Overview

Although income has remained same basically, factors such as change of product structure have driven up the profitability of Harbin Power and resulted in sharp increase of performance by 69% in 2010. However, the Company experienced scarce growth in the last five years and its competitiveness in the domestic market has declined to some extent. Therefore its growth is expected to be limited. Nevertheless, the beyond-expectation growth of nuclear power and export businesses is still worth further attention. Additionally, affected by factors such as increase of metal prices, the profitability of the Company may decline to some extent. To synthesize, we expect that the net profit of Harbin Power in 2011 and 2012 would respectively be RMB 907 million and RMB 1050 million, which means EPS of 0.66 and 0.76 respectively. Based on a conservative 10x PE ratio to the forecasted EPS in 2011, the target price in 12 months is HKD 7.82 and the rating is “hold”.

Performance increased driven by adjustment of product structure

Harbin Power is one of the three biggest domestic power generating equipment manufacturers. Thermal and hydro power units manufactured by Harbin Power, which are its traditional advantageous businesses, account for 30% of market shares in their respective markets. Its order share in the segment of conventional island steam turbine units of the third generation nuclear power system AP 1000 market has reached 72%.

According to the latest issued report of 2010, the Company realized a turnover of 28.8 billion (RMB, the same below) and a net profit of 1.024 billion in 2010, which respectively represent increase of 0.6% and 69% yoy. The earning per share was RMB 0.74 and the dividend per share was RMB 0.14.

Although the turnover remained essentially at the same level, the contribution of thermal power equipments dropped by almost 5 percent to 62.41% and the contribution of other businesses increased correspondingly, which is also the major factor that has driven up the profitability of the Company and resulted in the sharp increase of net profit. The rate of margin of the Company increased from 12.8% to 14.4% in 2010 yoy. In terms of product classification, the increase of gross margin of ancillary equipment for power stations was the highest, which was an 8 percents increase to 33.47%. The gross margin of main hydro power equipment has also increased by 2.11 percents to 25.24%. And the engineering services for power stations business has also experienced a turn around.

Lack of growth in the short term

Although the performance of Harbin Power experienced sharp increase in 2010, its income and profit in the last five years have not experienced growth and have even down slide. This is partly due to the environment of the power industry. The general trend is that the newly installed capacity of power generating equipment in the domestic market has declined since 2006. On the other hand, this is also a result of the decline of competitiveness of Harbin Power. The amount of newly signed contracts of Harbin Power is less than those of its competitors. In 2009 and 2010, such amount remained at about 42 billion, whereas the same amounts for Shanghai Electric and Dongfang Electric are respectively 70 billion and 56.8 billion. Currently, the in hand orders of the Company amount to 100 billion, which is even less than the amounts of the aforesaid two competitors as of 2009, which are respectively 190 billion and 130 billion.

Looking forwards, we estimate that the growth of the Company would be limited. Firstly, China is aggressively pushing forward its economic structural adjustment by replacing economic growth by economic development. The investment dominated economic model will be gradually transformed and the growth of GDP will also slow down, which means that the growth of power demand will also slow down in the future. Secondly, energy consumption indicators also show that the electricity consumption in terms of unit GDP growth in China is steadily declining. According to the emission mitigation targets imposed by Copenhagen Conference, China must also honor its promise of reducing its carbon emission per unit GDP by 40% to 45%. Based on the aforesaid factors, the growth of electricity consumption of China will slow down, which would restrain the growth of newly installed equipment capacity. Generally speaking, industrial environment makes it difficult for Harbin Power to realized growth beyond expectation. The increase of turnover of Harbin Power in the coming two years is expected to be no more than 10%.

Nuclear power and export businesses may worth attention

In terms of business structure, nuclear power and export businesses will hopefully bring unexpected growth for the Company in the future. However, Japan nuclear crisis will make it difficult to realize optimistic performance in the nuclear power in 2011.

25.9% of newly signed contracts in 2010 comes from nuclear power equipments and the current in hand orders of the Company also amount to 18 billion. The order share of 72% in the AP1000 conventional island steam turbine units market also indicates that the Company is at the frontier of the domestic market. Its nuclear power business is obviously of competitive edge. According to the twelfth five-year plan, the installed equipment capacity of nuclear power of China will reach 42.94 million KW by 2015 and 90million KW by 2020, which are far more than the installed equipments capacity in 2010, namely 10.82 million KW. This means that there is much room of growth for nuclear power in future. Although the emergency diesel generator was not activated due to loss of external power source in the recent Japan nuclear crisis, this is not an issue for the third generation AP1000 nuclear power technology which is being applied by China in its coastal areas and will be spread to inland areas. We estimate that the recent nuclear crisis will hinder the progress of China's nuclear power construction in the short term but will not affect the expansion of nuclear power in the medium and long term. The income contribution of nuclear power of Harbin Power is only 9%, which is remarkably lower than those of its competitors. This also means that there is room for expansion.

Another market noteworthy is the export market. According to the estimate of the International Energy Agency, the global accumulative investment in electricity during the period from 2007 to 2030 will exceed USD 11.3 trillion. In terms of the electrical industry, the markets of developed countries are nearly saturated, with the growth rate under 1%. Meanwhile, there is still room for growth in the markets of developing countries, where the annual growth rates are between 4% and 8%. Comparatively, China's generating equipment technology is already at the global frontier and the cost advantage will give domestic enterprise a good position in global competition. Currently, the contribution ratios of export businesses of Shanghai Electric and Harbin Power respectively exceed 16% and 18%. Another fact noteworthy is that, export businesses account for about 44% of the total newly signed contracts of Harbin Power in the last two years, which is much higher than competitors such as Dongfang Electric, of which the same ratio is 25%. From this perspective, the Company is at a good position in international competition. The contribution of international income is expected to greatly increase, which may drive performance increase.

Profitability may drop

Steel and non-ferrous metal are the major raw materials used for generating equipments. They account for 70%-80% of the total costs, among which steel accounts for over 50% of the total costs. According to relevant data since 2006, the gross margin of the Company exhibited a comparatively remarkable negative correlation to steel price. Based on the data of 2011, the average price of steel sheet has increased by 7.5% compared with the annual average price of 2010. The prices of copper and aluminum have also increased by 21% and 6.2% respectively. Looking forwards, Japan nuclear crisis would have a 20 to 30 million ton impact on steel capacity, mainly on steel sheet, which would not be able to be overcome in the short term. Therefore, we estimate that the gross margin of the Company in 2011 will decline to some extent due to the impact of cost increase.

Risks

Global economy may entrap in stagflation;

Expansion and profitability of international businesses affected by sharp appreciation of RMB.

Sharp slump of share price has reflected negative expectation essentially

Considering the expectations of limited room of business growth and decline of profitability of the Company, we estimate that the turnovers of Harbin Power in 2011 and 2012 would respectively be 29.8 billion and 32.1 billion. The net profit would respectively be 907 million and 1050 million, which respectively means EPS of 0.66 and 0.76.

Factors such as stagnation of performance and Japan nuclear crisis have pulled the share price of the Company from the high level of near 14 HDK in December of 2010 down to about 7.8 HKD, a slump up to 44%. We believe that the recent slump has essentially reflected the negative expectations. In terms of valuation, the historical PE of Harbin Power averages at 9.09. Based on a conservative 10x PE ratio to the forecasted EPS in 2011, the target price in 12 months is HKD 7.82 and the rating is “hold”.

Click Here for PDF format...