Oversupply Of Renewables And Stranded Coal Assets Will Pressure Earnings Ahead

Catalysts

About Huaneng Power International

Huaneng Power International is a major Chinese power producer with a large portfolio of coal fired, gas, wind, solar, hydro and overseas generation assets.

What are the underlying business or industry changes driving this perspective?

• Accelerating additions of wind and solar capacity, combined with rapid industry wide build out targeted at adding 1 billion to 2 billion kilowatts nationally, risk chronic oversupply and sustained tariff pressure that could cap revenue growth even as installed capacity rises.
• Growing reliance on market based trading, including volatile spot markets with periods of negative prices and expanding capacity payment regimes, increases earnings cyclicality and could compress net margins if pricing power erodes faster than costs can be reduced.
• Structural policy support for flexible coal as a balancing resource, coupled with declining utilization hours and asset retirements or impairments in regions like Shanghai and Shandong, points to rising stranded asset risk that may drive further write downs and depress future earnings.
• Large and ongoing capital expenditure needs for green transition, storage and grid related requirements under successive five year plans, alongside a still elevated debt to asset ratio and significant perpetual bonds, heighten refinancing and interest cost risks that could dilute future equity returns.
• Increasing exposure to ancillary service income, capacity payments and overseas operations as key profit contributors concentrates risk in policy sensitive and regulation driven revenue streams, which could lead to sharp swings in net profit if compensation rules or cross border frameworks tighten.

Assumptions

This narrative explores a more pessimistic perspective on Huaneng Power International compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Huaneng Power International's revenue will decrease by 2.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 5.0% today to 6.6% in 3 years time.
• The bearish analysts expect earnings to reach CN¥14.3 billion (and earnings per share of CN¥0.71) by about December 2028, up from CN¥11.6 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as CN¥17.2 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 7.0x on those 2028 earnings, down from 7.6x today. This future PE is lower than the current PE for the US Renewable Energy industry at 8.7x.
• The bearish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 13.03%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Sustained improvement in cost efficiency, including a 9.23% year on year decline in standard coal price to CNY 917 per ton and lower unit fuel costs in successive quarters, could support higher profitability than expected and underpin resilient earnings growth.
• Rapid expansion and effective marketization of renewables, with total installed capacity reaching 153 gigawatts and low carbon clean energy now 39.12% of capacity, may position the company to benefit from long term policy support for green transition and deliver structurally higher revenue and net margins.
• Stronger cash generation and disciplined capital management, illustrated by a CNY 30.7 billion increase in operating free cash flow, declining financial costs and a stable to rising dividend payout ratio, could improve investor confidence and support a higher valuation through better earnings quality and returns on equity.
• Resilient overseas operations at Tuas Power and the Sahiwal plant, which together generated CNY 1.799 billion profit before tax in the first half, may diversify earnings away from domestic cyclicality and provide a growing, relatively stable contribution to consolidated net profit.
• Gradual reduction in leverage, with the debt to asset ratio falling from 65.4% to 64.5% alongside refinancing of perpetual bonds at lower interest rates, could lower financial risk and interest expense, boosting future net profit and supporting a higher sustainable earnings base.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Huaneng Power International is HK$4.9, which represents up to two standard deviations below the consensus price target of HK$6.59. This valuation is based on what can be assumed as the expectations of Huaneng Power International's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of HK$8.35, and the most bearish reporting a price target of just HK$4.9.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be CN¥218.1 billion, earnings will come to CN¥14.3 billion, and it would be trading on a PE ratio of 7.0x, assuming you use a discount rate of 13.0%.
  
• Given the current share price of HK$6.18, the analyst price target of HK$4.9 is 26.1% lower.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.