Huaneng Power eyes pushing capacity growth up to 80GW in the next 3 years

From 65GW by end-2013.

Although the Huaneng Power International share price has tripled from its trough in early 4Q11, it is believed that the company’s ten-fold increase in EPS (albeit from a near loss situation) over the same period has not yet been fully priced in.

According to a research note from Barclays, it estimates that the company could generate a FCF yield of well over 30% on a normalized basis and also fully de-gear its balance sheet in less than five years.

The report said that annualised FCF potential of RMB30bn on a normalized basis could fully de-gear the balance sheet in the next five years, in a sector that is bogged down by heavy debt burdens and high finance costs.

Here’s more from Barclays:

Continuing capacity additions (although moderate) are likely to solidify Huaneng Power's earnings base with coal prices having further declined by c10% from the end-2013 level. We think its valuation also looks attractive on a P/E of 7.1x 2015E, a c30% discount versus its five-year historical average of 11.0x and a c15% discount versus the peer average. We rate Huaneng Power as Overweight with a 12-month DCF-based price target of HK$11.50, implying potential upside of 33%.

Transformation from inverse play on coal prices to fundamentally strong equity story: From an R2 of 77% between 2010 and 2013 (negative correlation) to an R2 of just 3% between 2013 and 2014 (with positive correlation), Huaneng Power's shares have diverged from being a contra play on coal prices, in our view.

Capacity growth will likely continue: Although overall capacity additions in the Chinese thermal power sector are slowing down, Huaneng Power has plans to continue growing capacity up to 80GW in the next three years (from 65GW by end-2013). Volume growth would improve long-term structural earnings potential, while strong free cash flow should help the company to maintain its net debt despite growth capex.

Re-rating potential should it emerge as a matured and low-beta utility: Beyond the rapid growth phase, global utility shares have traded on an average P/E multiple of 13-15x. Huaneng Power, the largest listed utility company in China, trades at 7.1x 2015E, implying a 30-50% discount vs both global peers and its own historical valuation. We think a 2014E dividend yield of 7.3% reinforces its potential to become an income stock with mid-cycle earnings averaging almost double its historical peak earnings.