus for growth
12M price target HK$2.80
±% potential +8% Feeling the impact of high coal costs, Datang was early venture into coal-
Target set on 22 Jun 11 related investments, including coal mines, coal-to-chemical and coal-to-gas
projects. It is set to “aggressively” develop hydro-power and coal-to-chemical
Shares in issue 12,310.0m
26.7%
projects, with six major profit areas in the company’s 12th FYP blueprint.
Free float (est.)
Management targets its non-power business to contribute over 35% of
Market cap US$9,531m revenue and 50% of profit by 2015. However, given constant delays and the
3M average daily volume disappointing progress of its non-power development, we are concerned that
HK$207.5m (US$26.7m) there is low visibility to management’s prospects of achieving its targets,
while the projects are capital-intensive and risk going over budget.
Foreign s'holding 26.7%

Major shareholders Uncertainty remains in non-power business. Underperform

China Datang 32.2%
Given that the near-term earnings contribution of its non-power business will
Beijing Energy Inv 10.4%
be limited, we apply the same valuation methodology that we use with other
IPPs to Datang, suggesting a 0.9x forward PB multiple and a HK$2.80 target
price. There is near-term risk associated in Datang achieving its milestones
for coal-to-chemical projects. Company’s net gearing ratio is also the second
Stock performance (%) highest among peers. We rate the company an Underperform.
1M 3M 12M
Absolute (10.1) (5.8) (22.9)
Relative (4.2) (0.9) (23.5) Financials
Abs (US$) (10.3) (5.7) (23.0) Year to 31 Dec 09A 10A 11CL 12CL 13CL
6.0 (HK$) (% 110 Revenue (Rmbm) 47,943 60,672 68,752 76,058 82,612
5.5 Datang Intl Power 100 Net profit (Rmbm) 1,537 2,570 1,983 2,699 3,343
Rel to CEI (RHS)
5.0
90
EPS (fen) 13.0 21.1 15.6 20.3 25.1
4.5 CL/consensus (20) (EPS%) - - 79 83 97
80
4.0 EPS growth (% YoY) (9.7) 61.6 (25.9) 29.8 23.8
70
3.5 PE (x) 17.5 10.7 13.5 10.0 7.8
60
3.0 Dividend yield (%) 3.2 3.1 2.3 3.0 3.9
2.5 50 FCF yield (%) (58.6) (19.4) (33.1) (30.4) (18.7)
2.0 40 PB (x) 1.0 0.9 0.7 0.7 0.6
Jun 09 Feb 10 Oct 10 Jun 11 ROE (%) 7.9 10.8 7.7 9.3 11.2
Source: Bloomberg
Net debt/equity (%) 399.3 380.6 310.7 304.9 287.7
www.clsa.com Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com

 
  
 Datang Intl Power - U-PF Chindia power

Hydro power capacity has Power structure (2005) Power structure (2010)
grown quickly over the
past five years
Hydro Wind
Hydro
0.5% 1%
11%

Coal-fired Coal-fired
99.5% 88%

Source: Company

Datang - 2010 attributable capacity

Heilongjiang

Jilin

Liaoning
Xinjiang 3%

Inner Mongolia Beijing

13% 2%
Tianjin
4%
Hebei
Shanxi 26%
10% Shandong
Ningxia
Qinghai 14%
2%
1%
Gansu
1% Jiangsu
Shaanxi Henan 6%
Xizang 7%
(Tibet)
Anhui Shanghai

Sichuan Hubei
2% Chongqing
Zhejiang
6%
5%

Hunan Jiangxi
Guizhou 2%
Fujian
5%

Yunnan Taiwan
6% Guangxi Guangdong
9%
Hong Kong

Hainan

Source: CLSA Asia-Pacific Markets

154 [email protected] 27 June 2011

 
  
 Datang Intl Power - U-PF Chindia power

Datang - Developing six major profit bases

Eas tern I nn er Mon g o lia E n erg y

C h em ic al P rof it b as e
Wes tern Inn er M on g o lia New energy
锡林林林
C o al-E lec tricity-A lu m in iu m P ro fit b a s e 内内内 辽宁 profit b as e
托托托 河北
河河

山山

江苏 P an- B o hai T he rm al
山西

四四 P o wer P ro fit B as e

福福
S ou thw es tern 云云
广东
Hy d ro po w er pro fit bas e
S o utheas tern C oas tal

C o al-F ired P o w er P ro fit B as e

Source: CLSA Asia-Pacific Markets

We expect non-power Revenue contribution split

business to account for
16% of revenue by 2013
(%) Power Non-power
100
90
80
70
60
50
40
30
20
10
0
2008 2009 2010 11CL 12CL 13CL

Source: Company, CLSA Asia-Pacific Markets

27 June 2011 [email protected] 155

 
  
 Datang Intl Power - U-PF Chindia power

We expect ROE to recover Datang - ROE

in 2012-13 after dropping
in 2011 12 (%)

11

10

4
2008 2009 2010 11CL 12CL 13CL

Source: CLSA Asia-Pacific Markets

Valuations are Share price and 12M forward PE bands Share price and 12M forward PB bands
undemanding but we see
near-term risk in 23 (log) 15 (log) max3.83x
achieving milestones of max50.0x
its chemical project 10 35.0x 9
2.67x

avg20.0x
avg1.51x
4 12.9x 5
1.11x
min5.9x
2 3 min0.71x

1 2
Jun 06 Feb 08 Oct 09 Jun 11 Jun 06 Feb 08 Oct 09 Jun 11

Source: Evaluator, CLSA Asia-Pacific Markets

Recommendation history - Datang International Power (991 HK)

Date Rec level Closing price Target
22 June 2011 U-PF 2.60 2.80
25 March 2011 U-PF 2.76 3.00
26 November 2010 U-PF 2.83 2.70
14 January 2010 SELL 3.47 2.70
07 January 2010 SELL 3.48 2.75
25 November 2009 SELL 3.59 3.14
23 October 2009 U-PF 4.08 3.70
17 September 2009 U-PF 4.41 4.10
17 August 2009 U-PF 4.96 4.10
Source: CLSA Asia-Pacific Markets

156 [email protected] 27 June 2011

 
  
 Datang Intl Power - U-PF Chindia power

Summary financials
Year to 31 December 09A 10A 11CL 12CL 13CL
Recovery of power Summary P&L forecast (Rmbm)
business and ramp-up of Revenue 47,943 60,672 68,752 76,058 82,612
non-power business will Op Ebitda 14,167 16,586 17,955 21,012 23,576
drive growth in 2012-13 Op Ebit 6,645 9,204 9,714 12,060 13,948
Interest income 33 38 77 88 84
Interest expense (4,111) (5,373) (6,602) (7,430) (7,752)
Other items 564 832 943 1,099 1,318
Profit before tax 3,131 4,700 4,132 5,817 7,597
Taxation (615) (871) (826) (1,163) (1,519)
Minorities/Pref divs (980) (1,259) (1,322) (1,955) (2,735)
Net profit 1,537 2,570 1,983 2,699 3,343
Capital expenditure to Summary cashflow forecast (Rmbm)
slow down going forward Operating profit 6,645 9,204 9,714 12,060 13,948
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 7,522 7,382 8,241 8,952 9,628
Working capital changes (5,534) 4,468 649 (624) (1,175)
Net interest/taxes/other 3,113 (3,544) (7,351) (8,505) (9,188)
Net operating cashflow 11,745 17,510 11,252 11,883 13,213
Capital expenditure (27,500) (22,844) (20,143) (20,100) (18,050)
Free cashflow (15,755) (5,335) (8,890) (8,217) (4,837)
Acq/inv/disposals (1,427) (2,199) 0 0 0
Int, invt & associate div 352 256 0 0 0
Net investing cashflow (28,575) (24,788) (20,143) (20,100) (18,050)
Increase in loans 19,891 20,471 6,000 7,000 7,000
Dividends (1,905) (9,067) (635) (810) (1,003)
Net equity raised/other (4,728) (2,211) 6,926 115 113
Net financing cashflow 13,258 9,193 12,291 6,305 6,110
Incr/(decr) in net cash (3,572) 1,915 3,401 (1,912) 1,273
Exch rate movements 1 22 0 0 0
Opening cash 5,078 1,506 3,443 6,844 4,932
Closing cash 1,506 3,443 6,844 4,932 6,205
Summary balance sheet forecast (Rmbm)
Cash & equivalents 1,506 3,443 6,844 4,932 6,205
Debtors 6,635 8,159 8,382 9,272 10,072
Inventories 1,841 4,012 3,526 3,690 3,704
Other current assets 6,683 4,279 4,825 5,319 5,762
Fixed assets 157,440 179,234 190,974 202,051 210,454
Intangible assets 2,123 2,498 2,660 2,731 2,750
Other term assets 1,171 1,534 1,625 1,723 1,829
Total assets 184,148 212,915 229,561 241,575 253,989
Short-term debt 26,936 34,185 32,537 34,101 35,665
Creditors 14,040 18,930 19,862 20,787 20,869
Other current liabs 418 1,168 1,168 1,168 1,168
Long-term debt/CBs 105,445 115,534 123,182 128,618 134,054
Provisions/other LT liabs 4,537 4,665 4,898 5,143 5,400
Minorities/other equity 6,650 7,583 8,905 10,859 13,594
Shareholder funds 26,123 30,850 39,009 40,898 43,238
Total liabs & equity 184,148 212,915 229,561 241,575 253,989
RoE will start to recover Ratio analysis
in 2012 but will remain a Revenue growth (% YoY) 29.9 26.6 13.3 10.6 8.6
EVA® negative company Ebitda growth (% YoY) 55.7 17.1 8.3 17.0 12.2
Ebitda margin (%) 29.5 27.3 26.1 27.6 28.5
Net profit margin (%) 3.2 4.2 2.9 3.5 4.0
Dividend payout (%) 56.1 33.2 30.5 30.0 30.0
Effective tax rate (%) 19.6 18.5 20.0 20.0 20.0
Ebitda/net int exp (x) 3.5 3.1 2.8 2.9 3.1
Net debt/equity (%) 399.3 380.6 310.7 304.9 287.7
ROE (%) 7.9 10.8 7.7 9.3 11.2
ROIC (%) 3.6 4.4 4.2 4.9 5.4
EVA®/IC (%) (2.8) (2.1) (2.2) (1.5) (1.0)
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 157

 
  
 Datang Intl Power - U-PF Chindia power

Notes

158 [email protected] 27 June 2011

 
  
 Dongfang Electric
HK$27.65 - UNDERPERFORM

Rajesh Panjwani On a high

[email protected] Dongfang Electric’s early entry to nuclear and wind power helped it post
(852) 26008271
the highest revenue and earnings Cagr among China’s three leading
equipment suppliers and command a premium valuation over peers. But a
slowdown in wind-power installations and delays in nuclear projects will
likely curb revenue and order growth. Gross margins could also narrow
from 2010 highs. With lower growth, we expect the valuation premium to
peers to continue to shrink. We maintain our Underperform call.

The edge is eroding

Dongfang Electric was the early entrant in nuclear and wind power, which
27 June 2011 helped it grow faster than Shanghai Electric and Harbin Power. But its edge is
less valuable with grid constraints hampering new wind turbine installations
China and the Fukushima accident putting a break on nuclear orders. Shanghai
Power Electric and Harbin Power are closing their knowledge gap in both segments
through JVs with foreign players. Thus the capability gap between Dongfang
Reuters 1072.HK
Bloomberg 1072 HK
and its competitors is eroding.

Priced on 22 June 2011

Revenue, order growth likely to slow
HS CEI @ 12,148.9
Slowdowns in wind and nuclear power businesses have a negative impact on
12M hi/lo HK$43.80/23.00 Dongfang’s revenue growth. We do not expect a major increase in thermal-
power capacity additions due to pressures on the government to meet energy
12M price target HK$27.00
±% potential -2% intensity and environmental targets. Thus nuclear power and overseas
Target set on 22 Jun 11 projects will drive most of Dongfang’s revenue growth. We expect orders to
decline in 2011, primarily from a lack of nuclear business.
Shares in issue 2,003.9m
Free float (est.) 50.2%
Margins likely to be under pressure
Market cap US$7,308m A robust 210bps expansion in gross margin helped Dongfang report strong
3M average daily volume earnings growth in 2010. Management guided for lower 2011 gross margins,
HK$577.0m (US$74.2m) given a rise in material costs and normalisation of unusually high margins for
Major shareholders
some businesses in 2010. Thus we see little growth for 2011. Even further
Dongfang Electric Group 49.8% out, earnings growth will be around 12-14%.

Growth factored in the valuations

We believe the company’s valuations premium over its Chinese and regional
peers is not justified given lacklustre earnings growth over next few years.
Even on an absolute level its 17x 2011 PE is rich for 13% earnings cagr over
2011-13CL. We maintain an Underperform.
Stock performance (%)
1M 3M 12M
Absolute (9.5) 0.5 11.5
Relative (3.5) 5.8 10.7 Financials
Abs (US$) (9.7) 0.6 11.4 Year to 31 Dec 09A 10A 11CL 12CL 13CL
60 (HK$) (%) 290 Revenue (Rmbm) 31,559 37,604 42,467 46,256 49,435
Dongfang Electric 270
50
Net profit (Rmbm) 1,712 2,606 2,666 2,985 3,389
Rel to CEI (RHS) 250
EPS (fen) 85.4 130.0 133.0 148.9 169.1
230
40
210 CL/consensus (21) (EPS%) - - 87 84 91
30 190 EPS growth (% YoY) 230.1 52.2 2.3 12.0 13.5
170 PE (x) 28.5 18.5 17.0 14.6 12.3
20
150
Dividend yield (%) 0.7 0.5 0.9 1.0 1.6
130
10
110 FCF yield (%) 6.7 0.7 1.6 5.4 5.1
0 90 PB (x) 5.6 4.4 3.4 2.7 2.2
Jun 09 Feb 10 Oct 10 Jun 11 ROE (%) 30.2 26.0 21.3 20.0 19.3
Source: Bloomberg
Net debt/equity (%) (151.9) (93.6) (70.5) (65.3) (58.3)
www.clsa.com Source: CLSA Asia-Pacific Markets

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 Dongfang Electric - U-PF Chindia power

Dongfang’s thermal High efficiency and clean energy earnings (2010 vs 2009)
power business shrank, High efficiency and clean energy 2009 2010 YoY chg (%)
while nuclear grew
Sales (Rmbm)
Nuclear (Conventional Island) 781 2,681 243
Thermal 19,634 16,779 (15)
Gas 545 935 72
Total 20,960 20,395 (3)
GPM (%)
Nuclear (Conventional Island) (28.4) 5.1 33
Thermal 18.8 21.8 3
Gas 27.7 5.2 (23)
Total 17.2 18.8 2
Gross profits (Rmbm)
Nuclear (Conventional Island) (221) 136
Thermal 3,683 3,653 (1)
Gas 151 48 (68)
Total 3,613 3,838 6

Wind and nuclear power New energy earnings (2010 vs 2009)

both grew strongly
New Energy 2009 2010 YoY chg (%)
Sales (Rmbm)
Wind 6,278 7,638 22
Nuclear (Nuclear Island) 1,303 1,881 44
Total 7,581 9,519 26
GPM (%)
Wind 18.0 19.8 1.8
Nuclear (Nuclear Island) 17.1 30.2 13.0
Total 17.8 21.8 4.0
Gross profits (Rmbm)
Wind 1,129 1,511 34
Nuclear (Nuclear Island) 223 568 154
Total 1,352 2,078 54

Hydro power revenue Hydro and environmental protection equipment earnings (2010 vs 2009)
declined in 2010 but may
Hydro power and environmental 2009 2010 YoY chg (%)
pick up going forward
protection equipment
Sales (Rmbm)
Hydro 3,016 2,611 (13)
Environmental Protection 230 346 50
Total 3,246 2,957 (9)
GPM (%)
Hydro 10.6 15.5 4.9
Environmental Protection 23.9 32.6 8.8
Total 11.5 17.5 5.9
Gross profits (Rmbm)
Hydro 320 404 26
Environmental Protection 55 113 106
Total 375 516 38
Source: Company

160 [email protected] 27 June 2011

 
  
 Dongfang Electric - U-PF Chindia power

Overseas orders drove Engineering and service earnings (2010 vs 2009)

strong growth in the Engineering and service 2009 2010 YoY chg (%)
engineering business
Sales (Rmbm)
Engineering 382 3,611 845
Service 352 875 149
Others 252 247 (2)
Total 987 4,733 379
GPM (%)
Engineering 23.8 16.5 (7.4)
Service 41.2 51.1 10.0
Others (2.1) 8.5 10.6
Total 23.4 22.4 (0.9)
Gross profits (Rmbm)
Engineering 91 594 553
Service 145 447 209
Others (5) 21 (500)
Total 231 1,062 361
Source: Company

Engineering accounts for Order mix

28% of new orders (%)
2010 New orders (Rmbm) 50,000
High efficiency and clean energy 21,500 43
New energy 12,500 25
Water energy and environmental protection 2,000 4
Engineering and service 14,000 28
Export 11,000 22
Backlog at the end of 2010 (Rmbm) 140,000
High efficiency and clean energy 88,200 63
New energy 22,400 16
water energy and environmental protection 14,000 10
Engineering and service 15,400 11
Export 22,400 16

Recommendation history - Dongfang Electric Corp (1072 HK)

Date Rec level Closing price Target
22 June 2011 U-PF 27.20 27.00
07 April 2011 U-PF 27.70 24.00
31 March 2011 U-PF 26.95 29.00
10 March 2011 U-PF 32.60 33.00
19 January 2011 U-PF 35.65 35.00
01 November 2010 O-PF 37.70 39.00
13 September 2010 O-PF 34.60 37.00
10 June 2010 BUY 24.85 25.00
25 May 2010 BUY 23.40 50.00
02 November 2009 BUY 19.55 25.00
03 August 2009 BUY 18.98 24.25
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 161

 
  
 Dongfang Electric - U-PF Chindia power

Summary financials
Year to 31 December 09A 10A 11CL 12CL 13CL
Summary P&L forecast (Rmbm)
Revenue 31,559 37,604 42,467 46,256 49,435
Op Ebitda 1,923 3,092 3,385 3,910 4,369
Op Ebit 1,383 2,233 2,361 2,755 3,215
Interest income 0 0 0 0 0
Interest expense (276) (119) (119) (119) (119)
Other items 620 771 903 1,008 1,092
Profit before tax 1,727 2,885 3,145 3,645 4,188
Taxation 9 (180) (377) (547) (670)
Minorities/Pref divs (24) (99) (101) (113) (129)
Net profit 1,712 2,606 2,666 2,985 3,389
Summary cashflow forecast (Rmbm)
Operating profit 1,383 2,233 2,361 2,755 3,215
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 541 858 1,025 1,155 1,155
Working capital changes 5,418 (650) (1,817) (817) (1,024)
Net interest/taxes/other 193 667 1,162 775 292
Net operating cashflow 7,535 3,109 2,731 3,868 3,637
Capital expenditure (4,277) (2,756) (2,000) (1,500) (1,500)
Free cashflow 3,258 353 731 2,368 2,137
Acq/inv/disposals 34 (214) 105 126 139
Int, invt & associate div (2,221) (39) 254 (1,397) (926)
Net investing cashflow (6,464) (3,009) (1,640) (2,770) (2,287)
Increase in loans (2,179) (1,952) 0 0 0
Dividends (321) (261) (400) (448) (678)
Net equity raised/other 4,468 957 (1,738) 337 (195)
Net financing cashflow 1,969 (1,255) (2,138) (111) (873)
Incr/(decr) in net cash 3,040 (1,155) (1,047) 987 477
Exch rate movements 0 0 0 0 0
Opening cash 11,786 14,826 13,671 12,624 13,612
Closing cash 14,826 13,670 12,623 13,611 14,089
Summary balance sheet forecast (Rmbm)
Cash & equivalents 14,826 13,671 12,624 13,612 14,089
Debtors 17,551 19,523 22,048 24,015 25,665
Inventories 27,023 32,187 36,878 40,077 42,742
Other current assets 4,617 4,289 3,813 3,901 3,969
Fixed assets 8,457 10,355 11,864 12,710 14,055
Intangible assets 106 131 131 131 123
Other term assets 1,429 1,539 1,539 1,539 1,539
Total assets 74,273 82,436 89,638 96,725 102,924
Short-term debt 467 2,366 2,366 2,366 2,366
Creditors 47,113 54,113 57,610 60,698 63,164
Other current liabs 14,600 13,077 14,415 15,763 16,656
Long-term debt/CBs 615 276 276 276 276
Provisions/other LT liabs 2,433 820 820 820 820
Minorities/other equity 361 746 847 960 1,089
Shareholder funds 8,684 11,038 13,304 15,841 18,552
Total liabs & equity 74,273 82,436 89,638 96,725 102,924
Ratio analysis
Revenue growth (% YoY) 13.9 19.2 12.9 8.9 6.9
Ebitda growth (% YoY) 24.2 60.7 9.5 15.5 11.8
Ebitda margin (%) 6.1 8.2 8.0 8.5 8.8
Net profit margin (%) 5.4 6.9 6.3 6.5 6.9
Dividend payout (%) 18.7 10.0 15.0 15.0 20.0
Effective tax rate (%) (0.5) 6.2 12.0 15.0 16.0
Ebitda/net int exp (x) 7.0 26.0 28.5 32.9 36.8
Net debt/equity (%) (151.9) (93.6) (70.5) (65.3) (58.3)
ROE (%) 30.2 26.0 21.3 20.0 19.3
ROIC (%) 0.0 0.0 81.8 46.1 38.1
EVA®/IC (%) 0.0 0.0 71.5 35.8 27.8
Source: CLSA Asia-Pacific Markets

162 [email protected] 27 June 2011

 
  
 GCL-Poly Energy
HK$3.83 - BUY

Charles Yonts Last man standing

[email protected] Beyond 2011, China and India will join North America as the new drivers
(852) 26008539
for solar demand, replacing Germany and Italy. As the largest, lowest-
cost producer of solar wafers, GCL is linked into the supply chains for
nearly all of the major downstream solar companies in China, and has a
strong head start in India’s burgeoning market. We expect GCL to emerge
from an oversupply driven period of dislocation in the solar sector in 1H12
to become one of the big consolidators in the market.

Lowering the bar: Latest on prices

Solar prices continue a long-running descent, with downstream (panel) prices
27 June 2011 and upstream (polysilicon) prices coming off gradually. But mid-stream (cell
and wafer) prices followed the collapse. We expect stability soon, driven by
Hong Kong seasonal demand in Germany. Downstream activity should stabilise before
Power mid-to-upstream sectors, with trends filtering up over a month or more.

Reuters 3800.HK
Bloomberg 3800 HK
Changes to the model: ASPs down, shipments up
We reduced our 11CL price assumptions by 9%, 13% for 12CL, to reflect the
Priced on 22 June 2011
current environment. We also added 3GW of wafer capacity, rampping-up
HK HSI @ 21,860.0
over the course of 2012, which bumps our year-end capacity projections for
12M hi/lo HK$5.72/1.41 GCL from 6.5GW in 11CL (as announced) to 9.5GW in 12CL. This adds about
Rmb6bn to 12CL capex, raising our net gearing forecast to just over 50%.
12M price target HK$5.11
±% potential +33%
Target set on 16 Jun 11 Sensitivity to cost-base pricing in 2012
Under our 2012 bear-case scenario, where prices adjust to marginal-producer
Shares in issue 972.4m
costs for polysilicon (US$25/KG) and wafers (US$0.44/W), our GCL earnings
Free float (est.) 49.5%
forecast drops 39%. The reduction suggests a share price of HK$3.20 or 10x
Market cap US$7,612m 12F PE. If the market decides solar is ex-growth (we disagree) and ascribes
3M average daily volume an 8x 12F PE, the value calculates to HK$2.60.
HK$775.4m (US$99.7m)

Major shareholders
Rolling over to 2012; back to BUY
Mr Zhu Gong Shan 30.5% Short-term, GCL’s share price performance will depend upon downstream
CIC 20.0% price stabilisation, which will then filter upstream. Looking beyond the
seasonal cycle, we see GCL as one of the few solar companies that will be
able to thrive in 2012 even under the most bearish pricing assumptions,
placing it at the front of the pack as the sector returns to growth. We base
our target on 10x 12CL PE for the company’s solar division and 1x 11CL PB
for its power business.
Stock performance (%)
1M 3M 12M
Absolute (11.8) (13.2) 142.4
Relative (6.3) (9.2) 130.9 Financials
Abs (US$) (11.9) (13.1) 142.1 Year to 31 Dec 08A 09A 10A 11CL 12CL
6.0 (HK$) (%) 180 Revenue (Rmbm) 3,521 4,356 15,570 27,422 35,134
5.5 GCL-Poly Energy Net profit (Rmbm) 2,006 (272) 3,370 5,713 6,823
160
5.0 Rel to HSI (RHS)
140
EPS (fen) 206.3 (26.6) 21.8 36.9 44.0
4.5
4.0 CL/consensus (17) (EPS%) - - - 82 84
120
3.5 EPS growth (% YoY) nm (112.9) nm 69.4 19.4
3.0 100
PE (x) 1.7 nm 15.3 8.5 6.8
2.5 80
Dividend yield (%) 0.7 0.0 0.0 0.0 0.0
2.0
60 FCF yield (%) 30.5 11.9 (8.1) (26.6) 12.4
1.5
1.0 40 PB (x) (3.9) 5.1 3.8 2.5 1.8
Jun 09 Feb 10 Oct 10 Jun 11 ROE (%) 250.4 (2.7) 29.7 33.4 29.2
Source: Bloomberg
Net debt/equity (%) (201.8) 20.1 30.6 90.5 52.7
www.clsa.com Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com

 
  
 GCL-Poly Energy - BUY Chindia power

Last man standing

Solar prices still falling Solar prices should continue to slip, but we expect prices to stabilise soon
with a seasonal demand pick-up in Germany.

Solar spot prices (updated 15 June 2011)

2.0 (US$/Watt) Polysilicon Wafer Cell Module

1.8

1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2
Feb 10 May 10 Jul 10 Oct 10 Jan 11 Mar 11 Jun 11

Source: PVInsights, CLSA Asia-Pacific Markets

Sensitivity to cost-base pricing in 2012

What if 2012 prices fall to marginal-producer costs? In the next table we
show an updated cost curve for polysilicon and wafer producers.

Polysilicon cost curve - 12CL

45 (US$/KG)
Bear-case Base-case Bull-case
demand demand demand
40

35

30

25

20

15

10

0
265 26,720 53,176 79,632 106,087 132,543 158,998 185,454 211,910 238,365

Volume (tons)

Source: CLSA Asia-Pacific Markets

Focusing on marginal Given GCL’s sales mix, we focus on the wafer cost curve to demonstrate that
producers marginal wafer producers will become loss making (at a COGS level) next
year at about US$0.54/Watt. This figure also assumes a polysilicon cost of
US$40/KG.

164 [email protected] 27 June 2011

 
  
 GCL-Poly Energy - BUY Chindia power

Wafer cost curve - 12CL - US$40/KG spot price - bottom at around US$0.54/Watt

0.8 (US$/Watt) Bear-case Base-case Bull-case

demand demand demand

0.7

0.6

0.5

0.4

0.3

0.2

0.1

0
0.0 3.2 6.3 9.5 12.6 15.7 18.9 22.0 25.2 28.3 31.4
Volume (GW)

Source: CLSA Asia-Pacific Markets

Poly prices could drop As the polysilicon cost curve illustrates, polysilicon prices could fall closer to
from US$50 per the US$25/KG range before reaching a marginal-producer cost. Assuming
KG to US$25
US$25/KG for polysilicon, the cost of the marginal wafer maker falls to
around US$0.44/Watt.

In the following average selling price (ASP) sensitivity chart, we show the
potential impact to GCL’s cost-based-pricing EPS, considering both
US$40/KG polysilicon and US$25/KG polysilicon, with margins at thin-to-
none for wafer makers.

GCL is still comfortably GCL - Earnings, valuation sensitivity to ASPs

profitable in a scenario 12CL
where competitors are
losing money Bull Base Bear
Blended ASP
Wafer (US$/Watt) 0.54 0.50 0.44
Margin (%)
Gross margin (%) 42 38 30
Operating margin (%) 36 32 24
Net profit margin (%) 25 21 14
EPS (fen) 56.1 44.6 27.4
EPS (HK¢) 66.0 52.5 32.2
Change from base (%) 26 - (39)
Value at 10x PE 6.60 5.25 3.22
Value at 8x PE 5.28 4.20 2.58
Source: CLSA Asia-Pacific Markets

Rolling over to 2012; back to BUY

Basing valuation on 10x We reduced our target price from HK$5.34 to HK$5.11, but raised our
12CL PE for solar and 1x recommendation from Outperform to BUY. We rolled over to 2012 for solar
11CL PB for power
earning valuations and now base our target on 10x 12CL PE for the solar
division and 1x 11CL PB for the power business.

27 June 2011 [email protected] 165

 
  
 GCL-Poly Energy - BUY Chindia power

Meaningful upside Following a dramatic fall in GCL’s share price, our new target leaves
remains considerable upside. Timing the stock will be tricky. While a strong seasonal
demand rebound is emerging in Germany, and demand elsewhere is picking up
steadily, prices have yet to stabilise, a necessary pre-cursor for share-price
performance. We expect that downstream prices will balance, then likely rise
slightly, before stabilisation filters up the chain. By mid-4Q11, we expect 2012
oversupply concerns to return (this has been our expectation since 2H11).

HK$5.11 target GCL Poly - valuation table

Solar business - 12CL PE (x)
8 9 10 11 12
3.86 4.34 4.83 5.31 5.79
Power 0.9 0.26 4.12 4.60 5.08 5.56 6.05
business - 1.0 0.28 4.14 4.63 5.11 5.59 6.07
11CL PB (x) 1.1 0.31 4.17 4.66 5.14 5.62 6.10

Earnings growth driven GCL Poly - key metrics

by sales growth and 2007 2008 2009 2010 2011 2012
cost cutting
Polysilicon production (tons) 154 1,850 7,454 16,399 30,096 47,832
Polysilicon sales (tons) 203 1,789 5,675 7,841 828 -
Wafers (MW) - - 37 1,395 5,425 8,875
Sales (Rmbm) 302 3,521 2,799 10,586 23,257 30,856
Gross profit (Rmbm) 221 2,555 1,020 4,285 9,313 11,702
Other income 14 69 - - - -
Operating profit (Rmbm) 114 2,410 965 3,650 7,918 9,851
Profit after tax (Rmbm) (48) 2,233 592 2,806 5,490 6,581
Sequential growth (%)
Sales (%) 1,067 (21) 278 120 33
Gross profit (%) 1,058 (60) 320 117 26
Net profit to equity shareholders (%) (70) 578 96 20
Margin (%)
Gross margin (%) 73 36 40 40 38
Operating margin (%) 68 34 34 34 32
Net profit margin (%) 63 21 27 24 21
Blended ASP
Polysilicon (US$/KG) 261 291 62 50 60 -
Wafer (US$/Watt) 0.0 0.85 0.80 0.60 0.50
Processing cost
Polysilicon (US$/KG) 73.1 67.6 36.6 28.9 21.8 19.8
Wafer (US$/Watt) 0.31 0.30 0.23 0.19

Recommendation history - GCL-Poly Energy Holdings (3800 HK)

Date Rec level Closing price Target
16 June 2011 BUY 3.43 5.11
20 April 2011 O-PF 4.81 5.34
23 March 2011 BUY 4.41 5.34
21 February 2011 BUY 3.77 4.70
18 January 2011 BUY 3.32 3.97
19 October 2010 BUY 2.41 3.25
26 August 2010 BUY 1.89 2.44
13 July 2010 O-PF 1.69 2.03
19 November 2009 SELL 2.31 1.49
19 October 2009 O-PF 1.98 2.36
Source: CLSA Asia-Pacific Markets

166 [email protected] 27 June 2011

 
  
 GCL-Poly Energy - BUY Chindia power

Summary financials
Year to 31 December 08A 09A 10A 11CL 12CL
Summary P&L forecast (Rmbm)
Revenue 3,521 4,356 15,570 27,422 35,134
Op Ebitda 2,519 1,198 5,838 9,583 12,303
Op Ebit 2,436 945 4,956 8,388 10,339
Interest income 18 34 37 47 107
Interest expense (147) (1,185) (511) (1,179) (1,785)
Other items 81 153 267 105 105
Profit before tax 2,387 (52) 4,748 7,361 8,765
Taxation (143) (82) (977) (1,500) (1,792)
Minorities/Pref divs (239) (138) (401) (149) (150)
Net profit 2,006 (272) 3,370 5,713 6,823
Summary cashflow forecast (Rmbm)
Operating profit 2,436 945 4,956 8,388 10,339
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 83 253 882 1,195 1,964
Working capital changes 2,321 (438) 543 (2,577) (330)
Net interest/taxes/other (231) 4,679 (1,571) (1,450) (1,744)
Net operating cashflow 4,609 5,440 4,810 5,556 10,230
Capital expenditure (3,595) (2,125) (9,010) (18,447) (4,470)
Free cashflow 1,014 3,315 (4,200) (12,891) 5,760
Acq/inv/disposals 0 809 0 0 0
Int, invt & associate div (129) (399) (475) (1,132) (1,678)
Net investing cashflow (3,724) (1,715) (9,485) (19,579) (6,148)
Increase in loans (424) (4,300) 6,426 16,275 4,059
Dividends 0 0 0 0 0
Net equity raised/other 515 3,936 0 0 0
Net financing cashflow 92 (364) 6,426 16,275 4,059
Incr/(decr) in net cash 977 3,362 1,752 2,252 8,141
Exch rate movements 0 0 0 0 0
Opening cash 1,046 2,022 5,384 7,136 9,388
Closing cash 2,022 5,384 7,136 9,388 17,529
Summary balance sheet forecast (Rmbm)
Cash & equivalents 2,022 5,384 7,136 9,388 17,529
Debtors 102 1,382 1,998 3,519 4,508
Inventories 67 640 1,388 2,445 3,132
Other current assets 300 101 135 135 135
Fixed assets 5,053 13,712 19,945 37,103 39,515
Intangible assets 5 516 966 1,061 1,155
Other term assets 1,380 1,104 2,255 2,255 2,255
Total assets 8,930 23,050 34,013 56,094 68,418
Short-term debt 1,479 4,431 5,404 10,031 11,490
Creditors 652 2,109 3,534 3,534 4,528
Other current liabs 3,433 604 1,515 1,515 1,515
Long-term debt/CBs 2,248 3,117 6,220 17,868 20,467
Provisions/other LT liabs 1,962 2,031 2,691 2,691 3,044
Minorities/other equity 0 531 1,034 1,034 1,034
Shareholder funds (845) 10,227 13,615 19,421 26,338
Total liabs & equity 8,930 23,050 34,013 56,094 68,418
Ratio analysis
Revenue growth (% YoY) 90.9 23.7 257.5 76.1 28.1
Ebitda growth (% YoY) 6107.8 (52.4) 387.2 64.1 28.4
Ebitda margin (%) 71.5 27.5 37.5 34.9 35.0
Net profit margin (%) 57.0 (6.2) 21.6 20.8 19.4
Dividend payout (%) 1.1 0.0 0.0 0.0 0.0
Effective tax rate (%) 6.0 (157.5) 20.6 20.4 20.4
Ebitda/net int exp (x) 19.5 1.0 12.3 8.5 7.3
Net debt/equity (%) (201.8) 20.1 30.6 90.5 52.7
ROE (%) 250.4 (2.7) 29.7 33.4 29.2
ROIC (%) 58.0 27.7 21.6 21.2 19.1
EVA®/IC (%) 48.9 16.7 12.7 12.2 10.1
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 167

 
  
 GCL-Poly Energy - BUY Chindia power

Notes

168 [email protected] 27 June 2011

 
  
 Harbin Power Equip
HK$8.71 - UNDERPERFORM

Rajesh Panjwani Low returns

[email protected] Harbin Power’s order mix has changed over the last couple of years to
(852) 26008271
include more engineering and nuclear projects. These two segments will
be the main growth drivers, but they will be lower-return businesses, at
least initially, and are likely to pressure Harbin’s gross margins. We
expect new orders to decline due to lower overseas and nuclear orders,
which will lower Harbin’s cash balance. With little earnings growth and
single-digit return ratios we keep our Underperform rating.

Rising share of engineering and nuclear

Harbin’s business mix has been undergoing a change over the last couple of
27 June 2011 years, though at a slower pace than its competitors. The share of thermal
power in total orders has been declining and orders from overseas EPC
China (engineering, procurement and commissioning) projects as well as nuclear
Power have picked up. These two lines will be the main growth drivers for the
company in the medium term.
Reuters 1133.HK
Bloomberg 1133 HK
Margins will be under pressure
Priced on 22 June 2011
A changing revenue mix over the next couple of years will pressure gross
HS CEI @ 12,148.9
margins. Margins on EPC projects are substantially lower than other segments
12M hi/lo HK$13.90/5.30 and management has indicated that it will be some time before its nuclear-
power business becomes profitable. Over the last few years Harbin’s costs
12M price target HK$8.90
±% potential +2% beneath the gross margin line have been rising rapidly: between 2006 and
Target set on 22 Jun 11 2010 its administrative, distribution and other operating expenses went from
6.6% of revenue to 12.4%. Hence cost pressures will be one of the key
Shares in issue 1,376.8m
49.1%
determining factors for future earnings.
Free float (est.)

Market cap US$1,540m Orders set to decline along with cash balance
3M average daily volume Harbin Power reported strong orderflow over the last couple of years.
HK$68.9m (US$8.9m) However, this was supported by one very large order from India - unlikely
Major shareholders
to be repeated - and nuclear power orders, which have slowed after the
Harbin Electric Corporation 50.9% government’s decision to halt approval of new projects. This will also
impact cash on the balance sheet. Harbin’s cash balance has been a large
percentage of its market cap, and a substantial part of this cash is from
customer advances. As the orderflow declines, we also expect Harbin’s
cash balance to come down over next few years. Use of cash on the
balance sheet is also a concern. The company recently spent Rmb1.35bn
to buy Datang A-shares, which were trading at 180% premium to their H-
Stock performance (%) shares: a bad investment in our view.
1M 3M 12M
Absolute (10.3) 2.1 48.9
Relative (4.4) 7.4 47.8 Financials
Abs (US$) (10.5) 2.2 48.7 Year to 31 Dec 09A 10A 11CL 12CL 13CL
18 (HK$) (%) 180 Revenue (Rmbm) 28,630 28,815 31,602 34,258 36,970
Harbin Power Equip
16
160
Net profit (Rmbm) 606 1,024 913 962 1,028
Rel to CEI (RHS)
14 EPS (fen) 44.0 74.4 66.3 69.8 74.6
12 140
CL/consensus (19) (EPS%) - - 95 91 91
10
120 EPS growth (% YoY) (41.8) 69.0 (10.9) 5.3 6.8
8
6 100
PE (x) 17.4 10.2 10.7 9.8 8.8
4 Dividend yield (%) 0.9 1.8 2.0 2.2 2.4
80
2 FCF yield (%) 3.0 16.7 (29.3) (17.7) 11.7
0 60 PB (x) 1.2 1.1 0.9 0.8 0.8
Jun 09 Feb 10 Oct 10 Jun 11 ROE (%) 7.7 10.7 8.9 8.7 8.7
Source: Bloomberg
Net debt/equity (%) (99.5) (94.8) (61.3) (41.7) (44.9)
www.clsa.com Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com

 
  
 Harbin Power Equip - U-PF Chindia power

Sales flat but mix Sales breakdown

has shifted Turnover (Rmbm) 06A 07A 08A 09A 10A
Thermal 21,837 20,464 20,493 19,221 17,984
Hydro 1,609 2,173 2,863 1,893 2,362
Engineering services 3,008 2,091 3,446 4,300 5,060
Ancillary equipment 1,053 1,125 1,161 1,251 919
AC/DC motors and others 1,592 1,797 1,940 1,964 2,490
Total turnover 29,098 27,649 29,904 28,630 28,815
YoY growth (%)
Thermal 65 (6) 0 (6) (6)
Hydro 32 35 32 (34) 25
Engineering services 34 (30) 65 25 18
Ancillary equipment 233 7 3 8 (27)
AC/DC motors and others 11 13 8 1 27
Total turnover 58 (5) 8 (4) 1
% of revenue
Thermal 75.0 74.0 68.5 67.1 62.4
Hydro 5.5 7.9 9.6 6.6 8.2
Engineering services 10.3 7.6 11.5 15.0 17.6
Ancillary equipment 3.6 4.1 3.9 4.4 3.2
AC/DC motors and others 5.5 6.5 6.5 6.9 8.6
Total turnover 100.0 100.0 100.0 100.0 100.0

Change in order-book mix Breakdown of new orders

is more drastic 05A 06A 07A 08A 09A 10A
New order book (Rmbm)
Thermal - domestic 13,300 18,400 35,800 31,786 20,541 17,691
Hydro 3,270 2,600 3,600 8,244 1,700 1,437
Engineering 740 4,100 7,000 10,500 10,302 8,840
Nuclear 2,098 6,236 10,965
Gas 960 2,100 1,000 - - -
Environmental 130 1,300 3,900 4,726 2,898 3,465
Total 18,400 28,500 51,300 57,354 41,677 42,398
Order book breakdown by value (%)
Thermal 72 65 70 55 49 42
Thermal - export 0 0 0 0
Hydro 18 9 7 14 4 3
Engineering 4 14 14 18 25 21
Nuclear 4 15 26
Others 6 12 10 8 7 8
Total 100 100 100 100 100 100
Source: Company, CLSA Asia-Pacific Markets

Changing mix will Harbin’s segmental gross margins

put pressure on (%) 2007 2008 2009 2010 11CL 12CL
gross margins
Thermal 16.7 14.8 13.4 14.1 13.9 13.9
Hydro 14.1 23.0 23.1 25.2 24.0 24.0
Gas 15.0 15.0 15.0 15.0
Nuclear 5.0 6.0
Engineering services 2.1 (10.0) (1.4) 3.4 4.0 4.0
Ancillary equipment 28.3 25.8 25.3 33.5 30.0 28.0
AC/DC motors and others 13.4 18.1 20.3 21.7 21.7 21.7
Overall 15.7 13.4 12.8 14.4 14.1 14.0
Source: Harbin Power, CLSA Asia-Pacific Markets

170 [email protected] 27 June 2011

 
  
 Harbin Power Equip - U-PF Chindia power

Increase in other Expenses below gross margin line

expenses has offset gross 2006 2007 2008 2009 2010
profit growth
Turnover 29,098 27,649 29,904 28,630 28,815
Distribution expenses 365 414 425 389 484
Administrative expenses 1,544 1,887 2,154 2,326 2,687
Other operating expenses 26 149 74 390 411
Total expenses 1,935 2,450 2,653 3,104 3,582
YoY growth (%)
Distribution expenses 13 3 (9) 25
Administrative expenses 22 14 8 16
Other operating expenses 483 (50) 427 5
Total expenses 27 8 17 15
% of sales
Distribution expenses 1.3 1.5 1.4 1.4 1.7
Administrative expenses 5.3 6.8 7.2 8.1 9.3
Other operating expenses 0.1 0.5 0.2 1.4 1.4
Total expenses 6.6 8.9 8.9 10.8 12.4

As new orders decline, Customer deposits as % of order flow

customer advances and
(Rmbm) 2007 2008 2009 2010
cash balance too
goes down New orders 51,300 57,354 41,677 42,398
Order backlog 69,565 98,176 112,475 126,977
Total customer deposits 18,804 23,716 23,335 19,274
Deposits as % new orders 36.7 41.4 56.0 45.5
Deposits as % last two years’ orders 23.6 21.8 23.6 22.9
Deposit as % order backlog 27.0 24.2 20.7 15.2
Source: CLSA Asia-Pacific Markets, Company

Recommendation history - Harbin Power Equipment (1133 HK)

Date Rec level Closing price Target
22 June 2011 U-PF 8.64 8.90
12 April 2011 U-PF 8.28 8.40
10 August 2010 U-PF 7.21 8.20
09 August 2010 U-R 6.82 5.83
13 April 2010 SELL 6.47 5.83
03 February 2010 SELL 6.42 7.10
11 August 2009 U-PF 8.58 7.10
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 171

 
  
 Harbin Power Equip - U-PF Chindia power

Summary financials
Year to 31 December 09A 10A 11CL 12CL 13CL
Summary P&L forecast (Rmbm)
Revenue 28,630 28,815 31,602 34,258 36,970
Op Ebitda 936 997 1,094 1,245 1,413
Op Ebit 561 568 608 712 837
Interest income 266 278 295 218 200
Interest expense (180) (132) (82) (82) (82)
Other items 338 696 447 489 509
Profit before tax 985 1,410 1,268 1,336 1,464
Taxation (227) (272) (254) (267) (322)
Minorities/Pref divs (151) (113) (101) (106) (114)
Net profit 606 1,024 913 962 1,028
Summary cashflow forecast (Rmbm)
Operating profit 561 568 608 712 837
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 375 428 486 533 576
Working capital changes 444 1,997 (2,510) (1,850) 764
Net interest/taxes/other (227) (272) (254) (267) (322)
Net operating cashflow 1,152 2,722 (1,669) (872) 1,855
Capital expenditure (833) (982) (1,200) (800) (800)
Free cashflow 319 1,739 (2,869) (1,672) 1,055
Acq/inv/disposals 53 35 0 0 0
Int, invt & associate div 389 561 633 595 598
Net investing cashflow (392) (387) (567) (205) (202)
Increase in loans (828) (1,157) 0 0 0
Dividends (97) (193) (193) (207) (220)
Net equity raised/other 4,028 (2,635) (759) (683) (615)
Net financing cashflow 3,103 (3,985) (952) (890) (835)
Incr/(decr) in net cash 3,864 (1,650) (3,189) (1,966) 818
Exch rate movements 0 0 0 0 0
Opening cash 10,302 14,166 12,516 9,327 7,361
Closing cash 14,166 12,516 9,327 7,361 8,178
Summary balance sheet forecast (Rmbm)
Cash & equivalents 14,166 12,516 9,327 7,361 8,178
Debtors 12,169 11,123 12,198 13,224 14,271
Inventories 14,230 12,563 13,896 15,101 16,338
Other current assets 7,021 8,049 8,147 8,107 8,055
Fixed assets 4,261 4,815 5,529 5,796 6,020
Intangible assets 0 0 0 0 0
Other term assets 0 0 1 2 2
Total assets 52,876 50,086 50,146 50,667 53,969
Short-term debt 1,289 507 507 507 500
Creditors 10,167 11,746 12,992 14,119 15,276
Other current liabs 19,565 16,615 15,365 14,579 16,425
Long-term debt/CBs 2,707 1,550 1,550 1,550 1,550
Provisions/other LT liabs 8,932 8,635 7,876 7,193 6,578
Minorities/other equity 1,578 1,395 1,496 1,603 1,717
Shareholder funds 8,639 9,638 10,359 11,116 11,924
Total liabs & equity 52,876 50,086 50,146 50,667 53,969
Ratio analysis
Revenue growth (% YoY) (4.3) 0.6 9.7 8.4 7.9
Ebitda growth (% YoY) (45.5) 6.5 9.8 13.8 13.5
Ebitda margin (%) 3.3 3.5 3.5 3.6 3.8
Net profit margin (%) 2.1 3.6 2.9 2.8 2.8
Dividend payout (%) 15.4 18.8 21.1 21.5 21.5
Effective tax rate (%) 23.0 19.3 20.0 20.0 22.0
Ebitda/net int exp (x) 0.0 0.0 0.0 0.0 0.0
Net debt/equity (%) (99.5) (94.8) (61.3) (41.7) (44.9)
ROE (%) 7.7 10.7 8.9 8.7 8.7
ROIC (%) 5.4 5.7 5.0 4.6 4.9
EVA®/IC (%) (2.6) (2.4) (3.1) (3.5) (3.1)
Source: CLSA Asia-Pacific Markets

172 [email protected] 27 June 2011

 
  
 Huadian Power
HK$1.52 - SELL

Juliet Zhu Still the most vulnerable

[email protected] Huadian’s profitability is the lowest among listed independent power
(86) 2120205913
producers (IPP). Most of its capacity is located in resource-rich Shandong
Rajesh Panjwani province but instead of benefiting from cut-rate coal costs, it suffers from
(852) 26008271 modest tariffs. Recent fee hikes will not offset increased cost burdens.
With the highest gearing among peers, its interest expenses exceed near-
term operating profits. Strong power demand and higher utilisation ratios
are unlikely to translate to higher profits.

Poor profitability unlikely to improve

Huadian managed to report a profit in 2010 by selling assets. The 85% net-
27 June 2011 profit decline in 2010 was expected given high unit fuel costs. The
government raised on-grid tariffs in Shandong by Rmb2.45fen/kwh, effective
China from April, along with lower hikes in other areas. We do not expect this to
Power reverse the company’s loss-making situation; we forcast spot coal prices to
climb 11% YoY in 2011 and our average coal cost for Huadian jumps by 7%
Reuters 1071.HK
Bloomberg 1071 HK
YoY. Despite strong utilisation and power generation growth, the company’s
profitability remains weak.
Priced on 22 June 2011
HS CEI @ 12,148.9
Cost burdens keep climbing
12M hi/lo HK$2.13/1.46 Rising coal prices and falling fulfilment and contract ratios drove the fuel-cost-
to-revenue ratio up from 55% in 2005 to 73% in 2010. Our commodity team
12M price target HK$1.20
±% potential -21% raised spot thermal-coal prices by 4-6% over 11-13CL, reflecting the stronger
Target set on 22 Jun 11 demand environment. We expect the fuel-cost-to-revenue ratio to stay above
70% in 11-12CL. Additionally, Huadian’s high gearing (406% in 2010) creates
Shares in issue 6,771.1m
41.0%
a huge and growing financial burden with net expenses 22% higher than
Free float (est.)
operating profit in 11CL and 5% higher in 12CL.
Market cap US$2,948m

3M average daily volume Weakest fundamentals. SELL.

HK$133.1m (US$17.1m) Huadian proposed a 600m A-share private placement to raise Rmb2.1 billion,
investing proceeds in capacity expansions and replenishing working capital.
Foreign s'holding 41.0%
We have not factored this into our model, given regulators have yet to
Major shareholders approve the move. However, although it would be helpful for the company to
China Huadian 47.2%
lower its gearing and save some costs, fundamentals are still the weakest
Shandong ITIC 11.8%
compared to peers. Our target price of HK$1.2 is based on 0.4x forward PB,
derived from our theoretical PB formula of (ROE-g)/(COE-g) where the
company only generates 4.8% average ROE while having a 9% COE. Our
recommendation is SELL.
Stock performance (%)
1M 3M 12M
Absolute (10.1) (0.7) (15.6)
Relative (4.1) 4.5 (16.2) Financials
Abs (US$) (10.3) (0.6) (15.7) Year to 31 Dec 09A 10A 11CL 12CL 13CL
3.5 (HK$) (%) 120 Revenue (Rmbm) 36,450 45,198 54,983 61,934 68,044
Huadian Power 110 Net profit (Rmbm) 1,157 170 (353) 143 1,992
3.0 Rel to CEI (RHS)
100 EPS (Rmb) 0.19 0.03 (0.05) 0.02 0.29
2.5 90 CL/consensus (14) (EPS%) - - (260) 24 218
80 EPS growth (% YoY) nm (86.8) (307.5) nm 1,290.0
2.0 70 PE (x) 7.0 52.8 nm 56.3 3.9
60 Dividend yield (%) 2.6 0.0 0.0 0.0 0.0
1.5
50 FCF yield (%) (114.2) (82.7) (221.2) (85.5) (65.1)
1.0 40 PB (x) 0.6 0.6 0.5 0.5 0.4
Jun 09 Feb 10 Oct 10 Jun 11 ROE (%) 8.5 0.4 (1.9) 0.8 10.3
Source: Bloomberg
Net debt/equity (%) 321.7 406.4 500.0 527.0 495.0
www.clsa.com Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com

 
  
 Huadian Power - SELL Chindia power

Attributable capacity by geographic exposure

Heilongjiang

Jilin

Liaoning
Xinjiang

Inner Mongolia Beijing

2%
Tianjin

Hebei
11%
Shanxi
Ningxia Shandong
Qinghai 10% 43%

Gansu
Jiangsu
Shaanxi Henan
Xizang 7%
(Tibet)
Anhui Shanghai
10%
Sichuan Hubei
11% Chongqing
Zhejiang
4%

Hunan Jiangxi
Guizhou
Fujian

Yunnan Taiwan
Guangxi Guangdong
3%
Hong Kong

Hainan

Source: CLSA Asia-Pacific Markets

Fuel-cost-to-revenue ratio Huadian - fuel-cost-to-revenue ratio

keeps going up
80,000 (Rmbm) Revenue Fuel cost Ratio (RHS) (%) 80

70,000
75
60,000
70
50,000

40,000 65

30,000
60
20,000
55
10,000

0 50
2005 2006 2007 2008 2009 2010 11CL 12CL 13CL

Source: Company, CLSA Asia-Pacific Markets

174 [email protected] 27 June 2011

 
  
 Huadian Power - SELL Chindia power

Financial costs up sharp, Net gearing ratio and financial expenses

eroding much profitability
9,000 (Rmbm) Financial expense Operating profit
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
(1,000)
(2,000)
2008 2009 2010 11CL 12CL 13CL

Two loss-making years Huadian ROE

out of the last five
10 (%)

(5)

(10)

(15)

(20)
2008 2009 2010 11CL 12CL

Source: CLSA Asia-Pacific Markets

Valuations are Share price and 12M forward PE bands Share price and 12M forward PB bands
not demanding but
12 7
fundamentals are max2.79x
6
the weakest 10
5
8 1.89x
4
6
3
4 max757.5x avg0.98x
2 0.74x
35.4x
2 avg20.7x 1 min0.50x
10.4x
0 min0.0x 0
Jun 06 Feb 08 Oct 09 Jun 11 Jun 06 Feb 08 Oct 09 Jun 11

Source: Evaluator, CLSA Asia-Pacific Markets

Recommendation history - Huadian Power International (1071 HK)

Date Rec level Closing price Target
22 June 2011 SELL 1.50 1.20
31 May 2011 U-PF 1.71 1.50
09 January 2011 SELL 1.53 1.30
26 November 2010 SELL 1.63 1.40
30 March 2010 U-PF 2.09 1.88
14 January 2010 U-PF 2.14 1.80
25 November 2009 U-PF 2.18 2.00
13 August 2009 O-PF 2.84 3.10
26 June 2009 O-PF 2.43 2.35
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 175

 
  
 Huadian Power - SELL Chindia power

Summary financials
Year to 31 December 09A 10A 11CL 12CL 13CL
Tariff hike assumptions Summary P&L forecast (Rmbm)
will help company to Revenue 36,450 45,198 54,983 61,934 68,044
reverse a loss-making Op Ebitda 8,392 6,403 9,135 11,002 14,086
in 2012 Op Ebit 4,271 1,726 3,828 5,156 7,952
Interest income 23 27 38 40 25
Interest expense (2,956) (3,397) (4,725) (5,450) (5,651)
Other items 345 1,847 341 465 602
Profit before tax 1,683 202 (519) 211 2,929
Taxation (101) (117) 104 (42) (586)
Minorities/Pref divs (425) 84 62 (25) (351)
Net profit 1,157 170 (353) 143 1,992
Summary cashflow forecast (Rmbm)
Operating profit 4,271 1,726 3,828 5,156 7,952
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 4,120 4,677 5,307 5,846 6,133
Working capital changes 2,212 2,207 (1,140) 362 (96)
Net interest/taxes/other (7,509) (2,551) (4,598) (5,467) (6,227)
Net operating cashflow 3,094 6,059 3,397 5,896 7,763
Capital expenditure (12,396) (13,469) (21,994) (12,800) (12,800)
Free cashflow (9,302) (7,410) (18,597) (6,904) (5,037)
Acq/inv/disposals (5,060) (7,003) 207 216 360
Int, invt & associate div 164 1,389 0 0 0
Net investing cashflow (17,292) (19,082) (21,787) (12,584) (12,440)
Increase in loans 10,050 16,616 18,796 6,399 4,949
Dividends (46) (76) 0 0 0
Net equity raised/other 3,567 (3,522) 0 0 0
Net financing cashflow 13,571 13,018 18,796 6,399 4,949
Incr/(decr) in net cash (627) (6) 406 (289) 272
Exch rate movements 0 0 0 0 0
Opening cash 1,869 1,242 1,236 1,642 1,353
Closing cash 1,242 1,236 1,642 1,353 1,625
Summary balance sheet forecast (Rmbm)
Cash & equivalents 1,242 1,236 1,642 1,353 1,625
Debtors 3,583 3,981 4,601 5,182 5,694
Inventories 1,346 1,760 1,831 2,030 2,133
Other current assets 1,387 2,628 2,758 2,894 3,037
Fixed assets 84,819 102,548 118,396 124,540 130,428
Intangible assets 1,127 4,764 5,604 6,413 7,193
Other term assets 2,908 2,072 2,175 2,284 2,300
Total assets 101,240 128,561 146,850 154,935 163,138
Short-term debt 24,360 34,574 47,589 56,204 62,757
Creditors 5,079 7,740 7,554 8,378 8,800
Other current liabs 2,777 4,347 4,213 4,669 4,907
Long-term debt/CBs 45,410 55,506 61,287 59,072 57,468
Provisions/other LT liabs 2,309 4,532 4,759 4,996 5,246
Minorities/other equity 5,219 5,687 5,625 5,650 6,001
Shareholder funds 16,086 16,176 15,823 15,967 17,958
Total liabs & equity 101,240 128,561 146,850 154,935 163,138
Highest net gearing Ratio analysis
among peers and also Revenue growth (% YoY) 21.5 24.0 21.7 12.6 9.9
lowest margin Ebitda growth (% YoY) 174.4 (23.7) 42.7 20.4 28.0
Ebitda margin (%) 23.0 14.2 16.6 17.8 20.7
Net profit margin (%) 3.2 0.4 (0.6) 0.2 2.9
Dividend payout (%) 18.4 0.0 0.0 0.0 0.0
Effective tax rate (%) 6.0 57.6 20.0 20.0 20.0
Ebitda/net int exp (x) 2.9 1.9 1.9 2.0 2.5
Net debt/equity (%) 321.7 406.4 500.0 527.0 495.0
ROE (%) 8.5 0.4 (1.9) 0.8 10.3
ROIC (%) 5.0 0.8 2.7 3.2 4.8
EVA®/IC (%) (1.6) (3.1) (3.2) (2.6) (1.1)
Source: CLSA Asia-Pacific Markets

176 [email protected] 27 June 2011

 
  
 Huaneng Power
HK$4.08 - SELL

Juliet Zhu Biggest is not the best

[email protected] With 50GW of consolidated installed power capacity, Huaneng is the
(86) 2120205913
largest listed independent power producer (IPP) in China. But its large
Rajesh Panjwani scale does not help profitability. Ebit margins and ROE have been among
(852) 26008271 the lowest among the listed IPPs. However, the effective tariff hike for its
projects has only been around 2%. Thanks to its high sensitivity to tariffs,
earnings will recover in 2012-13. ROE, however, will continue to drag due
to large share placements in 2010 and remain lower than peers. SELL.

Big and set to grow bigger

Huaneng is the largest listed IPP in China, controlling 50GW of power capacity
27 June 2011 in 18 provinces. It is also a wholly-owned subsidiary in Singapore. It is twice
the size it was five years ago. The quick growth in scale has been achieved
China through acquisitions and construction of new capacity. As Huaneng is
Power designed as the only platform for the parent to consolidate its conventional
energy business, we can expect further asset injections and growth.
Reuters 0902.HK
Bloomberg 902 HK
ADR HNP.N However, profitability is among the lowest
Getting bigger is not helping the company achieve higher profitability. After a
Priced on 22 June 2011
loss making 2008, earnings recovery is impeded by rising fuel cost pressures.
HS CEI @ 12,148.9
In 2010, it reported RoE is only 5%. Historic Ebit margin is only slightly better
12M hi/lo HK$5.18/4.02 than the most vulnerable play, Huadian. Even as earnings are forecast to
have 65% and 53% growth in 2011 and 2012 respectively, An enlarged
12M price target HK$3.60
±% potential -12% equity base after a two billion share placement in 2010 will result in lower
Target set on 22 Jun 11 ROE compared with others.
Shares in issue 14,055.4m Weak fundamentals and lack of near-term catalyst. SELL
Free float (est.) 26.6%
Our commodities’ team has once again revised up their spot-coal price
Market cap US$9,327m assumptions. With the spot-coal price forecast to increase by 11% in 2011
3M average daily volume
and another 1% in 2012, and tariff hikes typically lagging behind coal-price
HK$197.7m (US$25.4m) movement, cost pressure will continue to be the central problem for Huaneng.
Despite its low profitability, the effective tariff hike for Huaneng’s plants in the
Foreign s'holding 25.3%
recent round in May 2011 was only around 2%. The stock is quite sensitive to
Major shareholders tariff hikes. However, further tariff hikes are likely only if there is a decline in
HIPDC 36.1% rate of inflation and power shortages worsen. With low ROE and Ebit margin,
China Huaneng Group 11.2%
we rate the stock a SELL as fundamentals are weak and near-term positive
catalysts are limited after recent materialisation of tariff hikes. Our target
price of HK$3.60 is based on 0.75x 12CL PB.
Stock performance (%)
1M 3M 12M
Absolute (8.5) (6.0) (8.1)
Relative (2.5) (1.1) (8.8) Financials
Abs (US$) (8.7) (5.9) (8.2) Year to 31 Dec 09A 10A 11CL 12CL 13CL
7.0 (HK$) (%) 110 Revenue (Rmbm) 76,863 104,318 125,816 137,444 145,998
105 Net profit (Rmbm) 4,930 2,868 2,131 3,512 5,361
6.5 Huaneng Power 100
Rel to CEI (RHS) EPS (Rmb) 0.41 0.24 0.15 0.25 0.38
95
6.0
90 CL/consensus (20) (EPS%) - - 58 81 102
5.5 85 EPS growth (% YoY) nm (42.1) (36.0) 64.8 52.6
80 PE (x) 8.8 15.0 22.0 12.8 8.0
5.0
75
Dividend yield (%) 5.8 5.6 2.7 4.7 6.2
70
4.5
65 FCF yield (%) (17.2) (6.1) (19.1) (15.4) (4.9)
4.0 60 PB (x) 1.0 0.9 0.9 0.8 0.7
Jun 09 Feb 10 Oct 10 Jun 11 ROE (%) 11.0 5.0 3.6 5.8 8.5
Source: Bloomberg
Net debt/equity (%) 244.7 212.2 225.9 235.3 233.3
www.clsa.com Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com

 
  
 Huaneng Power - SELL Chindia power

Huaneng attributable capacity (2010)

Heilongjiang

Jilin

Liaoning
Xinjiang 10%

Beijing
Inner Mongolia 1%
Tianjin
1%
Hebei
6%
Shanxi
Ningxia
1% Shandong
Qinghai 14%

Gansu
3% Jiangsu
Shaanxi Henan 12%
Xizang 3%
(Tibet)
Shanghai
Anhui
Sichuan Hubei
2% Chongqing
Zhejiang
3%
9%

Hunan Jiangxi
Guizhou 2% 4%
Fujian
4%

Yunnan Taiwan
Guangxi Guangdong
11%
Hong Kong

Hainan

Huaneng’s current Huaneng - Capacity growth roadmap

capacity is twice that of
the 2005 level 60,000 (MW) Capacity YoY (RHS) (%) 60

50,000 50

40,000 40

30,000 30

20,000 20

10,000 10

0 0
2005 2006 2007 2008 2009 2010

Source: Company, CLSA Asia-Pacific Markets

178 [email protected] 27 June 2011

 
  
 Huaneng Power - SELL Chindia power

Huaneng’s Ebit margin is Ebit margin comparison

narrower than most 25 Huaneng CPI CRP Datang Huadian
(%)

20

15

10

(5)
2008 2009 2010 11CL 12CL 13CL
Source: Company, CLSA Asia-Pacific Markets

ROE is only better than Huaneng – ROE comparison

the weakest play Huadian
20 (%)

15

10

(5)

(10)
Huaneng CPI CRP Datang Huadian
(15)

(20)
2008 2009 2010 11CL 12CL 13CL
Source: CLSA Asia-Pacific Markets

Valuations are 12M forward PE bands 12M forward PB bands

undemanding but (log) (log)
14
fundamentals are 27 max1,447.4x
max3.04x

worsening 38.6x
9
2.24x
11 avg27.1x
13.6x avg1.45x
5 6
1.15x

2 4 min0.86x

1 min0.0x 3
Jun 06 Feb 08 Oct 09 Jun 11 Jun 06 Feb 08 Oct 09 Jun 11

Source: Evaluator

Recommendation history - Huaneng Power International (902 HK)

Date Rec level Closing price Target
22 June 2011 SELL 4.07 3.60
31 May 2011 U-PF 4.51 4.00
01 April 2011 U-PF 4.55 4.20
26 November 2010 U-PF 4.24 4.10
08 September 2010 U-PF 4.57 4.40
26 March 2010 O-PF 4.52 5.30
14 January 2010 O-PF 4.73 5.49
25 November 2009 O-PF 4.94 5.80
22 October 2009 O-PF 5.56 6.60
17 September 2009 O-PF 5.62 6.35
13 August 2009 O-PF 6.18 6.35
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 179

 
  
 Huaneng Power - SELL Chindia power

Summary financials
Year to 31 December 09A 10A 11CL 12CL 13CL
Profitability eroded by Summary P&L forecast (Rmbm)
higher operating cost and Revenue 76,863 104,318 125,816 137,444 145,998
interest expenses in 2011 Op Ebitda 17,746 19,076 19,912 22,888 26,308
Op Ebit 9,174 8,629 8,468 10,537 13,150
Interest income 60 89 170 106 56
Interest expense (4,260) (5,762) (6,096) (6,693) (6,823)
Other items 730 729 663 670 670
Profit before tax 5,704 3,685 3,204 4,621 7,054
Taxation (594) (843) (961) (924) (1,411)
Minorities/Pref divs (181) 27 (112) (185) (282)
Net profit 4,930 2,868 2,131 3,512 5,361
Summary cashflow forecast (Rmbm)
Operating profit 9,174 8,629 8,468 10,537 13,150
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 8,572 10,447 11,444 12,351 13,158
Working capital changes (393) 1,825 (1,406) (851) (3,884)
Net interest/taxes/other (2,372) (2,834) (7,086) (7,723) (8,404)
Net operating cashflow 14,981 18,067 11,420 14,314 14,021
Capital expenditure (22,426) (20,704) (20,352) (21,252) (16,147)
Free cashflow (7,445) (2,637) (8,932) (6,938) (2,126)
Acq/inv/disposals (2,613) (6,601) (535) (647) (778)
Int, invt & associate div 158 325 0 0 0
Net investing cashflow (24,880) (26,981) (20,887) (21,899) (16,925)
Increase in loans 15,727 11,072 9,217 4,599 5,458
Dividends (1,496) (2,777) (1,286) (2,116) (2,690)
Net equity raised/other (4,728) 4,768 16 18 19
Net financing cashflow 9,504 13,063 7,947 2,501 2,787
Incr/(decr) in net cash (395) 4,150 (1,520) (5,083) (117)
Exch rate movements 56 50 0 0 0
Opening cash 5,567 5,227 9,426 7,907 2,823
Closing cash 5,227 9,426 7,907 2,823 2,706
Capex will continue Summary balance sheet forecast (Rmbm)
to be funded by Cash & equivalents 5,227 9,426 7,907 2,823 2,706
increasing borrowings Debtors 10,043 10,909 12,635 13,803 14,662
Inventories 4,084 5,190 5,795 6,266 9,074
Other current assets 4,836 6,030 6,897 7,893 9,039
Fixed assets 140,777 155,225 163,092 170,901 172,743
Intangible assets 19,353 20,805 21,845 22,937 24,084
Other term assets 3,999 8,379 8,716 9,073 9,452
Total assets 197,887 227,938 240,058 248,185 257,696
Short-term debt 44,082 62,900 73,518 79,660 90,627
Creditors 14,525 19,555 21,296 23,027 23,900
Other current liabs 975 1,182 1,240 1,302 1,368
Long-term debt/CBs 85,067 79,016 77,615 76,073 70,564
Provisions/other LT liabs 2,591 2,860 2,998 3,143 3,295
Minorities/other equity 8,524 8,636 8,748 8,933 9,215
Shareholder funds 42,124 53,789 54,641 56,046 58,727
Total liabs & equity 197,887 227,938 240,058 248,185 257,696
Only single digit RoE in Ratio analysis
forecast periods Revenue growth (% YoY) 13.3 35.7 20.6 9.2 6.2
Ebitda growth (% YoY) 173.7 7.5 4.4 14.9 14.9
Ebitda margin (%) 23.1 18.3 15.8 16.7 18.0
Net profit margin (%) 6.4 2.7 1.7 2.6 3.7
Dividend payout (%) 51.4 84.4 60.0 60.0 50.0
Effective tax rate (%) 10.4 22.9 30.0 20.0 20.0
Ebitda/net int exp (x) 4.2 3.4 3.4 3.5 3.9
Net debt/equity (%) 244.7 212.2 225.9 235.3 233.3
ROE (%) 11.0 5.0 3.6 5.8 8.5
ROIC (%) 5.4 3.8 3.1 4.2 5.0
EVA®/IC (%) (1.3) (2.3) (2.7) (2.0) (1.2)
Source: CLSA Asia-Pacific Markets

180 [email protected] 27 June 2011

 
  
 Jindal Steel & Power
Rs612.85 - OUTPERFORM

Abhishek Tyagi Benefits of integration

[email protected] JSPL enjoys unique competitive advantages in both its steel and power
(91) 2266505055
businesses due to its high degree of backward integration. However, the
Abhijeet Naik expansion plans for both segments have seen significant delays, which
(91) 2266505060 has been disappointing. We still like the longer-term growth prospects of
the company, which should see 20% earnings Cagr over FY12-14. Our
Nitij Mangal SOTP based target price is Rs700: we maintain our Outperform rating.
(91) 2266505064

High level of backward integration

JSPL enjoys a high degree of backward integration for both its power and
steel businesses. The company has captive coal blocks with total reserves of
27 June 2011 2.5bn tonnes, which make it the private-sector company with the largest coal
reserves. Access to lower-cost iron ore (quasi-captive) and a lower
India dependence on coking coal drive JSPL’s cost advantages.
Materials
Delays in expansion projects have been disappointing
Reuters JNSP.BO
Bloomberg JSP IB
JSPL has commissioned only three 135MW units so far (two at Raigarh and
one at Angul) of the proposed 1,350MW (10 units) which were supposed to
Priced on 22 June 2011
be fully commissioned by June 2011. While some of the delay has been due
India Sensex @ 17,550.6
to holdups in getting environmental clearances, some is also down to the fact
12M hi/lo Rs755.25/572.70 that these units are taking longer than expected to stabilise. The onsite work
for Tamnar II project (2,400MW), which Jindal Power (96.5% subsidiary) is
12M price target Rs700.00
±% potential +14% developing, is yet to start, as the final go-ahead from MoEF is still pending.
Target set on 29 Apr 11 JSPL’s Greenfield steel plant at Angul is likely to commission by October 2012,
versus our earlier expectation of March 2012. The plate mill could come up
Shares in issue 930.8m
41.4%
earlier but the DRI units and steel-melting shop will come up only by October
Free float (est.)
2012. Given the ramp-up time needed, the volume benefit from Angul will
Market cap US$12,774m show mainly in FY14 and FY15, and less so in FY13.
3M average daily volume
Rs725.8m (US$16.2m) Good business mix; retain Outperform
Major shareholders
We see JSPL’s strong competitive advantages in both power and steel
Promoter & promoter group 58.4% businesses continuing in the coming years. This, combined with well-funded
FIIs 23.4% growth projects, will ensure a strong profit-growth trajectory over the long
term. The unique combination of steel and power also reduces the volatility
associated with commodity stocks. Our Rs700 SOTP target price comprises
Rs258 for the steel business including Shadeed Steel (6.5x FY12 EV/Ebitda),
Rs357 for JSPL’s 96.5% stake in Jindal Power and Rs85 for the captive-power
business (surplus power) of JSPL. Potential risks are a sharper-than-expected
Stock performance (%) fall in merchant power rates and project delays.
1M 3M 12M
Absolute (4.3) (7.2) (8.8)
Relative (0.2) (4.9) (7.8) Financials
Abs (US$) (4.1) (7.2) (6.4) Year to 31 Mar 09A 10A 11CL 12CL 13CL
780 (Rs) (%) 170 Revenue (Rsm) 108,510 110,915 131,116 174,552 204,099
730 160 Net profit (Rsm) 30,061 35,730 37,539 49,729 57,181
680 150 EPS (Rs) 32.4 38.4 40.3 53.4 61.4
630 140 CL/consensus (18) (EPS%) - - 99 99 101
580 130 EPS growth (% YoY) 139.1 18.5 5.1 32.5 15.0
530 120 PE (x) 18.9 16.0 15.2 11.5 10.0
480 110 Dividend yield (%) 0.0 0.2 0.4 0.5 0.7
Jindal Steel & Power
430
Rel to Sensex (RHS)
100 PB (x) 8.1 5.5 4.1 3.1 2.4
380 90 ROE (%) 55.1 41.2 30.8 30.6 26.9
Jun 09 Feb 10 Oct 10 Jun 11 Net debt/equity (%) 100.5 80.2 79.7 88.9 73.6
Source: Bloomberg
EV/Ebitda (x) 11.7 9.8 9.0 7.0 6.4
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 Jindal Steel & Power - O-PF Chindia power

Tamanr II will start Operational data for power business

contributing from Tamnar I FY12CL FY13CL FY14CL FY15CL
FY14 onwards
Generation (mkWh) 8,147 8,147 8,147 8,147
Sales (mkWh) 7,577 7,577 7,577 7,577
Merchant sales (mkWh) 6,440 6,440 6,440 6,440
Sales to Chattisgarh (mkWh) 1,136 1,136 1,136 1,136
% merchant 85.0 85.0 85.0 85.0
Average tariff (Rs/kWh) 3.9 3.4 3.5 3.5
Tamnar II
Generation (mkWh) 14,520 18,922
Sales (mkWh) 13,431 17,502
Merchant sales (mkWh) 2,238 2,917
Sales to Chattisgarh (mkWh) 5,037 6,563
Sales on Case 1 basis 6,156 8,022
% merchant 16.7 16.7
Average tariff (Rs/kWh) 3.14 3.15
Captives of JSPL
Generation (mkWh) 3,331 8,648 9,461 10,052
Available for sales (mkWh) 3,031 7,869 8,609 9,147
Consumption by steel (mkWh) 202 841 1,824 2,563
Outside sales (mkWh) 2,829 7,028 6,785 6,584
Source: CLSA Asia-Pacific Markets

Power segment will Breakdown between steel and power

contribute 43% (Rsm) FY12CL FY13CL FY14CL
of consolidated
earnings in FY12 Revenue
Steel 115,141 124,574 145,094
Shadeed Steel 20,074 28,204 28,204
Stand-alone power 10,168 25,372 24,819
Jindal Power 29,170 25,950 68,503
Total 174,552 204,099 266,620
Ebitda
Steel 44,516 50,064 61,210
Shadeed Steel 3,977 5,588 5,588
Stand-alone power 6,816 16,748 14,032
Jindal Power 24,467 21,138 46,062
Total 79,776 93,538 126,892
PAT
Steel 26,912 28,294 35,356
Shadeed Steel 1,266 2,877 2,877
Stand-alone power 3,469 9,916 7,506
Jindal Power 18,081 16,094 25,822
Total 49,729 57,181 71,561
EPS (Rs)
Steel 29 30 38
Shadeed Steel 1.4 3.1 3.1
Stand-alone power 3.7 10.7 8.1
Jindal Power 19.4 17.3 27.7
Total 53.4 61.4 76.9
Source: CLSA Asia-Pacific Markets

182 [email protected] 27 June 2011

 
  
 Jindal Steel & Power - O-PF Chindia power

Angul plant now likely to Details of JSPL’s near-term capex plans

come up by Oct 12 versus Details Capex (Rsm) Commissioning
our previous expectation
Brownfield expansion at Raigarh
of Mar 12
Power plant 540 MW 22,000 end-FY12
Total 27,500
Orissa greenfield project
Plate mill 1.5 mtpa 26,000 Oct 12
DRI 2 mtpa 31,410 Oct 12
Power plant 810 MW 34,820 Jul 12
Steel melting shop 1.6 mtpa 35,770 Oct 12
Total 128,000
Source: Company, CLSA Asia-Pacific Markets

JSPL has access to 2.5bn Coal blocks allocated to JSPL

tonnes of coal reserves Sector/ Coal block Reserves (mt) Date of allotment
Power
Gare Palma IV/2 123 1 Jul 98
Gare Palma IV/3 123 1 Jul 98
Jitpur 81 20 Feb 07
Amarakonda – Murgadangal 205 17 Jan 08
Total 532
Sponge iron
Gare Palma IV/1 124 21 Jun 96
Utkal B 1 228 29 Sep 03
Gare Palma V/6 156 13 Jan 06
Total 508
Coal to liquid
Ramchandi 1,500 27 Feb 09
Total 1,500
Grand total 2,540
Source: Ministry of Coal, CLSA Asia-Pacific Markets

Based on sum of parts Target price

Equity value - FY13 (Rs/sh)
Jindal Power 357 DCF value of JSPL's 96.5% stake
1,350MW power capacity in JSPL standalone 85 8x FY13 PE
Steel business 233 6.5x FY13 EV/Ebitda
Shadeed Steel 25 10x FY13 PE
Total 700
Note: 20% holdco discount applied to Jindal Power and Shadeed Steel value for SOTP calculation.
Source: CLSA Asia-Pacific Markets

Recommendation history - Jindal Steel & Power Ltd (JSP IB)

Date Rec level Closing price Target
29 April 2011 O-PF 677.35 700.00
26 January 2011 BUY 688.35 800.00
30 November 2010 BUY 622.40 745.00
23 August 2010 O-PF 688.70 740.00
30 July 2010 O-PF 622.40 656.00
14 July 2010 O-PF 632.30 690.00
15 April 2010 O-PF 723.55 800.00
30 March 2010 O-PF 716.35 765.00
13 February 2010 O-PF 615.50 700.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 183

 
  
 Jindal Steel & Power - O-PF Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
Earnings Cagr of 20% Summary P&L forecast (Rsm)
over FY12-14 Revenue 108,510 110,915 131,116 174,552 204,099
Op Ebitda 51,695 58,477 63,926 79,776 93,538
Op Ebit 42,054 48,508 52,416 66,741 76,672
Interest income 624 603 820 3,359 3,738
Interest expense (4,567) (3,576) (3,356) (5,664) (6,264)
Other items 0 0 0 0 0
Profit before tax 38,111 45,535 49,880 64,436 74,146
Taxation (8,040) (9,189) (11,840) (14,037) (16,368)
Minorities/Pref divs (10) (616) (501) (670) (597)
Net profit 30,061 35,730 37,539 49,729 57,181
Strong operating Summary cashflow forecast (Rsm)
cash flows Operating profit 42,054 48,508 52,416 66,741 76,672
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 9,641 9,970 11,510 13,035 16,867
Working capital changes (11,014) 3,290 (3,911) 688 (256)
Net interest/taxes/other (10,382) (11,480) (15,196) (18,685) (19,180)
Net operating cashflow 30,298 50,287 44,819 61,779 74,102
Capital expenditure (42,481) (61,817) (53,050) (116,105) (79,737)
Free cashflow (12,183) (11,530) (8,231) (54,326) (5,634)
Acq/inv/disposals (407) (1,597) 0 0 0
Int, invt & associate div 3,651 2,812 (15,787) 4,693 3,334
Net investing cashflow (39,237) (60,602) (68,837) (111,412) (76,403)
Increase in loans 11,172 4,909 60,948 63,013 26,552
Dividends (1,001) (1,399) (2,804) (3,351) (4,379)
Net equity raised/other 1,277 (2,312) (734) (1,686) (4,048)
Net financing cashflow 11,449 1,198 57,410 57,975 18,125
Incr/(decr) in net cash 2,510 (9,117) 33,393 8,342 15,824
Exch rate movements 0 0 0 0 0
Opening cash 7,735 10,245 1,128 34,521 42,863
Closing cash 10,245 1,128 34,521 42,863 58,687
Summary balance sheet forecast (Rsm)
Cash & equivalents 10,245 1,128 34,521 42,863 58,687
Debtors 53,967 67,383 68,263 74,810 78,779
Inventories 0 0 0 0 0
Other current assets 0 0 0 0 0
Fixed assets 126,863 178,444 220,217 323,287 386,157
Intangible assets 363 1,007 1,007 1,007 1,007
Other term assets 31 77 19,020 19,944 24,772
Total assets 193,057 251,223 346,212 465,095 552,586
Short-term debt 0 0 0 0 0
Creditors 34,194 50,900 47,870 55,104 58,817
Other current liabs 0 0 0 0 0
Long-term debt/CBs 81,133 86,042 146,990 210,003 236,555
Provisions/other LT liabs 7,170 8,455 10,289 11,877 15,704
Minorities/other equity 45 1,659 2,160 2,831 3,428
Shareholder funds 70,515 104,168 138,903 185,280 238,082
Total liabs & equity 193,057 251,223 346,212 465,095 552,586
Strong operating Ratio analysis
cash flows Revenue growth (% YoY) 97.7 2.2 18.2 33.1 16.9
Ebitda growth (% YoY) 118.8 13.1 9.3 24.8 17.3
Ebitda margin (%) 47.6 52.7 48.8 45.7 45.8
Net profit margin (%) 27.7 32.2 28.6 28.5 28.0
Dividend payout (%) 0.5 3.3 6.2 5.6 6.5
Effective tax rate (%) 21.1 20.2 23.7 21.8 22.1
Ebitda/net int exp (x) 13.1 19.7 25.2 34.6 37.0
Net debt/equity (%) 100.5 80.2 79.7 88.9 73.6
ROE (%) 55.1 41.2 30.8 30.6 26.9
ROIC (%) 26.4 22.6 17.5 16.7 15.0
EVA®/IC (%) 15.4 11.5 6.7 5.8 4.1
Source: CLSA Asia-Pacific Markets

184 [email protected] 27 June 2011

 
  
 JSW Energy
Rs64.75 - UNDERPERFORM

Abhishek Tyagi Coal worries

[email protected] JSW Energy’s business model is under strain, with a sharp correction in
(91) 2266505055
near-term tariffs and upward movement of thermal coal prices. The
Rajesh Panjwani company has not been able to get coal from its PT Sengai Belati contract,
(852) 26008271 and its recent bid for CIC Energy (coal concessions in Botswana) has
fallen apart. Earnings are likely to remain volatile unless JSW has firm
fuel tie-ups and reduces its exposure to the short-term power market. We
maintain our cautious outlook and reiterate our Underperform rating.

Commissioning of Barmer and Ratnagiri delayed

Barmer project (regulated-return) continues to face delays and the company
27 June 2011 is now targeting commissioning the project by end-FY12. The existing two
units (135MW each) are operating below the norms and the company
India incurred a loss of Rs100m in 4QFY11 and Rs350m for full year FY11. The
Power commissioning of Ratnagiri’s fourth unit (300MW) has also been delayed by
couple of months.
Reuters JSWE.BO
Bloomberg JSW IB Coal supplies remain a concern
Priced on 22 June 2011 JSW Energy’s business model continues to remain vulnerable to spot thermal
India Sensex @ 17,550.6 coal prices: 2GW operational plus under-construction capacity is based
12M hi/lo Rs136.30/64.35
entirely on imported coal. The company has been unable to secure coal from
its earlier agreement with PT Sengai Belati (Indonesia) given the ongoing
12M price target Rs72.00 dispute regarding the overlapping lease with another mining licence holder.
±% potential +11%
The company’s recent bid to acquire CIC Energy, which has coal mining
Target set on 22 Jun 11
concessions in Botswana, could not be concluded, with CIC Energy not
Shares in issue 1,640.1m meeting certain conditions. JSW Energy does not have a fallback option of
Free float (est.) 23.3% getting coal from a domestic source (coal linkage or a captive coal block).
Market cap US$2,369m
Falling merchant tariffs an added risk
3M average daily volume We expect JSW Energy to sell c.50% of its FY12 generation in the short-term
Rs97.6m (US$2.2m)
market, where there is no option of passing on fuel costs. In the current
Major shareholders scenario, where merchant tariffs have been under pressure and there is
Promoter & promoter group 76.7% continuous upward movement in fuel costs, the business model of JSW
FIIs 4.1%
Energy will be under acute stress. With 860MW of its merchant capacity in
South India it has some advantage, as the prices in that part of the country
are usually higher due to grid constraints. We maintain our negative stance
on the stock given its high exposure to spot thermal coal and very high
leverage to short-term tariffs. We maintain our Underperform call.

Stock performance (%)

1M 3M 12M
Absolute (8.5) (9.4) (49.0)
Relative (4.5) (7.2) (48.4) Financials
Abs (US$) (8.3) (9.4) (47.6) Year to 31 Mar 09A 10A 11CL 12CL 13CL
140 (Rs) (%) 140 Revenue (Rsm) 18,350 23,551 42,944 70,297 66,381
130 130 Net profit (Rsm) 2,767 7,509 8,420 11,095 7,718
120 120 EPS (Rs) 2.0 4.6 5.1 6.8 4.7
110 110 CL/consensus (18) (EPS%) - - 100 87 68
100 100 EPS growth (% YoY) (58.3) 126.1 12.1 31.8 (30.4)
90 90 PE (x) 32.0 14.1 12.6 9.6 13.8
80 80 Dividend yield (%) 0.5 1.4 1.8 1.8 1.8
JSW Energy (LHS)
70
Rel to Sensex
70 FCF yield (%) (42.8) (27.4) (25.1) (0.2) 2.7
60 60 PB (x) 6.0 2.2 1.9 1.6 1.5
Dec 09 Jun 10 Dec 10 Jun 11
ROE (%) 21.5 23.9 16.0 17.9 11.1
Source: Bloomberg
Net debt/equity (%) 385.1 151.5 150.6 129.8 114.5
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 JSW Energy - U-PF Chindia power

High proportion of short- Sales mix over the quarters

term sales in overall
sales mix
3,500 (mkWh) Long-term sales Short-term sales

3,000

2,500

2,000

1,500

1,000

500

0
4QFY10 1QFY11 2QFY11 3QFY11 4QFY11

Highest fuel cost in our Fuel costs over the quarters

utility coverage
3.0 (Rs/kWh)

2.5

2.0

1.5 2.80
2.60 2.66
2.34
2.13
1.0

0.5

0.0
4QFY10 1QFY11 2QFY11 3QFY11 4QFY11

Source: Company, CLSA Asia-Pacific Markets

Blended fuel cost will Key operational data

reduce with full
Operational data FY12CL FY13CL FY14
commissioning of Raj
West project Effective annual capacity (MW) 2,450 3,140 3,410
Generation (mkWh) 17,905 22,811 25,111
Sales (mkWh) 16,473 20,986 23,102
Merchant sales (mkWh) 7,287 8,581 10,696
PPA sales (mkWh) 9,186 12,405 12,405
Overall Tariff (Rs/kWh) 4.27 3.16 3.21
Merchant tariff (Rs/kWh) 4.25 3.50 3.55
Fuel cost (Rs/kWh) 2.74 1.98 1.85
O&M cost (Rs/kWh) 0.20 0.20 0.21
Fixed cost (Rs/kWh) 0.82 0.85 0.83
Source: CLSA Asia-Pacific Markets

186 [email protected] 27 June 2011

 
  
 JSW Energy - U-PF Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
Strong earnings growth Summary P&L forecast (Rsm)
in FY12 Revenue 18,350 23,551 42,944 70,297 66,381
Op Ebitda 5,319 12,189 15,673 21,992 20,709
Op Ebit 4,716 10,828 13,005 18,346 15,863
Interest income 171 742 1,302 2,154 2,497
Interest expense (1,209) (2,837) (4,325) (6,632) (8,714)
Other items 0 0 0 0 0
Profit before tax 3,678 8,733 9,982 13,867 9,646
Taxation (911) (1,224) (1,563) (2,772) (1,928)
Minorities/Pref divs 0 0 0 0 0
Net profit 2,767 7,509 8,420 11,095 7,718
To be FCF positive Summary cashflow forecast (Rsm)
in FY12 Operating profit 4,716 10,828 13,005 18,346 15,863
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 602 1,361 2,668 3,646 4,845
Working capital changes 11,070 (5,287) (8,068) (7,751) (3,719)
Net interest/taxes/other (2,121) (4,061) (5,888) (9,404) (10,643)
Net operating cashflow 14,268 2,842 1,718 4,837 6,347
Capital expenditure (52,145) (31,934) (28,368) (5,025) (3,432)
Free cashflow (37,877) (29,093) (26,651) (188) 2,915
Acq/inv/disposals (1,497) (12,350) 9,503 0 0
Int, invt & associate div 171 742 1,302 2,154 2,497
Net investing cashflow (53,471) (43,542) (17,563) (2,871) (936)
Increase in loans 36,545 19,430 15,800 1,631 (5,934)
Dividends (1,205) (1,434) (1,906) (1,906) (1,906)
Net equity raised/other 2,664 27,254 5,683 0 0
Net financing cashflow 38,005 45,249 19,576 (274) (7,839)
Incr/(decr) in net cash (1,198) 4,549 3,730 1,691 (2,428)
Exch rate movements 0 (252) 0 0 0
Opening cash 2,949 1,751 6,048 9,779 11,470
Closing cash 1,751 6,048 9,779 11,470 9,042
Summary balance sheet forecast (Rsm)
Cash & equivalents 1,751 6,048 9,779 11,470 9,042
Current assets (14,014) (8,727) (659) 7,092 10,811
Fixed assets 85,410 115,980 141,295 142,674 141,261
Intangible assets 172 171 171 171 171
Total assets 75,024 127,817 155,427 166,248 166,126
Long-term debt/CBs 59,272 78,701 96,376 98,007 92,074
Provisions/other LT liabs 814 1,161 1,562 1,562 1,562
Minorities/other equity 152 152 724 724 724
Shareholder funds 14,786 47,802 56,765 65,954 71,766
Total liabs & equity 75,024 127,817 155,427 166,248 166,126
Expect Ebidta margins to Ratio analysis
decline with fall in Revenue growth (% YoY) 41.9 28.3 82.3 63.7 (5.6)
merchant prices Ebitda growth (% YoY) (39.3) 129.2 28.6 40.3 (5.8)
Ebitda margin (%) 29.0 51.8 36.5 31.3 31.2
Net profit margin (%) 15.1 31.9 19.6 15.8 11.6
Dividend payout (%) 17.4 19.1 22.6 17.2 24.7
Effective tax rate (%) 24.8 14.0 15.7 20.0 20.0
Ebitda/net int exp (x) 5.1 5.8 5.2 4.9 3.3
Net debt/equity (%) 385.1 151.5 150.6 129.8 114.5
ROE (%) 21.5 23.9 16.0 17.9 11.1
ROIC (%) 6.9 10.4 8.8 10.1 8.4
EVA®/IC (%) (3.3) (0.5) (1.9) (0.4) (2.1)
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 187

 
  
 JSW Energy - U-PF Chindia power

Recommendation history - JSW Energy Ltd (JSW IB)

Date Rec level Closing price Target
22 June 2011 U-PF 66.60 72.00
29 April 2011 U-PF 75.15 80.00
24 February 2011 SELL 75.40 76.00
15 January 2011 SELL 90.10 88.00
26 July 2010 SELL 129.20 111.00
30 March 2010 SELL 112.15 98.00
27 March 2010 U-PF 114.85 98.00
18 March 2010 U-PF 111.10 93.00
Source: CLSA Asia-Pacific Markets

188 [email protected] 27 June 2011

 
  
 Lanco Infratech
Rs26.10 - OUTPERFORM

Abhishek Tyagi In value zone

[email protected] Lanco’s stock price has corrected by 62% over the past year on concerns
(91) 2266505055
about fuel supply, high merchant power exposure, high gearing and
Rajesh Panjwani frequent accounting changes. FY12 is shaping up to be another
(852) 26008271 challenging year for the company, with fuel supply likely to be its biggest
issue. We are factoring this into our forecast through low utilisation
hours, especially for merchant capacity. We believe there is value in the
stock at its current price for investors with risk appetite. Outperform.

FY12 would be tough year

Lanco could have 9.2GW generation capacity by the end of FY14, which is
27 June 2011 3.5x its current capacity. However, we expect FY12 to be challenging for
Lanco as it commissions more generation assets, deals with fuel shortages for
India both coal- and gas-based power projects, sorts out disputes related to power
Power purchase agreements while at the same time integrating the recent Griffin
acquisition in Australia.
Reuters LAIN.BO
Bloomberg LANCI IN Fuel supply is the biggest concern
Priced on 22 June 2011 Fuel supply is the biggest concern for Lanco over the next two to three years.
India Sensex @ 17,550.6 The company’s gas-based capacities are likely to suffer given the lower-than-
expected production from Reliance Industries’ KG D-6 gas field. Lanco is
12M hi/lo Rs74.70/25.10 dependent on Coal India for the supply of coal for most of its power projects
12M price target Rs34.00 which is struggling to increase production. We also see a high risk of lower
±% potential +30% allocation of coal to power projects selling power in the short-term market
Target set on 22 Jun 11 which would impact Lanco’s Amarkantak II (300MW) project.
Shares in issue 2,407.8m
Free float (est.) 32.1%
High gearing necessitates equity raising in 12-18 months
Lanco’s consolidated net gearing could be more than 400% in FY12. This is
Market cap US$1,404m higher than the 70:30 debt/equity norm as the company has used debt raised
3M average daily volume
at the parent0company level to fund equity for some projects. However, most
Rs47.5m (US$1.1m) of the special-purpose-vehicle (SPV) debt is project financed with the
underlying asset as collateral. The company has plans to spin-off the power
Major shareholders
Promoters 68.0% vertical into a separate entity through an IPO. We expect the company to
FIIs 19.8% raise US$750m at the power-company level, which at our valuations implies,
post money, a 76% holding of Lanco Infratech.

Sharp correction offers value

Lanco’s stock price has corrected by 62% over the past year on fears of falling
merchant tariffs, coal and gas shortages, high gearing and flip-flopping on
depreciation policy. However, we believe the stock offers value at current
Stock performance (%) valuations and our target of Rs34 is based on a 25% discount to fair value.
1M 3M 12M
Absolute (19.4) (32.3) (61.7)
Relative (15.9) (30.6) (61.2) Financials
Abs (US$) (19.3) (32.3) (60.7) Year to 31 Mar 09A 10A 11CL 12CL 13CL
80 (Rs) (%) 170 Revenue (Rsm) 60,062 80,320 77,837 127,612 152,929
70 150
Net profit (Rsm) 2,799 4,763 4,461 7,218 9,283
EPS (Rs) 1.3 2.0 1.9 3.0 3.9
60 130
CL/consensus (24) (EPS%) - - 69 76 76
50 110 EPS growth (% YoY) (20.9) 57.2 (6.4) 61.8 28.6
40 90 PE (x) 20.7 13.2 14.1 8.7 6.8
Dividend yield (%) 0.0 0.0 0.0 0.0 0.0
30 Lanco Infratech 70
Rel to Sensex (RHS) FCF yield (%) (19.6) (25.3) (22.3) (58.3) (44.1)
20 50 PB (x) 2.8 1.9 1.7 1.1 1.0
Jun 09 Feb 10 Oct 10 Jun 11
ROE (%) 19.5 20.9 17.2 19.0 18.9
Source: Bloomberg
Net debt/equity (%) 219.6 221.2 248.8 417.5 436.0
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 Lanco Infratech - O-PF Chindia power

Power capacity addition Project wise capacity ramp-up

over next three years:
FY12 - 1.2GW 10,000 (MW) Amarkantak Udupi
FY13 - 0.8GW Anpara Babandh
FY14 - 4.5GW Vidharbha Kondapalli
8,000 Aban Teesta
Budhil Uttranchal
6,000 VIPL VHPL

4,000

2,000

0
FY11 FY12 FY13 FY14 FY15

9.2GW power capacity Effective annual capacity

would be fully ramped up
by FY15 . . . 10,000 (MW)

8,000

6,000

4,000

2,000

0
FY11 FY12 FY13 FY14 FY15

. . . this should result in Generation growth is going to be strong with the ramp up in capacity
6x growth in generation
over FY11-15 70,000 (mkWh)

60,000

50,000

40,000

30,000

20,000

10,000

0
FY11 FY12 FY13 FY14 FY15

Source: CLSA Asia-Pacific Markets

190 [email protected] 27 June 2011

 
  
 Lanco Infratech - O-PF Chindia power

Lanco has 4Gw of untied Split of power selling arrangements of Lanco Infratech
capacity of the total Project Capacity Regulated Case1/Case 2 At variable Merchant
9.2GW portfolio (MW) cost
it is developing
Amarkantak I 300 300
Amarkantak II 300 300
Amarkantak III 660 198 33 429
Amarkantak IV 660 198 33 429
Udupi I 600 600 0
Udupi II 600 600 0
Anpara 1,200 0 1,100 100
Babandh I 660 132 33 495
Babandh II 660 132 33 495
Vidharba I 660 340 320
Vidharba II 660 340 320
Kondapalli I 368 368 0
Kondapalli II 366 0 366
Kondapalli III 732 0 732
Aban 120 120 0
Teesta 500 500 0
Budhil 70 70 0
Uttranchal 76 76 0
VIPL 10 10 0
VHPL 10 10 0
Total 9,212 2,326 2,768 132 3,986
Source: CLSA Asia-Pacific Markets

Tariff for FY12-14 for all power projects

(Rs/kWh) FY12 FY13 FY14

@ Variable Regulated PPA Merchant Avg @ Variable Regulated PPA Merchant Avg @ Variable Regulated PPA Merchant Avg
cost tariff cost tariff cost tariff
Amarkantak I - - - 4.0 4.0 - - - 3.5 3.5 - - - 3.6 3.6
Amarkantak - - - 3.0 3.0 - 2.7 - 3.5 2.7 - 2.7 - 2.7
II¹
Amarkantak - - - - - - - - - - 1.3 - - 3.6 3.4
III
Amarkantak - - - - - - - - - - 1.3 - - 3.6 3.5
IV
Udupi I - 3.7 - - 3.7 - 3.7 - 3.5 3.7 - 3.8 - 3.6 3.8
Udupi II - 3.8 - - 3.8 - 3.6 - 3.5 3.6 - 3.7 - 3.6 3.7
Anpara - - 2.3 4.0 2.4 - - 2.1 3.5 2.3 - - 2.2 3.6 2.3
Babandh I - - - - - - - - - - 1.1 3.5 - 3.6 3.4
Babandh II - - - - - - - - - - 1.1 3.6 - 3.6 3.4
Vidharba I - - - - - - - - - - 1.1 - 2.4 - 2.4
Vidharba II - - - - - - - - - - 1.1 - 2.4 3.6 3.0
Kondapalli I - - 3.2 - 3.2 - - 2.6 - 2.6 - - 2.6 - 2.6
Kondapalli II - - - 4.0 4.0 - - - 3.5 3.5 - - - 3.6 3.6
Kondapalli III - - - - - - - - 3.5 3.5 - - - 3.6 3.6
Aban - - 3.6 4.0 3.6 2.3 - 3.6 3.5 3.6 - - 3.4 - 3.4
Teesta - - - - - - - - - - - - 2.3 - 2.0
Budhil - - - - - - 2.6 - - 2.3 - 2.6 - - 2.3
Uttranchal - - - - - - - - - - - - - 3.6 3.1
VIPL - 3.6 - - 3.2 - 3.5 - - 3.1 - 3.4 - - 3.0
VHPL - 3.1 - - 2.7 - 3.0 - - 2.6 - 2.9 - - 2.5
¹ have assumed UI sales to continue in FY12. Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 191

 
  
 Lanco Infratech - O-PF Chindia power

Sales of power via different modes Proportion of sales via different modes

70,000 (mkWh) Free to the state @Variable cost Regulated

Merchant PPA - Case 1/2 Merchant
60,000 (%) Free to the state
PPA - Case 1/2
50,000 100
Regulated
40,000 @Variable cost 80

30,000 60
20,000 40
10,000 20
0 0
FY11 FY12 FY13 FY14 FY15 FY16 FY11 FY12 FY13 FY14 FY15 FY16

FY12 will see doubling of Project wise coal requirement

coal requirements Project FY11 FY12 FY13 FY14 FY15
for Lanco
Amarkantak I 1.5 1.6 1.6 1.6 1.6
Amarkantak II 1.2 1.3 1.6 1.6 1.6
Amarkantak III 0.0 0.0 0.0 2.4 3.3
Amarkantak IV 0.0 0.0 0.0 1.1 3.3
Udupi I 1.3 1.9 1.9 1.9 1.9
Udupi II 0.0 1.0 1.9 1.9 1.9
Anpara 0.4 6.0 6.0 6.0 6.0
Babandh I 0.0 0.0 0.0 1.3 3.1
Babandh II 0.0 0.0 0.0 0.7 3.1
Vidharba I 0.0 0.0 0.0 1.3 3.1
Vidharba II 0.0 0.0 0.0 0.7 3.1
Total 4.4 11.7 12.9 20.5 31.7

We have not built in any Split between international and domestic coal
coal imports for the
company except for the 35 Domestic Imported
Udupi project
30

25

20

15

10

0
FY11 FY12 FY13 FY14 FY15 FY16 FY17

Recommendation history - Lanco Infratech Ltd (LANCI IN)

Date Rec level Closing price Target
22 June 2011 O-PF 27.55 34.00
03 March 2011 O-PF 39.20 47.00
Source: CLSA Asia-Pacific Markets

192 [email protected] 27 June 2011

 
  
 Lanco Infratech - O-PF Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
Big pick up in Summary P&L forecast (Rsm)
earnings in FY12 Revenue 60,062 80,320 77,837 127,612 152,929
Op Ebitda 8,236 14,515 18,905 35,171 41,364
Op Ebit 7,163 11,036 15,367 27,694 31,818
Interest income 552 1,839 2,175 1,278 2,347
Interest expense (2,185) (3,554) (7,555) (14,134) (17,051)
Other items 0 0 0 0 0
Profit before tax 5,530 9,322 9,988 14,839 17,114
Taxation (1,690) (3,643) (3,850) (5,864) (5,640)
Minorities/Pref divs (1,041) (915) (1,677) (1,756) (2,191)
Net profit 2,799 4,763 4,461 7,218 9,283
Negative free cashflow Summary cashflow forecast (Rsm)
Operating profit 7,163 11,036 15,367 27,694 31,818
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 1,073 3,479 3,537 7,477 9,546
Working capital changes (5,849) (12,544) (4,516) 4,155 (9,169)
Net interest/taxes/other (563) (2,541) (3,824) (5,864) (5,640)
Net operating cashflow 1,824 (570) 10,565 33,462 26,555
Capital expenditure (13,190) (15,353) (24,559) (70,085) (54,284)
Free cashflow (11,366) (15,923) (13,994) (36,623) (27,729)
Acq/inv/disposals (3,532) (12,341) (963) (4,807) (4,807)
Int, invt & associate div (5,234) (4,752) 2,175 1,278 2,347
Net investing cashflow (21,956) (32,446) (23,347) (73,614) (56,743)
Increase in loans 22,527 28,534 12,031 57,550 49,659
Dividends 0 0 0 0 0
Net equity raised/other 99 4,205 (7,554) (14,134) (17,051)
Net financing cashflow 22,626 32,739 4,476 43,416 32,607
Incr/(decr) in net cash 2,494 (277) (8,306) 3,264 2,419
Exch rate movements 0 0 0 0 0
Opening cash 7,411 9,905 9,628 1,322 4,586
Closing cash 9,905 9,627 1,322 4,586 7,005
Gearing remains Summary balance sheet forecast (Rsm)
very high Cash & equivalents 9,905 9,628 1,322 4,586 7,005
Other current assets 41,605 60,412 107,650 128,226 122,488
Fixed assets 54,139 70,015 91,036 263,659 308,396
Total assets 115,485 160,283 221,200 411,868 457,231
Creditors 31,331 35,110 77,832 102,564 87,657
Long-term debt/CBs 55,970 83,614 95,645 241,084 290,743
Provisions/other LT liabs 7,208 8,111 9,815 11,571 13,762
Shareholder funds 20,976 33,448 37,909 56,649 65,070
Total liabs & equity 115,485 160,283 221,200 411,868 457,231
17-19% ROEs Ratio analysis
Revenue growth (% YoY) 85.8 33.7 (3.1) 63.9 19.8
Ebitda growth (% YoY) 19.1 76.2 30.2 86.0 17.6
Ebitda margin (%) 13.7 18.1 24.3 27.6 27.0
Net profit margin (%) 4.7 5.9 5.7 5.7 6.1
Dividend payout (%) 0.0 0.0 0.0 0.0 0.0
Effective tax rate (%) 30.6 39.1 38.5 39.5 33.0
Ebitda/net int exp (x) 5.0 8.5 3.5 2.7 2.8
Net debt/equity (%) 219.6 221.2 248.8 417.5 436.0
ROE (%) 19.5 20.9 17.2 19.0 18.9
ROIC (%) 9.4 8.4 8.7 8.2 6.7
EVA®/IC (%) 0.0 (0.3) 0.0 (0.5) (2.5)
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 193

 
  
 Lanco Infratech - O-PF Chindia power

Notes

194 [email protected] 27 June 2011

 
  
 Longyuan Power
HK$7.15 - UNDERPERFORM

Charles Yonts Blowing on

[email protected] We continue to have mixed views about Longyuan, China’s largest wind-
(852) 26008539
farm operator. On the one hand, returns are rising as they enjoy strong,
Rajesh Panjwani steady government support, and wind turbine prices continue to decline.
(852) 26008271 On the other, grid constraints show no sign of abating, and potential
growth areas - solar, offshore wind and foreign developments - come
with uncertain return structures. We reiterate our Underpeform call, with
16% upside to our DCF-derived HK$8.28 target price.

China’s biggest windfarm operator

Longyuan is China’s largest wind-farm operator, with 6.5GW of turbines (21%
27 June 2011 of the country’s total) connected to the grid as of end-2010. While we expect
the company to continue to add around 2GW of capacity per year, its share of
China the market will erode under heavy competition from other leading operators.
Power Though wind additions are driving earnings growth, Longyuan still derives
around half of its revenue from coal-fired plants.
Reuters 0916.HK
Bloomberg 916 HK
Longyuan benefits from falling turbine prices, decent growth . . .
Priced on 22 June 2011
Wind-farm operators in China enjoy generous, stable, government-support
HS CEI @ 12,148.9
policies. Given China’s power shortages and carbon-reduction targets, we
12M hi/lo HK$8.76/6.64 believe concerns that support for wind will be withdrawn are overblown.
Longyuan also benefits from the oversupply-induced collapse in turbine
12M price target HK$8.28
±% potential +16% prices, from Rmb5,200/kW in 2009 to Rmb3,600/kW in 2011. Stable tariffs
Target set on 22 Jun 11 and falling capex costs lead directly to an improving return profile.

Shares in issue 7,464.3m

Free float (est.) 31.3%
. . . offset by grid uncertainties and unclear new markets
There are considerable challenges - both physical and administrative, facing
Market cap US$6,852m China’s electricity grid system. While leaders are working hard to address the
3M average daily volume problems, there will continue to be a significant risk of curtailment and
HK$101.9m (US$13.1m) delayed connections at least until 2013. Potentially exciting new markets
include: solar in China, where Longyuan already has a large pipeline; offshore
Foreign s'holding 31.3%
wind in China; and wind-farm operations abroad. However, the prospects for
Major shareholders high, predictable returns, like onshore wind in China, are still questionable.
Guodian Group 63.7%
CIC 5.0%
Underperform
Following a recent selloff, Longyuan is looking fairly valued at 14x 12CL PE
and 1.5x 12CL PB against a 12% ROE. Our DCF-valuation implies an HK$8.28
price, or 16% upside. However, this is still relative downside versus our
Stock performance (%) market forecast for Hong Kong. We reiterate our Underperform rating.
1M 3M 12M
Absolute (13.4) (8.7) (7.9)
Relative (7.7) (3.9) (8.5) Financials
Abs (US$) (13.6) (8.6) (8.0) Year to 31 Dec 09A 10A 11CL 12CL 13CL
12 (HK$) (%) 150 Revenue (Rmbm) 9,744 14,213 16,452 18,428 20,508
11
Longyuan Power 140 Net profit (Rmbm) 894 2,019 2,441 3,080 3,324
Rel to CEI (RHS)
130
EPS (fen) 17.4 27.0 32.7 41.3 44.5
10
CL/consensus (20) (EPS%) - - 90 94 83
120
9 EPS growth (% YoY) 157.8 55.4 20.9 26.2 7.9
110
8 PE (x) 36.2 23.0 17.9 13.6 12.1
100
Dividend yield (%) 0.0 0.0 0.3 0.7 0.8
7 90
FCF yield (%) (37.6) (29.8) (22.3) (18.3) (18.4)
6 80 PB (x) 1.5 2.0 1.7 1.5 1.3
Dec 09 Jun 10 Dec 10 Jun 11
ROE (%) 10.1 10.4 11.2 12.4 11.9
Source: Bloomberg
Net debt/equity (%) 65.4 120.7 149.4 154.7 162.5
www.clsa.com Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com

 
  
 Longyuan Power - U-PF Chindia power

Blowing on
China’s largest operator, Longyuan capacity and share of China’s total capacity
but with a shrinking share
35,000 (MW) Longyuan's total wind capacity (%) 30
Share of China's capacity (RHS) 28
30,000
26
25,000 24

20,000 22
20
15,000 18
10,000 16
14
5,000
12
0 10
06A

07A

08A

09A

10A

11CL

12CL

13CL

14CL

15CL

16CL

17CL

18CL

19CL

20CL
Source: CLSA Asia-Pacific Markets, CEC

Wind driving growth Longyuan - Coal losing importance in divisional breakdown

2006 2007 2008 2009 2010 11CL 12CL

Divisional revenue (Rmbm)

Wind business 306 727 1,638 2,754 4,620 6,879 8,807

Coal business 4,028 4,018 4,374 5,873 8,025 7,666 7,685

Other 173 237 455 563 695 725 753

Adjusted Ebit (Rmbm)

Wind business 101 333 884 1,427 2,433 3,878 4,949

Coal business 872 699 287 955 848 880 950

Other (10) 10 21 38 65 10 10

Adjusted Ebit margin (%)

Wind business 33 46 54 52 53 56 56

Coal business 22 17 7 16 11 11 12

Other (6) 4 5 7 9 1 1
Source: CLSA Asia-Pacific Markets

In 2011, Longyuan started releasing monthly power-generation data.

Assuming similar seasonality to 2010, thus far the company is exactly on
pace to meet our 2011 generation target.

196 [email protected] 27 June 2011

 
  
 Longyuan Power - U-PF Chindia power

Longyuan - January-May generating data

Total power generation Share of Total power generation Share of Jan-May
(Jan-May 2010) (MWh) FY10A (%) (Jan-May 2010) (MWh) FY11CL (%) YoY (%)

Wind-power business 4,305,723 46 6,155,944 45 43

Among others: Heilongjiang 563,095 761,355 35

Jilin 278,088 286,948 3

Liaoning 420,326 747,931 78

Inner Mongolia 1,013,420 1,150,394 14

Jiangsu 437,074 443,317 1

Zhejiang 53,896 56,973 6

Fujian 288,830 484,267 68

Hainan 26,278 69,404 164

Gansu 262,245 737,320 181

Xinjiang 369,996 371,421 0

Hebei 549,706 840,655 53

Yunnan 42,768 128,488 200

Anhui - 70,278

Shandong - 7,191

Coal-power business 4,703,162 44 4,859,117 46 3

Other renewable-power business 29,854 32 71,451 42 139

Total 9,038,738 45 11,086,512 45 23

Source: CLSA Asia-Pacific Markets

Turbine price declines Wind turbine, EPC-price assumptions

show no signs of
abating, driven by
intense oversupply 12 (Rmbm/MW) EPC cost Turbine cost

10

8
6.0
5.2
6 4.6
3.8 3.4 3.4 3.3

0
08A 09A 10A 11CL 12CL 13CL 14CL

Source: CLSA Asia-Pacific Markets

Flat turbine installations We anticipate relatively flat wind-turbine installations in the range of 2GW pa
for the next few years. Upside risk to these numbers stems from: offshore
wind in China; injections from parent company, Guodian; and the
development of windfarms overseas. Between the three of them, there is

27 June 2011 [email protected] 197

 
  
 Longyuan Power - U-PF Chindia power

substantial risk that capex numbers will exceed company guidance/our

estimates. The more important question is what kind of returns they will be
able to generate with these assets. While impossible to predict without more
parameters, we believe returns are likely to be less attractive than for
onshore wind in China. Below we look at key operating metrics and
assumptions for Longyuan.

Grid connections are China grid connections installed versus connected

improving slightly, but
still not out of the woods
45,000 (MW) Installed (%) 40

40,000 Connected
Share not connected (RHS) 35
35,000

30,000
30
25,000

20,000
25
15,000

10,000 20
5,000

0 15
05A 06A 07A 08A 09A 10A

Source: GWEA, CLSA Asia-Pacific Markets

Utilization rates Longyuan - Key assumptions

falling slightly
2010 11CL 12CL 13CL
Wind capacity additions (MW) 2,009 1,920 2,040 2,160
Wind tariff change (%) 5 3 1 0
Wind utilisation change (%) (1) (1) (1) 0
Coal price change (%) 19 5 (1) 1
Coal tariff change (%) 5 1 1 1
CER contract price (€/ton) 12.0 12.0 12.0 6.7
Effective interest rate (%) 4.9 5.7 5.7 5.7

Longyuan - Key wind operating assumptions

08A 09A 10CL 11CL 12CL 13CL 14CL
Wind generation hours (hours) 2,354 2,268 2,217 2,195 2,173 2,173 2,195
Wind installation costs (Rmb/kWh) 9.8 9.0 8.4 7.6 7.2 7.2 7.2
Wind tariffs (Rmb/kWh) 0.48 0.48 0.49 0.50 0.50 0.50 0.50
CER contract price (€/Watt) 10.0 10.0 12.0 12.0 12.0 6.7 6.9
Source: CLSA Asia-Pacific Markets

We value Longyuan on a DCF-basis to reflect its long-term fixed, secure

contracts (with the two big grid companies and central government of China
as counterparties). Below are our key assumptions and sensitivity.

198 [email protected] 27 June 2011

 
  
 Longyuan Power - U-PF Chindia power

Our WACC assumptions WACC - Assumptions

Assumptions (%)
Risk free interest 4.0
Risk premium 6.0
Beta 1.0
Cost of equity 10.0
Cost of debt 6.3
Equity ratio 70
Debt ratio 30
WACC 8.9
Terminal growth rate 3.0

Target price set Free cashflow

at HK$8.28
Discounted FCF
Terminal value (Rmbm) 62,870
Terminal value (%) 71
Firm value 88,498
Less: net debt 33,086
Equity value 55,413
Minority interests 4,139
Net equity value 51,274
No. of shares 7,464
Target price 8.28

Base-case is 3% terminal DCF sensitivity analysis

growth rate
WACC Terminal growth rate

2.0% 2.5% 3.0% 3.5% 4.0%

7.9% 11.53 12.98 14.77 17.03 19.98
8.4% 8.90 10.01 11.34 12.99 15.08
8.9% 6.45 7.28 8.26 9.44 10.90
9.4% 4.92 5.60 6.38 7.32 8.45
9.9% 3.39 3.92 4.55 5.27 6.14

Recommendation history - China Longyuan Power (916 HK)

Date Rec level Closing price Target
22 June 2011 U-PF 7.21 8.28
22 August 2010 U-PF 8.06 7.54
25 June 2010 U-PF 7.73 7.06
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 199

 
  
 Longyuan Power - U-PF Chindia power

Summary financials
Year to 31 December 09A 10A 11CL 12CL 13CL
Summary P&L forecast (Rmbm)
Revenue 9,744 14,213 16,452 18,428 20,508
Op Ebitda 4,449 6,317 8,481 10,314 11,610
Op Ebit 2,858 4,081 5,424 6,658 7,446
Interest income 51 79 36 23 22
Interest expense (1,071) (1,177) (2,080) (2,490) (3,012)
Other items 105 228 295 325 357
Profit before tax 1,944 3,211 3,676 4,516 4,814
Taxation (296) (441) (443) (508) (515)
Minorities/Pref divs (753) (751) (792) (928) (975)
Net profit 894 2,019 2,441 3,080 3,324
Summary cashflow forecast (Rmbm)
Operating profit 2,858 4,081 5,424 6,658 7,446
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 1,590 2,236 3,057 3,655 4,164
Working capital changes 848 (985) (1,180) (341) (177)
Net interest/taxes/other (1,268) (1,360) (2,192) (2,650) (3,148)
Net operating cashflow 4,028 3,973 5,109 7,322 8,285
Capital expenditure (16,184) (17,845) (14,845) (14,965) (15,678)
Free cashflow (12,156) (13,872) (9,735) (7,643) (7,393)
Acq/inv/disposals 1,029 145 (2,662) 615 (1,402)
Int, invt & associate div 0 0 0 0 0
Net investing cashflow (15,156) (17,700) (17,507) (14,350) (17,080)
Increase in loans 9,386 2,359 9,286 7,147 9,106
Dividends 0 (632) (122) (308) (332)
Net equity raised/other 17,190 (413) 0 0 0
Net financing cashflow 26,575 1,313 9,164 6,839 8,774
Incr/(decr) in net cash 15,448 (12,414) (3,234) (189) (21)
Exch rate movements 0 0 0 0 0
Opening cash 1,055 16,503 4,089 856 667
Closing cash 16,503 4,089 856 667 646
Summary balance sheet forecast (Rmbm)
Cash & equivalents 16,503 4,089 856 667 646
Debtors 2,181 3,474 4,084 4,622 5,188
Inventories 333 632 657 651 657
Other current assets 1,350 1,949 1,930 1,930 1,930
Fixed assets 37,305 50,642 60,855 70,590 80,529
Intangible assets 6,827 8,538 10,112 11,687 13,262
Other term assets 2,523 3,665 5,181 4,320 5,451
Total assets 67,954 74,405 86,237 97,274 110,742
Short-term debt 17,087 17,200 18,119 18,571 18,524
Creditors 1,943 1,515 1,629 1,743 1,856
Other current liabs 4,662 6,200 5,304 5,381 5,664
Long-term debt/CBs 16,219 19,975 28,342 35,037 44,190
Provisions/other LT liabs 2,363 2,101 2,318 2,318 2,318
Minorities/other equity 3,780 4,139 4,931 5,859 6,834
Shareholder funds 21,900 23,275 25,594 28,365 31,357
Total liabs & equity 67,954 74,405 86,237 97,274 110,742
Ratio analysis
Revenue growth (% YoY) 13.9 45.9 15.8 12.0 11.3
Ebitda growth (% YoY) 77.7 42.0 34.3 21.6 12.6
Ebitda margin (%) 45.7 44.4 51.5 56.0 56.6
Net profit margin (%) 9.2 14.2 14.8 16.7 16.2
Dividend payout (%) 0.0 0.0 5.0 10.0 10.0
Effective tax rate (%) 15.3 13.7 12.0 11.3 10.7
Ebitda/net int exp (x) 4.4 5.8 4.1 4.2 3.9
Net debt/equity (%) 65.4 120.7 149.4 154.7 162.5
ROE (%) 10.1 10.4 11.2 12.4 11.9
ROIC (%) 6.6 6.7 7.0 7.3 7.1
EVA®/IC (%) (1.5) (1.4) (1.2) (0.9) (1.0)
Source: CLSA Asia-Pacific Markets

200 [email protected] 27 June 2011

 
  
 NHPC
Rs23.00 - UNDERPERFORM

Abhishek Tyagi Lack of triggers

[email protected] NHPC is planning to add 1.2GW of new capacity in FY12, which we believe
(91) 2266505055
is very optimistic and significantly higher than its MoU target of 560MW.
Rajesh Panjwani The return profile for NHPC will continue to be inferior to its peers, NTPC
(852) 26008271 and Power Grid, given its long project gestation, higher susceptibility to
delays and suboptimal capital structure. The company has been lobbying
for higher returns for hydro projects but we do not expect changes to
significantly impact its profitability. We keep our Underperform rating.

Targeting to add 1.2GW in FY12

NHPC is targeting 1.2GW of new power generation capacity in FY12. The
27 June 2011 company has however only signed MoUs with the government to commission
560MW of capacity during the year: Nimoo Bazgo (45MW), Chutak (44MW),
India Chamera III (231MW) and Uri II (240MW). Our estimates factor in 560MW
Power capacity commissioned in FY12 and another 812MW in FY13.

Reuters NHPC.BO New estimated project costs 20% higher

Bloomberg NHPC IB NHPC is currently building 4.5GW of new capacity. The cost of the under-
Priced on 22 June 2011 construction projects has increased 20% from the last “approved project
India Sensex @ 17,550.6 costs”. The rises have been as much as 60-100% in some cases. Local unrest
in J&K has impacted progress of the Chutak and Uri projects, while Teesta III
12M hi/lo Rs34.40/22.25
and IV have been hit by frequent strikes related to demands for Gorkhaland.
12M price target Rs25.00 Geological surprises and flash floods have also led to cost increases.
±% potential +9%
Target set on 22 Jun 11 No news yet on higher returns for hydro generation
Shares in issue 12,300.7m
NHPC has been lobbying for higher returns for the hydro business, given the
Free float (est.) 13.6% disadvantage of a longer construction period vis-à-vis coal-based projects.
The company has suggested: return on construction work in progress;
Market cap US$6,310m
differentiated tariffs for peak and off-peak hours; higher return on equity
3M average daily volume (than coal-based projects) to make IRRs comparable for coal and hydro
Rs29.7m (US$.7m) projects. There has been no news one any of these and we do not expect any
Major shareholders changes which would significantly impact profitability or valuations.
Government of India 86.4%
FII 1.8% Maintain Underperform
NHPC has underperformed the market by 22% in past year. We have built
delays into the commissioning schedule of the expansion projects, but cannot
rule out further holdups given the nature of the business. The company
commissioned only 120MW of capacity in FY11, as against its 831MW target,
and we believe the 1.2GW number for FY12 is very optimistic. We do not see
Stock performance (%) any meaningful upside from the current 15.2.5x FY12 earnings and 1.1x PB,
1M 3M 12M with 7.4% ROE. We maintain our Underperform call.
Absolute (6.1) 1.1 (20.1)
Relative (2.0) 3.6 (19.3) Financials
Abs (US$) (5.9) 1.1 (18.0) Year to 31 Mar 09A 10A 11CL 12CL 13CL
38 (Rs) NHPC (LHS) (%) 110 Revenue (Rsm) 34,937 45,210 42,989 50,001 56,640
Rel to Sensex
36
100
Net profit (Rsm) 12,109 14,941 17,842 18,642 20,828
34 EPS (Rs) 1.0 1.2 1.5 1.5 1.7
90
32 CL/consensus (11) (EPS%) - - 99 95 85
30 80 EPS growth (% YoY) (0.7) 17.8 19.4 4.5 11.7
28
70 PE (x) 22.3 18.9 15.9 15.2 13.6
26 Dividend yield (%) 1.3 2.4 2.6 2.6 2.8
60
24 PB (x) 1.5 1.2 1.1 1.1 1.0
22 50 ROE (%) 7.0 7.0 7.4 7.4 7.8
Aug 09 Apr 10 Nov 10 Jun 11
Net debt/equity (%) 62.1 39.9 35.6 41.7 44.3
Source: Bloomberg
EV/Ebitda (x) 12.4 6.6 6.9 6.7 6.4
www.clsa.com Source: CLSA Asia-Pacific Markets

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 NHPC - U-PF Chindia power

Capacity currently under Projects under construction

construction: 4.5GW Project State Capacity (MW)
Nimoo Bazgo J&K 45
Chutak J&K 44
Kishanganga J&K 330
Uri -II J&K 240
Parbati II Himachal Pradesh 800
Chamera III Himachal Pradesh 231
Parbati III Himachal Pradesh 520
Teesta Low Dam III West Bengal 132
Teesta Low Dam IV West Bengal 160
Subansiri Lower Arunanchal Pradesh 2,000
Total 4,502

Many NHPC projects have Status of projects under construction (as per new anticipated project costs)
been delayed
Uri II
Teesta Low Dam Stage III
Parbati Stage II
Chamera III
Chutak
Parbati Stage III
Nimoo Bazgo
Teesta Low Dam Stage IV
Subansiri Lower Hydro
Kishanganga (% complete)

0 10 20 30 40 50 60 70 80 90

NHPC currently trying to Projects waiting for approvals

get approval for c.6GW
Project State Proposed installed Comments
of projects
capacity (MW)
Kotli Bhel Stage IA Uttarakhand 195 Forest clearance to be obtained
from MoEF
Kotli Bhel Stage IB Uttarakhand 320 Forest clearance to be obtained
from MoEF
Kotli Bhel Stage II Uttarakhand 530 Forest clearance to be obtained
from MoEF
Dibang Arunachal Pradesh 3,000 Waiting for environment and
forest clearance
Teesta IV Sikkim 520 Waiting for environment and
forest clearance
Tawang I Arunachal Pradesh 600 Waiting for CEA concurrence
Tawang II Arunachal Pradesh 800 Waiting for CEA concurrence
Total 5,965
Source: NHPC, CLSA Asia-Pacific Markets

202 [email protected] 27 June 2011

 
  
 NHPC - U-PF Chindia power

NHPC has added 3GW NHPC’s capacity additions over the years
capacity over last
10 years 5,500 (MW)
4,950
4,400
3,850
3,300
2,750
2,200
1,650
1,100
550
0
CY81
CY82
CY83
CY84
CY85
CY86
CY87
CY88
CY89
CY90
CY91
CY92
CY93
CY94
CY95
CY96
CY97
CY98
CY99
CY00
CY01
CY02
CY03
CY04
CY05
CY06
CY07
CY08
CY09
CY10
CY10
Source: NHPC, CLSA Asia-Pacific Markets

Recommendation history - National Hydroelectric Power (NHPC IB)

Date Rec level Closing price Target
22 June 2011 U-PF 23.30 25.00
08 April 2011 U-PF 25.60 27.00
16 June 2010 U-PF 28.85 26.00
30 March 2010 SELL 30.55 26.00
03 October 2009 U-PF 34.50 26.00
04 September 2009 SELL 36.10 25.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 203

 
  
 NHPC - U-PF Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
Earnings Cagr of 7% Summary P&L forecast (Rsm)
over FY11-13 Revenue 34,937 45,210 42,989 50,001 56,640
Op Ebitda 24,038 34,238 31,610 37,505 42,914
Op Ebit 17,476 21,410 23,047 27,932 31,707
Interest income 0 0 0 0 0
Interest expense (7,760) (7,394) (4,685) (7,923) (8,927)
Other items 5,578 6,473 5,804 5,156 5,118
Profit before tax 15,294 20,490 24,166 25,165 27,898
Taxation (1,678) (4,528) (4,833) (5,033) (5,580)
Minorities/Pref divs (1,507) (1,020) (1,490) (1,490) (1,490)
Net profit 12,109 14,941 17,842 18,642 20,828
Negative free cash flow Summary cashflow forecast (Rsm)
Operating profit 17,476 21,410 23,047 27,932 31,707
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 6,563 12,827 8,563 9,573 11,207
Working capital changes 1,846 (609) 1,265 2,303 2,180
Net interest/taxes/other (1,678) (805) (4,833) (5,033) (5,580)
Net operating cashflow 24,207 32,824 28,042 34,774 39,514
Capital expenditure (40,727) (35,299) (36,130) (48,989) (44,146)
Free cashflow (16,521) (2,476) (8,088) (14,214) (4,631)
Acq/inv/disposals 2,556 (15,543) 21,014 2,735 2,735
Int, invt & associate div (923) (973) 1,119 (2,767) (3,809)
Net investing cashflow (39,094) (51,816) (13,997) (49,020) (45,219)
Increase in loans 20,755 14,206 (14,709) 19,292 20,902
Dividends (3,795) (7,924) (7,380) (7,380) (7,995)
Net equity raised/other 530 48,546 0 0 0
Net financing cashflow 17,490 54,827 (22,089) 11,912 12,906
Incr/(decr) in net cash 2,602 35,835 (8,045) (2,334) 7,201
Exch rate movements 0 0 0 0 0
Opening cash 23,459 26,061 61,895 53,851 51,516
Closing cash 26,061 61,895 53,851 51,516 58,718
High cash reserves Summary balance sheet forecast (Rsm)
Cash & equivalents 26,061 61,895 53,851 51,516 58,718
Debtors 7,636 15,338 12,897 15,000 16,992
Inventories 415 483 602 700 793
Other current assets 18,161 20,942 19,790 22,649 25,355
Fixed assets 341,348 363,636 391,203 430,619 463,557
Intangible assets 0 0 0 0 0
Other term assets 0 0 0 0 0
Total assets 411,534 495,749 490,783 530,190 572,385
Short-term debt 0 0 0 0 0
Creditors 37,406 47,347 45,138 52,501 59,472
Other current liabs 0 0 0 0 0
Long-term debt/CBs 149,310 163,515 148,806 168,098 189,000
Provisions/other LT liabs 26,226 29,949 29,949 29,949 29,949
Minorities/other equity 14,667 15,895 17,385 18,876 20,366
Shareholder funds 183,925 239,043 249,505 260,766 273,599
Total liabs & equity 411,534 495,749 490,783 530,190 572,385
Return ratios are very low Ratio analysis
due to very high Revenue growth (% YoY) 19.2 29.4 (4.9) 16.3 13.3
construction work in Ebitda growth (% YoY) 4.7 42.4 (7.7) 18.6 14.4
progress and cash levels Ebitda margin (%) 68.8 75.7 73.5 75.0 75.8
Net profit margin (%) 34.7 33.0 41.5 37.3 36.8
Dividend payout (%) 28.2 45.3 41.4 39.6 38.4
Effective tax rate (%) 11.0 22.1 20.0 20.0 20.0
Ebitda/net int exp (x) 3.1 4.6 6.7 4.7 4.8
Net debt/equity (%) 62.1 39.9 35.6 41.7 44.3
ROE (%) 7.0 7.0 7.4 7.4 7.8
ROIC (%) 4.9 4.9 5.0 5.6 5.9
EVA®/IC (%) (6.0) (5.7) (5.6) (5.0) (4.8)
Source: CLSA Asia-Pacific Markets

204 [email protected] 27 June 2011

 
  
 NTPC
Rs175.15 - BUY

Rajesh Panjwani Growth with safety

[email protected] NTPC’s capacity additions have picked up pace in FY11 after a series of
(852) 26008271
disappointments over the last few years. The company also has a decent
Abhishek Tyagi pipeline of expansion projects and has signed PPAs totalling 100GW,
(91) 2266505055 which will help it to add more capacity on a regulated-returns basis (cost
plus fixed returns). We believe NTPC enjoys distinct competitive
advantages in getting more coal from linkages (from Coal India) and it
should outperform in the current scenario of a domestic coal shortfall.

Capacity addition gaining momentum

NTPC added 2.5GW of new generating capacity in FY11, after three
27 June 2011 disappointing years in which it cumulatively added only 3.7GW (3GW
organic). However this should change and we now expect 3.5-4GW of annual
India additions by the company over the next couple of years, as many large power
Power projects are nearing commissioning.

Reuters NTPC.NS Big pipeline of regulated-return projects

Bloomberg NTPC IS
NTPC has c.15GW of capacity currently under construction and has invited
Priced on 22 June 2011 equipment-supply bids for another c.16GW of power projects. It is likely to
India Sensex @ 17,550.6 decide the bulk tenders for multiple 660MW and 800MW units in FY12. NTPC
12M hi/lo Rs222.30/165.15 has also signed power purchase agreements totalling c.100GW with various
states as per CERC (Central Electricity Regulatory Commission) norms, which
12M price target Rs210.00
effectively means that most of the capacity added over the next 8-10 years
±% potential +20%
Target set on 7 Apr 11 should be on a regulated-return basis.

Shares in issue 8,245.5m Enjoys structural benefits for getting more coal from linkages
Free float (est.) 15.5% Most of NTPC’s power projects are close to the mines (owned by Coal India)
Market cap US$32,175m from which they get their coal supplies. NTPC has dedicated merry-go-round
railway facilities and its own railway rakes (1 rake = 56 wagons) to transport
3M average daily volume
Rs434.2m (US$9.7m)
coal from the mines to its power projects. No other consumer of coal in the
country enjoys enjoyed this advantage, and thus we believe NTPC will
Foreign s'holding 3.4% continue to be preferred for future coal allocations.
Major shareholders
Government of India 84.5% Upgrade to a BUY
FIIs 3.4% NTPC has underperformed the market by 11% over the last year, mainly due to
disappointments over new capacity additions and concerns over lower
incentives given falling utilisation levels. We expect a pick-up in capacity growth
over the next two to three years, which translates into 13% earnings Cagr. Coal
availability will be key, but we believe NTPC is better placed to handle that risk
Stock performance (%) than most other power utilities. We recently upgraded the stock to a BUY.
1M 3M 12M
Absolute 1.4 0.5 (12.3)
Relative 5.8 3.0 (11.3) Financials
Abs (US$) 1.6 0.5 (10.0) Year to 31 Mar 09A 10A 11CL 12CL 13CL
250 (Rs) NTPC (LHS) (%) 110 Revenue (Rsm) 421,104 463,777 531,139 594,080 671,731
Rel to Sensex
240 105 Net profit (Rsm) 82,014 87,282 88,292 97,580 111,109
230 100
EPS (Rs) 9.9 10.6 10.7 11.8 13.5
95
220
90 CL/consensus (22) (EPS%) - - 97 101 102
210
85 EPS growth (% YoY) 10.6 6.4 1.2 10.5 13.9
200
80 PE (x) 17.6 16.5 16.4 14.8 13.0
190
75
180 Dividend yield (%) 2.1 2.2 2.3 2.5 2.5
70
170 65 FCF yield (%) (4.2) (1.5) (7.8) 0.6 (0.4)
160 60 PB (x) 2.5 2.3 2.1 2.0 1.8
Jun 09 Feb 10 Oct 10 Jun 11 ROE (%) 14.9 14.6 13.6 13.9 14.6
Source: Bloomberg
Net debt/equity (%) 19.2 25.8 43.9 44.8 47.7
www.clsa.com Source: CLSA Asia-Pacific Markets

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 NTPC - BUY Chindia power

NTPC has c.15GW power Projects under construction

capacity currently Project Capacity (MW)
under construction . . . Sipat I 1,980
Jhajjar 1,000
Simhadri II 500
Vallur 1,500
Mouda I 1,000
Rihand III 1,000
Vindhyachal IV 1,000
Bongaigaon 750
Barh I 1,980
Barh II 1,320
Nabinagar 1,000
Muzaffarpur II 390
Koldam 800
Tapovan Vishnugarh 520
Singrauli small hydro 8
Total 14,748

. . . and has invited bids Projects for which bids are invited
for another 16GW worth Project Capacity (MW)
of power projects Under 660MW bulk tender
Solapur 1,320
Meja 1,320
Mouda II 1,320
Nabinagar 1,980
Total 5,940
Under 800MW bulk tender
Lara 1,600
Daripalli 1,600
Kudgi 2,400
Gajmara 1,600
Total 7,200
Other thermal projects
Tanda 1,320
Unchahar 500
Vindhyachal 500
Total 2,320
Hydro projects
Lata Tapovan 171
Rammam III 120
Raupsiyabagar Khasiyabara 261
Total 552
Renewable projects
Wind Modurgudda 36
Wind Chakala 39
Wind Guledagudda 100
Solar Dadri 5
Total 180
Grand total 16,192
Source: Company, CLSA Asia-Pacific Markets

Domestic coal supplies Status of coal and gas supplies for NTPC projects
actually decreased for FY10 FY11 % YoY
NTPC in FY11 due to Coal (mt)
logistics constraints - Domestic 129.9 126.6 (2.5)
- Imported 6.3 10.6 67.6
Total 136.2 137.2 0.7
Equivalent domestic coal 140.0 143.6 2.6
Gas (mmscmd)
- APM + PMT 9.1 9.0 (0.9)
- Long term/Fallback/spot RLNG 4.5 2.9 (35.7)
- KG D6 0.4 1.9 445.7
Total 13.9 13.8 (0.8)
Source: CLSA Asia-Pacific Markets

206 [email protected] 27 June 2011

 
  
 NTPC - BUY Chindia power

NTPC will get 145mt Coal supply for NTPC’s power projects for FY12
of coal from Coal India Station Capacity Annual contracted quantity
in FY12 . . . (MW) (ACQ)
A. Supply of ACQ quantity for the stations commissioned prior to 31.03.2009 except
Farakka, Kahalgaon & Ramagundam-lll
Singrauli 2,000 11
Rihand 2,000 10.5
Unchahar 1,050 5.7
Tanda 440 2.7
. . . the company will Dadri 840 4.4
import c.14-15mt of coal
Korba 2,100 12.2
for its balance
Vindhyachal 3,260 17.2
requirements
Simhadri 1,000 5.2
Talcher Kaniha 3,000 17.3
Talcher 460 2.5
Badarpur 705 4.2
Sipat-I I 1,000 5.8
Sub Total 17,855 98.7
B. Long term linkage for Farakka & Kahalgaon
Farakka 1,600 25.8
Kahalgaon-I 840
Kahalgaon-ll 1,500
C. Long term linkage for Ramagundam-lll
Ramagundam-lll 500 2.5
D. Supply of coal for units commissioned during 2009-10 and 2010-11 as per LOA/
long-term linkage quantity
Dadri-ll (2x490 MW) 4.03
Sipat-I (1x660 MW) 3.05
Farakka-lll (1x500 MW) 2.20
Simhadri-ll (1x500 MW) 2.31
Korba-III (1x500 MW) 2.31
Sub Total 13.9
E. Supply of coal for units to be commissioned during 2011-12 as per LOA quantity
and pro-rata basis based on unit commissioning for the following projects
Sipat-I (2x660 MW) 3.14
Simhadri-ll (1x500 MW) 1.25
Sub Total 4.39
Grand Total (A+B+C+D+E) 145.30

NTPC is aiming to Projects expected to be commissioned in FY12 as per MoU

commission 4.3GW Project Capacity (MW)
capacity in FY12
Sipat Stage I 1,320
Jhajjar 1,000
Vallur 1,000
Simhadri Stage II 500
Mouda Stage I 500
Total 4,320

Recommendation history - NTPC Ltd (NTPC IS)

Date Rec level Closing price Target
22 June 2011 BUY 176.45 210.00
07 April 2011 O-PF 191.80 210.00
28 July 2010 O-PF 201.35 225.00
30 March 2010 O-PF 203.20 230.00
27 July 2009 U-PF 210.65 200.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 207

 
  
 NTPC - BUY Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
Earnings Cagr of 13% Summary P&L forecast (Rsm)
over FY12-14 Revenue 421,104 463,777 531,139 594,080 671,731
Op Ebitda 107,098 124,104 127,643 146,397 171,322
Op Ebit 83,454 97,603 101,206 115,305 135,197
Interest income 32,806 28,562 25,363 24,793 24,721
Interest expense (20,229) (18,089) (18,030) (20,713) (26,576)
Other items 11,518 6,033 1,507 2,072 4,436
Profit before tax 107,549 114,109 110,047 121,457 137,778
Taxation (25,535) (26,827) (21,754) (23,877) (26,668)
Minorities/Pref divs 0 0 0 0 0
Net profit 82,014 87,282 88,292 97,580 111,109
Strong operating Summary cashflow forecast (Rsm)
cash flows Operating profit 83,454 97,603 101,206 115,305 135,197
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 23,644 26,501 26,436 31,092 36,125
Working capital changes (12,794) (16,330) 3,689 (6,618) (13,755)
Net interest/taxes/other (25,535) (26,827) (21,754) (23,877) (26,668)
Net operating cashflow 68,769 80,947 109,577 115,902 130,899
Capital expenditure (129,116) (101,965) (221,513) (107,322) (136,590)
Free cashflow (60,347) (21,018) (111,936) 8,580 (5,691)
Acq/inv/disposals 12,070 (11,868) 4,535 (3,756) (1,000)
Int, invt & associate div 24,095 16,506 8,840 6,152 2,581
Net investing cashflow (92,951) (97,327) (208,137) (104,926) (135,009)
Increase in loans 79,398 29,040 126,580 45,298 60,428
Dividends (34,700) (36,608) (37,632) (42,337) (47,041)
Net equity raised/other (7,899) 2,195 1,150 0 0
Net financing cashflow 36,799 (5,373) 90,098 2,962 13,388
Incr/(decr) in net cash 12,617 (21,753) (8,462) 13,937 9,277
Exch rate movements 0 0 0 0 0
Opening cash 242,126 254,743 232,990 224,528 238,465
Closing cash 254,743 232,990 224,528 238,465 247,743
Summary balance sheet forecast (Rsm)
Cash & equivalents 254,743 232,990 224,528 238,465 247,743
Debtors 35,842 66,514 63,737 71,290 80,608
Inventories 32,434 33,477 38,242 42,774 53,739
Other current assets 78,261 63,571 66,198 68,935 71,785
Fixed assets 593,426 668,656 863,733 939,962 1,040,428
Intangible assets 0 0 0 0 0
Other term assets 0 201 0 0 0
Total assets 1,042,514 1,125,085 1,311,578 1,420,323 1,554,198
Short-term debt 0 0 0 0 0
Creditors 74,391 76,876 80,720 84,756 88,994
Other current liabs 32,495 30,705 35,165 39,332 44,473
Long-term debt/CBs 365,038 394,078 520,658 565,957 626,385
Provisions/other LT liabs (3,111) (949) 0 0 0
Minorities/other equity 0 0 0 0 0
Shareholder funds 573,701 624,375 675,035 730,278 794,347
Total liabs & equity 1,042,514 1,125,085 1,311,578 1,420,323 1,554,198
Return ratios will improve Ratio analysis
with commissioning of Revenue growth (% YoY) 17.1 10.1 14.5 11.9 13.1
more projects Ebitda growth (% YoY) 2.9 15.9 2.9 14.7 17.0
Ebitda margin (%) 25.4 26.8 24.0 24.6 25.5
Net profit margin (%) 19.5 18.8 16.6 16.4 16.5
Dividend payout (%) 36.2 35.9 37.4 36.3 31.9
Effective tax rate (%) 23.7 23.5 19.8 19.7 19.4
Ebitda/net int exp (x) 0.0 0.0 0.0 0.0 92.4
Net debt/equity (%) 19.2 25.8 43.9 44.8 47.7
ROE (%) 14.9 14.6 13.6 13.9 14.6
ROIC (%) 11.1 11.0 9.9 9.7 10.3
EVA®/IC (%) 1.7 1.6 0.4 0.1 0.8
Source: CLSA Asia-Pacific Markets

208 [email protected] 27 June 2011

 
  
 Power Grid
Rs101.95 - OUTPERFORM

Rajesh Panjwani Steady growth

[email protected] We expect Power Grid to enjoy a 16% EPS Cagr over FY12-14, buoyed by
(852) 26008271
Rs475bn capex. We doubt competitive bidding guidelines will impact the
Abhishek Tyagi company’s growth over the next four to five years given the number of
(91) 2266505055 regulated-return projects at its disposal. Power Grid does not have any
fuel-supply related risks that plague most power utilities’ performance.
We recently upgraded the stock from Underperform to Outperform and
increased our target price from Rs105 to Rs117 based on 2.1x FY13 PB.

Capex will drive 12% earnings growth over FY12-14

Powergrid is on track to execute Rs475bn in capital expenditure over the next
27 June 2011 three years. The addition to the gross block over this period would be
Rs310bn, taking its regulated equity base from Rs119bn in FY11 to Rs244bn
India by FY14 end. The company’s earnings are likely to post a 12% Cagr over the
Power same time after building in 5% equity dilution in FY14.

Reuters PGRD.BO Order awards should pick-up in FY12

Bloomberg PWGR IB
The first three quarters of FY11 saw very sluggish order awards by Power
Priced on 22 June 2011 Grid. Momentum picked up in 4Q11, especially with the big HVDC order. The
India Sensex @ 17,550.6 company ended the year with Rs171bn in order awards, up 39% YoY. We
12M hi/lo Rs113.80/91.80 expect the trend to improve in FY12 as the traction for capex in the 12th Five
Year Plan picks up.
12M price target Rs117.00
±% potential +15%
Competitive bidding will not impact medium-term growth
Target set on 22 Jun 11
The introduction of competitive bidding in the transmission space is unlikely
Shares in issue 4,629.7m to impact Power Grid in the next four to five years. Central Electricity
Free float (est.) 30.6% Regulatory Commission (CERC has already approved the Rs580bn capex for
Market cap US$10,528m high-capacity transmission corridors (HCTC) which are slated for the 12th Five
Year Plan based on a cost plus model. With memorandum of understandings
3M average daily volume
Rs343.5m (US$7.7m)
signed for more expansion projects before the January 2011 deadline, Power
Grid will have enough projects to execute for the next four to five years
Major shareholders where it need not bid competitively.
GoI 69.4%
FIIs 12.1%
Upgrade to Outperform
In the current scenario, where most of the generating companies are facing
fuel-supply challenges and falling tariffs, we expect Power Grid to
Outperform. The company has a superior track record in terms of execution
vis-à-vis other peers and we expect 16% earnings growth over FY12-14.
However, we note that Power Grid will need to raise more equity sometime in
Stock performance (%) FY14 to fund its expansion plans (we build in 5% dilution).
1M 3M 12M
Absolute 1.3 4.8 (0.5)
Relative 5.8 7.4 0.6 Financials
Abs (US$) 1.6 4.8 2.1 Year to 31 Mar 09A 10A 11CL 12CL 13CL
125 (Rs) (%) 110 Revenue (Rsm) 56,900 71,275 83,712 118,641 139,085
Power Grid (LHS) 105
120 Net profit (Rsm) 16,906 20,409 26,969 30,010 35,821
Rel to Sensex
100
115
EPS (Rs) 4.0 4.8 6.1 6.5 7.7
95
90 CL/consensus (18) (EPS%) - - 99 101 102
110
85 EPS growth (% YoY) 11.4 20.7 25.8 6.2 19.4
105 80 PE (x) 25.4 21.0 16.7 15.7 13.2
100 75
70
Dividend yield (%) 1.4 1.7 2.2 2.4 2.9
95 FCF yield (%) (9.2) (7.8) (18.4) (12.8) (10.0)
65
90 60 PB (x) 2.9 2.7 2.2 2.0 1.8
Jun 09 Feb 10 Oct 10 Jun 11
ROE (%) 12.0 13.4 14.5 13.4 14.6
Source: Bloomberg
Net debt/equity (%) 178.0 195.3 174.1 198.7 213.4
www.clsa.com Source: CLSA Asia-Pacific Markets

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 Power Grid - O-PF Chindia power

Power Grid is set to meet Year wise capex of Power Grid

its guidance of Rs550bn
capex over FY08-12 - 11th 180,000 (Rsm)
plan period
160,000

140,000

120,000

100,000

80,000

60,000

40,000

20,000

0
FY06 FY07 FY08 FY09 FY10 FY11 FY12E

Order awards for Month wise order awards by Power Grid

equipments languished
fro most of FY11 100 (Rsbn)
FY09 FY10 FY11
90
Rs144bn Rs123bn Rs171bn
80
70
60
50
40
30
20
10
0
08

09

09
08

08

08

08

09

10

10

10
08
08

08

09
09
09

09

09
09
09

09

10

10

10

10

10

11
10
10

10

11
11
08

09

10
May

Nov

May
Jan

Nov

May
Jan

Nov

Jan
Jun

Jun

Jun
Apr

Aug

Oct

Feb
Mar

Aug

Oct

Feb
Mar
Sep

Dec

Apr

Sep

Dec

Feb
Mar
Apr

Aug

Oct
Sep

Dec
Jul

Jul

Jul

Source: Company, CLSA Asia-Pacific Markets

Power Grid targets Power Grid spending targets over various five-year plans
spending to double
in XII plan 1,000 (Rsbn) Spending target (LHS) (%) 170
900 Growth over pervious plan 160

800 150
140
700
130
600
120
500
110
400
100
300
90
200 80
100 70
0 60
IX X XI XII

Source: Power Grid, CLSA Asia-Pacific Markets

210 [email protected] 27 June 2011

 
  
 Power Grid - O-PF Chindia power

High capacity Details of nine high capacity power transmission corridors (HCPTC)
power transmission
Corridor presents a Section Description Project cost
Rs580bn opportunity (Rsm)

Section-I Transmission System Associated with Phase-I Generation 87,520

Projects in Orissa

Section-II Transmission System Associated with IPP projects in 57,090

Jharkhand

Section-III Transmission System Associated with IPP projects in Sikkim 13,040

Section-IV Transmission System Associated with IPP projects in 12,430

Bilaspur complex, Chattisgarh & IPPs in Madhya Pradesh

Section-V Transmission System Associated with IPP projects in 288,240

Chattisgarh

Section-VI Transmission System Associated with IPP projects in 20,650

Krishnapatnam Area, Andhra Pradesh

Section-VII Transmission System Associated with IPP projects in 23,570

Tuticorin Area, Tamil Nadu

Section-VIIII Transmission System Associated with IPP projects in 29,860

Srikakulam Area, Andhra Pradesh

Section-IX Transmission System Associated with IPP projects in 48,210

Southern Region for transfer of power to other regions

Total 580,610

Recommendation history - Power Grid (PWGR IB)

Date Rec level Closing price Target
22 June 2011 O-PF 101.95 117.00
9 November 2010 U-PF 98.35 105.00
30 March 2010 U-PF 106.70 98.00
30 July 2009 U-PF 117.00 90.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 211

 
  
 Power Grid - O-PF Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
A 12% earnings Cagr Summary P&L forecast (Rsm)
over FY12-14 Revenue 56,900 71,275 83,712 118,641 139,085
Op Ebitda 46,345 58,933 70,339 92,133 108,469
Op Ebit 35,405 39,136 48,345 63,109 73,206
Interest income 0 0 0 0 0
Interest expense (16,423) (15,432) (16,597) (30,322) (33,430)
Other items 3,303 2,559 6,500 5,831 6,319
Profit before tax 22,286 26,263 38,247 38,618 46,095
Taxation (5,380) (5,854) (11,278) (8,608) (10,274)
Minorities/Pref divs 0 0 0 0 0
Net profit 16,906 20,409 26,969 30,010 35,821
Negative free cashflow Summary cashflow forecast (Rsm)
due to strong capex Operating profit 35,405 39,136 48,345 63,109 73,206
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 10,940 19,797 21,994 29,023 35,263
Working capital changes 9,154 13,141 (5,910) 15,208 3,534
Net interest/taxes/other (738) (5,294) (11,643) (12,583) (14,274)
Net operating cashflow 54,761 66,780 52,786 94,757 97,729
Capital expenditure (94,301) (100,191) (135,645) (155,000) (145,000)
Free cashflow (39,540) (33,412) (82,859) (60,243) (47,271)
Acq/inv/disposals 1,434 1,396 882 3,290 1,862
Int, invt & associate div (11,936) (11,673) (9,486) (24,491) (27,111)
Net investing cashflow (104,803) (110,468) (144,250) (176,201) (170,249)
Increase in loans 62,020 59,514 64,660 114,880 76,024
Dividends (5,909) (7,370) (9,238) (10,265) (12,253)
Net equity raised/other (436) 33 40,066 4,157 4,157
Net financing cashflow 55,675 52,176 95,488 108,772 67,928
Incr/(decr) in net cash 5,633 8,488 4,024 27,328 (4,592)
Exch rate movements 0 0 0 0 0
Opening cash 18,656 24,289 32,776 32,643 55,814
Closing cash 24,289 32,776 36,801 59,971 51,222
Summary balance sheet forecast (Rsm)
Cash & equivalents 24,289 32,776 36,801 59,971 51,222
Debtors 13,736 22,149 31,621 36,868 27,817
Inventories 2,976 3,449 3,815 5,741 6,730
Other current assets 42,129 37,899 32,935 35,420 38,096
Fixed assets 444,144 524,834 638,486 764,462 874,199
Intangible assets 0 0 0 0 0
Other term assets 55 36 24 0 0
Total assets 543,257 635,675 757,332 912,822 1,006,562
Short-term debt 0 0 0 0 0
Creditors 61,234 76,346 71,138 100,750 94,250
Other current liabs 21,898 24,583 28,755 24,008 28,657
Long-term debt/CBs 284,654 344,168 408,828 523,708 599,732
Provisions/other LT liabs 29,235 31,160 34,941 30,941 26,941
Minorities/other equity 0 0 0 0 0
Shareholder funds 146,236 159,419 213,670 233,415 256,983
Total liabs & equity 543,257 635,675 757,332 912,822 1,006,562
Return ratios are below Ratio analysis
regulatory returns due to Revenue growth (% YoY) 23.3 25.3 17.5 41.7 17.2
high CWIP Ebitda growth (% YoY) 23.4 27.2 19.4 31.0 17.7
Ebitda margin (%) 81.5 82.7 84.0 77.7 78.0
Net profit margin (%) 29.7 28.6 32.2 25.3 25.8
Dividend payout (%) 35.0 36.1 36.0 37.6 37.6
Effective tax rate (%) 24.1 22.3 29.5 22.3 22.3
Ebitda/net int exp (x) 2.8 3.8 4.2 3.0 3.2
Net debt/equity (%) 178.0 195.3 174.1 198.7 213.4
ROE (%) 12.0 13.4 14.5 13.4 14.6
ROIC (%) 7.0 6.7 6.2 7.4 7.4
EVA®/IC (%) (2.8) (3.2) (3.4) (2.5) (2.5)
Source: CLSA Asia-Pacific Markets

212 [email protected] 27 June 2011

 
  
 Shanghai Electric
HK$4.06 - OUTPERFORM

Rajesh Panjwani Catching up

[email protected] Shanghai Electric’s boiler JV with Alstom and its potential collaboration
(852) 26008271
with Siemens for wind turbines are steps in the right direction. With the
domestic slowdown, Chinese equipment makers a increasingly targeting
overseas markets. An Alstom-SEG JV has the advantage of low costs and
top-notch technology. These should help boost growth and close SEG’s
valuation gap versus Dongfang. We expect SEG to be the best-performing
Chinese power equipment suppler. We rate the stock an Outperform.

Taking the right steps

Shanghai Electric and Alstom have decided to combine their boiler businesses
27 June 2011
into a 50:50 JV. This will be the largest boiler maker globally, and technology
China will be the property of the JV. We think this deal is a long-term positive for
SEG as it addresses concerns over SEG’s technological capability to supply
Power super-critical boilers to overseas markets. This JV will be a stronger player
Reuters 2727.HK
than either SEG or Alstom alone, given the combination of SEG’s low costs
Bloomberg 2727 HK and Alstom’s technological input. SEG may also collaborate with Siemens for
Priced on 22 June 2011
wind-turbine manufacturing. Siemens is a leader in offshore and Shanghai
HS CEI @ 12,148.9 Electric plans to target this market aggressively, as well as onshore.

12M hi/lo HK$5.88/3.37

Cost control will be important
12M price target HK$4.90 In 2010, SEG reported a sharp increase in expenses below the gross-
±% potential +21% margin line due to a significant rise in R&D expenses, higher provisions for
Target set on 22 Jun 11
bad debts and continued high provisions for onerous contracts.
Shares in issue 12,823.6m Management has said that provisions for onerous contracts and bad debts
Free float (est.) 42.2% should reduce in future, which should help expand margins. A higher tax
Market cap US$11,609m
rate will partly offset this, as some of the businesses that enjoyed an
incentive rate will be exiting the tax concessions.
3M average daily volume
HK$156.9m (US$20.2m)
Earnings growth to pick up; new JVs could offer upside
Major shareholders
After no earnings growth over the last three years, we believe SEG’s nuclear
Shanghai Electric Corp 57.8%
power businesses, large overseas projects and its foray into offshore-wind
turbines could help revive growth over the next couple of years. The JV with
Alstom could provide upside to orders and revenue over the medium term.
We see higher growth for Shanghai Electric than its peers and this should help
it close the valuation gap versus Dongfang.

Stock performance (%)

1M 3M 12M
Absolute (4.7) (1.9) 14.0
Relative 1.6 3.2 13.2 Financials
Abs (US$) (4.9) (1.8) 13.9 Year to 31 Dec 09A 10A 11CL 12CL 13CL
6.5 (HK$) (%) 160 Revenue (Rmbm) 57,622 62,957 67,838 76,240 82,157
Shanghai Electric
6.0 Rel to CEI (RHS) 150 Net profit (Rmbm) 2,453 2,784 3,132 3,476 3,759
5.5
140 EPS (fen) 19.6 21.9 24.6 27.4 29.6
130 CL/consensus (20) (EPS%) - - 103 101 100
5.0
120 EPS growth (% YoY) (8.7) 11.6 12.5 11.0 8.2
4.5
110 PE (x) 18.2 16.1 13.5 11.6 10.3
4.0
100 Dividend yield (%) 0.0 3.5 2.2 2.6 3.4
3.5 90 FCF yield (%) 6.4 1.5 0.5 3.2 6.1
3.0 80 PB (x) 2.0 1.7 1.4 1.3 1.1
Jun 09 Feb 10 Oct 10 Jun 11 ROE (%) 11.6 11.9 11.8 11.9 11.8
Source: Bloomberg
Net debt/equity (%) (39.8) (47.9) (46.0) (45.1) (45.0)
www.clsa.com Source: CLSA Asia-Pacific Markets

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 Shanghai Electric - O-PF Chindia power

JV with Alstom will help Scope of the businesses being merged into the new JV
boost overseas sales

Source: Alstom

Strong growth in New energy segment breakup comparision (2009 versus 2010)
nuclear and wind- (Rmbm) 2009 2010 YoY chg (%)
power businesses Revenue
Nuclear power nuclear island equipment 1,801 2,311 28
Wind power equipment 1,244 3,006 142
Forging components 1,395 1,384 (1)
Total revenue (after elimination) 3,998 6,200 55
Total gross profits 485 877 81
Overall GPM (%) 12.1 14.1 2.0 (ppt)
Total operating profits 42 505 1,102
Overall OPM (%) 1.1 8.1 7.1ppt
A big improvement Nuclear power nuclear island equipment
in nuclear-power Gross profits 192 346 80
business margins GPM (%) 10.7 15.0 4.3 (ppt)
Wind power
Gross profits 172 295 72
GPM (%) 13.8 9.8 (4.0) (ppt)
Total order backlog (year end) 24,481 24,609 0.5
Total new orders 7,983
Wind equipment
Order backlog 4,998 4,026 (19)
New orders 5,648 2,542
Nuclear power nuclear island equipment
Order backlog 17,933 19,223 7
New orders 3,971

Thermal power business High efficiency and clean energy

slows down; power T&D Revenue (Rmbm) 2009 2010 YoY chg (%)
retains strong growth Turbines 6,368 6,461 1
Turbine generator 2,732 2,656 (3)
Boiler 10,359 10,072 (3)
Auxiliary equipment 2,263 2,464 9
Power T&D equipment 1,922 2,177 13
Other 3,802 3,331 (12)
Total (after elimination) 27,446 27,161 (1)
Total gross profits 4,303 4,706 9
Overall GPM (%) 15.7 17.3 2
Total operating profits 1,362 1,351 (1)
Overall OPM (%) 5.0 5.0 0
Total order backlog (year end) 125,749 129,093 3
Total new orders 36,326
Source: CLSA Asia-Pacific Markets. Company

214 [email protected] 27 June 2011

 
  
 Shanghai Electric - O-PF Chindia power

Industrial equipment Industrial equipment

business growth driven Revenue (Rmbm) 2009 2010 YoY chg (%)
by printing equipment
and elevators Elevator 8,336 10,184 22
Electric motors 2,545 2,660 5
Machine tools 1,589 1,646 4
Printing equipment 504 871 73
Metro-rail transportation equipment 939 626 (33)
Crankshaft 166 201 21
Other 2,269 2,384 5
Total sales 16,348 18,572 14
Total gross profits 3,099 3,539 14
Overall GPM (%) 19.0 19.1 0
Total operating profits 770 909 18
Overall OPM (%) 4.7 4.9 0

Power plant engineering Modern service

will be key growth driver
(Rmbm) 2009 2010 YoY chg (%)
of modern services
Power plant engineering 10,035 10,105 1
Integrated TD engineering 1,459 1,547 6
Financial service 384 481 25
Internatoinal trade service 608 761 25
Total sales 12,486 12,894 3
Total gross profits 678 917 35
Overall GPM (%) 5.4 7.1 2
Total operating profits 428 496 16
Overall OPM (%) 3.4 3.8 0
Power plant engineering order backlog (year end) 62,639 87,964 40
Total new orders 40,952
Source: CLSA Asia-Pacific Markets, company

Recommendation history - Shanghai Electric Group (2727 HK)

Date Rec level Closing price Target
22 June 2011 O-PF 4.03 4.90
29 March 2011 U-PF 3.86 4.30
10 March 2011 U-PF 4.82 5.30
19 January 2011 U-PF 5.18 5.50
28 October 2010 BUY 4.71 5.60
13 September 2010 BUY 3.87 4.50
13 April 2010 O-PF 3.82 4.20
24 February 2010 O-PF 3.55 4.27
07 January 2010 O-PF 3.60 3.90
19 August 2009 U-PF 3.32 3.20
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 215

 
  
 Shanghai Electric - O-PF Chindia power

Summary financials
Year to 31 December 09A 10A 11CL 12CL 13CL
Summary P&L forecast (Rmbm)
Revenue 57,622 62,957 67,838 76,240 82,157
Op Ebitda 2,759 3,038 3,709 4,329 4,741
Op Ebit 1,771 1,936 2,498 3,005 3,327
Interest income 159 140 291 410 440
Interest expense (59) (52) (58) (58) (58)
Other items 1,358 2,002 2,136 2,336 2,513
Profit before tax 3,229 4,025 4,867 5,693 6,222
Taxation (7) (228) (594) (951) (1,093)
Minorities/Pref divs (768) (1,014) (1,141) (1,266) (1,369)
Net profit 2,453 2,784 3,132 3,476 3,759
Summary cashflow forecast (Rmbm)
Operating profit 1,771 1,936 2,498 3,005 3,327
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 988 1,102 1,211 1,324 1,414
Working capital changes 2,476 447 (1,773) (932) 141
Net interest/taxes/other (399) (509) 775 387 (534)
Net operating cashflow 4,835 2,975 2,711 3,784 4,348
Capital expenditure (1,955) (2,283) (2,500) (2,500) (2,000)
Free cashflow 2,880 692 211 1,284 2,348
Acq/inv/disposals 1,122 1,231 926 1,054 1,153
Int, invt & associate div (402) 756 1,467 1,659 1,768
Net investing cashflow (1,236) (295) (107) 213 921
Increase in loans 0 0 0 0 0
Dividends 0 (1,590) (940) (1,043) (1,316)
Net equity raised/other (1,497) 3,043 (793) (1,604) (2,313)
Net financing cashflow (1,497) 1,453 (1,733) (2,647) (3,629)
Incr/(decr) in net cash 2,103 4,133 871 1,350 1,641
Exch rate movements 0 0 0 0 0
Opening cash 12,707 14,810 18,943 19,814 21,164
Closing cash 14,810 18,943 19,814 21,164 22,804
Summary balance sheet forecast (Rmbm)
Cash & equivalents 14,810 18,943 19,814 21,164 22,804
Debtors 13,614 15,977 16,658 18,722 20,175
Inventories 19,532 19,872 21,464 22,381 22,181
Other current assets 22,152 22,052 22,789 23,299 23,549
Fixed assets 12,279 13,461 14,749 15,925 16,511
Intangible assets 1,516 1,345 1,345 1,345 1,345
Other term assets 3,027 4,284 4,577 4,738 4,907
Total assets 89,626 98,212 103,673 109,851 113,749
Short-term debt 901 396 396 396 396
Creditors 12,818 15,968 16,468 18,517 19,910
Other current liabs 42,870 44,515 46,086 46,455 45,080
Long-term debt/CBs 2,342 2,021 2,021 2,021 2,021
Provisions/other LT liabs 1,631 810 867 928 995
Minorities/other equity 6,589 7,500 8,641 9,907 11,276
Shareholder funds 22,474 27,002 29,195 31,628 34,072
Total liabs & equity 89,626 98,212 103,673 109,851 113,749
Ratio analysis
Revenue growth (% YoY) (2.4) 9.3 7.8 12.4 7.8
Ebitda growth (% YoY) (23.1) 10.1 22.1 16.7 9.5
Ebitda margin (%) 4.8 4.8 5.5 5.7 5.8
Net profit margin (%) 4.3 4.4 4.6 4.6 4.6
Dividend payout (%) 0.0 57.1 30.0 30.0 35.0
Effective tax rate (%) 0.2 5.7 12.2 16.7 17.6
Ebitda/net int exp (x) 0.0 0.0 0.0 0.0 0.0
Net debt/equity (%) (39.8) (47.9) (46.0) (45.1) (45.0)
ROE (%) 11.6 11.9 11.8 11.9 11.8
ROIC (%) 10.9 11.1 12.3 12.4 12.2
EVA®/IC (%) 0.9 1.1 2.3 2.4 2.2
Source: CLSA Asia-Pacific Markets

216 [email protected] 27 June 2011

 
  
 Suzlon
Rs45.15 - UNDERPERFORM

Rajesh Panjwani Little scope for error

[email protected] While order booking and sales were strong in Suzlon’s domestic business
(852) 26008271
in FY11, international operations disappointed. Strength in domestic
Aditya Bhartia business alone is unlikely to be sufficient to force a turnaround.
(91) 22 66505077 Management’s FY12 guidance for 35-45% YoY revenue growth and a 6-
7ppt improvement in Ebit margin also looks aggressive. Net gearing ratio
Abhishek Tyagi remains high at 1.5x. While acquisition of the remaining Repower stake
(91) 22 66505055
will be a positive, it is time consuming and may require lender approval.

Domestic business strong but overseas weak

Suzlon Wind’s domestic sales (1,169MW, +70% YoY) and order booking
27 June 2011 (2,292MW, +170% YoY) picked up sharply in FY11. However, international
sales fell 55% YoY to 352MW. Moreover, overseas order backlog stood flat YoY
India at 877MW, implying that any significant recovery in the international business
Materials is unlikely in the near term. We believe that a turnaround for Suzlon Wind will
be difficult to achieve (break-even level of 2GW annual sales, according to
Reuters SUZL.BO management) on the strength of domestic business alone.
Bloomberg SUEL IB

Priced on 22 June 2011 High leverage leaves little room for disappointment
India Sensex @ 17,550.6 Suzlon Wind’s net debt stood at Rs102bn (1.5x gearing ratio) at FY11-end.
12M hi/lo Rs66.30/42.80
Foreign currency convertible bonds (FCCBs) of US$247m will mature in June
2012, while another US$142m will mature in October 2012, with a conversion
12M price target Rs50.00 price 50-90% higher than the current market price. Auditors included a
±% potential +11%
matter of emphasis for non-provision of premium on redemption of
Target set on 31 May 10
convertible debentures (Rs5.8bn) in 4QFY11 results.
Shares in issue 1,556.8m
Free float (est.) 45.2% Aggressive FY12 guidance
Market cap US$1,790m
While 4QFY11 net profit of Rs2.1bn was better than our estimates, this was
on account of forex gains of Rs2.35bn and a positive tax charge of Rs600m.
3M average daily volume Adjusting for forex gains, Suzlon Wind reported a loss of Rs810m at the PBT
Rs1,153.4m (US$25.8m)
level, suggesting that any meaningful improvement in operational
Foreign s'holding 12.4% performance is yet to be seen. Management has guided for consolidated
Major shareholders
revenue of Rs240-260bn (+35-45% YoY. We believe that the firm is likely to
Promoters 54.8% miss this target, especially as the overseas business remains weak.
FIIs 12.4%
Maintain U-PF
The acquisition of the remaining Repower stake will be a positive
development for Suzlon. However, synergy benefits could take time to
materialise. In the meantime, poor international sales and upcoming debt
Stock performance (%) payments are major concerns. The risk-reward profile looks unfavourable and
1M 3M 12M we maintain our Underperform rating with a target price of Rs50.
Absolute (10.9) (1.0) (20.0)
Relative (6.9) 1.5 (19.1) FinancialsFinancials
Abs (US$) (10.7) (1.0) (17.9) Year to 31 Mar 09A 10A 11CL 12CL 13CL
130 (Rs) (%) 110 Revenue (Rsm) 260,817 206,197 162,466 220,320 248,672
120 Suzlon (LHS) 100 Net profit (Rsm) 2,364 (9,827) (15,739) (894) 3,981
110 Rel to Sensex 90 EPS (Rs) 1.6 (6.4) (9.5) (0.5) 2.3
100 80
CL/consensus (21) (EPS%) - - 153 (26) 51
90 70
EPS growth (% YoY) (80.4) (507.5) nm nm nm
80 60
70 50 PE (x) 28.6 nm nm nm 19.8
60 40 Dividend yield (%) 0.0 0.0 0.0 0.0 0.0
50 30 FCF yield (%) (193.8) 88.2 1.5 (3.8) 11.5
40 20 PB (x) 0.8 1.1 1.3 1.3 1.2
Jun 09 Feb 10 Oct 10 Jun 11
ROE (%) 4.3 (11.1) (22.9) (0.9) 6.6
Source: Bloomberg
Net debt/equity (%) 107.8 140.8 132.5 137.3 114.3
www.clsa.com Source: CLSA Asia-Pacific Markets

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 Suzlon - U-PF Chindia power

Domestic business strong, overseas weak

International sales were Suzlon Wind’s domestic sales (1,169MW, up 70% YoY) and order booking
down 55% YoY in FY11 (2,292MW; up 170% YoY) picked up sharply in FY11. However, international
sales disappointed at a modest 352MW, down 55% YoY. Moreover, overseas
order backlog stood flat YoY at 877MW, implying that any significant
turnaround in international business is unlikely in the near term.
Management believes that the break-even level for the Suzlon Wind
business is 2,000MW annual sales, which will be difficult to achieve on the
strength of domestic business alone. There are no signs of any improvement
in the overseas segment.

Sales increased by a Wind turbine sales over quarters

modest 4% YoY to
1,521MW in FY11
1,200 (MW) Domestic Exports

FY07 FY08 FY09 FY10 FY11

1,000
1,455MW 2,311MW 2,790MW 1,460MW 1,521MW

800

600

400

200

0
1QFY07

2QFY07

3QFY07

4QFY07

1QFY08

2QFY08

3QFY08

4QFY08

1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11
Domestic sales were Quarterly domestic wind-turbine sales
strong at 1,169MW,
up 70% YoY
450 (MW)
400 FY07 FY08 FY09 FY10 FY11
945MW 975MW 749MW 688MW 1,169MW
350
300
250
200
150
100
50
0
1QFY07

2QFY07

3QFY07

4QFY07

1QFY08

2QFY08

3QFY08

4QFY08

1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11

Source: CLSA Asia-Pacific Markets

218 [email protected] 27 June 2011

 
  
 Suzlon - U-PF Chindia power

Domestic order backlog Quarterlydomestic order backlog

is about 60% of the
total backlog 1,800 (MW) India order backlog (LHS) (%) 70
1,600 As a % of total backlog
60
1,400
50
1,200
1,000 40

800 30
600
20
400
10
200
0 0
1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11
Poor international Quarterly wind-turbine sales in international markets
sales in FY11
900 (MW) South America USA
800 EU Australia- NZ
China Others
700
600
500
400
300
200
100
0
1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11

International order book Quarterly overseas order backlog

has stayed flat over the
last five quarters 3,000 (MW) South America USA
EU Australia-NZ
2,500 China

2,000

1,500

1,000

500

0
1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11

Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 219

 
  
 Suzlon - U-PF Chindia power

High gearing leaves little room for disappointment

Suzlon’s net debt stood at Rs102bn at 4QFY11-end, implying a net gearing
ratio of about 1.5x. Of this, FCCBs of US$247m will become redeemable/
convertible in June 2012, while another US$142m will mature in October
2012, with the conversion price 50-90% higher than the current market price.
These FCCBs were restructured at the beginning of FY11. We note that
auditors had included a matter of emphasis for non-provision of premium on
redemption of convertible debentures (Rs5.8bn) in 4QFY11 results.

Suzlon’s net debt stood at Suzlon Wind debt break-up

Rs102bn at the end of the (Rsm) 4QFY10 1QFY11 2QFY11 3QFY11 4QFY11
fourth quarter . . .
Acquisition loans 20,830 21,550 20,850 20,730 20,740
FCCBs 21,510 22,250 21,530 21,410 21,360
. . . implying 1.5x Working cap/capex/other loans 62,840 64,730 68,320 68,980 70,230
net gearing Gross external debt 105,190 108,530 110,700 111,120 112,330
Promoter loans 11,750 11,750 - - -
Gross debt 116,940 117,580 110,700 111,120 112,330
Cash (15,410) (12,580) (12,600) (9,450) (10,230)
Net debt 101,530 107,700 98,090 101,670 102,100
Source: Suzlon, CLSA Asia-Pacific Markets

US$389m worth of FCCBs Suzlon’s FCCB s

will become redeemable/ Category Conversion Coupon rate Redemption Outstanding
convertible in price (Rs) (%) premium (%) value (US$m)
Jun/Oct-12 . . .
June 2012- old 97.26 0.0 145.2 211
Oct 2012 - old 97.26 0.0 144.9 121
. . . conversion price is June 2012- exchange 76.68 7.5 150.2 36
50-90% above current Oct 2012 - exchange 76.68 7.5 157.7 21
market price
July 2014 - new issue 90.38 0.0 134.2 90
April 2016 - new issue 54.01 5.0 108.7 175
654

Suzlon has already Restructuring of FCCBs

restructured its FCCBs Category Face value (US$m) Comments
Original Post-restructuring
FCCB - Jun 12 (US$)
Option not exercised 211.3 211.3 Conversion price reduced
from Rs360 to Rs97;
no interest payment
New bonds issued (3:5) 59.3 35.6 Three issued for every five;
conversion price reduced
from Rs360 to Rs77; 7.5%
interest rate
Buy-back (54.6%) 29.4 0
Total 300 246.9
FCCB - Oct 12 (US$)
Option not exercised 121.4 121.4 Conversion price reduced
from Rs375 to Rs97; no
interest payment
New bonds issued (3:5) 34.7 20.8 Three issued for every five;
conversion price reduced
from Rs375 to Rs77; 7.5%
interest rate
Buy-back (54.6%) 44 0
Total 200.1 142.2
Source: CLSA Asia-Pacific Markets

220 [email protected] 27 June 2011

 
  
 Suzlon - U-PF Chindia power

Significant operational improvement is yet to be seen

Suzlon Wind reported a Having posted losses for seven successive quarters, Suzlon Wind business
PBT loss of Rs810m in reported a profit of Rs2.14bn in 4QFY11. However, this was on account of
4QFY11, adjusted for
forex gains of Rs2.35bn and positive tax charge of Rs600m. Adjusted for
forex gains
forex gains, Suzlon Wind reported a loss of Rs810m at the PBT level. Revenue
was down 27% YoY to Rs30.4bn. We are, therefore, yet to witness a
meaningful improvement in Suzlon Wind’s performance.

Rs2.4bn forex gain and Suzlon Wind’s 4QFY11 performance

positive tax charge 4QFY10 4QFY11 % YoY FY10 FY11 % YoY
in 4Q helped Suzlon Net sales 41,500 30,370 (26.8) 96,340 91,740 (4.8)
report better-than- Expenditure (36,870) (28,250) (23.4) (97,530) (90,770) (6.9)
expected numbers Ebitda 4,630 2,120 (54.2) (1,190) 970 (181.5)
Ebitda margin(%) 11.2 7.0 (418)bps (1.2) 1.1 229bps
Depreciation (1,060) (1,070) 0.9 (3,120) (3,590) 15.1
Interest (2,330) (2,310) (0.9) (8,580) (8,620) 0.5
Other income 290 450 55.2 810 1,230 51.9
PBT 1,530 (810) (152.9) (12,080) (10,010) (17.1)
Forex (1,120) 2,350 600 400
Extraordinary item 70 (100.0) 2,120 (370) (117.5)
PBT after extra ordinary item 480 1,540 220.8 (9,360) (9,980) 6.6
Tax (2,850) 600 (121.1) (2,360) 260 (111.0)
Tax rate (%) 186.3 74.1 (11,221)bps (19.5) 2.6 2,213bps
Net profit (2,370) 2,140 (190.3) (11,720) (9,720) (17.1)
Miniroty interest (60) 20 (30) 30
Net profit after MI (2,430) 2,160 (188.9) (11,750) (9,690) (17.5)
Expenditure break up
Consumption of raw materials 25,480 19,530 (23.4) 63,920 60,610 (5.2)
- as a % of sales 61.4 64.3 290bps 66.3 66.1 (29)bps
Staff costs 2,380 2,570 8.0 9,100 9,410 3.4
- as a % of sales 5.7 8.5 272bps 9.4 10.3 81bps
Other Expenditure 9,010 6,150 (31.7) 24,510 20,750 (15.3)
- as a % of sales 21.7 20.3 (147)bps 25.4 22.6 (283)bps
Total expenditure 36,870 28,250 (23.4) 97,530 90,770 (6.9)
- as a % of sales 88.8 93.0 417bps 101.2 98.9 (230)bps
Source: CLSA Asia-Pacific Markets

Repower’s strong At a consolidated level, Suzlon reported PAT of Rs4.3bn in 4QFY11 (4QFY10:
performance partly loss of Rs3.1bn). REpower posted strong performance, more than doubling its
on account of
revenue to Rs42bn and increasing PAT 4x to Rs2.5bn on account of Ebitda
accounting change
margin expanding from 5.4% in 4QFY10 to 11.5% in 4QFY11. One important
reason for strong perfromance of REpower is a change in accounting policy in
4Q FY11. Till 3Q FY11, financials of REpower were adjusted to align with
accounting practices at Suzlon. This was discontinued in 4Q FY11 leading to
revenue being higher by Rs9.7bn and profit higher by Rs1.1bn.

Suzlon’s guidance Suzlon has guided for consolidated revenue of Rs240-260bn and Ebit margins
looks aggressive of 7-8% for FY12. This compares with our expectation of Rs220bn revenue
and 6% Ebit margins. We expect the company to break-even in FY12; while
on the basis of management guidance, Suzlon could generate of profit of Rs3-
6bn (EPS of Rs1.8-3.5).

We believe that the The company's guidance of a 34-45% revenue growth and 6-7ppt
company will miss improvement in Ebit margin (from 1.3% in FY11) looks quite aggressive. It
its guidance
will require a significant pick up in volumes in both domestic and overseas
markets and a strong control on costs.

Recommendation history - Suzlon Energy Ltd (SUEL IB)

Date Rec level Closing price Target
31 May 2010 U-PF 61.05 50.00
28 June 2009 U-PF 123.35 70.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 221

 
  
 Suzlon - U-PF Chindia power

Summary financials
We believe that Suzlon Year to 31 March 09A 10A 11CL 12CL 13CL
will find it difficult to Summary P&L forecast (Rsm)
meet its FY12 guidance Revenue 260,817 206,197 162,466 220,320 248,672
Op Ebitda 27,916 10,465 5,226 16,051 21,676
Op Ebit 22,185 3,834 (1,428) 9,360 14,941
Interest income 0 0 0 0 0
Interest expense (10,539) (14,580) (12,166) (12,954) (12,947)
Other items (4,475) 4,409 (360) 2,772 3,318
Profit before tax 7,171 (6,337) (13,954) (822) 5,312
Taxation (2,883) (3,561) (1,500) 223 (880)
Minorities/Pref divs (1,924) 72 (285) (295) (451)
Net profit 2,364 (9,827) (15,739) (894) 3,981
We don’t see Suzlon Summary cashflow forecast (Rsm)
generating meaningful Operating profit 22,185 3,834 (1,428) 9,360 14,941
operating cash flows in Operating adjustments 0 0 0 0 0
the near term Depreciation/amortisation 5,731 6,631 6,654 6,691 6,734
Working capital changes (39,661) 23,887 8,208 (11,033) (216)
Net interest/taxes/other (17,897) (13,732) (11,490) (10,626) (11,423)
Net operating cashflow (29,641) 20,620 1,944 (5,608) 10,037
Capital expenditure (101,505) 40,278 (800) 2,630 (1,000)
Free cashflow (131,146) 60,897 1,144 (2,977) 9,037
Acq/inv/disposals 31,368 (10,873) 0 0 0
Int, invt & associate div 0 0 0 0 0
Net investing cashflow (70,137) 29,405 (800) 2,630 (1,000)
Increase in loans 49,354 (22,021) 0 0 0
Dividends (10) 0 0 0 0
Net equity raised/other 11,522 (31,405) 11,694 667 914
Net financing cashflow 60,866 (53,426) 11,694 667 914
Incr/(decr) in net cash (38,912) (3,402) 12,838 (2,310) 9,951
Exch rate movements 10 1,745 1,643 894 (3,981)
Opening cash 69,602 30,700 29,043 43,524 42,108
Closing cash 30,700 29,043 43,524 42,108 48,077
Stretched balance sheet Summary balance sheet forecast (Rsm)
Cash & equivalents 30,700 29,043 43,524 42,108 48,077
Debtors 87,390 61,918 58,548 82,660 88,697
Inventories 71,740 59,943 43,645 60,661 62,942
Other current assets 0 0 0 0 0
Fixed assets 140,661 93,752 87,898 78,576 72,842
Intangible assets 11,989 11,989 11,989 11,989 11,989
Other term assets 31,119 22,650 19,691 24,029 26,274
Total assets 373,649 290,218 276,218 310,946 321,744
Short-term debt 0 0 0 0 0
Creditors 105,950 84,267 75,365 107,617 117,320
Other current liabs 9,580 9,949 4,433 6,613 7,257
Long-term debt/CBs 148,700 126,679 130,668 131,562 127,581
Provisions/other LT liabs 0 0 0 0 0
Minorities/other equity 24,105 3,310 3,595 3,890 4,342
Shareholder funds 85,314 66,013 62,157 61,263 65,245
Total liabs & equity 373,649 290,218 276,218 310,946 321,744
We build in revival in Ratio analysis
revenue growth Revenue growth (% YoY) 90.7 (20.9) (21.2) 35.6 12.9
and improvement Ebitda growth (% YoY) 40.3 (62.5) (50.1) 207.1 35.0
in margins . . . Ebitda margin (%) 10.7 5.1 3.2 7.3 8.7
Net profit margin (%) 0.9 (4.8) (9.7) (0.4) 1.6
Dividend payout (%) 0.1 0.0 0.0 0.0 0.0
Effective tax rate (%) 40.2 (56.2) (10.7) 27.2 16.6
Ebitda/net int exp (x) 2.6 0.7 0.4 1.2 1.7
. . . but high gearing
Net debt/equity (%) 107.8 140.8 132.5 137.3 114.3
remains a concern
ROE (%) 4.3 (11.1) (22.9) (0.9) 6.6
ROIC (%) 8.4 3.1 (1.1) 4.8 8.8
EVA®/IC (%) (1.0) (12.6) (13.8) (5.5) (2.1)
Source: CLSA Asia-Pacific Markets

222 [email protected] 27 June 2011

 
  
 Tata Power
Rs1,241.20 - BUY

Rajesh Panjwani Expansion on track

[email protected] Tata Power’s power generation capacity is set to expand from 3.1GW to
(852) 26008271
8.5W over the next 21 months. The company has already started the
Abhishek Tyagi preliminary work on its pipeline projects totalling 10GW. In a scenario
(91) 22 66505055 where most of utilities would struggle to get coal for their projects, Tata
Power has a net long position on coal and also has Tata Steel as a fall
back option for the domestic coal requirements. It remains our preferred
pick in the Indian utility space. Maintain BUY.

FY12-13 to be big years for capacity addition

Tata Power would be adding 5.4GW power generation capacity over the next
27 June 2011 21 months (the company added only 944MW new capacity over the last six
years). The prominent projects among this would be Maithon (1.1GW) and
India Mundra (4GW). The company has complete fuel security for these expansions
Power and power-purchase agreements in place for the off-take.

Reuters TTPW.BO Pipeline projects are well diversified

Bloomberg TPWR IB
Beyond the 5.3GW capacity, which is already under construction, the
Priced on 23 June 2011 company has pipeline projects of around 10GW. The company is under
India Sensex @ 17,727.5 various stages of preparedness for starting work on these projects and is
12M hi/lo Rs1,465.0/1,142.2 going through the grind of getting all clearances and allocations in place. The
fuel mix is well diversified for the pipeline projects, with projects based on
12M price target Rs1,475.00
coal, gas, hydro, wind, geothermal and solar as energy sources.
±% potential +19%
Target set on 20 May 11
Sitting pretty with net long position on coal
Shares in issue 237.3m While most of the power utilities in the country are struggling to meet their
Free float (est.) 48.5% coal requirements, Tata Power is in a sweet spot with its net long coal position
Market cap US$6,562m due to its 30% stake in the Indonesian coal mines. With the increased
production of the Indonesian mines (we expect 75mt production by FY14) and
3M average daily volume
Rs311.9m (US$7m)
the expected bullish environment for thermal coal prices, Tata Power should
have strong cashflows from the coal mining business. We have already
Major shareholders factored in potential negative impact from having to buy Indonesian coal from
Tata family 33.2%
FIIs 18.3% Bumi mines at market rates instead of agreed upon lower rate.

Maintain BUY
Tata Power remains our preferred pick in the Indian Power space given its mix
of business models (regulated/competitive bidding/merchant), diversified fuel
mix, long position on coal and good execution record. We have raised our
target price to Rs1,475 and maintain our BUY rating. Near-term triggers are
Stock performance (%) project commissioning and firm thermal-coal prices.
1M 3M 12M
Absolute 2.1 (1.2) (6.1)
Relative 3.6 1.4 (6.0) Financials
Abs (US$) 2.9 (1.5) (3.4) Year to 31 Mar 09A 10A 11CL 12CL 13CL
1,600 (Rs) (%) 120 Revenue (Rsm) 175,875 189,858 194,508 236,447 265,655
Tata Power (LHS)
1,500 Rel to Sensex
115 Net profit (Rsm) 11,912 19,052 20,881 25,918 23,038
110 EPS (Rs) 53.9 83.1 88.0 109.2 97.1
1,400 105
CL/consensus (25) (EPS%) - - 104 113 95
100
1,300 EPS growth (% YoY) 4.6 54.2 5.9 24.1 (11.1)
95
1,200 90 PE (x) 23.0 14.9 14.1 11.4 12.8
85 Dividend yield (%) 0.9 1.0 1.0 1.0 1.0
1,100
80 PB (x) 3.2 2.6 2.2 1.9 1.6
1,000 75 ROE (%) 14.4 19.3 16.1 17.8 13.9
Jun 09 Feb 10 Oct 10 Jun 11
Net debt/equity (%) 135.6 128.0 139.4 138.8 119.6
Source: Bloomberg
EV/Ebitda (x) 9.4 8.3 6.7 6.4 7.0
www.clsa.com Source: CLSA Asia-Pacific Markets

Find CLSA research on Bloomberg, Thomson Reuters, CapIQ and themarkets.com - and profit from our evalu@tor® proprietary database at clsa.com

 
  
 Tata Power - BUY Chindia Power

Tata Power is the largest Tata Power existing capacity and expansion plans
private-sector utility Capacity (MW) Fuel
Operational capacity
Mumbai -thermal 1,580 Coal/gas/oil
Mumbai -hydro 447 Hydro
Wind 228 Wind
Solar 3 Solar
Jojobera 428 Domestic coal
IEL 240 Domestic coal
Belgaum 81 Gas
Haldia 120 Gas
Total operational 3,127
Under implementation
Mundra 4,000 Imported coal
Maithon 1,050 Domestic coal
Dagacchu 126 Hydro
Mithapur 25 Solar
Lodhivali 40 Diesel
Wind 148 Wind
Total under implementation 5,389
Under planning
- Phase 1
Coastal Maharashtra 1,600 Imported coal
Naraj Marthapur 660 Partially met through Mandakini coal block
Tiruldih 1,980 Partially met through Tubed coal block
Dugar Hydro power 236 Hydro
Sorik Marapi 240 Geothermal
Visapur - Wind 88 Wind
Solar 10 Solar
Total phase 1 4,814
- Phase 2
Maithon II 1,320 Domestic coal
Mundra II 1,600 Imported coal
Kalinganagar 600 Coal/gas
Tamakoshi -hydro 880 Hydro
Wind 200 Wind
Bhivpuri CCGT 450 Gas
Total phase 2 5,050
Total under planning 9,864

Tata Power has well Fuel source wise operational and under implementation/planned capacity
diversified fuel mix Fuel source Operational Under Planning Grand total
implementation
Geothermal 240 240
Hydro 447 126 1,116 1,689
Solar 3 25 10 38
Thermal 2,449 5,090 8,210 15,749
Wind 228 148 288 664
Grand Total 3,127 5,389 9,864 18,380
Source: Company, CLSA Asia-Pacific Markets

224 [email protected] 27 June 2011

 
  
 Tata Power - BUY Chindia Power

Capacity to increase Capacity addition over next two years

2.7x by FY13 end
9,000 (MW) Capacity Addition
FY12 additions (2,863MW)
 Maithon 1,050MW 7,500
 Mundra 1,600MW
 Wind 148MW
6,000
 Mithapur 25MW
 Loadhivali 40MW
4,500

FY13 additions (2,526MW)

3,000
 Mundra 2,400MW
 DHPC 126MW
1,500

0
Existing capacity FY12 FY13 Total

Coal realisations have Coal realisation over the quarters Coal sales over the quarters
picked up in 4QFY11T
100 (US$/t) 20 (mt)

80 16

60 12

40 8

20 4

0 0
1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11

1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11
Source: Company, CLSA Asia-Pacific Markets

Our SOTP for Tata Power SOTP of Tata Power

is Rs1,475 Rs/sh Comments
Value of power business 481 16x FY12 earnings
Value of investments 318
Maithon 62 1.5x P/B
Mundra (82) DCF based value
Indonesian coal mines 695 11x FY12 earnings
Total 1,475

Recommendation history - Tata Power (TPWR IB)

Date Rec level Closing price Target
23 June 2011 BUY 1,241.20 1,475.00
20 May 2011 BUY 1,217.25 1,410.00
15 February 2011 BUY 1,241.30 1,480.00
09 January 2011 BUY 1,386.70 1,600.00
26 May 2010 BUY 1,203.05 1,430.00
17 April 2010 BUY 1,328.10 1,580.00
30 March 2010 BUY 1,367.15 1,630.00
20 January 2010 O-PF 1,419.75 1,500.00
29 October 2009 O-PF 1,397.95 1,350.00
02 August 2009 O-PF 1,302.05 1,220.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 225

 
  
 Tata Power - BUY Chindia Power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
Summary P&L forecast (Rsm)
Revenue 175,875 189,858 194,508 236,447 265,655
Op Ebitda 33,693 38,379 45,374 63,119 66,267
Op Ebit 27,128 29,602 35,572 51,243 51,729
Interest income 0 0 0 0 0
Interest expense (8,129) (7,818) (8,102) (11,427) (16,752)
Other items 5,639 5,889 4,105 3,336 3,693
Profit before tax 24,638 27,673 31,575 43,152 38,669
Taxation (11,651) (6,287) (9,756) (15,182) (13,488)
Minorities/Pref divs (1,076) (2,335) (938) (2,052) (2,144)
Net profit 11,912 19,052 20,881 25,918 23,038
Summary cashflow forecast (Rsm)
Operating profit 27,128 29,602 35,572 51,243 51,729
Operating adjustments 0 0 0 0 0
Depreciation/amortisation 6,565 8,777 9,802 11,876 14,538
Working capital changes 11,013 (4,839) 3,020 713 497
Net interest/taxes/other (11,651) (6,287) (9,756) (15,182) (13,488)
Net operating cashflow 33,055 27,254 38,638 48,650 53,275
Capital expenditure (68,532) (73,664) (70,353) (69,520) (29,180)
Free cashflow (35,477) (46,410) (31,715) (20,870) 24,095
Acq/inv/disposals (1,260) 1,689 (2,000) (2,000) (2,000)
Int, invt & associate div (2,489) (1,929) (3,997) (8,091) (13,060)
Net investing cashflow (72,281) (73,904) (76,350) (79,611) (44,240)
Increase in loans 50,298 43,035 41,098 48,083 16,354
Dividends (2,560) (2,850) (2,963) (2,963) (2,963)
Net equity raised/other (2,355) 17,793 0 0 0
Net financing cashflow 45,383 57,978 38,135 45,121 13,392
Incr/(decr) in net cash 6,157 11,328 423 14,160 22,428
Exch rate movements 0 0 0 0 0
Opening cash 5,623 11,780 23,108 23,531 37,691
Closing cash 11,780 23,108 23,531 37,691 60,118
Summary balance sheet forecast (Rsm)
Cash & equivalents 11,780 23,108 23,531 37,691 60,118
Debtors 30,235 39,845 35,011 42,560 47,818
Inventories 10,146 9,539 11,670 14,187 15,939
Other current assets 22,304 24,410 23,924 29,083 32,676
Fixed assets 157,464 224,658 285,208 342,853 357,495
Intangible assets 48,316 42,744 42,744 42,744 42,744
Other term assets 5,692 3,899 3,899 3,898 3,898
Total assets 318,450 399,024 458,811 547,839 597,511
Short-term debt 0 0 0 0 0
Creditors 48,086 59,505 52,517 63,841 71,727
Other current liabs 19,725 14,576 21,396 26,009 29,222
Long-term debt/CBs 141,434 184,469 225,567 273,651 290,005
Provisions/other LT liabs 13,572 14,370 14,370 14,370 14,370
Minorities/other equity 9,444 12,097 12,097 12,097 12,097
Shareholder funds 86,189 114,007 132,864 157,872 180,091
Total liabs & equity 318,450 399,024 458,811 547,839 597,511
Ratio analysis
Revenue growth (% YoY) 61.6 8.0 2.4 21.6 12.4
Ebitda growth (% YoY) 66.5 13.9 18.2 39.1 5.0
Ebitda margin (%) 19.2 20.2 23.3 26.7 24.9
Net profit margin (%) 6.8 10.0 10.7 11.0 8.7
Dividend payout (%) 21.5 14.5 14.2 11.4 12.9
Effective tax rate (%) 47.3 22.7 30.9 35.2 34.9
Ebitda/net int exp (x) 4.1 4.9 5.6 5.5 4.0
Net debt/equity (%) 135.6 128.0 139.4 138.8 119.6
ROE (%) 14.4 19.3 16.1 17.8 13.9
ROIC (%) 8.0 9.6 8.2 9.3 8.6
EVA®/IC (%) (1.4) (1.1) (2.1) (0.7) (1.5)
Source: CLSA Asia-Pacific Markets

226 [email protected] 27 June 2011

 
  
 Thermax
Rs584.75 - OUTPERFORM

Rajesh Panjwani Moving into the big league

[email protected] Thermax can now take on EPC projects for independent power plants
(852) 26008271
(IPP) and supply utility size boilers (+300MW), versus only catering to
Aditya Bhartia captive power plants (20-50MW) until three years back. Its environment
(91) 2266505077 business should also benefit from stricter government regulations for
controlling pollution. While slowing industrial capex and intensifying
Abhishek Tyagi competition could result in muted order flow growth in the near term,
(91) 2266505055
valuations look reasonable at 16.4x FY12 PE. Maintain Outperform.

Expanding the addressable market

Thermax, through its JV with Babcox and Wilcox (B&W), is now capable of
27 June 2011 supplying utility size boilers (+300MW). The JV has already placed bids for
the NTPC’s 9 x 800MW bulk tender. Thermax is also undertaking complete
India EPC projects, thereby significantly expanding its addressable market.
Materials Moreover, Thermax’s Environment business (c.20% of FY11 revenues) should
benefit from increased focus by the government to control pollution.
Reuters THMX.BO
Bloomberg TMX IB
Orderflow disappointed in FY11, but should gradually improve
Priced on 22 June 2011
Strong execution boosted Thermax’s FY11 revenue by 58% YoY to Rs53bn.
India Sensex @ 17,550.6
However, order inflows fell by 5% YoY, to Rs60bn, on account of only one
12M hi/lo Rs926.90/542.65 large project win - a 72MW combined-cycle plant (Rs5.8bn). By contrast,
Thermax had announced Rs19.7bn in orders in FY10. We believe that order
12M price target Rs680.00
±% potential +16% inflows will gradually improve over the next few quarters. Thermax won two
Target set on 22 Jun 11 large projects, aggregating Rs7.7bn, at the opening of FY12, which should
somewhat ease investor concerns regarding order delays. Moreover, while
Shares in issue 119.2m
38.0%
Jawaharlal Nehru National Urban Renewal Mission (JNNURM) projects saw
Free float (est.)
significant delays in FY11, a pick up in FY12 should help order flows in the
Market cap US$1,554m environment segment.
3M average daily volume
Rs66.9m (US$1.5m) Maintain O-PF
Major shareholders
Thermax faces near term headwinds in the form of delays in finalisation of
Promoters 62.0% orders. In addition, intense competition, higher proportion of EPC work and
FIIs 9.1% higher commodity costs could squeeze margins; we model Ebitda margin to
contract by 80bps in FY12, to 10.5%. However, these concerns are reflected
in Thermax’s 16.4x FY12 and 13.8x FY13 PE valuation (about a 20% discount
to its five-year average). Strategic enhancements allow the company to tackle
larger projects such as ESP supply, heating and cooling solutions for
combined-cycle gas developments and environmental products. We maintain
Stock performance (%) our Outperform call with a 12-month forward target of Rs680 (15x FY13 PE).
1M 3M 12M
Absolute 0.5 2.1 (20.9)
Relative 4.9 4.7 (20.0) Financials
Abs (US$) 0.7 2.1 (18.8) Year to 31 Mar 09A 10A 11CL 12CL 13CL
1,000 (Rs) (%) 180 Revenue (Rsm) 34,603 33,703 53,366 59,765 69,174
900 170 Net profit (Rsm) 2,890 1,443 4,051 4,241 5,043
160 EPS (Rs) 24.2 12.1 34.0 35.6 42.3
800
150
CL/consensus (26) (EPS%) - - 107 96 98
700 140
EPS growth (% YoY) (0.6) (50.1) 180.7 4.7 18.9
600 130
120 PE (x) 24.1 48.3 17.2 16.4 13.8
500
110 Dividend yield (%) 0.9 0.9 0.9 1.0 1.2
400 Thermax (LHS)
Rel to Sensex
100 FCF yield (%) (1.2) 7.6 5.3 3.6 5.4
300 90 PB (x) 7.0 6.5 5.0 4.0 3.2
Jun 09 Feb 10 Oct 10 Jun 11
ROE (%) 33.0 13.8 32.4 26.7 25.7
Source: Bloomberg
Net debt/equity (%) (36.8) (60.9) (69.6) (66.9) (68.7)
www.clsa.com Source: CLSA Asia-Pacific Markets

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 Thermax - O-PF Chindia power

Order inflows in 4QFY11 Order inflows

stood at Rs15.3bn,
up 4% YoY 35 (Rsbn)

30

25
The order backlog fell 5%
QoQ in 4QFY11 20

15

10

0
1QFY07

2QFY07

3QFY07

4QFY07

1QFY08

2QFY08

3QFY08

4QFY08

1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11
Thermax won only one Order inflow distribution
large project in FY11 but
announced two for FY12 80 (Rsbn) Environment orders
Large Energy orders
70
Energy product orders 15
60 13
13
13 11
50 11
6
40 20

9
30
3
11 47
5 42 43
20
31
25
10 19 18

0
FY07 FY08 FY09 FY10 FY11 FY12 FY13

EPC proportions should Installation by Thermax over years

rise going forward as
Thermax undertakes 1,400 (MW) EPC (LHS) (%) 45
larger projects Boiler (LHS)
1,200 EPC as a proportion of total
40
1,000

35
800

600
30

400
25
200

0 20
FY08 FY09 FY10 11E 12E

Source: CEA, CLSA Asia-Pacific Markets

228 [email protected] 27 June 2011

 
  
 Thermax - O-PF Chindia power

Large orders booked

Order booking date Client Value (Rsm) Description
July 2008 Essar 3,800 Two 750TPH (2,400MWt output) pulverised-coal fired boilers.
August 2008 SAIL 4,150 Captive power plant.

October 2008 Brahmani 2,970 Captive power plant – the project is on hold.
August 2009 CFBC boilers 2,550 Four 250TPH coal-cum washery rejects circulating fluidised bed combustion (CFBC)
boilers, which are for setting up a captive power plant for their cement works in Uttar
Pradesh.
September 2009 Meenakshi 10,010 Turnkey supply for a 270MW power plant set up by a Hyderabad-based infrastructure
company.
November 2009 CPP Orissa 4,778 Turnkey CPP; 2 x 60MW.
January 2010 Bajaj Hindustan 2,400 Boilers for two 90MW IPPs to be set up in Uttar Pradesh, which will use coal (both
Indian and imported) to generate power.
April 2010 Indian petro major 5,800 Combined-cycle power plant (72MW) from Indian petro chemical major for its
aromatic complex in a SEZ.
April 2011 Steel sector PSU 3,660 A 120MW captive power plant - two blast furnace gas-fired boilers and one steam
turbine-generator along with necessary auxiliaries and power the evacuation system.
April 2011 Grasim 4,030 EPC work for three 32MW co-generation plants.
Source: CLSA Asia-Pacific Markets

Share in cogeneration, Captive plants (operational or expected to become operational) in the 11th plan
bagasse/biomass Equipment supplier Commissioned (MW) Under construction (MW)
and waste heat
BHEL 2,249 2,547
projects grows
Thermax 1,995 2,478
Chinese 1,134 2,520
Others 1,731 840
Total 7,109 8,386
Thermax’s market share (%) 28.1 29.5
Source: CEA, CLSA Asia-Pacific Markets

Thermax trades at about Thermax’s 12-month forward PE ratio

a 20% discount to its
average multiples 40 (x)

35

30
+1sd26.2x
25

20 avg20.8x

15 -1sd15.4x

10
Jun 06 Apr 07 Feb 08 Dec 08 Oct 09 Aug 10 Jun 11

Recommendation history - Thermax Ltd (TMX IB)

Date Rec level Closing price Target
22 June 2011 O-PF 591.25 680.00
31 January 2011 O-PF 663.60 805.00
12 November 2010 O-PF 875.35 945.00
14 May 2010 O-PF 674.05 725.00
01 January 2010 O-PF 608.35 600.00
04 October 2009 O-PF 536.25 550.00
30 August 2009 O-PF 460.75 525.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 229

 
  
 Thermax - O-PF Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
Current order backlog is Summary P&L forecast (Rsm)
1.1x 12CL revenues Revenue 34,603 33,703 53,366 59,765 69,174
Op Ebitda 4,219 3,947 6,022 6,265 7,382
Op Ebit 3,867 3,505 5,508 5,652 6,709
Ebitda margins likely to Interest income 0 0 0 0 0
come down Interest expense (38) (20) (39) (54) (54)
Other items 418 (630) 597 753 898
Profit before tax 4,247 2,855 6,066 6,351 7,552
Taxation (1,357) (1,416) (2,015) (2,110) (2,509)
Minorities/Pref divs 0 4 0 0 0
Net profit 2,890 1,443 4,051 4,241 5,043
Strong cash generation Summary cashflow forecast (Rsm)
with strict control over Operating profit 3,867 3,505 5,508 5,652 6,709
working capital Operating adjustments 0 0 0 0 0
Depreciation/amortisation 351 442 514 613 673
Working capital changes (1,874) 4,687 1,993 (639) (159)
Net interest/taxes/other (1,317) (2,573) (1,990) (2,085) (2,484)
Net operating cashflow 1,028 6,062 6,025 3,542 4,739
Capital expenditure (1,856) (741) (2,335) (1,000) (1,000)
Free cashflow (828) 5,321 3,690 2,542 3,739
Acq/inv/disposals 4,158 (2,260) (250) (500) (500)
Int, invt & associate div 404 519 597 753 898
Net investing cashflow 2,706 (2,482) (1,988) (747) (602)
Increase in loans 41 39 600 0 0
Dividends (697) (695) (764) (834) (973)
Net equity raised/other 38 82 (39) (54) (54)
Net financing cashflow (618) (574) (203) (888) (1,027)
Incr/(decr) in net cash 3,116 3,006 3,834 1,907 3,110
Exch rate movements 0 0 0 0 0
Opening cash 580 3,695 6,701 10,535 12,442
Closing cash 3,695 6,701 10,535 12,442 15,552
Net cash positive Summary balance sheet forecast (Rsm)
Cash & equivalents 3,696 6,702 10,536 12,443 15,553
Debtors 5,719 7,984 12,642 14,158 16,387
Inventories 5,267 5,744 7,763 8,950 10,102
Other current assets 410 594 940 1,053 1,219
Fixed assets 5,088 5,484 7,305 7,692 8,019
Intangible assets 0 0 0 0 0
Other term assets 2,224 3,282 5,197 5,820 6,736
Total assets 23,847 33,494 48,336 54,569 62,969
Short-term debt 0 0 0 0 0
Creditors 12,766 21,409 31,765 34,379 38,408
Other current liabs 957 985 1,559 1,746 2,021
Long-term debt/CBs 41 80 680 680 680
Provisions/other LT liabs 160 144 169 194 219
Minorities/other equity 0 94 94 94 94
Shareholder funds 9,924 10,782 14,069 17,477 21,547
Total liabs & equity 23,847 33,494 48,336 54,569 62,969
Healthy return ratios Ratio analysis
Revenue growth (% YoY) (0.6) (2.6) 58.3 12.0 15.7
Ebitda growth (% YoY) (1.1) (6.4) 52.6 4.0 17.8
Ebitda margin (%) 12.2 11.7 11.3 10.5 10.7
Net profit margin (%) 8.4 4.3 7.6 7.1 7.3
Dividend payout (%) 20.6 41.3 16.2 16.9 16.5
Effective tax rate (%) 32.0 49.6 33.2 33.2 33.2
Ebitda/net int exp (x) 110.7 194.4 153.3 115.4 136.0
Net debt/equity (%) (36.8) (60.9) (69.6) (66.9) (68.7)
ROE (%) 33.0 13.8 32.4 26.7 25.7
ROIC (%) 80.6 62.2 604.9 364.7 250.2
EVA®/IC (%) 67.0 48.6 591.3 351.1 236.6
Source: CLSA Asia-Pacific Markets

230 [email protected] 27 June 2011

 
  
 Voltas
Rs156.90 - BUY

Aditya Bhartia Cool player

[email protected] We expect an improved performance from Voltas’ electro-mechanical
(91) 2266505077
products (EMP) business in FY12, as execution improves and its
Rajesh Panjwani subsidiary, Rohini Industrials, breakseven. India’s low penetration of
(852) 26008271 room air conditioners, rising disposable income and improving power
distribution should benefit the company’s unitary cooling products (UCP)
division. Slow order inflows in the Middle East and potential margin
pressure are already reflected in the stock’s valuation at 13.4x FY12 PE.

Challenging FY11
In FY11, electro-mechanical projects (EMP) business disappointed, with
27 June 2011 revenues falling by 2% YoY. The segment’s Ebit margins also fell by 170bps,
to 8.2%, on account of intense pricing competition, rising material costs and
India Rohini Industrials’ losses of Rs310m. Impact were partly offset by strong
Industrials revenue growth in UCP (+31% YoY) and engineering (+21% YoY) businesses.

Reuters VOLT.BO
Bloomberg VOLT IB
Performance should improve in FY12
With management touting breakeven at Rohini Industrials in FY12 and
Priced on 22 June 2011
execution across two large projects in Qatar picking up, the EMP business
India Sensex @ 17,550.6
should show meaningful improvement over the next few quarters. We expect
12M hi/lo Rs262.50/147.35 revenue to rise 13% YoY and Ebit margins to stay flat in FY12. Domestic
order inflows should continue to be strong in FY12, while international orders
12M price target Rs205.00
±% potential +31% should revive by 2HFY12 as large projects (like trans-GCC metro link, Qatar
Target set on 23 May 11 FIFA World Cup) are planned to be awarded in the Middle East.

Shares in issue 330.9m

Free float (est.) 70.0%
Improving power penetration should help air conditioning sales
Strong structural drivers such as low penetration of air conditioners (AC) at
Market cap US$1,158m c.3% (compared to 53% for China), rising disposable income and improving
3M average daily volume power distribution bode well for room AC market in India. We consequently
Rs166.0m (US$3.7m) expect that it should grow at 20-25% annually. This should result in strong
revenue growth for Voltas’ UCP business, especially since it has managed to
Foreign s'holding 11.3%
improve its market share from about 11% in FY04 to c.18% now.
Major shareholders
Tata Group 30.5%
Maintain BUY
DIIs 33.8%
Voltas faces risks of slow international-order booking and margin compression
in the near term but this is already reflected in the company’s valuation of
13.4x FY12 and 10.8x FY13 PE (about a 20% discount to five-year average).
A Middle East revival in order booking should boost the stock price. We
Stock performance (%) maintain our BUY recommendation with a target price of Rs205.
1M 3M 12M
Absolute (3.4) 0.1 (21.8)
Relative 0.9 2.5 (21.0) Financials
Abs (US$) (3.1) 0.1 (19.8) Year to 31 Mar 09A 10A 11CL 12CL 13CL
290 (Rs) Voltas (LHS) (%) 160 Revenue (Rsm) 43,259 48,059 51,768 59,721 69,951
Rel to Sensex
270 150 Net profit (Rsm) 2,516 3,810 3,573 3,860 4,792
250 EPS (Rs) 7.6 11.5 10.8 11.7 14.5
140
230
CL/consensus (24) (EPS%) - - 100 100 105
210 130
190
EPS growth (% YoY) 21.3 51.4 (6.2) 8.0 24.1
120
170 ROE (%) 36.8 40.4 28.5 25.4 26.0
110
150 FCF yield (%) 0.5 6.9 0.6 8.0 7.3
100
130 Net debt/equity (%) (34.2) (39.5) (27.1) (41.0) (46.7)
110 90 PE (x) 20.6 13.6 14.5 13.4 10.8
Jun 09 Feb 10 Oct 10 Jun 11
PB (x) 6.6 4.8 3.8 3.1 2.6
Source: Bloomberg
EV/Ebitda (x) 16.8 9.8 10.1 8.2 6.2
www.clsa.com Source: CLSA Asia-Pacific Markets

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 Voltas - BUY Chindia power

Strong domestic orders; overseas to revive from 2HFY12

Strength led by In FY11, domestic-order booking was strong in the EMP business, at Rs18.7bn
infrastructure and (+29% YoY). Robust order inflows from industrial and infrastructure sectors
industrial sectors
led the growth. However, international order booking disappointed in 2HFY11,
partly due to social unrest in the Middle East. This trend could continue in the
near term. However, Middle East orders should revive beyond 2HFY12 as
certain large projects (trans-GCC metro link, Qatar FIFA World Cup, Abu
Dhabi Airport) are up for bidding.

Order pipeline Order booking

is strong
14 (Rsbn) Domestic International
FY10 FY11
12 Rs24bn Rs32bn

10

0
1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 3QFY11 4QFY11

Source: Voltas, CLSA Asia-Pacific Markets

Outlook for sectors likely to contribute to MEP order flow

Sector Near-term Comments
outlook

Metro trains Positive  Metro under way/planned in Delhi, Mumbai, Bengaluru, Hyderabad, Mumbai, Chennai, Pune, Lucknow, Kanpur,
Ahmedabad, Ludhiana, Kochi, Indore and Chandigarh - total investment of US$40bn over the next 10-15 years.
 In the near term, MEP awards are likely to come from Delhi, Mumbai, Bangalore, Chennai and Kolkata metros.
 In particular, Bangalore, Chennai and Kolkata metro train stations should present a strong MEP potential of around
Rs12bn over the next 18 months. This is because these metros involve construction of underground stations.
 In FY12-13, MEP work on stage three of the Delhi metro should also commence.

Airport Neutral/  Investment in Indian airports, about Rs200bn over the next five years per media articles.
Positive
 Plans of modernising 35 non-metro airports, of this 16 are completed. Some MEP work should result.
 There are 12 greenfield airports planned over next few years. Delays possible but there’s significant MEP potential.
 Progress has been slow in new project awards, especially for greenfields. In the near term, we only expect MEP
project awards for Goa and Port Blair.
 When execution on new airports pick up, it will emerge as a significant MEP opportunity.

Healthcare Positive  A study conducted by FICCI and Ernst & Young suggests that by the end of 2025, India will need 1.75m additional
hospital beds; the public sector is only expected to contribute 15–20% of the US$86bn investment.
 At present, India has only 860 hospital beds per million people, versus the world average of 2,600.
 A significant proportion of hospital construction cost is spent on MEP work since hospitals require different air-
conditioning types for operation theatres, patient rooms and diagnostic centres.

Hospitality Positive  All major hotel chains (such as Starwoods, Marriott, Indian Hotels) plan to add to their hotel portfolio.

Power sector Positive  A total of 26GW in capacity has been added in the XI plan (FY07-12) so far, with a further 20GW under
construction. Target for XII plan (FY12-17) is likely to be about 100GW.
 Total project costs for power plants include 1-3% in electrification and plumbing work.

Education Positive  Currently the education sector accounts for 7% of India’s private consumption.
 We estimate the Kindergarten to grade-12 segment as a US$20bn market and private professional colleges to be
a US$1.7bn market. We anticipate these to have 13-14% and 16-17% Cagrs, respectively, over FY10-12.

Source: Planning Commission, Ministry of Civil Aviation, Metro trains’ websites, media articles, CLSA Asia-Pacific Markets

232 [email protected] 27 June 2011

 
  
 Voltas - BUY Chindia power

Improving power penetration should help room AC sales

India has a low household penetration of ACs, at about 3%. This compares
with 53% for China and more than 80% for more developed countries. As
discussed in Anirudha Dutta’s strategy report Mr and Mrs Asia, penetration
of air conditioners will increase in India, as per-capita income rises.
Moreover, the industry will benefit from wider power distribution across the
country, with strong power generation capacity additions planned over the
next few years. Consequently we believe that single-room AC sales should
grow 20-25% annually. We note that Voltas has improved its market share
from 11% in FY04 to about 18% now.

Air-conditioner penetration vs disposable income Air-conditioner penetration

100 Ownership of air-conditioner (% of household) 120 (%) China Japan USA

90 y = 24.167Ln(x) - 161.44 Japan India Indonesia
Taiwan
R2 = 0.8195 100
80 HK
70 Singapore 80
60
China Korea
50 60
40
40
30
Malaysia
20 Thailand 20
10 Philippines
Indonesia Disposable income per capita (US$)
0 India 0
0 5,000 10,000 15,000 20,000 25,000 30,000 1977 1983 1989 1995 2001 2007 2013 2019

Source: Euromonitor, CLSA Asia-Pacific Markets

Power-capacity addition in India Lower penetration of electrical products in rural areas

(MW) Lifestyle
16,000 11th plan
8th plan 9th plan 10th plan 11%
14,000 12,282 19,015 21,095 c.50,000
12,000
10,000
Income
8,000
23%
6,000 Electricity
4,000 56%

2,000

0 Lifestyle &
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11E
FY12E

income
10%

Source: Ministry of Power, National Council of Applied Economic Research, CLSA Asia-Pacific Markets

Recommendation history – Voltas (VOLT IB)

Date Rec level Closing price Target
23 May 2011 BUY 162.35 205.00
04 February 2011 BUY 181.10 240.00
26 October 2010 BUY 243.60 284.00
Source: CLSA Asia-Pacific Markets

27 June 2011 [email protected] 233

 
  
 Voltas - BUY Chindia power

Summary financials
Year to 31 March 09A 10A 11CL 12CL 13CL
16% revenue and EPS Summary P&L forecast (Rsm)
Cagr over FY11-13 Revenue 43,259 48,059 51,768 59,721 69,951
Op Ebitda 2,831 4,606 4,508 5,189 6,410
Op Ebit 2,621 4,392 4,298 4,945 6,144
Interest income 86 83 87 93 133
Interest expense (128) (98) (165) (160) (120)
Other items 1,137 941 1,025 769 854
Profit before tax 3,717 5,318 5,245 5,647 7,010
Taxation (1,172) (1,472) (1,729) (1,787) (2,218)
Minorities/Pref divs (29) (36) 57 0 0
Net profit 2,516 3,810 3,573 3,860 4,792
Robust cash flow Summary cashflow forecast (Rsm)
generation, thanks to low Operating profit 2,621 4,392 4,298 4,945 6,144
capex and working Operating adjustments 935 956 1,125 769 854
capital needs Depreciation/amortisation 210 214 210 243 266
Working capital changes (1,831) (348) (3,066) 497 (696)
Net interest/taxes/other (1,331) (1,690) (1,729) (1,787) (2,218)
Net operating cashflow 603 3,524 839 4,668 4,349
Capital expenditure (367) 33 (507) (537) (565)
Free cashflow 236 3,557 331 4,130 3,783
Acq/inv/disposals 482 (1,013) 0 0 0
Int, invt & associate div 520 (93) 5 113 138
Net investing cashflow 636 (1,073) (502) (424) (427)
Increase in loans 1,077 (1,463) 994 0 0
Dividends (619) (772) (772) (965) (1,158)
Net equity raised/other (128) (98) (183) (180) (125)
Net financing cashflow 330 (2,333) 39 (1,145) (1,283)
Incr/(decr) in net cash 1,569 119 376 3,098 2,639
Exch rate movements 0 0 0 0 0
Opening cash 3,002 4,571 4,689 5,065 8,163
Closing cash 4,571 4,689 5,065 8,163 10,802
Strong balance sheet Summary balance sheet forecast (Rsm)
Cash & equivalents 4,571 4,689 5,065 8,163 10,802
Debtors 9,521 10,060 11,907 13,139 15,389
Inventories 11,194 11,441 12,942 13,736 15,389
Other current assets 0 0 0 0 0
Fixed assets 2,280 2,262 2,548 2,842 3,141
Intangible assets 675 764 764 764 764
Other term assets 2,203 2,078 2,238 2,582 3,024
Total assets 32,007 33,633 37,803 43,565 50,849
Short-term debt 0 0 0 0 0
Creditors 11,782 11,142 11,907 13,139 14,690
Other current liabs 10,353 11,149 10,827 12,461 14,561
Long-term debt/CBs 1,814 352 1,345 1,345 1,345
Provisions/other LT liabs 0 0 0 0 0
Minorities/other equity 159 139 82 82 82
Shareholder funds 7,897 10,852 13,642 16,537 20,172
Total liabs & equity 32,007 33,633 37,803 43,565 50,849
ROIC better than ROE as Ratio analysis
Voltas earns only modest Revenue growth (% YoY) 35.1 11.1 7.7 15.4 17.1
returns on surplus cash Ebitda growth (% YoY) 11.9 62.7 (2.1) 15.1 23.5
Ebitda margin (%) 6.5 9.6 8.7 8.7 9.2
Net profit margin (%) 5.8 7.9 6.9 6.5 6.8
Dividend payout (%) 21.0 17.4 18.5 21.4 20.7
Effective tax rate (%) 31.5 27.7 33.0 31.6 31.6
Ebitda/net int exp (x) 68.5 295.7 58.0 77.0 0.0
Net debt/equity (%) (34.2) (39.5) (27.1) (41.0) (46.7)
ROE (%) 36.8 40.4 28.5 25.4 26.0
ROIC (%) 76.9 78.9 48.1 44.7 52.8
EVA®/IC (%) 62.4 64.3 33.6 30.1 38.2
Source: CLSA Asia-Pacific Markets

234 [email protected] 27 June 2011

 
  
 Appendices Chindia power

Appendices

1. China’s energy targets ............................................................... 236

2. Indian power Q&A ...................................................................... 237

3. BHEL Management Q&A.............................................................. 244

4. Chindia’s power mix ................................................................... 247

5. Wind power ................................................................................ 255

6. Solar (PV) .................................................................................. 259

7. Power capacity addition trends in India ..................................... 266

8. India power plants under construction....................................... 267

9. India’s coal-asset ownership...................................................... 268

10. Indian state-utilities’ financials................................................ 269

11. Private power distribution in India........................................... 270

12. India’s cross subsidies ............................................................. 272

13. Protests against power projects in India .................................. 273

14. EVA® and SOEs in China............................................................ 274

15. Generation equipment .............................................................. 276

16. India’s T&D equipment outlook ................................................ 285

All prices quoted herein are as at close of business 22 June 2011, unless otherwise stated

27 June 2011 [email protected] 235

 
  
 Appendices Chindia power

Appendix 1: China’s energy targets

Reduce energy intensity China set the following targets for its 12th five year plan to help transition to a
and improve less energy-intensive economy. Responsible departments must make public
environmental protection
yearly progress reports toward meeting key targets, which include:
‰ Decrease energy intensity (energy used per GDP unit) 16% by 2015.
‰ Decrease carbon intensity (carbon emissions per GDP unit) 17% by 2015.
‰ Increase non-fossil fuels as a proportion of primary energy to 11.4% by
2015, from the current 8.3%.
‰ Decrease water intensity (water consumed per unit of value-added
industrial output) 30% by 2015.
‰ Increase the forest coverage rate to 21.66% and forest stock by 600
million cubic meters by 2015.
These also impact new ‰ Increase R&D expenditures from 1.8% to 2.2% of GDP by 2015.
power capacity growth
‰ Decrease sulphur dioxide and chemical oxygen demand (a measure of
water pollution) by an additional 8% by 2015 (these were reduced by
14.29% and 12.45% during the 11th five year plan).
‰ Reduce two key pollutants, nitrogen oxide and ammonia nitrogen, by 10%
by 2015. Reducing industry’s heavy metal pollution is also a key focus.

China may cap energy at At the same time, Chinese energy officials also suggested that under the
4bn TCE for 2015 sectoral energy plan, due out soon, there will be a total energy cap for 2015
of 4 billion tons of coal equivalent (TCE) units. The cap equates to the 16%
energy intensity reduction target at a GDP growth rate of 7.5% per year.
Given the 11.4% non-fossil fuel energy goal, the new target effectively sets
the fossil fuel ceiling at 3.54bn TCE.

Only possible if energy To achieve these targets, China must expand its energy efficiency programs
efficiencies are taken to a large number of companies. Significantly, in the 12th five-year plan the
seriously
1,000 Enterprises Program expands to a 10,000 Enterprises Program. This
recognises the importance of industrial power consumption and the scope of
necessary savings there.

New approaches such as The 12th five-year plan also encourages new approaches to energy and
carbon taxes are also carbon savings. These include encouraging experiments with market-based
being considered
mechanisms, such as a cap and trade system and carbon taxes. They also
include new approaches to energy efficiency, such as demand-side
management and encouraging Energy Service Companies (ESCOs).

China is holding firm to its China’s goals are in line with commitments it made at Copenhagen and then
commitment to reduce reaffirmed at the Cancun climate change conferences. These were:
carbon intensity by 2020
‰ To reduce carbon intensity by 40-45% by 2020, as compared to 2005.
‰ To increase the non-fossil fuels share of its energy mix to 15% by 2020.
‰ To increase domestic forest cover by 40 million hectares and forest-stock
volume by 1.3 billion cubic meters by 2020, over a 2005 baseline.

Improving service sector Its economic targets tie in with its energy targets. China aims to raise the
will help China lower share of service sector value-added output to 47% of GDP, up 4ppt, as well as
energy intensity
raise domestic consumption.

236 [email protected] 27 June 2011

 
  
 Appendices Chindia power

Appendix 2: Indian power Q&A

Question How are your upcoming projects placed in terms of fuel security? For
the projects that are based on domestic coal linkages, how much coal
do you expect to get from Coal India and how do you plan to source
the remaining coal? What proportion of coal (for domestic linkage
based projects) will you import over FY12-14?
Tata Power Projects the company has under construction are fully secured on the fuel
front. There is an offtake agreement for 8-11mt with KPC (Kaltim Prima
Coal), which is sufficient for the Coastal Gujarat Power Limited (SPV for
Mundra project) plant's requirements. Maithon would source 1.66mt per
annum from Bharat Coking Coal Limited (BCCL), 1.98mt per annum from
Central Coalfields Limited (CCL) and 0.05 - 1mt per annum from Tata Steel.
The agreement with Tata Steel takes care of any shortfall from CCL. Please
note that the regulated model permits complete pass through of fuel costs to
the customer (subject to procurer consent), which permits us to purchase
domestic coal to fulfill any gap. We could also import coal for Maithon
although we do not feel that it will be required.
Lanco The current installed capacity of the group stands at 3.2GW, which would
reach about 4GW in a couple of months. Of the 4GW, 3GW is coal based
capacity; imported coal supplies 1.2GW and the balance 1.8GW is based on
domestic coal. Further coal based capacity additions only happen in FY14 with
the likes of Amarkantak III and IV, Babandh and Vidarbha (all 1,320MW)
coming into operation.
Based on our estimates, we are confident of receiving close to 70% of our
coal requirement from domestic sources and the remaining 30% will be
imported. Over FY12-14, a large chunk of our coal requirement will be met
from imported coal, as 1.2 GW of the existing capacity is based on imported
coal. This requirement has been tied up on a long-term contract basis and is
on a pass through mechanism. The major requirement of imported coal will
hit us in FY14 when a larger coal based capacity comes into operation and
that is the time when imported coal requirements will be met from the Griffin
mines. With the acquisition of a mine in Australia and long-term tie-ups, we
can manage our portfolio efficiently.
NTPC For 13 out of 15 existing projects, in operation as at 31 March 2009, NTPC
has fuel supply agreements with Coal India. Two power stations receive coal
pursuant to coal supply allocated by the Ministry of Coal, pending finalisation
of Fuel Supply Agreement (FSA). These agreements are effective for a period
of 20 years from 1 April 2009. For the new projects, which are super-critical
machines and which are awarded through bulk tenders, as per the approval of
the Union Cabinet, directions have been sent to allocate coal to these
projects. Four Projects, totaling 5940MW already have coal allocation.
NTPC established a mechanism for coal imports to the tune of 16 million tons
in FY2011-12 and it has also established a mechanism for buying coal
through e-auction, bilateral agreement with coal companies, etc. NTPC has
also been allocated six coal mining blocks and extraction of coal from the first
mine will start in 2012. These mines are expected to meet around 20-25% of
NTPC’s coal requirement. Therefore, NTPC does not see any threat in fuel
security. Further, NTPC is also taking steps to identify and acquire coal mines
abroad. Discussions and negotiations in this regard are in advanced stages in
Australia, Indonesia, Botswania, Mozambeque, etc.
CESC Currently two new projects are under implementation - Chandrapur 600MW and
Haldia 600MW. Both projects have coal linkage from Coal India subsidiaries. As
such, in CESC we ensure near full materialisation of contracted quantity of coal

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from CIL subsidiaries and a small quantum is imported for blending purposes.
Similar models can be followed for upcoming projects as well. More so, we have
also tie-ups with overseas mining sources to ensure fuel security.
Adani Power In the first phase of our expansion plans, we are setting up 4,620MW capacity
in Mundra, Gujarat and 1,980MW capacity at Tiroda, Maharashtra. For the
Mundra projects we will use a combination of domestic and imported coal. We
will need 17.4mt per annum of coal (when all of 4.6GW is up and running), of
which we plan to import 7.4mt (through Adani Enterprises) and source the
balance 10mt via Coal India linkages. Tiroda is a domestic coal based project
and we have coal linkages from South Eeastern Coalfields Limited /Western
Coalfields Limited (Coal India subsidiaries) in the form of long term/tapering
linkages. Our total requirement for the first phase of 1,980MW would be
about 8mtpa. We will be looking to operate the Tiroda plant mostly on
domestic coal but if there is need we might go for partial blending with e-
auction/imported coal. We are expanding our Tiroda project by setting up
another 1,320MW at the same location and we have another greenfield
project under development in Kawai, Rajasthan. We have applied for linkages
for both these projects.

Question We have seen recently that power demand has been very elastic to
power tariffs. Do you foresee a situation in which it would be difficult
to sell power unless reasonably priced? What could be a sustainable
power tariff in your view?
Tata Power The company's exposure to the merchant market is smaller than other
companies - about 7%. The merchant market had tempered and had seemed
to have settled around Rs.3.50 - 4 per kWh - there is adequate demand, but
the lack of commitment of SEBs to provide uninterrupted power because of
poor efficiency and lack of funds with the SEBs seems to make them prefer to
load shed. With increasing dependence on imported coal, the long term price
would depend on imported coal prices.
Lanco Definitely India is a price sensitive country and power is no exception. With
increasing uncertainty on various fronts and majorly with fuel, we have seen
increasing trends in power tariff bids. We feel sustainable long-term prices
will be near to the regulated price.
NTPC The country still faces acute shortage of electricity. The energy deficit in the
year 2010-11 was 8.5% and the peak deficit was 10.3%. Though a downward
movement of the deficit was observed in recent years, given the expected
growth rate of the economy in the 8.0% to 9.0% range, the deficit could
widen further, if sufficient capacity addition does not happen at a faster rate.
With the prevailing shortage scenario, there are not many options available
for the distribution utilities for selecting the sources of supply of their choice.
When available, the utilities do avail cheaper options like hydro power, mainly
during the monsoon period. But this is a seasonal or occasional phenomenon
as can be seen from the average price data of electricity in the short-term
market. Though the price was falling from the peak level seen April 2009, it
has again started rising in the past two to three months.
NTPC operates as one of the lowest cost operators and therefore has not
seen any significant stranding of its plants. A total of 10 out of 15 coal
based NTPC plants are set up as pit-head stations, having lower fuel costs.
NTPC’s tariff structure provides for a full recovery of capacity charges and
incentive components based on availability of the stations. This does not
get impacted, even during the period when the units are not scheduled for
drawl by the customer.

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CESC Currently, we supply power under a West Bengal Eelctrciity Regulatory

Commission (WBERC) framework where we make regulatory returns and
certain incentives. For our upcoming projects, a large quantity of power would
be sold under long-term PPA / case-1 bids where the prices are highly
competitive. We would keep a sizeable portion of the power open for
Merchant market operations. The mix would be maintained in a judicious
manner to ensure recovery of fixed costs and flexibility on higher returns.

Adani Power We realised a merchant tariff of Rs4.77/kWh in FY11 and we have taken steps
to sell our untied capacity at a decent tariff in FY12. We have a letter of
award (LOA) with Uttar Pradesh (UP) to sell 600MW of power at Rs4.7/kWh
(at UP bus bar) for one year starting June 2011. Similarly we have tied up
800MW of power at Rs4.1kWh (at Maharashtra bus bar) with Maharashtra for
a period of one year and one day.

Question Given the propensity of state utilities to back down on power

purchases (especially in non-election periods) is there a risk to tariffs
and/or merchant-power-capacity utilisation levels in the country?
What are reasonable tariffs and utilisations rates for merchant power
going forward in your view?
Tata Power We have not been overly optimistic in terms of the merchant market rates
particularly because there is no oversight on SAIDI (System Average
Interruption Duration Index), SAIFI (System Average Interruption Frequency
Index) and the quality of power, as responsibility is cast upon most of the
state distributors and hence the amount of load shedding would generally not
reflect true need. While we think there is adequate unfulfilled demand,
utilisation levels are dependent on the quality of supply, oversight and
financial strength of the SEBs, assuming the tariff is reasonable. We expect
merchant tariffs to be below Rs4.00 for the next few months.
Lanco Given the financial health of the state utilities they have been reluctant to buy
power at high rates but that doesn’t mean the utilities will not be buying
merchant power in today’s deficit scenario. Last year was an exception with
the exceptionally good and extended monsoon, which led to higher
generation from Hydro capacity, which met a lot of utilities’ demand. Even
with all odds, most of the power generators are able to finish FY11 with a
merchant (bilateral) realisation of around Rs4.50 per unit. We are not
foreseeing days of over Rs6.00 per unit average realisation, instead we are
expecting utilities to continue to be buyers at around Rs4.00/unit until FY14
when the general elections are scheduled and the country would remain to be
in a deficit state. There after, the merchant prices should come off and match
the long-term prices in the long run.
In terms of utilisation levels, barring coal issues, we expect merchant plants
to operate at around the same levels as the long-term PPA plants in the near
to short term. However, the merchant plants could take a hit on utilisation
levels in the long run.
NTPC Of the total installed capacity of 34,194MW, NTPC has 150MW for selling
through merchant power routes.
Due to availability of cheaper power during the monsoon season, there is a
low demand for the merchant power at that point of time. However, it does
not affect NTPC because its Merchant Power capacity is less than 0.5% of our
capacity. Further, we have already contracted part of the merchant power
capacity on a long term basis through MoU.

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Further, as far as NTPC is concerned, our business model is based on the long
term contracts with the utilities and distribution companies, which ensures
higher utilisation of our generation capacity.
CESC Even if such propensity existed for some time, it cannot be generalised as
such and given the security mechanism generally built into PPAs;
apprehension may be somewhat unfounded.
Adani Power We don’t see the states backing down as a trend. Even last year we had a PLF
of 85% for a year as a whole and we couldn’t have achieved that had there
been any significant backing down by states. We believe there is enough
power demand and people are willing to pay for it. We have already tied up
about 85% (on a Net basis) of our planned capacity in long term PPAs so our
utilisation rates are not too dependent on merchant power. Our short-term
PPAs, as mentioned above, is in the range of Rs4.1-4.7/kWh for the next one
year for about 1,400MW capacity.

Question How safe are your PPAs? Do you have default escrows in place if SEBs
default? With domestic coal shortages would you be allowed to show
availability based on imported coal for tariff recovery?
Tata Power The Company's experience with its PPAs has been reasonable and no change
is expected in this, given the quality of our off takers, for both the regulatory
and captive power space and competitiveness of our generation. The terms
of the PPA for both Mundra and Maithon require a letter of credit (LC) and an
escrow account to be in place. Maithon is the only project that we have on
domestic coal in the regulated space - we would be free to show availability
on imported coal, assuming we get permission from the procurers.
Lanco Till this time, SEBs have not defaulted on the payment and in fact, they are
regularly claiming early payment rebates. In our opinion they will claim early
payment rebates in future also by clearing dues on time. Definitely, there are
some provisions available in case of default but that may be different from
project to project.
Availability based on imported coal depends on each PPA. We are trying to
ensure availability based on imported coal by incorporating relevant
provisions wherever we entering into long-term PPA’s.
NTPC The capacity of each power station owned by NTPC is contracted to various
customers under the PPAs.
NTPC has taken sufficient measures to protect its receivables from the SEBs.
NTPC enters into long-term contracts with SEBs and their successive entities
for guaranteed off-take of output from the stations before commencement of
the projects. Nearly 90% of our sales of electricity are to SEBs and state
owned distribution companies, for which payments are secured through LC
and Tripartite Agreements, signed between the Government of India, Reserve
Bank of India and State Governments. The Tripartite Agreement, which is
available upto 2016, is an effective mechanism for settlement of overdues in
case of default in payments to NTPC by the SEBs. With these measures in
place, NTPC has been able to realise 100% of its current bills for the eighth
successive year in 2010-11.
Beyond 2016, our sales are secured through supplementary agreements with
our customers, under which customers have agreed to create a first charge
on their own receivables in our favour and, in the event of a payment default,
assign such receivables into an escrow account.
Our PPAs provide for recovery of energy charges based on actual cost and
normative parameters. The Central Electricity Regulatory Commission does

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not prohibit usage of import coal and the tariff of our stations takes into
account the actual cost of coal consumed for generation of electricity. In the
tariff, there is no distinction with respect to the source of coal used.
However, there is a technical limit to the use of imported coal in the present
generation of boilers, which have been designed to make them suitable for
Indian coal. Recently, CEA wrote a letter to all the manufactures of boilers
and project developers to adopt the design to make boilers suitable for higher
percentage of imported coal.
CESC Since we are a distribution entity, currently, we do not have any PPA for
selling any power outside our licence area. Also we are not facing any major
issue in coal availability for our operational power plants.
Adani Power Presently we receive our payments within seven to nine days under a long-
term PPA. Thus our experience is very good. Further, our long term PPAs have
three-tier safety features: States establish an LC for one month of the invoice;
default escrow where the receivables from the end user are collected - this is
used once the first step fails; and an option to sell power to a third party.

Question Apart from coal shortages, transportation bottlenecks for coal are
also becoming a serious issue. Do you think any of your projects
could be impacted by lack of transportation capacity - even if coal
(domestic or imported) were to be available?
Tata Power For both Mundra and Maithon, transport is not expected to pose any problems.
Until the rail line is set up in Maithon, we will transport coal by road - it is a
short distance of about 17km and the transport contracts are in place.
Lanco Transportation bottlenecks for coal is definitely a contentious issue today and
for the same reason our strategy has been to set up the power plants closer
to the mines, ones which are based on domestic coal and in the coastal areas
where the fuel is imported.
NTPC For transportation of coal to Pithead stations, NTPC uses its own dedicated
Merry-Go-round (MGR) railway system and almost 60% of the total coal
requirement is supplied through this MGR system. For other stations, railway
logistics are in position for transportation of coal. For future power stations,
coal linkages from a particular mine are accorded only after ensuring
transportation logistics.
However, for Farakka and Kahalgaon in the eastern region where the linked
mines could not be fully developed, part of the coal requirement is to be met
with procurement of coal from other sources. For transportation of this coal,
congestion in the railway network is being faced. NTPC is mitigating this
problem by constantly interacting with Railways.
Further, NTPC in association with Inland Waterways Authority of India (IWAI)
has taken initiatives to start transportation of imported coal through inland
waterways (National Waterways - 1) to Farakka STPP. The process of selection
of an operator for unloading the coal from ocean going vessels and
transporting it through waterways to Farakka STPP is in progress.
CESC We do not face any major transport bottlenecks. For our upcoming projects
also we do not forsee any major issue from a transport point of view.

Adani Power Our project locations have been selected taking into account the logistics
requirements. We have not faced any constraints in our operations so far and
neither do we expect any. For our projects which are far away from the coast
lines, like Tiroda and Kawai, we intend to use only domestic coal. If there is
need, we might use e-auction coal for these projects on a very limited basis.

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Question SEB finances have been deteriorating every year. Have you re-
assessed your expansion plans and spilt between long-term and
merchant composition of assets because of this?
Tata Power We have been circumspect on the merchant space. Our expansion plans are
not predicated on the merchant market.
Lanco It is true that the SEB finances have been deteriorating but they have been
weak for quite some time now. In spite of the weak financials, there is no
delay; forget about default in the payment to generators. In terms of
expansion plans, we have not stopped further expansion as we are confident
the government would take adequate steps to improve the power business
environment, though we are keeping a close eye on the developments in the
space and devising our strategy accordingly. In terms of a split between long
term and merchant composition, gradually we are shifting from merchant to
long term as we are anticipating that the merchant rates will converge
towards long-term rates by FY14 not just for the deteriorating utilities
financials but other factors as well.
CESC Currently, we do not sell power to SEBs under PPA. For our Haldia 600MW
project, 75% of the power would be sold to CESC itself under a long-term PPA
and in the Chandrapur project, we are in an advanced stage of tie-up of
around 50% power under a long-term PPA.
Adani Power Most of the state utilities have filed revised tariff petitions reducing
deterioration of SEBs. Currently we haven’t changed our plans.

Question The two most discussed solutions for solving the SEB losses problem
have been privatisation of distribution and open access for industrial
consumers. What are your thoughts regarding both?
Tata Power We are open to distribution opportunities and would evaluate the model used
before we bid. Privatisation of distribution and distribution reform is essential.
Open access for industrial customers would be a first step in this direction.
Lanco We have been propagating the same for some time now and would also add
tariff hikes as a possible solution for the problem. Privatisation will help to
bring in efficiency in the system and help bring down transmission &
distribution (T&D) losses, which account for the larger part of SEB losses.
Though a few steps have already been taken by privatisation of few circles,
still the final format of privatisation is still under evaluation and will take time
before we get to see the fruits of the same on a larger level. In Open access,
though there are now provisions laid out for it, we have made very little
progress and it will take time to implement the open access in a true sense.
NTPC NTPC is a generating company and it has won several laurels for its efficient
and professional operations. Transmission and distribution are not the core
business of NTPC and, therefore, it would not be fair on our part to comment
on these issues. However, NTPC feels that making available reliable and 24 x
7 power to any consumer would automatically yield good results for the
distributor. Distributors are regularly striving for this and making several
improvements in their distribution system by implementing “Open Access”
and giving options to consumers to access power at differential rates. We
have seen many success stories and a few failures also, for which state
governments are consistently sharing their experiences and improving their
systems because it has now been widely acknowledged that economic
development at the rate of 8-9% growth will only be possible if the growth in
the power sector matches the same.
CESC The Government needs to do a lot of work for privatisation of distribution
areas and for open access. In the future, we believe that there would be a

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strong open access regime, highly liquid power exchanges and a large
number of power trading companies which would make a strong and vibrant
market for power in the country.

Question What percent of blending imported coal can your equipment (which is
designed for domestic coal) support?
Tata Power This is dependent on the boiler and configuration of the balance of the plant.
We are confident that we can use blending quite flexibly, once we light them
up and test it. However there would be an odd impact on the heat rate.
Lanco Generally, a power plant can take a certain percent to design capacity. So, it
depends on the individual boiler configuration and the characteristics of
domestic coal and imported coal. If we are importing 4700-kcal coal and
blending it with 3500-Kcal coal, than we can blend imported coal in higher
proportion than a imported coal with 6000 Kcal. So, in definite terms, it’s
difficult to quantify the proportion as it depends, boiler to boiler and coal to
coal. Roughly, say a boiler is designed for a 3500-kcal coal, it can take coal
with a blended gcv of 3000-4000 kcal.
NTPC At the moment, our present installed equipments can blend imported coal up
to 20%. However, we are upgrading equipment for our future plants to allow
up to 30% blending. We feel that this is adequate because the cost of
imported coal is much higher than the domestic coal and blending beyond this
would not be economically viable for the ultimate consumer.
CESC Our upcoming plants are designed to take around 30% imported coal.
Adani Power All plants are designed to accept blended coal as well.

Question Your company has one of the largest portfolios of green energy in the
country. What are you targets for wind and solar power over next few
years? How are the returns on these projects compared to
conventional power projects?
Tata Power We hope to add 300MW of solar capacity over the next fiver years and about
100-200MW of wind every year. Returns on a standalone basis would be
about 15% for solar projects and 10-12% for wind projects. Wind returns,
considering tax depreciation, would be considerably higher.

Question Is power distribution an attractive proposition for the private sector?

We saw recently that even so called ‘successes’ in Delhi and Mumbai
are reeling with huge regulatory assets on their balance sheets?
CESC The power distribution business would be attractive to private sector only if
the regulatory mechanism is independent and is guided by the laid down
principles and the regulations. There should not be any interference from the
state government in the decisions of the regulator and it should allow
justifiable returns to the distribution entities.
Adani Power Presently we do not have any firm plans for this business.

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Appendix 3: BHEL Management Q&A

Question Over the last couple of years, 20-30GW of annual equipment (BTG)
orders were placed in the industry, of which BHEL won 14-16GW. Do
you think coal shortages will slow power-capacity additions in India?
Power capacity additions The country needs power capacity in order to continue growing at over 8%
and BTG orders annually. We think coal shortages are a short-term issue and should be
resolved in due course. Until then, there is a strong pipeline of projects that
have faced delays and should be awarded in FY12.

We already guided for 14-16GW in new orders for FY12. Improvement in

market share for super-critical projects also helps us achieve this. For
instance, BHEL is L1 for two Rajasthan utility projects and has recently won
an order for three 660MW units in Bajaj Hindusthan. Moreover, the next few
quarters will see further bulk-tender awards from NTPC.

CLSA comment BHEL met order flow guidance in FY11 despite delays in NTPC’s bulk-tender
awards and Rajasthan utility orders. We believe order flows will remain strong
over FY12-13 at about Rs635bn, though our project-by-project analysis
suggests higher levels are possible. Order inflows should be led by the two
NTPC bulk tenders and orders from SEBs with which BHEL has JVs.

Question How do you see the split between public & private-sector projects
in FY12?
Public/private sector split There are some large public sector projects that should be awarded. We
expect that the two NTPC bulk tenders (11 x 660MW and 9 x 800MW) should
be awarded in FY12. Projects for electrostatic precipitators (ESPs) will also get
awarded, in addition to the BTG sets. We also expect the Tamil Nadu
government, with which we already have a JV, could place an order (2 x
800MW). In the private sector, we are not seeing any slowdown in project
award actively. Therefore, there will be a healthy mix of private and public
sector orders in FY12.

CLSA comment We estimate that the two NTPC bulk tenders could contribute about Rs120bn
to BHEL’s order flow, while an EPC order for 2 x 800MW by a SEB with which
BHEL has a JV can add another Rs80bn. In addition, BHEL is the L1 for two
Rajasthan projects (Suratgarh and Karchana), which are together valued at
Rs110-120bn. On the private sector side, BHEL is in discussions with a
number of IPPs (like Jaiprakash, Visa Power, JSPL, DB Power etc);
consequently orders should remain strong.

Question How competitive is BHEL in executing super-critical projects? Will

imported components be significantly higher for super-critical
equipment in comparison to sub-critical parts?
Super-critical orders BHEL has strong competitive advantages over smaller players and new
entrants in the super-critical space. BHEL’s import component for super-
critical projects will be higher than with sub-critical ones, initially, but will
gradually come down as we indigenise technology. Conversely, import
components for new entrants will remain significantly higher than ours, as
they will procure components from their foreign JV partners.

CLSA comment BHEL will largely localise super-critical technology by FY13-14, when it starts
becoming a meaningful part of revenue. Consequently, the level of imported
components lessens. On the other hand, new entrants like Thermax (JV with
B&W), BGR (JV with Hitachi), Bharat Forge (JV with Alstom) etc will all have
higher import quantities, bought from their JV partners.

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Question Some recent BHEL order wins came from independent power
producers (IPP) that are not very large and relatively inexperienced
in power generation. Is there a risk that BHEL’s current order backlog
might not get executed at the same pace as expected?
Inexperienced and BHEL does not count any project in the backlog unless it is financially closed
relatively smaller IPPs and an advance has been received. For instance, we received a Rs5bn
advance from Bajaj Hindusthan order. BHEL also does due diligence for
projects by speaking to lenders, evaluating promoters’ profiles etc. So, we are
confident that there should not be any significant delay from IPP projects.

Question Alstom and Shanghai Electric (SEC) formed a JV to supply boilers

globally. Given that BHEL has a technology-transfer agreement with
Alstom, which gives it exclusivity to sell once-through boilers in
India, how do you see the scenario panning out? Alstom management
has commented that their JV will also supply boilers to India.
Alstom-SEC JV The Alstom-SEC JV cannot supply once-through type boilers in India for the
same technology for which Alstom and BHEL have a technology-transfer
agreement. They can continue to sell boilers of different technologies. For
instance, both Alstom and SEC separately supply boilers in India currently
and they can continue to do that.

CLSA comment It is highly unlikely the Alstom-SEC JV will not service the large Indian
equipment market. Moreover, SEC has taken a number of orders from Indian
IPPs (like Reliance Infra) and will have to continue supplying India in order to
honour its commitments.

Question Are you still contemplating setting up a Non-Banking Financial

Company (NBFC)? What is the rationale?
NBFC The board had recommended some changes when we submitted our last
proposal. We will go back to the board once we have made those
modifications.

The NBFC business will help us generate higher returns, compared to the 6-
6.5% that we currently generate on surplus cash parked in government
securities. Moreover, the NBFC will help BHEL win more equipment orders.

Question Does BHEL plan to enter into more JVs with state governments?
What’s the strategy here?
JVs with state BHEL has already received a 3 x 800MW order from the Karnataka JV and we
governments expect that a 2 x 800MW order from the Tamil Nadu JV should also come
through in FY12. In addition, we have JVs with the Madhya Pradesh and
Maharashtra governments and look to enter more JVs in FY12.

CLSA comment BHEL is in discussions with West Bengal, Jharkhand and Orissa state
governments to form JVs. The size of projects for which BHEL enters into JVs
is generally large (1,600-2,400MW). Moreover, these projects are typically
awarded on an EPC basis, which means that order values for each is
significant, at Rs80-120bn. Orders from these projects, along with NTPC bulk
tenders, present reasonably strong visibility over the next two years.

Question How do you see the outlook for the industrial business?
Industrial business We see strong growth in the transport business, and it could reach the levels
of power in 10 years or so. We can supply locomotives equal to the Indian
Railways’ own factories. BHEL is bidding with GE for diesel locomotives and
with Alstom for Insulated Gate Bipolar Transistor (IGBT)-based locomotives
and propulsion systems, which can be upgrade to 12,000 HP for Electrical

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Motor Units (EMUs). Indian Railways’ vision document names BHEL as a

source for procuring 200 locomotives annually. Currently we supply only
about 50-60 locomotives a year.

The captive power business will also grow strongly because captive plants are
becoming bigger. Last year was a good year for us on the transmission side,
with BHEL winning the first HVDC order in India, in consortium with ABB. On
the renewable business, as discussed earlier, we expect slow progress in the
near term, but this can pick up sharply in a couple of years. The company is
also looking to expand its defence business.

Question Do you see the Fukushima accident tapering India’s nuclear plans?
Nuclear business India’s plan of having 20GW of nuclear capacity by 2020 is likely to go
through. The Prime Minister has reinforced this belief time and again. BHEL
already has an order for two 700MW nuclear generator sets. We expect eight
units to get awarded to our BHEL-NPCIL JV over the next three years or so.

Question You recently bagged some solar orders. Is that going to be a focus
area going forward?
Solar opportunity Yes, BHEL has entered into a strategic alliance with BEL for formation of a JV
setting up manufacturing a facility (240 MW) for silicon wafers, solar cells and
modules. BHEL has also signed an agreement with Abengoa (Spain) for
providing mirrors, heat exchangers etc for solar thermal plants. BHEL has
larger plans in solar power and would expand the business in a modular
fashion. We believe that while initial offtake for solar is likely to be slow, the
business has strong long-term potential.

Question What kind of revenue growth do you expect over the next couple of
years?
Revenue growth The current order backlog should guarantee 15-20% annual revenue growth
over the next couple of years.

CLSA comment We expect 17% revenue Cagr over FY11-14 and BHEL’s current order backlog
provides revenue visibility until FY14. Even at the end of FY14, BHEL will have
a healthy backlog-to-revenue ratio of about 3x.

Question Do you think that pricing pressure will squeeze margins?

Margins Pricing pressure has always been there. BHEL has been competing with
Chinese companies for about five years now, and is still able to sustain or
improve its margins. Increasing revenue will give us operating leverage
benefits, and with wages settled until FY17, employee costs as a percentage
of sales should fall. Moreover, localisation for super-critical equipment is
increasing.

CLSA comment We build in Ebitda margins improving by 150bps over FY11-14 despite an
increase in material costs, on account of employee and overhead costs
dropping as a percentage of revenue.

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Appendix 4: Chindia’s power mix

China will reduce the Chindia is set for a dramatic change in power mix over the next decade as the
share of coal in its power two giants of Asia move in opposite directions to meet their respective power
mix
needs. In China, the main concern will be minimising CO2 emissions by
reducing the share of coal in its energy mix. In order to achieve this, we
believe China will increase the share of no/low carbon-energy generation
capacity like hydro, nuclear, wind, solar, biomass, waste to energy and others
from the current 29% to 34% by 2015 and 38% by 2020.

While in India coal-fired On the other hand, in India, the priority will be increasing base load and
power capacity will rise overall power generation capacity to reduce the chronic power shortages.
Share of wind power in India’s capacity is already at 8% and scope for this
to increase is limited given meagre wind resources compared to those in
China. The pace of nuclear power development in India will also be slower.
There is big scope for expansion of solar power which should take off in a
next few years. However, in the near to medium term India will focus on
thermal power additions and coal power capacity will rise from 54% in FY11
to 62% in FY21.

China’s power capacity mix 2010-2020

2010 2015 Waste 2020 WTE
Fuel oil Waste gases
Fuel oil gases etc. Biomass 1% Waste
1% etc.
Gas 1% 1% 1% gases etc.
1% Gas Hydro Gas 1%
3%
3% 20% 4%

Hydro Nuclear Hydro Nuclear

22% Nuclear 19%
2% 3%
1%

Wind Wind Wind

3% 8% 11%
Coal
Coal Coal
64%
69% Solar 57% Solar
1% 3%

India’s power capacity mix 2010-2020

2010 Other 2015 Other Other
2020
renewables renewables Wind renewables
2% 2.2% 10.9% 3.1%
Wind
Wind
10.3%
8%
Hydro Hydro
16.2% 13.1%
Hydro
22% Coal
Coal Nuclear
Nuclear 61.5%
Nuclear 54% Coal 4.2%
3.0%
3% 58.9% Diesel
Diesel
Diesel 0.3%
0.4%
1% Gas Gas Gas
10% 8.9% 6.9%

Source: CEA, CLSA Asia-Pacific Markets

India is 10 years behind We forecast that by FY21, 82% of India’s power generation will come from
China in its power mix thermal energy sources, which will account for 69% of installed capacity. By
development
contrast, thermal sources of power generation in China will fall from 81%
currently to less than 74% by 2020. We believe China has already peaked out
in terms of thermal energy’s share of the power generation mix last year and
is now set to shrink. In many ways, India is where China was ten years ago in
its power development cycle.

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Solar power has the What can help improve India’s power mix substantially is solar power. India
potential to change has very high solarity and in the next few years solar power can achieve grid
India’s power mix
parity in some regions in the country. Some states have already announced
aggressive plans for solar power. We are factoring in moderate increases in
solar power in India but this could be much higher.

China: A leaner and greener power sector

Coal power capacity Overall we expect a dramatic change in the profile of China’s power sector. By
share to fall sharply 2015 we forecast the share of coal-power capacity to decline to 74% from
78% in 2010 and then to 68% by 2020.

Wind power will Wind power will witness the highest increase in the capacity share among all
witness a significant available technologies - rising from 3% in 2010 to 8% in 2015. This is based
increase
on already aggressive ramp up in capacity additions and it being the most
economic source of renewable power generation in China.

Nuclear power will see Nuclear power generation is also in for a substantial pickup due to much
temporary slowdowns in higher utilisation levels (over 80%) compared with less than 35% for wind
capacity additions . . .
and solar. Thus, despite nuclear’s share of capacity remaining around 2-3%
for the next decade, we anticipate its share of generation to rise to 3% of by
2015 and 4.2% by 2020.

. . . but will still rise to Although the recent turmoil in Japan’s Fukushima Daiichi nuclear plant has
7% of power generated forced China to suspend new starts for most of 2011, the government has
by 2030
indicated that it will resume new starts after the safety planning is complete.
We forecast nuclear’s share of power generation to rise to 7% by 2030.

Solar will rise from a We expect solar to account for 0.3% of total power capacity by 2015 and
(very) small base 1.0%% by 2020. Natural gas capacity is also set to increase its share - from
2.8% in 2010 to over 4% in 2020. We believe the share of biomass and waste
to energy power capacity will expand from a share of 0.4% in 2010 to 0.8%
in 2015 and nearly 1.6% by 2020. Like in India, we expect big upside
potential to share of solar power in China, which will depend on technology
breakthroughs and cost reduction.

China’s mix of power generation

Fuel Waste to Biomass Waste to Biomass Waste to

Wast 0.4% Energy 0.4% Energy 1.0% Energy
0.1% Fuel 0.2% Wast Wast
heat/gas Fuel 0.5%
Biomass 0.3% heat/gas heat/gas
0.4% 0.2%
0.1% Gas 0.3% 0.3%
2.9% Nuclear Gas
Gas Nuclear Hydro
Hydro 3.3% 3.7% Hydro Nuclear
2.6% 1.8% 15.3%
16.2% 14.8% 4.9%
Wind
Wind 3.7% Wind
1.2% 5.6%
Solar
Coal 0.4% Coal Solar
Coal
73.2% 67.9% 1.1%
77.1%

2010 2020
2015

Source: CEIC, CLSA Asia-Pacific Markets

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China’s capacity grwoth is China - Power capacity addition across the plan periods
flat from the 12th FYP to
the 13th FYP 600,000 (MW) Thermal Hydro Wind Nuclear Solar

500,000

400,000

300,000

200,000

100,000

0
11th Plan 12th Plan 13th Plan
Source: CEC, CLSA Asia-Pacific Markets

India is in a higher India - Power capacity addition across the plan periods
growth phase than China
140,000 (MW) Coal Gas Nuclear Hydro Renewables
120,000

100,000

80,000

60,000

40,000

20,000

0
11th Plan 12th Plan 13th Plan
Source: CLSA Asia-Pacific Markets

China added 16.5GW of The move to green up the power mix has begun in earnest. In 2010, China
wind capacity in 2010 added 13.5GW of grid connected wind-power capacity and 16.5GW in
total, the highest in the world, up 20% over 2009. In 2010, China
surpassed the United States to have the highest installed wind-power
capacity in the world. China has not yet begun building solar plants with
the same gusto but we expect the falling prices to soon trigger a sharp
increase in solar-power installations.

Renewables and nuclear China’s capacity additions

are a growing part
of the energy mix 120,000 (MW) Thermal Hydro Wind Solar Nuclear

100,000

80,000

60,000

40,000

20,000

0
11CL

12CL

13CL

14CL

15CL

16CL

17CL

18CL

19CL

20CL
2005

2006

2007

2008

2009

2010

Source: CEC, CLSA Asia-Pacific Markets

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The government has also announced policies to aggressively promote waste

to energy and biomass projects and we expect a sharp growth in capacity for
these too. We also forecast a sharp increase in natural gas-based power
capacity addition from 27GW in 2010 to 75GW by 2020. There is upside risk if
supply manages to evolve more quickly than expected.

China’s power mix China’s total capacity trend by type

in for a big change
2,000,000 (MW) Thermal Hydro Nuclear Wind Solar
1,800,000
1,600,000
1,400,000
1,200,000
1,000,000
800,000
600,000
400,000
200,000
0

11CL

12CL

13CL

14CL

15CL

16CL

17CL

18CL

19CL

20CL
2005

2006

2007

2008

2009

2010

Source: CEC, CLSA Asia-Pacific Markets

Solar will grow the most China's installed capacity forecast (GW)
but from a small base Year 2010 11CL 12CL 13CL 14CL 15CL 20CL
Total capacity 962 1,060 1,161 1,267 1,370 1,474 1,976
Coal 656 716 774 831 879 925 1,134
Gas 27 30 33 36 40 45 75
Fuel oil 8 8 8 8 8 8 8
Hydro 213 228 244 261 280 300 370
Nuclear 11 12 15 20 26 32 56
Wind 31 47 64 82 101 120 227
Solar 1 2 3 7 11 17 55
Others 16 17 19 21 24 27 51
Source: CEC, CLSA Asia-Pacific Markets

Our total installed power capacity addition target for China is slightly higher
than that by government body China Electricity Council. By 2015 we estimate
higher capacity addition than government for coal, wind, gas and solar power
capacity. Even in the longer run we expect higher capacity addition for
renewables and gas compared to government estimates.

Most of our estimates are China power capacity - government targets versus CLSA estimates
more aggresive than the Capacity mix 2015 2020
government’s . . .
CEC CLSA CEC CL
Thermal excluding gas power 933 953 1,169 1,153
Hydro 325 300 390 370
Nuclear 43 32 90 56
Wind 100 120 180 227
solar 5 17 20 55
Biomass and others 3 7 5 21
Gas 30 45 40 75
Total capacity 1,436 1,474 1,887 1,958
Base load as % of total (%) 70.3 70.3 69.1 66.7
Non-fossil capacity (GW) 433 445 596 674
% of total 30.2 30.2 31.6 34.4
Source: CEC, CLSA Asia-Pacific Markets

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Nuclear - New additions to decline sharply

. . . except for nuclear One area where our capacity addition targets differ substantially from those
which has not been of government is nuclear power. We believe CEC targets have not been
revised post Japan
revised to take into account the impact of Fukushima accident and the other
earthquake
general problems being faced by the nuclear power industry in China. We
believe that capacity addition by 2020 will be around 55GW versus
government target of 90GW. We believe there is a downside risk to our
nuclear power estimates.

Some experts believe that there will be just temporary slowdown of a few
months in nuclear power construction and after that nuclear power
construction pace will go back to same level as in 2009 and 2010. The reason
for this is because China does not have much option other than nuclear to
achieve its CO2 emissions and carbon targets. They believe that the
Fukushima accident will cause the government to enhance safety features in
nuclear power plants but will not impact the medium and long-term goals of
nuclear power capacity addition (40GW by 2015 and 80GW by 2020).

We believe safer development of nuclear power in China is not possible

without slowing down the pace of development and there will be significant
impact on China’s medium and long-term nuclear power targets.

We expect slower growth It is too early for the lessons to have been learned from Fukushima as the
in nuclear additions crisis is still ongoing and there is still lack of clarity on a number of issues.
Our discussions with other experts on nuclear power in Energy Research
Institute of NDRC suggest that there will be multiple rounds of consultations
before the Nuclear Safety Plan is finalised. It appears unlikely that the plan
will be finalised before mid-2012. The plan will have to also discuss the
critical issue of choice of technology. Most likely, China will go for Gen III
technology which will take longer to absorb and will also slowdown the pace
of nuclear power build out.

Even before the Fukushima incident, serious concerns were being raised
about the safety of China’s rapid nuclear power development. To assume that
all these concerns (reproduced below) will be brushed aside and China will
resume construction of nuclear power plants at earlier breakneck pace is
nothing but wishful thinking.

Concerns raised by SCRO Some points from the State Council Research Office’s (SCRO) report on
China’s nuclear power development before Fukushima accident:
Only China is building ‰ The Gen II designs underestimate the risk of severe accidents and this is
Gen II reactors on a evidenced by the disasters in US and former Soviet Union.
massive scale
‰ Gen III (AP1000) has become the mainstream reactor in developed
countries while only China is building Gen II units on a massive scale.
‰ The life span of Gen II could reach 60 years. That means most of the Gen
II units under construction would not retire until 2070-2080 when Gen IV
or even Gen V is widely adopted.
Lack of proper laws and ‰ The quality of nuclear power unit equipment is still not satisfactory.
regulations on nuclear
power safety ‰ The number of regulatory staffs is less than necessary.
‰ There is lack of proper laws and regulations on nuclear power safety.
Fuel securing and waste ‰ The capability in nuclear fuel securing and nuclear waste treatment is
management capability weak compared with aggressive construction of nuclear power plants.
weak versus build out
‰ Nuclear power operators face financial constraints and they do not have
access to capital market yet.

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Recommendations by SCRO
Recommends limiting ‰ China should control the installed capacity in operation below 70GW
installed capacity below and total capacity (in operation and under construction) below 100GW
70GW by 2020
by 2020.
‰ Strengthen the authority of Nuclear Safety Bureau.
‰ Improve the ability to secure nuclear fuel supply and to treat nuclear
waste. An independent nuclear fuel corporate is suggested.

The chart below shows that most of China’s nuclear power development is
close to the coast and is in the most populous provinces in China.

Location of nuclear power plants being built in China

Heilongjiang

Jilin

Liaoning
Xinjiang

Inner Mongolia Beijing

Tianjin
Hebei
Shanxi
Ningxia Shandong
Qinghai
Gansu
Jiangsu
Shaanxi Henan
Xizang
(Tibet)
Anhui Shanghai

Sichuan Hubei
Zhejiang
Chongqing

Hunan Jiangxi
Guizhou
Fujian

Top 10 provinces by population

Yunnan Taiwan
Nuclear power plants in operation Guangxi Guangdong
Nuclear power plants under construction
Hong Kong

Hainan

Source: IAEA, CLSA Asia-Pacific Markets

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India: Coal will remain king

Coal power capacity In India, the power mix is also changing, but in the opposite direction as
share will rise coal’s share of capacity will rise sharply from 54% in FY11 to 60% in FY16
and 62% in FY21.

Hydro will drop the most Hydro will face the biggest drop in share of power capacity as it falls from
22% in FY11 to 13% in FY21. We expect growth in new capacity additions for
hydro to remain flat given increasing difficulties being faced in constructing
hydro power plants.

Wind power will Wind power will witness the highest increase in capacity share among all
witness the biggest rise renewable energy sources - rising from 8.2% in FY11 to 11% in FY21. India
out of renewables
will continue to be a major player globally for new wind additions. In 2010, it
trailed only China and the United States with more than 2GW of wind power
capacity added. India is already the fifth largest wind market in the world and
this is set to rise over the next decade.

Nuclear will also rise and After wind power, nuclear comes in at third for biggest rise in share of power
increase to 4.2% of capacity. India will add 1-2GW of nuclear power per annum over the next
power generated by FY21
decade as its share rises from 2.8% in FY11 to 4.2% in 2020. This will have
an even bigger impact on India’s power generation mix due to the higher
utilisation of nuclear power plants.

Gas and diesel will both Finally, both gas and diesel are set to decrease in share over the next ten
decrease share in yeas with gas falling from 10% of capacity in FY11 to just under 7% by FY21.
power capacity

India’s mix of power generation

2010 Renewables 2015 2020 Renewables

Renewables
4% 5%
4%
Hydro Hydro
Hydro
10% 8%
14%
Nuclear
Nuclear
5%
Nuclear 4%
3%

Thermal
Thermal Thermal
79%
82% 82%

Coal makes up the India’s capacity additions

lion’s share of
capacity additions 30,000 (MW) Coal Gas Nuclear Hydro Renewables

25,000

20,000

15,000

10,000

5,000

0
FY11CL

FY12CL

FY13CL

FY14CL

FY15CL

FY16CL

FY17CL

FY18CL

FY19CL

FY20CL

FY21CL
FY06

FY07

FY08

FY09

FY10

Source: CEA, CLSA Asia-Pacific Markets

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India’s energy mix India’s total capacity trend by type

in for a big change
450,000 (MW) Coal Gas
400,000 Diesel Nuclear
Hydro Wind
350,000
Other renewables
300,000
250,000
200,000
150,000
100,000
50,000
0

FY11CL

FY12CL

FY13CL

FY14CL

FY15CL

FY16CL

FY17CL

FY18CL

FY19CL

FY20CL

FY21CL
FY06

FY07

FY08

FY09

Source: CEA, CLSA Asia-Pacific Markets FY10

Coal-fired power capacity India's installed capacity forecast

is still growing fast
FY11CL FY12CL FY13CL FY14CL FY15CL FY21CL
in India
Total 173,626 190,026 210,826 231,526 250,926 391,726
Coal 93,918 103,918 117,918 130,918 144,918 240,918
Gas 17,706 18,206 19,706 23,206 24,206 27,206
Diesel 1,200 1,200 1,200 1,200 1,200 1,200
Nuclear 4,780 5,780 7,380 7,380 7,380 16,280
Hydro 37,567 39,267 40,467 41,667 42,867 51,267
Wind 14,158 17,158 19,458 22,158 24,958 42,858
Other 4,297 4,497 4,697 4,997 5,397 11,997
Source: CLSA Asia-Pacific Markets

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Appendix 5: Wind power

China has very poor oil and gas resources but abundant wind power
resources and among the world’s highest wind-power potential. Thus, along
with hydro, wind has been established as the workhorse in China’s renewable
energy portfolio. It will form the second-largest share of capacity additions
after thermal, accounting for 11.5% of total capacity and 5.6% of generation
by 2020.

Wind power set to rise Share of wind power

drastically over
next 20 years 18 (%) Wind power as % of installed capacity
16 Wind power % of total generation
14
12
10
8
6
4
2
0
11CL

12CL

13CL

14CL

15CL

16CL

17CL

18CL

19CL

20CL

21CL

22CL

23CL

24CL

25CL

26CL

27CL

28CL

29CL

30CL
2009

2010

Source: CEIC, CLSA Asia-Pacific Markets

Wind installations likely We forecast China’s wind market to continue to grow over the next five years,
to grow 4-5% near term albeit at a much more pedestrian rate than the 124% Cagr it achieved from
2005 to 2010. We expect China’s annual new grid-connected wind
installations to expand at 4% to 5% Cagr from 2011 to 2015 after increasing
46% YoY in 2010. We forecast total installed (and connected) capacity to
grow from 31GW in 2010 to 120GW in 2015 and 227GW in 2020.

China’s wind market has China wind installation forecast - grid connected
grown 58% on average
for the past ten years 500,000 120
Installed capacity YoY Growth (RHS) (%)
450,000
100
400,000
350,000
80
300,000
250,000 60
200,000
40
150,000
100,000
20
50,000
0 0
11CL
12CL
13CL
14CL
15CL
16CL
17CL
18CL
19CL
20CL
21CL
22CL
23CL
24CL
25CL
26CL
27CL
28CL
29CL
30CL
2005
2006
2007
2008
2009
2010

Source: GWEC, CLSA Asia-Pacific Markets

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Maximum potential - China’s wind resources

Over 6,600GW of China has tremendous wind-power potential. According to an October 2009
potential onshore study by consultancy Black and Veatch, over 6,600GW of onshore wind could
wind capacity
theoretically be installed (roughly 7x its total installed power capacity
currently). This does not count bodies of water, steep slopes, urban areas,
farmland or protected area, but assumes that 50% of all other land is used to
develop wind farms. By comparison, the US, the largest producer of wind
power, has potential to install 10,458GW of onshore wind power, according to
a 2010 study from the National Renewable Energy Laboratory (NREL).

China’s best wind China’s wind resource potential

resources are in the north
and northwest

Source: CWEA

Wind tariffs in China

In 2009, the NDRC simplified China’s wind tariff regime by setting four
regional rates to be used across the country, depending on the regions’ wind
resources (Figure 22). Tariffs are fixed for 30,000 hours (about 14 years of
operation), after which point they are expected to reset to the prevailing
thermal power rate.

Tariffs funded by a The higher tariffs are funded by a Rmb0.004/kWh surcharge on each kilowatt
Rmb0.004/kWh hour (kWh) of electricity sold as of November 2009. Rocketing wind
surcharge on each kWh of
generation in particular has forced up the surcharge by 400% from the
electricity sold
original Rmb0.001/kWh introduced with the Renewable Energy Law in 2006.
Based on this surcharge, we estimate that China could support roughly 45-
50GW of wind power, which we expect it to reach this year.

The cost of turbines is After 2012, we see risk that tariffs for new projects will slowly start to fall as
trending down making the cost of turbines continues to trend down. If not wind tariffs, the other
wind power cheaper
incentives, such as VAT refunds and reduced income tax rates. Wind tariffs
are set for 30,000 hours. After this time we assume that project tariffs will be
adjusted down to the prevailing thermal tariff. Thus, a wind farm set up in
2009 at a (average, ex-VAT) tariff of Rmb0.48/kWh would move to
Rmb0.41/kWh in around 2023 (30,000 hours/2,200 hours pa = 13.5 years).

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Chinese wind tariffs under the new regime

Zone Benchmark on-grid tariff Tariff Applicable regions
(Rmb/kWh, incl VAT) (Rmb/kWh, ex-VAT)¹
1 0.51 0.47 Inner Mongolia - All areas other than those in Zone 2
Xinjiang - Urumqi, Klamyi, Shihezi, Yili Kazak and Changi Hui
autonomous regions
2 0.54 0.50 Inner Mongolia - Chifeng city, Tongliao city, Xinga’anmeng,
Hulun Buir
Hebei - Zhangjiakou city, Chengde city
Gansu - Zhangye, Jiayuguan, Jiaquan
3 0.58 0.53 Jilin - Baicheng, Songyuan
Heilongjiang - Jixi, Shuangyashan, Qitaihe, Suihua, Yichun,
Daxingan
Gansu - All except areas specified in Zone 2
Xinjiang - All areas except specified in Zone 1
Ningxia - All
4 0.61 0.56 Everywhere else
¹ Wind operators get an automatic rebate of 50% of the 17% VAT paid, so effective rate is 8.5%. Source: NDRC, CLSA Asia-Pacific Markets

Current market situation

In 2010, China accounted for an impressive 46% of global installations, its
highest ratio by this measure ever. We expect China will continue to account
for a majority of wind installations globally even as its own growth slows
down. Global wind demand hopes hinge substantially on the US, but the
country’s wind sector has been struggling since 2010.

China’s share has grown China’s share of the annual wind market: Up from 4% in 2004 to 36% in 2009
ninefold in six years
45,000 (MW) China (LHS) Global (LHS) China's share (%) 50

40,000 45

35,000 40
35
30,000
30
25,000
25
20,000
20
15,000
15
10,000 10
5,000 5
0 0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: GWEC, CLSA Asia-Pacific Markets

China overtakes USA Wind installations (YE10) - China No.1 Wind additions (YE09) - China No.1

UK Italy Canada
3% 3% UK 2%
RoW RoW
Europe - other 14% 3% China
16%
3% 21%
France China France
3% 46% 3%
USA
Italy
Germany 20%
3%
4% India
Spain USA
7%
4% India 14% Germany
Spain
6% 14%
11%

Source: GWEC

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Future growth - Long-run targets are clearly there

In the long run, policy support for wind power is strong. It is an important
contributor to stated goals to reduce carbon intensity by 40% by 2020, as
well as to make 15% of energy renewable by 2020. We wrote extensively on
these points in our Emission possible December 2009 report.

Specifically, support for wind is easiest to see in the National Development and
Reform Commission’s (NDRC) wind energy targets. Officially, the 2020 target
still sits at 30GW, which has been surpassed already. However, it has long been
clear that these targets were too low, and the NDRC has increasingly leaked
intentions to raise the 2015 target to 100-120GW.

We estimate 227GW of wind power capacity by 2020

Our estimate for total installed wind power capacity at 227GW in 2020 as we
believe new additions should stay close to 16-18GW for a few years.

Installations expected to We expect installations to increase to around 20GW per annum towards the
increase to 20GW end of the decade. From an equipment manufacturer’s point of view, these
per annum
numbers are not necessarily all that exciting as these imply at best mid-single
digit growth rates beyond 2011. Does it mean that we are conservative in our
forecasts and are underestimating the capacity additions? We do not think so
unless there is a major technological breakthrough either in wind-power
generation technology or power storage technology.

Geographical distribution of wind resources and grid constraints

Wind penetration in some The two most important and inter-related constraints to higher wind-power
provinces has reached capacity additions are the geographical distribution of wind power and grid
levels of Denmark
connection. While most of the wind power capacity in China is concentrated in
the north, northwestern and northeastern China, most of country’s power
demand is from the east coast.

Chinese government The Chinese government is allocating substantial capex to address the grid
planning large grid issue. However, while it takes a couple of quarters to set up a wind farm it
investment
takes two to five years to plan and set up a major transmission line. Over the
past few years build out of the transmission grid has substantially lagged
installation of wind power capacity resulting in an ever-increasing amount of
wind power capacity not connected to the grid.

As shown below, at the end of 2010 around 11.2GW out of the total 42.2GW
(26.5% of total) of installed capacity was not connected to the grid.

Grid connectivity is still Gap between installations and connections is growing

the biggest problem for 45,000 32
(MW)
wind power
40,000 30

35,000 28
26
30,000
24
25,000 Installed (LHS)
22
Connected (LHS)
20,000
20
Share not connected
15,000
18
10,000 16
5,000 14
0 12
05A 06A 07A 08A 09A 10A

Source: GWEC, CLSA Asia-Pacific Markets

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Appendix 6: Solar (PV)

Despite ample sunshine, China’s solar market has been a footnote in global
demand, and not even a footnote in China’s overall energy mix. That is about
to change. Solar is poised for a takeoff in China, similar to wind around 2005.
Policy support is coming in as prices fall from above Rmb30 per Watt in 2006
to Rmb15 Watt this year and, we believe, below Rmb10 per Watt around
15CL, or competitive with current wind turbine prices.

Best resources in the Solar resources in China are relatively good . . .

north and northwest

Source: CREIA

China has good solar . . . especially compared to the leading markets in Europe
resources compared
to Europe

Source: EPIA

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Solar to see Cumulative Chinese solar installations

substantial growth
140,000 Installed capacity YoY Growth (RHS) (%) 160

120,000 140

120
100,000
100
80,000
80
60,000
60
40,000
40
20,000 20

0 0
11CL
12CL
13CL
14CL
15CL
16CL
17CL
18CL
19CL
20CL
21CL
22CL
23CL
24CL
25CL
26CL
27CL
28CL
29CL
30CL
2009
2010

Source: CEIC, CLSA Asia-Pacific Markets

All-in costs - Rmb8 per Watt within the decade

Solar panel accounts for In large-scale installations in China, the solar panel accounts for roughly two
two thirds of total price thirds of the total price. The remaining third, or balance of systems (BoS),
consists of an inverter, other components, engineering and procurement costs
and labour. We are assuming that BoS costs fall at an average 5% pa from
the current Rmb6-8 per Watt. Prices will, of course, vary depending on the
size of the system and location.

Panel prices are Chinese solar installation prices (Rmb/Watt)

dropping as well
35 (Rmb/Watt) Non-panel installation price

30 Solar panel price in China

25

20

15

10

0
06A

07A

08A

09A

10A

11CL

12CL

13CL

14CL

15CL

16CL

17CL

18CL

19CL

20CL

Source: CLSA Asia-Pacific Markets

From capital costs to LCOE

Based on our projections for declining capital costs on solar installations, the
levelised cost of electricity (LCOE) for solar power will fall from the current
Rmb1-1.3/kWh to Rmb46-63 cents/kWh by 20CL.

We base our calculations on utility-scale systems assuming the following:

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LCOE for solar falling to Assumptions for calculating solar LCOE

Rmb46-63 cents/kWh
Panel cost (Rmb/W) 10.90 PV capacity factor
by 20CL
BoS cost (Rmb/W) 6.00 Sunlight hours per day 4.1
System cost (Rmb/W) 16.90 Sunlight hours per year 1,497
System nameplate (kW) 10,000 DC/AC derate (%) 90
Capital cost (Rmb) 169,000,000 System capacity factor (%) 15.4
% financed 66 Shanghai sunlight hours 4.1
Loan amount (Rmb) 111,540,000 Lhasa sunlight hours 5.7
Net capital cost (Rmb) 57,460,000
Debt interest rate (%) 6
Loan period (years) 10
Source: CLSA Asia-Pacific Markets

The bottom of the cost range is based on sunlight hours in Lhasa, Tibet (5.7
hours per day, according to NREL), while the top is based on more standard
Chinese exposures of 4.1 hours per day (Shanghai).

LCOE declining Levelised cost of electricity in China

1.8 (Rmb/kWh)

1.6

1.4

1.2

1.0

0.8

0.6

0.4
09A 10CL 11CL 12CL 13CL 14CL 15CL 16CL 17CL 18CL 19CL 20CL

Source: CLSA Asia-Pacific Markets

Solar - Grid risks

Intermittency Unlike wind, solar does not yet face any serious grid constraints. However, this
is as much an issue of scale as anything. Even under our blue-sky scenario,
solar accounts for less than 5% of global electricity production by 2020, but will
be much higher than that in certain regions. As such, it would face the same
grid constraints and demand for energy storage as wind does today.

Conclusion
We expect China’s solar PV capacity to grow from 893MW in 2010 to 17.7GW
in 2015 and 53.1GW by 2020. We expect the first major demand to pick up
from 2011 with a second major demand pick up from year 2013, driven by
increasing affordability of solar power generation. Activity on solar power
development in China has picked up in recent months and the government
has invited bids for 280MW of capacity in mostly northwestern provinces.

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We expect sharp growth Annual solar power capacity additions in China (PV and CSP)
in solar power
installations in China
9,000 (MW)
8,200 8,200
7,700 7,700
8,000

7,000 6,600

6,000 5,600

5,000 4,400

4,000 3,435

3,000
1,800
2,000
800
1,000

0
11CL 12CL 13CL 14CL 15CL 16CL 17CL 18CL 19CL 20CL

Source: CLSA Asia-Pacific Markets

Concentrating solar thermal power (CSP)

Solar thermal power Discussion about China’s solar potential tends to focus on photovoltaic (PV).
technology is the dark However, the official target applies to solar thermal power, as well as PV. Solar
horse of the renewable
thermal power technology (alternatively summarised as CSP or STP) works by
energy field
focusing the sun’s energy on a receiver pipe that runs inside a single-axis
reflector. The water or organic working fluid in the pipe is therefore heated to
drive a steam turbine, producing reliable power in any sun-rich region.

Storing energy as heat is also much cheaper than storing electricity in

batteries, providing CSP with an economical means to overcome intermittency
issues and even provide base-load electricity.

China has potential China has tremendous potential for CSP, centred on the desert regions of the
for CSP northwest. Industry consultant Black & Veatch estimates that China has
sufficient resources for around 16,000GW of CSP, enough to generate some
42,000TWh/yr.

Potential solar thermal capacity Potential solar thermal generation

18,000 (GW) 50,000 (TWh/yr)

16,000

14,000 40,000

12,000
30,000
10,000

8,000
20,000
6,000

4,000 10,000
2,000

0 0
China US Spain China US Spain

Source: Black & Veatch

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In January 2010, a US CSP equipment maker announced a licensing

agreement with Penglai Electric, a privately-owned Chinese electrical power
equipment manufacturer to produce and install 2GW of solar thermal power.
They are scheduled to break ground on the first 92MW plant in 2010.

CSP began picking up Globally, CSP started picking up sharply in 2005 after nearly 20 years of
again in 2005 stagnation. Global capacity grew from 354MW in 2005 to 662MW as of 1Q10,
with growth dominated by the US and, more recently, Spain. According to
Ren21, 2.4GW of capacity was being built or under contract by early 2010,
with Middle-Eastern markets in particular supplementing the US and Spain.

CSP still an underdog but The other solar - Concentrating solar thermal (CSP)
could be competitive soon

Source: Rocky Mountain Institute (From CLSA’s Carbon Management)

Our estimates could be The cost of electricity from existing CSP plants is roughly US$0.13-17/kWh,
too bearish if new meaning that CSP with thermal storage is competitive today relative to gas-
projects prove successful
fired power plants in the USA. The US Department of Energy (DOE) aims to
over the next two years
reduce costs to US$0.7-10/kWh by 2015 and to US$0.5-7/kWh by 2020;
leading CSP producer Ausra (unlisted) has similar price targets but for five
years earlier. Equipment producers and venture capital firms are aiming for
similar results, but by 2012.

CSP faces grid constraints The irony of CSP plants is that they only make sense in very dry regions, but
due to remote they need a steady supply of water to keep the mirrors and lenses clean.
location of resources
Given the concentration of solar thermal resources in the northwest of the
country, development will face many of the same grid constraint issues
currently facing wind power development.

We expect 5GW of We expect 1.7GW of CSP capacity by 2015 and 5GW in 2020. CSP is a bit of a
CSP by 2020 wild card. If plants being built now in Spain and the US prove as cost
competitive as expectations, we would expect to see a more significant ramp
in activity in China from around 2013.

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Nearly sunrise for Indian solar

Given India’s acute need for more power generating assets, and its ample
sunshine, solar seems like a no-brainer for the country. Expectations are
accordingly high for India to grow from its current status as a relatively
unimportant market for solar products (c.2% of worldwide demand) to
become one of the key drivers of solar growth. A raft of new policies, and of
course falling prices, will help facilitate this shift. But first, difficulties in
administration and execution need to be worked through.

Solar insolation in India . . . . . . compared to that in Europe

Source: EPIA, CLSA Asia-Pacific Markets

Expectations are high for India launched its Jawharlal Nehru National Solar Mision (NSM) in January
India solar expansion 2010, with the target of reaching 22 GW of solar capacity by 2022 from
around 300 MW as of YE10. Guidelines were set for a generous feed-in tariff
(FIT) system, and the NSM generated a lot of excitement. However, it has
failed to generate many viable projects, due in part to a reverse bidding
system that has allowed relatively inexperienced companies win with
uneconomical bids. In the first year, only 282 MW of solar photovoltaics (PV)
had been approved for phase one of the NSM.

India's National Solar Mission

(MW) Phase 1 Phase 2 Phase 3 Total

Period Until Mar 12 Apr 12 - Apr 13 - Apr 17 - Mar

Mar 13 Mar 17 22
Off-grid PV 200 800 1,000 2,000
Small-scale PV 100 2,900 16,000 20,000
5 MW ground-mounted installations 150 350
Large-scale solar thermal 500
Total 1,300 3700 17,000 22,000
Source: CLSA Asia-Pacific Markets, Photon International

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We are still optimistic While this has been somewhat disappointing, it is far too early to dismiss
despite a slow start India as a potential major solar market. As government works out the kinks
in the NSM, several other important initiatives have been introduced at the
national level. First is the introduction of solar-specific Renewable Purchase
Obligations (RPOs), to grow from 0.25% until 2013 to 3% by 2022. Solar-
specific renewable energy certificates are also being introduced. Contrast this
with the US, where there is no coherent national program.

Perhaps more importantly, some of the country’s economic heavyweight

states have embarked on their own solar support programs. Most notably,
Gujarat aims to develop 1 GW of projects by 2012 and 3 GW by 2015.

With regional support plans and prices for solar PV falling faster than
expected, we project that India will easily beat its solar targets for 2022.

We expect high double- Indian solar cumulative installations

digit growth in next 10Y
25,000 (MW) Cumulative installations (%) 180
Growth (RHS) 160
20,000 140
120
15,000
100
80
10,000
60

5,000 40
20
0 0
2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020
Source: CLSA Asia-Pacific Markets, EPIA (For historical up through 10A)

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Appendix 7: Power capacity addition trends in India

Capacity addition across five year plans

16,000 (MW) Actual addition Energy deficit (RHS) (%) 14

14,000 12,282MW 19,051MW 21,095MW ~50,000MW 12

12,000
10

10,000 8th plan 9th plan 10th plan 11th plan

8
8,000
6
6,000

4
4,000

2,000 2

0 0

FY11E

FY12E
FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

Owner wise capacity addition in first four years of 11th five year plan FY10

5,500
(Centre) (State) (Private)
5,000

4,500 8.8GW 13GW 11GW

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

0
FY08 FY09 FY10 FY11 FY08 FY09 FY10 FY11 FY08 FY09 FY10 FY11

Source: CEA, CLSA Asia-Pacific Markets

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Appendix 8: India power plants under construction

State-wise power plants under execution

Punjab
Punjab Uttar
Uttar Pradesh
Pradesh
3,840MW
3,840MW 6,420MW
6,420MW

Haryana
Haryana West
West Bengal
Bengal
3,440MW
3,440MW 4,200MW
4,200MW

Delhi
Delhi
1,610MW
1,610MW

Rajasthan
Rajasthan
2,895MW
2,895MW Assam
Assam
540MW
540MW

Gujarat
Gujarat Bihar
Bihar
10,280MW
10,280MW 4,690MW
4,690MW

Madhya
Madhya Pradesh
Pradesh
12,230MW Jharkhand
Jharkhand
12,230MW
4,830MW
4,830MW
Maharashtra
Maharashtra
7,900MW
7,900MW

Orissa
Orissa
5,980MW
5,980MW
Karnataka
Karnataka
3,365MW
3,365MW Chhattisgarh
Chhattisgarh
12,110MW
12,110MW

Andhra
Andhra Pradesh
Pradesh
11,690MW
11,690MW
> 10GW
Tamil
Tamil Nadu
Nadu
5-10GW 5,660MW
5,660MW

2-5GW

2-5GW

Source: CEA, CLSA Asia-Pacific Markets

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Appendix 9: India’s coal-asset ownership

R Power has the largest Coal assets owned by the companies domestically and overseas
domestic coal reserves Company Overseas coal assets Domestic coal assets
followed by Jindal Power
Adani Enterprises ‰ Bunyu (Indonesia) - 150mt
and Essar Power
‰ Galilee (Australia) - 7.8bn t (JORC
reserves)
‰ Bukit Asam (Indonesia) - 2 bn
tonnes reserves

Lanco ‰ Griffin Coal (Australia)1.1bn tons ‰ Rampia - 112mt (Lanco's

reserves (JORC) - produces 4mtpa share)
currently

JSW Energy ‰ CIC Energy - 2.6bn tonnes

resources in Botswana (NI 43-101
compliant)
‰ SACMH coal assets - 50mt
reserves in S Africa

Reliance Power ‰ Srivijaya Bintangtiga Energy, ‰ Rampia - 112mt (R Power's

Bryayan Bintangtiga Energy and share)
Sugico Pendragon Energy in Musi ‰ Moher - 402mt
Adani’s and Tata’s were Rawas, South Sumatra area of
‰ Moher Amlori 192mt
the first ones to buy coal Indonesia - reserves of 2bn
assets abroad tonnes ‰ Chhatrasal - 150mt
‰ Kerandari - 972mt

Tata Power ‰ KPC (Indonesia) - 1.5bn tonnes ‰ Tubed - 48mt mineable

reserves (Tata's share 30%) reserves (Tata's share)
‰ Arutmin (Indonesia) - 557m ‰ Mandakini - ~100mt reserve
tonnes reserves (Tata's share (Tata's share)
30%)

GMR ‰ PT Barasentosa Lestari ‰ Rampia - 112mt (GMR's share)

(Indonesia) - reserves of 100mt
‰ Homeland (GMR has 38.5% stake)
owns operational Kendal Mines
and other coal blocks (South
Africa) with total mineable
reserves of 300mt

Essar Power ‰ Areis (Indonesia) - 2P reserves of ‰ Mahan - 125mt (60% Essar)

64mt ‰ Chakla - 71mt
We will see more ‰ Mozambique -Resource of 35mt ‰ Ashok Karkatta -100mt
acquisitions by Indian
companies in the coming ‰ Rampia - 112mt (Essar's share)
years given the expected Indiabulls Power - -
domestic coal crunch CESC ‰ Mahuagarhi - 110mt (CESC's
share)
‰ Sarisatolli - 141mt (opertaional
since FY03)

Jaiprakash Power ‰ Amelia (North) and Dongri Tal

II - reserves of 250mt

GVK ‰ Tokisud - 93mt

‰ Seregarha -75mt (GVK's share)

Jindal Power ‰ Gare Aplam IV 2 - 123mt

‰ Gare Aplam IV 3 - 123mt
‰ Jitpur 81mt
‰ Amarakonda 205mt (Jindal
Power's share)

Sterlite Energy ‰ Rampia - 112mt (Sterlite's

share)
Source: Companies, CLSA Asia-Pacific Markets

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Appendix 10: Indian state-utilities’ financials

Profit (w/o dep, tax) of state gencos/transcos/trading companies

90,000 (Rsm)

80,000

70,000

60,000

50,000

40,000

30,000

20,000

10,000

0
FY02 FY03 FY04 FY05 FY07 FY08 FY09

P&L of state power utilities

(Rsm) FY07 FY08 FY09
Income - distribution 1,319,050 1,495,320 1,703,810
Expenditure - distribution 1,529,430 1,767,600 2,143,330
Profit (loss) - distribution (210,380) (272,280) (439,520)
Profit/(loss) - gencos, transcos and trading utilities 66,530 80,180 43,030
Total profit/(loss) without depreciation, write-offs subsidy and tax (143,850) (192,100) (396,490)
Subsidy booked 136,170 195,220 296,820
Income tax 3,970 4,410 4,740
Deferred tax (410) 4,660 (680)
Total profit /(Loss) without depreciation, writeoffs for all utilities (11,650) (1,290) (104,410)
Subsidy unpaid 7,540 30,460 112,890
Unrealised revenue 46,010 43,980 66,680
Cash profit/(loss) on revenue and subsidy realised basis for all utilities (65,200) (75,730) (283,980)
Depreciation & writeoffs 119,840 119,470 125,680
Total book profits/losses of all utilities (131,080) (125,420) (229,410)
Total profits/loss on subsidy received basis of all utilities (138,620) (155,880) (342,300)
Total profits/loss without subsidy of all utilities (267,250) (320,640) (526,230)
Source: PFC, CLSA Asia-Pacific Markets

Comparison of losses in various sectors

1,200 (Rsbn) Oil/LPG Power Fertilizer

1,000

800

600

400

200

0
FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

Source: Budget documents, CLSA Asia-Pacific Markets

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Appendix 11: Private power distribution

Success stories in India Privatisation of electricity distribution has been a great success in India with
all three power utilities performing well. New Delhi Power Limited (NDP) has
been a case study in itself with an all round performance and it has been
improving it year after year. Two other utilities BSES Yamuna (BYPL) and
BSES Rajdhani (BPPL) have also reduced the AT&C losses significantly in their
respective licence areas.

NDPL has shown Performance of NDPL since privatisation

remarkable performance
Parameter 2002-03 2009-10
on every parameter
AT&C Losses (%) 56.39 17.80 (2008-09)
Turnover (Rsm) 8,500 34,000
Peak Load (MW) 930 1,259
Annual Energy Requirement (m unit) 3,927 6,911
Total Registered Consumers 7,00,000 11,00,000
Number of Employees 5,600 3,998
Area (km²) 510 510
Population serviced in Network area (approx) (m) 4.5 5.0
Number of consumers (per km²) 1,372 2,157
Employees per ‘000 consumers 8.00 3.63
Employees per million unit input 1.42 0.58

Falling AT&C losses and NDPL - AT&C losses NDPL - Billing and collection efficiency
improving billing and
50 (%) 110 (%)
collection efficiency
45
100
40
90 NDPL Collection efficiency
35
30 80 NDPL Billing efficiency
25
70
20
60
15
10 50
FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10

Source: NDPL, CLSA Asia-Pacific Markets

Losses have reduced by AT&C losses in BRPL and BYPL licence areas
31-49% over seven year
period 70 (%)

60

50

40

30 BYPL
BRPL
20

10

0
FY03 FY04 FY05 FY06 FY07 FY08 FY09

Source: BRPL, BYPL, CLSA Asia-Pacific Markets

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Torrent took over Bhiwandi is another success story of the franchisee model. Torrent Power has
distribution in Bhiwandi taken over the operations of power distribution in this distribution circle in
circle in Jan-07
January 2007. The AT&C losses have decreased from 55% to 20% since then.

24% reduction in losses Performance of Bhiwandi Franchisee Model

since Jan 2007
Parameter At the time of take Performance as
over by Franchisee of Jun 2010
(Jan 2007)
T&D losses (%) 42.30 18.79
AT&C losses (%) 54.64 20.20
Failure rate of transformers (%) 40 3.70
No. of 22 kV feeders (no.) 46 82
No. of overloaded feeders (no.) 35 na
Capacity of EHV transformers (MVA) 650 1000
Capacity of distribution transformers MVA (Nos.) 780 960
(no.) (2,254) (2,571)
Collection efficiency 78.6 99.5
Consumer metering (%) 23 100
Source: Infraline, CLSA Asia-Pacific Markets

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Appendix 12: India’s cross subsidies

Ideally should be Category-wise Tariff Realisation as percentage of cost of supply
between 80% & 120%
State (%) Domestic Agriculture Non domestic/ Industry
Commercial
Andhra Pradesh (FY 08) 88 4 214 140
Assam 80 72 130 110
Bihar 52 27 116 101
Chhattisgarh (FY 08) 58 54 145 115
Delhi (FY 07) 76 41 145 129
Gujarat 82 27 129 144
Haryana 80 6 100 100
Himachal Pradesh 50 20 154 111
Jharkhand (FY 07) 42 48 155 124
J&K (FY 08) 31 46 53 60
Kamataka 100 17 162 -
Kerala 59 26 150 155
Madhya Pradesh 92 72 148 129
Maharashtra 100 40 170 120
Orissa 76 na na 122
Punjab 99 41 131 99
Rajasthan 90 41 131 99
Uttar Pradesh 71 49 96 137
Uttarakhand 69 24 123 116
Source: CERC, CLSA Asia-Pacific Markets

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Appendix 13: Protests against power projects in India

Protests against power projects turned ugly

Project Company Incident Date

Tilaiya Reliance Power While on his visit to the Chatra District, Manoj Ojha, Reliance Power’s Apr 11
General Manager for Networking in Jharkhand, was brutally shot and
another Reliance Power employee was injured.
(www.NDTV.com)

Naraj Marthapur Tata Power Unknown persons dragged out an assistant manager of Tata Power Oct 10
Company Limited (TPCL) from his car, poured petrol on his body and set
him on fire, causing severe burns.
(http://ibnlive.in.com/generalnewsfeed/news/miscreants-set-afire-tata-
power-employee/369317.html)

Jaitapur Nuclear Power Corporation Tabrez Sayekar, 30, resident of a fishing village in Ratnagiri district, was Apr 11
killed when the police opened fired on a mob of 700 villagers that
vandalised the local police station and torched a police van. Four locals
were injured in the protests, and 60 were arrested.
(http://www.hindustantimes.com/News-Feed/mumbai/1-dead-in-firing-in-
Jaitapur-N-plant-protest/Article1-686937.aspx)

Srikakulam East Coast Energy The firing incident on Monday in at Kakarapalli village in Srikakulam Feb 11
mandal, where two agitators died and several others injured, protesting
against the establishment of 2,640-MW thermal power plant by East Coast
Energy rocked the Andhra Pradesh Legislative Assembly, with members
cutting across political parties, demanding its cancellation.
(http://www.thehindubusinessline.com/companies/article1501074.ece)

Srikakulam Nagarjuna Power Nagarjuna Constructions proposed power plant in Srikakulam district of Jul 10
Andhra Pradesh is facing stiff resistance, protests by locals against the
project have turned violent today with 3 people killed in police firing.
(http://www.moneycontrol.com/news/cnbc-tv18-comments/nagarjunas-
proposed-power-plantap-faces-protests_469965.html)

Amravati Indiabulls Power According to numerous petitions admitted by the court, the state Apr 11
government has decided to allocate 87.6 MCM (million cubic metres) of
water to the Indiabulls thermal plant in a district, which has seen
thousands of suicides by farmers over the years.
(http://www.domain- com/industry/power/20110421_indiabulls.html)

Source: Media articles, CLSA Asia-Pacific Markets

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Appendix 14: EVA® and SOEs in China

EVA® a key performance The State-owned Assets Supervision and Administration Commission (SASAC)
indicator for SOEs in put in place key performance indicators for central government SOEs in March
China
2010 in order to improve efficiency and increase monitoring transparency as a
shareholder. Each year, performance contracts are signed by top SOE
management. EVA® is the largest component of the performance score,
although the hurdle is low at only 5.5% cost of capital. These return-focused
performance targets go hand in hand with SASAC’s central-SOE-restructuring
policy. The agency aims to reduce the number of central SOEs to 100, which
will create another wave of asset injections in the next few years. As SOEs
account for about 75% of the A-share market cap, the change in SOE culture
should gradually increase investor awareness of EVA®/ROE. We certainly
expect that in five years we will find better statistical correlations for these
parameters, not just evidence among share quartiles.

Performance indicators According to the SASAC announcement on the central SOEs’ management-
are judged by annual and performance indicator in December 2009, quantitative measures are divided
three-year targets
into two periods: annual targets and three-year targets.

Annual targets include three measures:

1. Net profit excluding non-operating gains. This measure has a basic score
of 30 once the target is achieved and up to six points can be added for
overachievers or deducted for underachievers.
2. EVA®, calculated based on a 5.5% cost of capital benchmark. For
enterprises with policy responsibility, a 4.1% cost of capital applies. An
additional 0.5% is added to the benchmark for enterprises with an
asset/liability ratio of over 75% (industrial SOEs) or over 80% (non-
industrial SOEs). This measure has a basic score of 40 with a maximum
addition/deduction of eight points.
3. Industry-specific indicators (eg, military enterprises or research-based
enterprises) which are set on a case-by-case basis. This criterion has a
20% weighting adjustment to a basic score.

SOE’s with a policy Three-year targets include:

responsibility use a lower
cost of capital for EVA 1. State-owned capital appreciation ratio. This has a basic score of 40 with a
calaculation maximum addition/deduction of eight points. In general, state-owned
capital refers to the share equity-base increase over the years,
benchmarked against a set of growth targets. Implicitly, this includes
earnings growth and captures any nonperforming-asset writedown.
2. Operating-revenue growth. This indicator has a score of 20 with a
maximum addition/deduction of four points.
3. Industry-specific indicators (energy conservation, environmental
protection, sustainable development, competitive advantage, etc). This
criterion has a 20% weighting adjustment to a basic score.

The important point is that these targets are linked directly to the
performance bonus for each SOE and EVA® is the most important element.

Local governments are also rolling out EVA® measures for their SOEs. For
example, Hubei’s SASAC announced in March 2011 that provincial-
government-owned SOEs will also be subject to EVA®-based performance
measures.

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SOE‘s ROA has been SOEs’ total ROA

continually improving
over the last 12 years 9 (%)

0
1998 2000 2002 2004 2006 2008 2009

As has their total revenue SOEs’ total revenue as % of GDP

as a % of GDP
170 (%)
160
150
140
130
120
110
100
90
80
70
1995 1998 2000 2002 2005 2007 2009

Note: Data includes central and local SOEs. Source: CLSA Asia-Pacific Markets, Wind

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Appendix 15: Generation equipment

Outlook for Indian power generation equipment makers
BTG market has grown Thermal power generation equipment market has expanded to 20-25GW of
strongly in last five years annual orders in the last five years, from 5-7GW in the 10th Five Year Plan
(FY02-07). India embarked a strong power capacity addition program in the
11th plan, with a target to add 78GW. BTG equipment orders of around 20GW
of this capacity were placed in the first two years of the plan (FY08-09). Since
FY08, about 70GW of coal equipment has been ordered for the 12th plan.

70GW of coal equipment Power generation equipment award over quarters

has been ordered for
the 12th plan 12,000 (MW) XI plan XII plan
5GW 5GW 7GW 21GW 25GW 22GW 24GW 10GW
10,000

8,000

6,000

4,000

2,000

0
Pre FY03
1QFY04
2QFY04
3QFY04
4QFY04
1QFY05
2QFY05
3QFY05
4QFY05
1QFY06
2QFY06
3QFY06
4QFY06
1QFY07
2QFY07
3QFY07
4QFY07
1QFY08
2QFY08
3QFY08
4QFY08
1QFY09
2QFY09
3QFY09
4QFY09
1QFY10
2QFY10
3QFY10
4QFY10
1QFY11
2QFY11
20GW of XI plan The 11th plan BTG equipment awards
equipment has been
ordered in the first two 8,000 (MW) Commissioned Under construction
years of the plan
7,000
5GW 5GW 7GW 19GW 16GW 3GW
6,000
5,000
4,000
3,000
2,000
1,000
0
Pre FY03
1QFY04
2QFY04
3QFY04
4QFY04
1QFY05
2QFY05
3QFY05
4QFY05
1QFY06
2QFY06
3QFY06
4QFY06
1QFY07
2QFY07
3QFY07
4QFY07
1QFY08
2QFY08
3QFY08
4QFY08
1QFY09
2QFY09

Note: Data as at the end of 2QFY11. Source: CLSA Asia-Pacific Markets

We expect 20GW of annual awards by utilities to continue

Thermal equipment for India plans to add c.100GW of power capacity in the 12th Five Year Plan. Of
the 12th plan has been this, 70-85GW could be thermal, which has largely been ordered already.
largely ordered
However, actual ordering is likely to be higher than new capacity addition
targets in the 12th plan on account of anticipated slippages in execution.
Consequently, we believe that c.20GW of annual ordering could sustain over
the next few years.

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We believe that 20GW of Over FY12-13, orders will be driven by two NTPC bulk tenders (11 x 660MW
annual equipment orders and 9 x 800MW) as well as strong SEB orders. SEBs have ordered only 13GW
should sustain . . .
for 12th plan so far (18% of the total awards), compared to 21GW (36% of
total BTG orders placed) in the 11th five year plan. Only 4GW of orders have
been placed by SEBs in the six quarters ending 2QFY11. Our conversations
with industry participants suggest that Rajasthan, UP and Maharashtra
governments, specifically plan to award certain large BTG orders over the
next two years.

. . . driven by NTPC NTPC 660MW bulk tender

bulk tenders . . . Project State Agency Capacity (MW)
Tanda UP NTPC 1,320
Solapur Maharashtra NTPC 1,320
Nabinagar Bihar NTPC-Bihar 1,980
Meja UP NTPC-UP 1,320
Ragunathpur WB DVC 1,320
Total 7,260

NTPC 800MW bulk tender

Project State Agency Capacity (MW)
Lara Chhatisgarh NTPC 4,000
Daripalli Orissa NTPC 3,200
Total 7,200
Source: CLSA Asia-Pacific Markets

. . . and stronger state Sector-wise award of 12th plan projects over years
sector awards
12 (GW) Central Private State
9GW 19GW 24GW 10GW
10

0
Pre FY08

1QFY08

2QFY08

3QFY08

4QFY08

1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

Government sector Equipment awards by sector for 11th plan Equipment awards by sector for 12th plan
ordering has been week
so far for the12th plan State Central
12%
13GW 18% 8GW
19GW
State Central
21GW
36% 33%

Private Private
31% 70%
50GW
19GW

Source: CEA, CLSA Asia-Pacific Markets

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Some SEBs plan to award Select projects planned to be awarded for SEBs over the next two years
large projects Project State Capacity (MW)
Chhabra - III Rajasthan 1,320
Suratgarh Rajasthan 1,320
Dholapur Rajasthan 330
Korba South Chhattisgarh 1,000
Kalgurki Karnataka 1,500
Yadgir Karnataka 1,000
Chausa Bihar 1,320
Total 7,970
Source: CLSA Asia-Pacific Markets

From FY13 onwards, ordering for 12thI plan should also start flowing through,
which should help sustain 20GW of annual order inflows.

Captive orders could add another 3GW annually

Around 15GW of captive At the end of the first 3.5 years of the 11th plan (until 2QFY10), 7GW of
capacity addition likely captive capacity was commissioned, with another 8GW being under
for 12th plan
construction, slated to be added over FY11-12. Therefore, captive capacity
addition is likely to stand at c.3GW per annum. We expect that captive project
awards should continue at a similar run rate over the next few years. Our
conversations with industry participants suggest that oil and gas,
petrochemicals and sugar industries are likely to continue investing heavily in
expanding their capacities.

We expect that captive Captive plants operational/ expected to become operational in 11th plan
segment will countinue to Equipment supplier (MW) Commissioned Under construction
order c.3GW annually
BHEL 2,249 2,547
Thermax 1,995 2,478
Chinese 1,134 2,520
Others 1,731 840
Total 7,109 8,386
Source: CEA, CLSA Asia-Pacific Markets

Threat of Chinese competition should ease

BHEL has a 55% market share in coal-based generation equipment ordered
for plants targeted to become operational in the 11th five year plan, with
Chinese companies having 31% share and others (Alstom, GE, Toshiba,
Siemens) having 14%. In the 12th plan, Chinese companies have increased
their market share to 40% in boilers and 43% for turbine-generator (TG)
sets, with BHEL’s share falling to 40-41%.

Chinese companies have Market share of coal capacity in 11th plan Market share of coal capacity in 12th plan¹
increased their market
share in 12th plan . . . Siemens
Others Asltom
Russia 1%
14% 1%
3%
L&T
8%

Japan BHEL
Chinese BHEL 4% 40%
31% 55%
China
43%

¹ TG set data is presented for the 12th plan. Includes orders placed up to 2QFY11-end. Source: CEA,
CLSA Asia-Pacific Markets

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. . . with BHEL losing Split of BTG awards by equipment supplier over quarters
market share in the last
few years 12,000 (MW) BHEL Chinese Others
5GW 5GW 7GW 21GW 25GW 22GW 24GW 10GW
10,000

8,000

6,000

4,000

2,000

0
Pre FY03
1QFY04
2QFY04
3QFY04
4QFY04
1QFY05
2QFY05
3QFY05
4QFY05
1QFY06
2QFY06
3QFY06
4QFY06
1QFY07
2QFY07
3QFY07
4QFY07
1QFY08
2QFY08
3QFY08
4QFY08
1QFY09
2QFY09
3QFY09
4QFY09
1QFY10
2QFY10
3QFY10
4QFY10
1QFY11
2QFY11
Source: CEA, CLSA Asia-Pacific Markets

The fall in BHEL’s market share and increase in Chinese companies’ share in
the 12th plan can be partly attributed to BHEL’s lower market share in super-
critical orders, where it has a 23% share versus 53% for other rating types.

BHEL’s market share in Market share of various players across different equipment configurations
super-critical has been
lower 30 (GW) Others
L&T
25
Russia

20 Korea
China
15 BHEL

10

0
250MW or less 270-500MW 525-600MW 660-800MW

Note: Includes orders placed up to 2QFY11-end. Source: CEA, CLSA Asia-Pacific Markets

Going forward, we believe that threat from Chinese competition will ease, as
domestic capacity ramps up and consequently delivery schedules improve. We
have repeatedly highlighted quality issues with Chinese equipment since 2007
- after our trips to factories of Indian and Chinese equipment suppliers and
visits to their customers. Recently, government policies have also increased
the attractiveness of domestically-manufactured equipment vis-à-vis Chinese
equipment. Moreover, appreciation of Renminbi has also reduced the
attractiveness of Chinese equipment.

Quality concerns with of Chinese equipment

Chinese players have Our conversations with industry participants suggest that Chinese equipment
been unable to customise manufacturers have been unable to customise their product to suit Indian
their equipment
conditions (higher ash content and extreme weather conditions). As a result,
most plants using Chinese equipment (especially state utility plants) are
running at capacity utilisation levels lower than NTPC plants, which mostly
use BHEL equipment.

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Quality check for Our conversations with a power equipment expert suggested that even
Chinese equipment quality checks and tests are not as strict for Chinese equipment as they are
not as stringent as for
for BHEL. As a result, there is a reason to believe that their failure rate as
domestic equipment
well as O&M costs will be higher once they become operational. We note that
in Sep-10, in Durgupur Power Plant, a turbine supplied by Dongfang become
inoperable due to some technical snag. The utility subsequently approached
BHEL for re-commissioning of the plant since its maintenance contract with
Dongfang had lapsed. Media articles also suggest that Sterlite Energy’s
600MW Jharsugda unit (awarded to SEPCO-III) suffered damages in coal and
ash handling systems, while Haryana’s Hissar plant (bid out to Shanghai
Electric) faced recurring instances of tube leakages.

Reduced price gap

Price differential drops The price gap between domestic and Chinese equipment has reduced because
to c.15% when larger of two reasons. Firstly, utilities have now started asking Chinese suppliers for
boilers and ESPs
larger boilers, ESPs and ash handling systems, which reduces the price
are ordered
differential from 25-30% to c.15%. Secondly, Renminbi has appreciated by
over 16% over the last three years, diluting the attractiveness of Chinese
equipment.

Appreciation of Chinese Renminbi has appreciated against the Indian Rupee over the last three years
currency has also
reduced attractiveness 0.20 (Rs/Rmb)
of Chinese equipment
0.19

0.18

0.17

0.16

0.15

0.14

0.13
Jun 07 Dec 07 Jun 08 Dec 08 Jun 09 Dec 09 Jun 10 Dec 10 Jun 11

Source: Bloomberg, CLSA Asia-Pacific Markets

Large orders placed by Lanco and Reliance Infra are deceptive

Prima facie, pricing of Reliance Infra placed a large order of 36 x 660MW to Shanghai Electric, while
Lanco and Reliance Infra Lanco placed 16 x 660MW order to Harbin. Pricing of these orders was up to
orders is much lower
40% lower than domestic equipment. This raised the concern that Chinese
equipment suppliers will continue to win large orders and industry-wide
pricing will come under pressure.

However, this is deceptive However, we note that a lot of projects for which orders have been placed are
deceptive as they are years away from construction start and some of them
may not even see light of the day. Chinese equipment makers understand this
(at least one of them has not received any advance for these orders yet) and
are not recognising the entire reported value as order inflow. Advances will be
received as and when work on these projects begins.

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Reliance Power placed Projects for which Reliance Power has placed bulk BTG order on Harbin
36x660MW order on SEC Project name Configuration Capacity (MW) Order value (Rsm)
for Krishnapatnam,
Krishnapatnam I 6 X 660MW 3,960 65,504
Chitrangni and
Tilaiya plants Krishnapatnam II 6 X 660MW 3,960 65,504
Chitrangni I 6 X 660MW 3,960 63,319
Chitrangni II 6 X 660MW 3,960 63,319
Lanco placed 16x660MW Tilaiya I 6 X 660MW 3,960 61,870
BTG orders on Harbin for
Tilaiya II 6 X 660MW 3,960 61,870
projects yet to be named
Total 23,760 381,386
Source: Reliance Power, Harbin, CLSA Asia-Pacific Markets

Reliance Power and Lanco Size of recent orders versus existing and under construction capacity
orders are significantly
larger than their existing 25 (GW) Operational 23.8

capacity as well as Under construction

capacity under
construction . . . 20 Orders on Chinese companies

15.5
15
. . . some of the orders
placed on Chinese 10.6
companies might not 10
become operational ever

5 3.8
2.1
1.0

0
Lanco Reliance Power

Source: Companies, Media reports, CLSA Asia-Pacific Markets

We believe orders to Moreover, as a result of front-loading years of future orders to today, we

Chinese equipment expect future orders to Chinese suppliers to decline going forward. These
suppliers will decline
orders have been placed by Reliance Infra and Lanco - which have historically
preferred Chinese equipment suppliers and were not expected to use
domestic equipment, in any case. As opposed to this, there are some private
sector players (like Jaiprakash, JSPL, Jindal Photo, Adhunik Power, Monnet
Power, Abhijeet Group, Visa Power and DB Power) that have historically
placed orders on domestic equipment manufacturers. They should continue to
prefer Indian suppliers.

Jaiprakash, JSPL, Jindal Private sector players using domestic equipment

Photo, Adhunik Power, Player Project Configuration Capacity Value Awarded in
Monnet Power, Abhijeet (MW) (Rsm)
Group, Visa Power and
Jaiprakash Bara 3 x 660MW 1,980 55,640 FY10
DB Power have favoured
BHEL to Chinese Indiabulls Nasik I 5 x 270MW 1,350 28,890 FY10
suppliers in the past Indiabulls Amravati I 5 x 270MW 1,350 28,890 FY10
Indiabulls Nasik II 5 x 270MW 1,350 28,890 FY11
Indiabulls Amravati II 5 x 270MW 1,350 28,890 FY11
JSPL Raigarh 4 x 600MW 2,400 50,400 FY10
Indiabulls returned
to BHEL after cancelling Jindal Photo Derang 2 x 600MW 1,200 26,000 FY10
an order to a Adhunik Power Palampur, Srirampur 2 x 270MW 540 12,800 FY10
Chinese company Monent Power Malibrahmani 2 x 525MW 1,050 26,300 FY10
Abhijeet Ranchi 4 x 270MW 1,080 25,250 FY11
Visa Power Raigarh 2 x 600MW 1,200 26,650 FY11
DB Power Baradarha 2 x 600MW 1,200 26,650 FY11
Avantha Power Korba 1 x 600MW 600 14,750 FY10
Source: Companies, media reports, CLSA Asia-Pacific Markets

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Favourable government policies

Government has imposed Government policies have been favourable for domestic manufacturers in the
visa restrictions and last few years. The government imposed visa restrictions to limit the number
domestic manufacturing
of Chinese workers at project sites to the lower of 1% of workforce or 40
base condition
labourers, which was recently increased to 10% and 300 workers (150 in case
of plant expansions) respectively. This restriction impacts Chinese equipment
suppliers’ ability to finish projects in India in time. Moreover, government has
been encouraging domestic manufacturing of components. For example, the
NTPC-DVC bulk tender had the condition that the supplier should set up
manufacturing capacity in a phased manner in India. This condition effectively
disqualified Chinese companies from bidding.

Import duty could also In addition, the government is contemplating the imposition of import duty on
get imposed Chinese equipment even on ultra-mega projects. This would further dilute
their attractiveness.

Lower capital cost Comparison of Chinese equipments with Indian equipments

and shorter execution
cycle are the main Advantages Disadvantages Risks
Advantages Disadvantages Risks
advantages of
Chinese equipments . . .
Unfavourable
Unfavourable
Lower
Lower cost
cost Lower
Lower efficiency
efficiency govt
govt policies
policies
. . . but there are
numerous risks
associated with using Shorter
Shorter execution
execution
Chinese equipment Higher
Higher cost
cost of
of spares
spares
cycle
cycle

Longevity
Longevity of
of plant
plant

Source: CLSA Asia-Pacific Markets

Fears of over-capacity in domestic markets are exaggerated

Prima facie, it seems that India is moving towards surplus power generation
equipment manufacturing capacity, with 20-25GW of capacity to be added
over the next few years.

Announced capacity addition plans by various companies

Company/JV name Capacity Expected year Comments
(MW) of completion
Boilers
BHEL's expansion 5,000 2012 Expansion from 15GW to 20GW expected to be completed by Mar 12
L&T - MHI 4,000 2010 Started booking revenues from 2QFY11
Thermax - B&W 3,000 2012/2013 Rs7bn investment; sub-critical boilers of 300MW+ and super-critical boilers
GB Engineering - Ansaldo 2,000 2012 Facility likely to be set up by Dec 12
Cethar Vessels - Riley 8,000 - Facility already operational, though utilisation rates are low at 20-30%
BGR Energy - Hitachi 3,000 2012 BGR has signed a technological collaboration agreement with Hitachi for
supercritical boilers; it has acquired land for setting manufacturing facility
Boiler capacity addition 25,000
Existing BHEL boiler capacity 10,000
Industry capacity post expansion 35,000
Turbine Generators (TG)
BHEL's expansion 5,000 2012 Expansion from 15GW to 20GW
L&T - MHI 4,000 2010 Commenced production in July 2010
JSW - Toshiba 3,000 2011/012 Cornerstone for Rs8bn plant at Ennore laid in Feb 10
Bharat Forge - Alstom 5,000 2012 Facility likely to be ready in 2012
BGR Energy-Hitachi 3,000 2012/2013
TG capacity addition 20,000
Existing BHEL TG capacity 15,000
Industry capacity post expansion 35,000
Source: Media articles, company releases, CLSA Asia-Pacific Markets

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Actual production is However, our recent conversation with two new entrants, Cethar Vessels and
generally lower than GB Engineering-Ansaldo in Trichy, suggest that this is not the case.
rated capacities
Management teams of the two companies believe that there is no
overcapacity in the Indian market as actual production tends to be
significantly lower than rated manufacturing capacities. Rated capacities are
based on the maximum production that can be achieved if all that can be
outsourced (mostly non-pressure parts) is sub-contracted. Given that vendors
do not have sufficient capacities, most equipment manufacturers are able to
produce lower than their capacities.

Companies sub-contract We also note that at times companies sub-contract work to competitors, and
work to competitors therefore just adding up the capacities leads to double counting. For instance,
we saw Cethar’s manufacturing facilities being used for doing some piping
work for BHEL, corroborating managements’ comments that capacities of
more than one player could be used to manufacture equipment.

BHEL sub-contracted Cethar’s pipe manufacturing facility in Unit-VII in Trichy

a part of piping
work to Cethar

Source: CLSA Asia-Pacific Markets

Lastly, rated capacity is calculated assuming a certain mix of unit sizes as well
as mix of fuels. If actual production is different from the assumed mix, as is
usually the case, effective production is lower than rated capacity.

Capacity utilisation can BHEL’s current and future capacity

be 100% only if actual (MW) Current capacity Future capacity
production is the same
Coal 10,000 15,000
as the mix of unit
sizes and fuels Gas 1,000 1,000
Hydro 2,500 2,500
Nuclear 1,500 1,500
Total 15,000 20,000
Source: BHEL, CLSA Asia-Pacific Markets

BHEL’s revenues suggest We note that BHEL’s revenues over the last few years also imply that actual
production of 6-10GW, production has been 6-10GW, compared to rated capacity of 10-15GW.
lower than rated capacity

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BHEL’s power segment revenues and production (in MW)

450 (Rsbn) Power revenues (LHS) (GW) 22

400 Production 20

350 Rated manufacturing capacity 18

300 16

250 14

200 12

150 10

100 8

50 6

0 4
FY07 FY08 FY09 FY10 11CL 12CL

¹ Production (in MW) is calculated by assuming realisations of Rs26m/MW, which has been the average
value of orders received over the last few years. Source: BHEL, CLSA Asia-Pacific Markets

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Appendix 16: India’s T&D equipment outlook

Outlook for Indian T&D equipment manufacturers
T&D investments should With a surge in generation capacity, India also needs a sharp increase in
pick up over the next expenditure on T&D networks to evacuate, transmit and distribute the power
few years
produced. It is because of this reason that the government had targeted
US$68bn investment in T&D in the 11th plan, implying more than doubling of
investments compared to the 10th plan. Of this, US$32bn was targeted to be
invested in transmission sector, while the remaining US$36bn was to be spent
on distribution segment.

US$142bn investment Power T&D spending target for 11th plan and requirements for 12th plan
envisaged in T&D sector
in 12th plan . . . 120 (US$bn) XI plan target
110

100 Requirement for XII plan

89
86
. . . more than double of 80
XI plan targets
60 53

36
40 32

20

0
Generation Transmission Distribution

Source: CEA, Key inputs for 12th plan, CLSA Asia-Pacific Markets

T&D spending could Despite the sharp increase in T&D spending targeted in the 11th Five Year Plan,
be higher than India’s investment in T&D has lagged capex in generation until now. However,
generation capex
this should change in the 12th plan as there is a need to augment inter-regional
capacity and cut distribution losses. As per the initial expectations of Central
Electricity Authority (CEA) for the 12th plan, investment required in T&D network
in India could be as high as US$142bn (Rs11.4tn), compared to US$110bn in
generation. Of this, US$53bn is required to be spent on transmission and the
remaining US$89bn on distribution. PowerGrid has also doubled its spending
target on transmission from US$22bn (Rs1tn) in 12th plan, from US$11bn
(Rs500bn) in the 11th plan.

PowerGrid targets PowerGrid spending targets over various five-year plans

spending to double
in 12th plan 1,200 (Rsbn) Spending target (LHS) (%) 180
Growth over pervious plan
1,000 160

800 140

600 120

400 100

200 80

0 60
IX X XI XII

Source: PowerGrid, CLSA Asia-Pacific Markets

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Transmission capex: national grid, technology improvements

Transmission capex on Transmission capacity is required to be expanded in order to evacuate power
account of national grid from surplus regions to supply to deficit regions and to enable electricity
plans and technology
trading. This will need inter-regional capacity to be set up and an integrated
improvements
national grid to be established. Moreover, in order to transmit electricity over
long distances, there is also a need to upgrade technology.

Need to transmit power National grid expansion to match power supply with demand. Most of
for long distances India’s coal resources are concentrated in Eastern and Central India, while
most hydro resources are in North East. In addition, a number of power
plants based on imported coal are getting established/ under planning in
coastal areas. Contrary to this, power demand shortages are the highest in
Northern and Western India. Therefore, significant investment is required to
expand the country’s inter-regional grid capacity in order to match power
supply with demand.

Power plants and main Main centres of electricity generation and consumption in India
centres of power demand
are at different locations

Source: Ministry of Power (MoP), CEA, CLSA Asia-Pacific Markets

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By FY12, 31GW of inter- Inter-regional capacity expansion

regional capacity is likely
80 (GW) 220kV 75GW

70 HVDC mono-pole
HVDC B-T-B
60
HVDC bi-pole
50
400kV
40 765kV 37GW
31GW
30
21GW
20 16GW

9GW
10 5GW

0
FY02 FY05 FY07 FY10 FY12 target FY12 likely FY17 req.

Source: CEA, PowerGrid, CLSA Asia-Pacific Markets

75GW of inter-regional In the 11th plan, target was set to expand the inter-regional transmission
capacity planned by FY17 capacity to 37GW, an addition of 21GW capacity to 16GW at the beginning of
the plan. At the end of FY10, inter-regional capacity stood at 21GW (addition
of 5GW over FY07-10), and it seems that 11th plan targets are likely to be
missed. PowerGrid anticipates that inter-regional capacity should stand at
31GW at the end of FY12, and there will be a need to expand it to 75GW by
the end of 12th plan (FY12-17). Thus 11th plan total inter-regional grid
capacity addition is 15GW and as per 12th plan target another 44GW needs to
be added in the 12th plan - which is over about 200% growth.

India needs higher Need to improve technology to transmit over long distances. Not only
transmission voltages and India has to grow its transmission network, the country also needs higher
new technologies for bulk
transmission voltages and new technologies for bulk transmission of
transmission
electricity over long distances. Some of the key technological advances over
the past few decades include: introduction of 220kV in 1960; 400kV in 1977;
HVDC back-to-back link in 1989; +/-500kV HVDC bi-pole line in 1990; 765kV
transmission line in 2007; and +/-600kV HVDC bi-pole line in 2011.

PowerGrid takes 765kV and 500kV HVDC transmission lines added over various five year plans
lead in higher
voltage category . . . 3,500 C entral addition State addition
(ckm) 76 5kV (%) 50 0 kV
3,000

2,500

2,000

1,500

1,000

500

0
VII

VIII

XI

VII

VIII

XI
IX

IX

Note: 11th plan shows figures for four years (FY07-11). Source: PowerGrid, CEA, CLSA Asia-Pacific
Markets

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. . . while state 400kV and 220kV transmission lines added over various five year plans
governments cater to low
voltage capacity additions 30,000 C entral addition State addition
(ckm) 4 0 0 kV (%) 2 2 0 kV
25,000

20,000

15,000

10,000

5,000

0
VII

VIII

XI

VII

VIII

XI
IX

IX

X
Note: 11th plan shows figures for four years (FY07-11). Source: PowerGrid, CEA, CLSA Asia-Pacific
Markets

We note that PowerGrid has taken the lead in bringing out technological
advancements, while SEBs have concentrated on adding low-voltage capacity
(mainly 220kV and 400kV). For example, 82% of 765kV transmission lines
and 100% of 765kV substations added so far have been contributed by
PowerGrid.

Power Grid’s achievement While the achievement rate (ie, actual addition/ target addition) had been
rate for 765/500kV lines high for PowerGrid at 80-100% so far, it is likely to dip in the 11th plan.
likely to slip in 12th plan
This especially holds true for 765kV and +/-500kV HVDC transmission
lines and sub-stations. Mid-term review of the 11th plan noted that actual
addition of 765kV and +/-500kV HVDC lines could fall short of targets by
48% and 70% respectively.

Actual addition Target addition for 11th plan, progress so far and tentative targets for 12th plan
for 765/500kV lines Category Target addition Actual addition Target addition
could be 48-70% lower in 11th plan up to Oct 09 in 12th plan
than targets
Transmission lines (ckm)
765kV 5,273 1,088 25,000
HVDC 5,400 1,480 5,000
400kV 47,446 16,982 50,000
220kV 30,396 10,813 40,000
Sub-station (MVA)
765kV 24,500 4,500 110,000
HVDC 8,500 500 18,000
400kV 51,960 28,190 80,000
220kV 72,731 32,578 95,000
Source: Planning commission, CEA, CLSA Asia-Pacific Markets

Delays should be According to the mid-term review of the 11th plan, low addition of high
compensated in 12th plan voltage lines and sub-stations has been on account of delays in generation
capacities coming on-stream. These transmission lines should, therefore, be
set up in the 12th plan, once corresponding generation capacities become
operational. For the 12th plan, CEA anticipates a sharp pick up in high voltage
transmission lines and sub-stations. PowerGrid’s High Capacity Transmission
Corridor will also require massive investments, estimated at around Rs580bn.

288 [email protected] 27 June 2011

 
  
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High Capacity Power Details of nine High Capacity Power Transmission Corridors (HCPTC)
Transmission Corridor Section Description Project cost
presents a Rs580bn (Rsm)
opportunity Section-I Transmission System Associated with Phase-I Generation Projects 87,520
in Orissa
Section-II Transmission System Associated with IPP projects in Jharkhand 57,090
Section-III Transmission System Associated with IPP projects in Sikkim 13,040
Section-IV Transmission System Associated with IPP projects in Bilaspur 12,430
complex, Chattisgarh & IPPs in Madhya Pradesh
Section-V Transmission System Associated with IPP projects in Chattisgarh 288,240
Section-VI Transmission System Associated with IPP projects in 20,650
Krishnapatnam Area, Andhra Pradesh
Section-VII Transmission System Associated with IPP projects in Tuticorin 23,570
Area, Tamil Nadu
Section-VIIII Transmission System Associated with IPP projects in Srikakulam 29,860
Area, Andhra Pradesh
Section-IX Transmission System Associated with IPP projects in Southern 48,210
Region for transfer of power to other regions
Total 580,610
Source: PowerGrid, CLSA Asia-Pacific Markets

Distribution capex: aimed at cutting losses, rural electrification

India’s power sector is characterised by inadequate and inefficient power
supply. This leads to high distribution losses, which occur on both sides of the
energy meter - the utility side as well as the consumer side.

High distribution Aggregate technical and commercial (AT&C) losses over years
losses . . .
38 (%) (%) 100

36 95

34 AT&C losses (LHS) 90

Billing efficiency
32 85
Collection efficiency

30 80

28 75

26 70

24 65
FY03 FY04 FY05 FY06 FY07 FY08 FY09
Source: CEA, CLSA Asia-Pacific Markets

. . . at the utility side as On the utility side, main causes are non-standard and antiquated distribution
well as the consumer side engineering practices, inefficient and overloaded distribution equipment,
faulty and poor maintenance practices, lack of investment in system upgrade,
faulty meters, and poor commercial management and accounting practices.
At the consumer end, problems relate to lack of meters, prevalence of flat
rate tariffs over metered tariffs, non-payment, theft, illegal connections,
rampant political interference, and inefficient electricity use.

Need to bring down While AT&C losses have been falling over the last couple of years, they still
losses to make remain high at about 29%. The Planning Commission has time and again
distribution financially
expressed concern over the slow pace of reforms in the distribution sector
viable
and stressed the need to make the distribution sector financially viable.

Poor progress in APDRP In the 11th plan, the government had targeted to spend ~US$20bn (of the
programme . . . total US$36bn allocated for distribution sector) on two ambitious schemes:
Accelerated Power Development and Reform Program (APDRP) and Rajiv

27 June 2011 [email protected] 289

 
  
 Appendices Chindia power

. . . while RGGVY spending Gandhi Gramin Vidyutikaran Yojana (RGGVY). According to the mid-term
picked up only in FY11 review of 11th five year plan, little progress has been made on the APDRP
program so far. The performance of RGGVY had also been poor until FY10,
only to pick up in FY11 (with 37,000 villages becoming electrified).

55k villages electrified in Electrification of villages over years

FY08-11
40,000 (No.)
IX plan X plan XI plan
35,000 13k villages 45k villages 55k villages

30,000
25,000
20,000
15,000
10,000
5,000
0
FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11
Note: 11th plan data for four years (FY07-11). Source: CEA, CLSA Asia-Pacific Markets

Sharp pick up in spending In the 12th five year plan, massive investment will be required to bring about
in 12th plan reforms in the distribution sector to cut T&D losses. Based on early
indications given by the CEA, there is a requirement for an investment of
~US$90bn in the 12th plan, though it is unlikely that such an amount will
actually get spent.

Near-term headwinds: slow orders, intensifying competition

Slow orders and Despite significant investments planned in the long term, T&D equipment
intensifying competition suppliers are facing strong headwinds as of now. These are in the form of
present near term
slow ordering for transformers and substations by PowerGrid and intensifying
headwinds
competition in the industry, leading to margin erosion.

Slow ordering by PowerGrid for transformers and sub-stations

PowerGrid ordering PowerGrid accounts for 40-50% of investment in India’s transmission sector.
picked up in 4QFY11 Its ordering had been slow in 9mFY11 at Rs42bn, down 27% YoY. However, it
revived sharply in 4QFY11 (Rs130bn, up 97% YoY); consequently overall
FY11 awards stood at Rss171bn, up 40% YoY.

Rs171bn worth of orders PowerGrid project awards over months

awarded in FY11
140 (Rsbn)
FY09 FY10 FY11
120
Rs144bn Rs123bn Rs171bn
100

80

60

40

20

0
1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11

Source: PowerGrid, CLSA Asia-Pacific Markets

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Strong transmission line/ However, ordering has been skewed in favour of transmission lines/towers
tower orders but (Rs56bn, up 16% YoY). Moreover, the agency awarded a large Rs53bn HVDC
poor sub-station/
multi-terminal package order to ABB-BHEL consortium. On the contrary,
transformer orders
ordering has lagged for transformers and substations (Rs26bn, down 42%
YoY). This is the segment that most of the large T&D equipment suppliers
(like ABB, Areva and Crompton) target, and slow ordering has led to order
inflows falling YoY for most of them.

Only Rs26bn of Sub- Transmission line/tower orders Sub-station, transformer orders

station, transformer
orders awarded 50 (Rsbn) 25 (Rsbn)
by PowerGrid FY09 FY10 FY11 FY09 FY10 FY11
40 20
Rs45bn Rs48bn Rs55bn Rs35bn Rs45bn Rs26bn
30 15

20 10

10 5

0 0
1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11

1QFY09

2QFY09

3QFY09

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11
Source: PowerGrid, CLSA Asia-Pacific Markets

Frequent changes in One of the main reasons for delays in award of transformers/ sub-station
qualification norms orders is frequent changes in qualification conditions. For example, the
agency introduced indigenous manufacturing condition in its tender for
transformers as well as sub-stations in mid-FY11 (ie, for supplying equipment
to PowerGrid, the supplier should now have domestic manufacturing facilities
through a subsidiary/JV within six months of the award of the contract).
Similarly, PowerGrid separated circuit breakers from sub-station EPC orders.
Such frequent changes in bidding documents led to procedural delays.

Transformer ordering Our conversations with industry participants suggest that transformer
unlikely to revive over ordering is unlikely to revive over the next couple of quarters. However, given
next few quarters
the sharp pick up in power capacity addition in the country, we believe it is
matter of time before order awards from PowerGrid for substations and
transformers picks up.

We believe orders We expect that PowerGrid should award about Rs150bn worth of orders in
will pick up from FY12, with the proportion of transformers and sub-stations going up to 20-
2HFY12 onwards
25% from 15% in FY11. This should translate into strong earnings and order
flow growth for T&D equipment manufacturers form FY13 onwards.

Intensifying competition is eroding returns

Bidding has As discussed earlier, T&D market should expand rapidly over the next
become aggressive . . . couple of years, as it did in the initial few years of the 11th plan. However,
competitive dynamics have changed since then, with most equipment
manufacturers undertaking aggressive capacity addition. Consequently,
bidding has become more aggressive and it is now difficult to sustain/
expand margins.

27 June 2011 [email protected] 291

 
  
 Appendices Chindia power

. . . leading to Ebitda margins of T&D equipment suppliers

lower margins

(%) ABB Areva Crompton (standalone) Crompton (consol)

18
16
14
12
10
8
6
4 Strong T&D ordering Flat T&D ordering over FY09-11

2 Slow capacity expansion Sharp capacity expansion

0
FY05 FY06 FY07 FY08 FY09 FY10 FY11

Source: Companies, CLSA Asia-Pacific Markets

Ebitda margins of ABB and Areva have declined sharply in the past few
years, on account of their losses in noncore areas like rural electrification,
some operational inefficiencies and rampant industry-wide pricing
pressure and metal cost increases. After having maintained or expanded
its margins for 11 successive quarters, Crompton’s margins also narrowed
sharply in 4QFY11.

Strong capacity addition Capacity utilisation for mid-to-high voltage substation/transformer manufacturers

120,000 (MVA) (%) 100

ABB (LHS) Areva (LHS)
95
100,000 Crompton (LHS) BHEL (LHS)
Capacity utilisation 90
80,000
85

60,000 80

75
40,000
70
20,000
65

0 60
FY06 FY07 FY08 FY09 FY10

Note: Siemens data is not considered because transformer utilisation levels have remained very low for
the company at 10-15%. Source: Companies, CLSA Asia-Pacific Markets

Chinese/Korean players Not only has competition intensified among domestic players, but a number
are exerting pricing of overseas operators (mainly Chinese and Korean) have also entered the
pressure
fray. For example, 33-45% of 765kV transformer/ sub-station awards by
PowerGrid in FY09-11 have gone to overseas players.

292 [email protected] 27 June 2011

 
  
 Appendices Chindia power

They have won 33-45% of Market share of players in PowerGrid’s 765kV transformer/substation orders
765kV transformer/ sub-
station awards by
PowerGrid in FY09-11 (%) ABB Areva Crompton Siemens Boading Hyosung Hyundai TBEA
100
7
90 20
11
33
80 Korean/Chinese Korean/Chinese
15 16
70
60 13 10 15
50
21 18
40 17

30 11
26
20 33
10 22
8
3
0
FY09 FY10 FY11

Source: PowerGrid, CLSA Asia-Pacific Markets

Some orders won by Moreover, even the orders won by MNCs operational in India (like ABB, Areva
Indian companies also and Siemens) will not be serviced by their Indian subsidiaries alone. For
executed by overseas
example, for the US$1.1bn HVDC order that was won by ABB-BHEL, only
subsidiaries
around 30% of the value of the work will be carried by Indian companies
(US$135m by ABB India and US$200m by BHEL). The remaining US$765m
worth of work will be executed by ABB (Sweden).

In addition, a number of Crompton’s reactor and transformer orders will need

to be executed by the domestic entity in tandem with its overseas
subsidiaries/ JV partners. Overall, we estimate that over the last three years,
parent companies of ABB/Areva and Siemens, together with overseas
subsidiaries of Crompton, have increased their share in PowerGrid awards,
from Rs3.6bn in FY09 (2.5% of total project awards) to Rs41.7bn by FY11
(24.3% of total orders awarded).

24% of orders won by Orders won by parents of ABB/Areva/Siemens, overseas subsidiaries of Crompton
ABB, Areva, Siemens and
Crompton in FY11 will be
executed by overseas 45 (Rsbn) (%) 30
entities
40
Crompton 25
35
Siemens
30 Areva 20

25 ABB
15
20 As a % of total awards (RHS)

15 10

10
5
5

0 0
FY09 FY10 FY11 excl HVDC FY11

Source: Companies, CLSA Asia-Pacific Markets

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 Appendices Chindia power

Indigenous It was earlier anticipated that indigenous manufacturing condition introduced

manufacturing condition by PowerGrid in FY11 will ease competitive threat from Chinese and Korean
doesn’t deter overseas
players. However, this has clearly not happened. The new indigenous
competition
manufacturing condition requires an equipment supplier to have a domestic
manufacturing facility (either in-house or through a subsidiary or JV) within
six months of the award of the contract, failing which initial guarantee is
forfeited by PowerGrid. Our conversations with industry participants suggest
that overseas players have been able to circumvent this provision by agreeing
to form JVs with smaller domestic players.

Realisations are coming As a result, overseas players have continued to bid aggressively, resulting in
down sharply average realisations coming down. While a part of the decline in average
765kV transformer/ substation order values could be on account of change in
scope of work, we understand that it is also a result of aggressive pricing. For
instance, Crompton Greaves suggests that while in physical volume terms
(i.e. MVA terms), its growth was 31% YoY in 9mFY11, in value terms it was
only 2%. Management highlighted that some of the decline in realisation is
also on account of change in scope of work, product mix etc.

Who will emerge as winners?

Given that pricing is becoming aggressive, T&D equipment suppliers will have
to rationalise costs in order to protect their margins. In addition, companies
possessing advanced technologies will be able to counter competition better,
compared to the ones that offer commoditised products.

More cost efficient companies better placed

Crompton is the most We believe that Crompton is the most efficiently run company in the Indian
efficient T&D equipment T&D sector. This is evident from the company’s relatively stable margins
supplier in India
(though they narrowed in 4QFY11), better return ratios and relatively stricter
control over working capital. As opposed to this, some of its competitors have
unsuccessfully tried to diversify into unrelated areas (like rural electrification
by ABB) and/or found it difficult to protect their margins.

Crompton has been able Ebitda margins of various T&D equipment suppliers
to better sustain its
margins . . . 18 (%)

16

. . . by benefitting from 14
operational efficiencies
12
and global sourcing
10

8
ABB
6 Areva
4 Crompton (standalone)
Crompton (consol)
2

0
FY05 FY06 FY07 FY08 FY09 FY10 FY11

Source: Companies, CLSA Asia-Pacific Markets

294 [email protected] 27 June 2011

 
  
 Appendices Chindia power

Crompton has also Net working capital as a % of revenue for T&D equipment suppliers
shown better control
on working capital than 18 (%)
its competitors 16
14
12
10
8
6 ABB
Areva
4
Crompton (standalone)
2 Crompton (consol)
0
FY05 FY06 FY07 FY08 FY09 FY10 FY11

All this leads to ROCE of various T&D equipment suppliers

significantly better
returns for investors 45 (%)
40
35
30
25
20 ABB
15 Areva
10 Crompton (standalone)
5 Crompton (consol)

0
FY05 FY06 FY07 FY08 FY09 FY10 FY11

Source: Companies, CLSA Asia-Pacific Markets

Diversified presence Moreover, Crompton has a diversified presence, and its overseas exposures
also helps and consumer and industrial businesses should help offset pricing pressure in
the domestic T&D equipment market to some extent. We note that
Crompton’s operating margins in international business are lower than most
of its competitors. Management also suggests that there is a scope to
improve margins over a medium term in international subsidiaries through
operational efficiencies and better material procurement procedures. In the
near term, however, margins could remain under pressure on account of
rising commodity prices, changing nature of business (more EPC work) and
intensifying competition.

. . . in offsetting Crompton’s segmental exposure Crompton’s geographic exposure

weakness in a particular
Others
business/geography Industrial 10%
14%
N. America
11%
India
Consumer
47%
18%
Asia
Power 15%
68%
Europe
17%

Source:Crompton Greaves, CLSA Asia-Pacific Markets

27 June 2011 [email protected] 295

 
  
 Appendices Chindia power

Crompton’s international Ebit margin comparison of various global T&D companies

margins are lower than
global majors
Crompton - Standalone

ABB - Power
Management believes
that there is a scope Hyosung - Ind Mat
to improve margins by
200-250bps pver TBEA
next 2-3 years
Siemens T&D

Crompton- International

Mitsubishi Elec Energy

Toshiba Power Sys (%)

0 2 4 6 8 10 12 14 16

Source: Companies, CLSA Asia-Pacific Markets

Technology will offer an important competitive edge

Technology will be Companies with more advanced technologies will be able to better withstand
a differentiator competitive pressures. While three years back, the technology gap between
MNC T&D equipment suppliers and their Indian counterparts was wide, it has
narrowed. Crompton especially has made some focussed acquisitions to
bridge its technology gap, though it still needs to acquire domain knowledge
for sub-station and industrial automation projects and HVDC technology.

BHEL and Crompton have 765kV/1,200kV transformer. Crompton Greaves as well as most of the
made progress in Indian subsidiaries of MNC players are now capable of manufacturing 765kV
developing 1,200kV
transformers indigenously. We note that Crompton has also developed a
transformer
1,200kV ultra-high voltage transformer, which is being examined by
PowerGrid as of now.

Indian companies lack HVDC. Parent entities of ABB and Siemens have expertise in the HVDC area
HVDC skill as of now and are likely to dominate the Indian market in the near term. For instance,
US$765m worth of work will be executed by ABB (Sweden) on the US$1.1bn
HVDC tender awarded to BHEL-ABB consortium. Our conversations with ABB
India’s management indicate that they would try to indigenise technology as
they execute a few projects with the parent company. Crompton Greaves has
been scouting for acquisitions in the HVDC area for the last two years, but
have not been able to finalise anything.

Crompton enters Sub-station automation. Until now, ABB and Siemens have dominated the
sub-station automation sub-station automation market in India. However, with the acquisition of QEI,
market with the
Crompton has been able to bridge this technology gap. Management
acquisition of QEI
anticipates that the company can win about 20% of the domestic market
(c.Rs25bn) over the next two years. With competition being less intense in
this business, profit margins are relatively better. For instance, ABB’s margins
in its automation segment have been 7-15% over the last three years,
compared to 0-12% for the power products and systems business.

296 [email protected] 27 June 2011

 
  
 Chindia power

Notes

27 June 2011 [email protected] 297

 
  
 Chindia power

Notes

298 [email protected] 27 June 2011

 
  
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20 Hunter Street Mumbai 400021 6766 Ayala corner Paseo de Roxas Suite 220
Sydney NSW 2000 Tel: (91) 22 6650 5050 Makati City Boston, MA 02110
Tel: (61) 2 8571 4200 Fax: (91) 22 2284 0271 Tel: (63) 2 860 4000 Tel: (1) 617 295 0100
Fax: (61) 2 9221 1188 Fax: (63) 2 860 4051 Fax: (1) 617 295 0140

China - Beijing Indonesia Singapore USA - Chicago

CLSA Limited - Beijing Rep Office PT CLSA Indonesia CLSA Singapore Pte Ltd Credit Agricole Securities
Unit 10-12, Level 25 WISMA GKBI Suite 901 80 Raffles Place, No.18-01 (USA) Inc
China World Trade Centre Tower 2 Jl Jendral Sudirman No.28 UOB Plaza 1 227 W. Monroe Street
1 Jian Guo Men Wai Ave Jakarta 10210 Singapore 048624 Suite 3800
Beijing 100004 Tel: (62) 21 2554 8888 Tel: (65) 6416 7888 Chicago, IL 60606
Tel: (86) 10 5965 2188 Fax: (62) 21 574 6920 Fax: (65) 6533 8922 Tel: (1) 312 278 3604
Fax: (86) 10 6505 2209

China - Shanghai Japan Taiwan USA - New York

CLSA Limited - Shanghai Rep Office Credit Agricole Securities Asia BV CLSA Limited Credit Agricole Securities
Room 910, 9/F Tokyo Branch Taiwan Branch (USA) Inc
100 Century Avenue 15/F, Shiodome Sumitomo Building 27/F, 95 Tun Hwa South Road 15/F, Credit Agricole Building
Pudong New Area 1-9-2, Higashi-Shimbashi Section 2 1301 Avenue of The Americas
Shanghai 200120 Minato-ku, Tokyo 105-0021 Taipei New York 10019
Tel: (86) 21 2020 5888 Tel: (81) 3 4580 5533 (General) Tel: (886) 2 2326 8188 Tel: (1) 212 408 5888
Fax: (86) 21 2020 5666 (81) 3 4580 5171 (Trading) Fax: (886) 2 2326 8166 Fax: (1) 212 261 2502
Fax: (81) 3 4580 5896

China - Shenzhen Korea Thailand USA - San Francisco

CLSA Limited - Shenzhen Rep Office CLSA Securities Korea Ltd CLSA Securities (Thailand) Ltd Credit Agricole Securities
Room 3111, Shun Hing Square 15/F, Sean Building 16/F, M Thai Tower (USA) Inc
Di Wang Commercial Centre 116, 1-Ka, Shinmun-Ro All Seasons Place Suite 850
5002 Shennan Road East Chongro-Ku 87 Wireless Road, Lumpini 50 California Street
Shenzhen 518008 Seoul, 110-061 Pathumwan, Bangkok 10330 San Francisco, CA 94111
Tel: (86) 755 8246 1755 Tel: (82) 2 397 8400 Tel: (66) 2 257 4600 Tel: (1) 415 544 6100
Fax: (86) 755 8246 1754 Fax: (82) 2 771 8583 Fax: (66) 2 253 0532 Fax: (1) 415 434 6140

Hong Kong Malaysia United Kingdom

CLSA Limited CLSA Securities Malaysia Sdn CLSA (UK)
18/F, One Pacific Place Bhd 12/F, Moor House
88 Queensway Suite 20-01, Level 20 120 London Wall
Hong Kong Menara Dion London EC2Y 5ET
Tel: (852) 2600 8888 27 Jalan Sultan Ismail Tel: (44) 207 614 7000
Fax: (852) 2868 0189 50250 Kuala Lumpur Fax: (44) 207 614 7070
Tel: (60) 3 2056 7888
Fax: (60) 3 2056 7988 CLEAN
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CLSA Sales Trading Team

Australia (61) 2 8571 4201 Malaysia (60) 3 2056 7852
China (Shanghai) (86) 21 2020 5810 Philippines (63) 2 860 4030
Hong Kong (852) 2600 7003 Singapore (65) 6416 7878
India (91) 22 6622 5000 Taiwan (886) 2 2326 8124
Indonesia (62) 21 573 9460 Thailand (66) 2 257 4611
Japan (81) 3 4580 5169 UK (44) 207 614 7260
Korea (82) 2 397 8512 US (1) 212 408 5800 CLSA is certified ISO14001:2004

© 2011 CLSA Asia-Pacific Markets ("CLSA").

Key to CLSA investment rankings: BUY = Expected to outperform the local market by >10%; O-PF = Expected to outperform the local market
by 0-10%; U-PF = Expected to underperform the local market by 0-10%; SELL = Expected to underperform the local market by >10%.
Performance is defined as 12-month total return (including dividends). 01/01/2011