HK Utilities:FY17results preview;prefer CKI in Hold-rated sector

类别:投资策略 机构:德意志银行 研究员:Thomas Zhu,Michael Tong 日期:2018-01-08

Prefer CKI in Hold-rated sector.

    The HK utilities sector has generated a total return of ~15% in 2017, but hasunderperformed the HSI Index by ~25ppt, driven by the strong performance ofthe index as a result of cyclical recovery. We still believe the sector is fully valued,with a rising outlook for the US treasury yield, the stocks only offering a dividendyield ~1.6% above the US yield (in line with the historical average) and potentialregulatory changes. We prefer CKI among the Hold-rated names - CKI shouldhave the lowest payout ratio if we assume dividend yields rise to the same level(e.g. 5%) in 2019e for all stocks as a result of higher US treasury yields, implyingthat CKI has the greatest sustainability for its dividend and also has the greatestflexibility to increase the dividend further if needed.

    Australia power market updated.

    Electricity prices have fallen from their high levels during March this year, andforward prices suggest strong yet lower prices over the next 2-3 years, potentiallybringing prices back to levels at the beginning of 2017. The 2018 wholesaleelectricity forward curves have been flat, and thus point to tightness in thewholesale electricity market, particularly as the summer months get underway.

    The recent increases in prices were driven by reduced coal generation, highgas prices and energy policy uncertainty. While we expect strong wholesaleprices to benefit the generation assets of CLP, the positive impact may be offsetby the increased power sourcing cost for retail customers. In the meanwhile,competition, churn and discounting remain high in the Australian energy market.

    Potential UK regulation change.

    On 11 Dec, Ofgem hosted a seminar on the next round of energy pricecontrols and developed their ideas further on how to ensure their view of returnlegitimacy. The seminar suggests that Ofgem is continuing to consider alternativeapproaches to the next price controls and ways to limit the instances of highreturns to top-performing companies. A shift away from the current form ofan eight-year control period to shorter periods also seems likely, based on theseminar. On 13 Dec, UK water regulator, Ofwat, published its framework forthe 2019 regulatory review, which proposed an initial point estimate for allowedreturn on capital of 2.4% (currently at 3.7%). While this has no impact for CKI/PAH earnings in 2017-19e and CKI/PAH's assets have been top performers in theUK, potential cuts in allowed returns for the next regulatory period (starting withNorthumbrian Water for CKI in 2020) could be negative for CKI/PAH's longer-term profitability - we expect CKI/PAH to derive ~54%/51% of earnings from the UKby 2019e.

    Earnings and target price revisions.

    Based on revised FX rate assumptions (revised up 6%/9%/9% for GBP and8%/6%/6% for AUD in 2017-19e), business updates and recent companymanagement comments, we revise recurring earnings by -1% to +21% for thesector in 2017-19e. For operations, we revise up Australia earnings for CKI/PAH,driven by a higher ROE assumption for Duet based on management guidance.

    We also raise Other Countries earnings for CKI, as we factor in Ista. We fine-tuneour recurring earnings forecasts for CLP in 2017-19e. We raise our target pricesby 3% to 9% for the sector.

    FY17 results preview.

    HK utilities companies under our coverage are scheduled to report FY17 resultsstarting from February. We expect CKI/PAH to report an 8%/7% yoy increase inFY17 recurring earnings, and CLP to report flattish results. We expect CKI/PAH'searnings growth to be driven by a profit contribution from Duet, earnings growthwith SAPN and VPN and also profit contribution from Ista (for CKI only).

    Valuation and risks.

    We use an SoTP valuation for the sector. Key risks: regulatory developments,M&A progress and foreign currency movement (see company investment thesissection for full details).

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