Emerging UHV risks, shrinking upside; d/g Pinggao and XJ Electric

Deutsche Bank Markets Research Asia China Utilities Utilities Industry China A-share T&D equipment Date 8 June 2017 Recommendation Change Emerging UHV risks, shrinking upside; d/g Pinggao and XJ Electric UHV-driven profit growth cycle likely coming to an end ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017. Luka Zhu Research Associate (+852 ) 2203 6173 luka.zhu@db.com Michael Tong, CFA Research Analyst (+852 ) 2203 6167 michael.tong@db.com Key Changes Company Target Price Rating 000400.SZ 22.20 to 18.00(CNY) Buy to Hold 600312.SS 19.90 to 14.30(CNY) Buy to Hold 601179.SS 6.20 to 5.86(CNY) - Source: Deutsche Bank Companies Featured XJ Electric (000400.SZ),CNY16.50 Hold 2016A 2017E 2018E P/E (x) 17.9 13.8 13.6 EV/EBITDA (x) 13.4 10.2 9.7 Price/book (x) 2.6 2.0 1.8 Pinggao Electric (600312.SS),CNY13.45 Hold 2016A 2017E 2018E P/E (x) 17.7 13.3 12.7 EV/EBITDA (x) 11.1 7.3 7.1 Price/book (x) 2.3 1.9 1.8 China XD (601179.SS),CNY5.46 Hold 2016A 2017E 2018E P/E (x) 24.8 21.5 19.9 EV/EBITDA (x) 10.8 9.4 8.5 Price/book (x) 1.5 1.4 1.4 Source: Deutsche Bank We see increasing uncertainty over the outlook for China’s UHV investment. Project approvals are likely to be affected by persisting power oversupply and rising distributed energy investment. Nearly halfway through the year, we observe signs of UHV project delay and tenders falling shy of expectations. For UHV suppliers, potential UHV order contractions would make the product mix less favorable and point to a weaker earnings growth profile in FY18-19 (2-9%). With modest and less visible growth ahead, valuations (13-14x FY17E) offer limited upside. We downgrade Pinggao and XJ Electric to Hold; we prefer XJ for its more defensive DC investment outlook and higher distribution exposure. Less visibility in UHV project approvals In February (Outlook diverges in voltage level; top pick: XJ Electric), we raised a concern that the prevailing power oversupply would reduce visibility in domestic UHV project approvals next year and beyond. We have now become more cautious, as signs of project delays and YTD tenders come to light. Large-scale thermal project cancellations/delays and government promotion of distributed energy add uncertainty to project approvals. UHVDC has a better outlook than UHVAC, due to less tech controversy and better export potential. UHV products now contribute c.35-40% of gross profit to Pinggao, XJ, and China XD. Our base-case UHV tender scenario points to 15-30% yoy UHV gross profit decline in FY18. Grid investment growth slows; structural shift towards a distribution network 1-4M17 grid investment growth slowed to 4.7%, compared to 44% in 1-4M16 (against a low-base 2015) and 17% in FY16. This came in line with our expectation that domestic grid investment had almost plateaued. Against an overall grid investment slowdown, a structural shift towards a distribution network continues, as YTD distribution automation equipment tenders pick up. Nevertheless, the profitability of primary mid-low voltage equipment, which accounts for most of distribution network equipment investment, is still weak despite an expected moderate pricing recovery. Rise in exports will likely only partially mitigate domestic headwinds Riding on the One Belt, One Road (OBOR) initiative, T&D equipment exports have been rising steadily. The T&D equipment companies we cover guide >20% yoy growth in export sales. However, we believe the rise in export sales will not fully offset domestic headwinds, in view of still-low revenue contributions (c.10%/below), overseas order intake/delivery risks, and volatile margins. Below-consensus FY18-19E earnings; downgrade Pinggao, XJ Electric to Hold Mainly due to more conservative UHV assumptions, we cut our FY17-18 earnings forecasts for Pinggao, XJ Electric and China XD by 1-12%, and introduce FY19 forecasts. Our FY18/19 forecasts are 6-17% below consensus. Current valuations (13-14x FY17E) appear fair vs. a weaker profit growth outlook (2-9% in FY18-19E vs. 12-39% in FY17E). Hence, we cut our target prices and downgrade Pinggao and XJ Electric to Hold, and maintain our Hold on China XD. Valuations and risks We base our target prices on DCF methodology, with WACCs of 7.7-7.9%. Key risks: variance in grid investments, UHV approvals/orders and export sales, market share changes with competit