Abaci's Common Sense Investing

I've always had good impressions about power companies, especially those in China where demand seems to be growing with no end in sight. Selling power is an easy business, all is needed is a growing population and fair regulatory environment for it to prosper. Buying power companies is more like making a country bet. The higher growth is the country, the better return is for the power companies.

But the problem with China now is the government wants higher growth but without a rising electricity bill. Since it majority owns all the power assets in the country, it manages to ban all tariff hike at the moment. Power companies, faced with rising coal price (60+% of their operating cost) but unable to pass it on, can only pursue volume, i.e. to sell more electricity via expansion. They are also diversifying into alternative power but that's more a strategic move than an economical one, as this won't have material impact on the results until in the medium term.

The critical questions one needs to consider are:

(1) Can the expansion and increased turnover make up for the loss from the rising coal price?
(2) How long will the price control stay in place?

I've focused only on Datang (991) and Huaneng (902). This part will only deal with the 07 interim data and I will tackle the final results later. I'll try to answer the two questions as I go along.

SIZE

Datang
Asset size: $100b
Power generated: 56b kwh, up 35%
Revenue: $15.5b, up 42%
Commitment: $15b

Hueneng
Asset size: $110b
Power generated: 81b kwh, up 14%
Revenue: $23b, up 21%
Commitment: $10b

Hueneng appears more efficient as it generates close to 50% more power and revenue from the same asset base. But it's a distorted scene because of Datang's high growth in recent years (look at growth in power generated and revenue instead). Datang actually has doubled its asset base since 12/04 (I tracked 3-yr data) whereas Huaneng has only increased its assets by about 50% over the same period. Once those new capacities are up and running, Datang will probably produce just as much turnover or may even surpass Huaneng. Another point to note is Datang has 50% more capital commitment in new capacities than Huaneng, indicating strong growth prospect.

EARNINGS

Datang
Recurring profit: $1.8b, up 42%
EBIT margin: 25.3%
EBT margin: 19.3%
Net margin: 14.6%
Net margin after MI: 11.7%
2006 ROE: 14.6% (excluding A-share issue in Dec)
Gearing: 1.72x

Huaneng
Recurring profit: $2.3b, up 7%
EBIT margin: 15%
EBT margin: 13.3%
Net margin: 10.9%
Net margin after MI: 10%
2006 ROE: 13.9%
Gearing: 1.43x

On each dollar of revenue, Datang had much higher margin (25.3% vs 15%), even before leverage. This has been another consistent trend since 12/04. So Datang seems to have done something very right (which I don't know). After paying out financing costs which were twice as much in proportion to sales, since Datang was more heavily geared, the margin gap was still very wide (19.3% vs 13.3%).

Then two unusual items caught my attention - tax and MI. Somehow Huaneng paid profits tax at a much lower rate whereas Datang had a much higher MI payout ratio. Stange isn't it given the two are running the same business? The net effect is such that the net margin after tax and ROE of the two were very close, with slight edge went to Datang (whose figure was distorted by its faster expansion). I checked past figures and found this pretty much has been a consistent trend for the past 3 years.

I have some speculative reasons for these differences, like Huaneng's plants are younger, or some of Datang's lucrative deals had to be compensated by a bigger minority stake. But much time will need to be spent to gain a better insight.

For now, let's just say both are very well-oiled machines, with one running at a faster speed.

DISCLOSURE: I don't hold 991 or 902 at time of writing.