MM October 13, 2019 10:43 PM GMT China's Urbanization 2.0 Beneficiaries of the Greater Bay Area's Transition to Low- Carbon Energy Nuclear is the best option for GBA's transition to low carbon. We double upgrade CGN Power to OW and upgrade HKEI to OW. Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report. += Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. MM Contributors MORGAN STANLEY ASIA LIMITED+ MORGAN STANLEY ASIA LIMITED+ Simon H.Y. Lee, CFA Beryl Wang Equity Analyst Research Associate +852 2848-1985 +852 3963-3643 [email protected] [email protected] MORGAN STANLEY ASIA LIMITED+ MORGAN STANLEY ASIA LIMITED+ Yishu Yan Eva Hou Research Associate Equity Analyst +852 3963-2846 +852 2848-6964 [email protected] [email protected] MM China's Urbanization 2.0 Beneficiaries of the Greater Bay Area's Transition to Low- Carbon Energy uclear is the best option for GBA's transition to low carbon. We double upgrade NCGN Power to OW and upgrade HKEI to OW. Industry View Nuclear renaissance from 2020: We expect acceleration of nuclear China Utilities — Attractive approvals upon commissioning of China's first Hualong One unit. Nuclear is competitive with coal under new market structure, and From To will replace coal to become the core baseload power source. CGN WHAT’S HK Electric Investments (2638.HK) CHANGED Power will be the key beneficiary. Price Target HK$7.00 HK$8.60 Rating Equal-weight Overweight Hydropower from Yunnan and Tibet from 2025: West to East CK Infrastructure Holdings Ltd (1038.HK) Power supplied 36.2% of Guangdong's power demand in 2018. We Rating NA Equal-weight Price Target NA HK$54.00 expect 10-20GW of additional power to Guangdong by 2030, pri- Power Assets Holdings Ltd (0006.HK) marily supplied by China Yangtze Power's Wudongde (5GW) and Price Target NA Equal-weight Huaneng Hydro's planned 10GW of Tibetan hydropower. Rating NA HK$57.00 CGN Power Co., Ltd (1816.HK) Hong Kong to import from Guangdong: Hong Kong's target of Rating Underweight Overweight decarbonization by 2050 requires 80% clean energy, vs. local Price Target HK$1.80 HK$2.52 China Yangtze Power Co. (600900.SS) resources of 3-4%. Import nuclear from Guangdong is the only viable Price Target Rmb18.00 Rmb20.00 option. We expect CLP to import more from 2025 and HKEI to con- HuanengLancang River Hydropower Inc (600025.SS) nect with Guangdong via undersea power lines. Price Target Rmb4.39 Rmb4.50 Upgrade CGN Power and HK Electric Investments to OW: For CGN GBA will be China's leading region in carbon reduction and air Power, we see acceleration of approvals based on Hualong One and quality: The Paris Agreement, air pollution and energy efficiency rising dividends with its strong FCF. HKEI offers the highest yield pressure, and GBA's power tariff affordability – the highest in China among HK utilities and regulated asset growth from undersea con- – all point to GBA becoming China's leader in its decarbonization nection with Guangdong nuclear plants. strategy. We expect clean energy to be 80% of GBA's installed Maintain OW on China Yangtze Power and EW on Huaneng capacity by 2035, far ahead of China's average of 65%. Hydro: CYPC may have dividend growth upside from 2021 based on GBA's plan to reduce coal: GBA has 32GW of coal power capacity a 70% payout ratio. Huaneng Hydro's capex on 10GW capacity in today and plans a 31% reduction by 2035, to 22GW. Excluding coal, Tibet could delay dividend upside. nuclear and imported hydropower are the most competitive energy Resume coverage of CKI and PAH at EW: We see rising near-term sources vs. gas and offshore wind. We expect increases of 180% in FX volatility in GBP ahead of Brexit, with regulatory resets in UK and nuclear and 50% in hydropower imports. Australian assets cutting related earnings by ~10%. CKI's three acqui- sitions in 2017 generated 5% ROE, lower than expected. MM Contents 5 The Fundamental Backdrop 63 China Yangtze Power Company – Financials and Earnings Estimates 6 Key Conclusions 65 China Yangtze Power Company – Valuation 8 Summary of Stock Ideas Methodology 14 China: Guangdong GBA Action Plan 2018-2020 67 China Yangtze Power – Financial Summary and China Southern Grid Power Industry Planning to 2035 68 CLP Holdings – Maintain EW Rating 23 Nuclear – Long-awaited Renaissance from 2020 69 CLP Holdings – Changes in Earnings Estimates 25 Hydropower – Goes Further West from Yunnan 70 CLP Holdings – Valuation Methodology to Tibet 72 CLP Holdings – Financial Summary 27 Cutting Coal and Replacing It with Gas and Offshore Wind – Expensive Options Unlikely to 73 HK Electric Investment – Upgrade to OW from Replace Baseload Demand EW 32 Hong Kong: The Path to Decarbonization 74 HK Electric Investments – Changes in Earnings Estimates 37 Electricity Generators in Hong Kong – CLP Holdings and HK Electric Investments 75 HK Electric Investments – Valuation Methodology 41 CGN Power – Double Upgrade to OW from UW 77 HK Electric Investments – Financial Summary 47 CGN Power – Changes in Key Assumptions and 78 CK Infrastructure Holdings and Power Assets Earnings Estimates Holdings – Resuming Coverage at EW 49 CGN Power – Valuation Methodology 82 CKI and PAH – Changes in Earnings Estimates 51 CGN Power – Financial Summary 83 CKI and PAH – Valuation Methodology 52 Huaneng Hydro – Maintain EW Rating 87 CK Infrastructure Holdings – Financial Summary 55 Huaneng Hydro – Changes in Key Assumptions 88 Power Assets Holdings – Financial Summary and Earnings Estimates 89 Appendix 1: Power Exports from Western to 58 Huaneng Hydro – Valuation Methodology Eastern China 60 Huaneng Hydro – Financial Summary 90 Appendix 2: Guangdong Power Exchange and Market Power Sales 61 China Yangtze Power Company – Maintain OW Rating 4 MM The Fundamental Backdrop Greater Bay Area (GBA) development plan – energy section: Requirements under the Paris Agreement for China and Hong China aims for the Greater Bay Area 1 to become an international Kong – and why timing is imminent: Under the Paris Agreement of first-class bay area for living, working, and traveling, with an 2015, all countries need to draw up their own mid-century (2050) emphasis on a green, low-carbon, and sustainable ecological system. long-term development strategy for low greenhouse gas emissions We believe GBA's power system, which accounts for >50% of by 2020, with a view to holding the increase in global temperature emissions, is essential for GBA to increase green energy utilization, below two degrees. China and the Hong Kong Special Administrative improve air quality, and promote a low-carbon lifestyle. Region (as part of China) will have to present their own decarboniza- tion strategies in 2020 (countries to submit updated climate Why GBA will be China's leading region in air quality and carbon pledges). We expect both China and Hong Kong will need to finalize reduction: We believe GBA has the potential to lead China's various their public consultation process and related strategies before the regions in air quality, green power utilization, and carbon reduction, end of 2019/early 2020. in order to support its ambitious aim to become one of the most liv- able bay areas in the world. GBA's progress on air quality/carbon reduction: China officially announced Greater Bay Area planning in February 2019, while 1. Aggressive target: Guangdong announced a ban on new coal Guangdong announced its 2018-2020 GBA Action Plan in July 2019. power plants in 2018. It raised its 2020 gas utilization plan China Southern Power Grid (CSPG) has initiated long-term power and approved 10GW of additional gas IPP capacity. planning and analysis for GBA and published a report in June 2019. By 2. Already the leader: In 2018, the Pearl River Delta had the 2020, GBA aims for PM2.5 of <34ug/m3, vs. Beijing at 55, Shanghai lowest PM2.5 emissions among regions in China and the at 37, and Tianjin at 53. Shenzhen announced the most ambitious highest utilization of clean energy. Shenzhen is the first PM2.5 target – 20ug/m3 by 2020, and 15 ug/m3 by 2030 – making Chinese city to set an air quality target by 2030 in line with it the first city in China to set this target in line with the most stringent the United Nations benchmark. standard of the United Nations, ahead of Hong Kong. In addition, GBA 3. Availability of resources: With its ports and coastal areas, also leads China. China is committed to achieving carbon emission GBA has the best access to imported fuel (LNG) and offshore peak by around 2030 and maintaining its absolute coal power fleet gas fields in the South China Sea. GBA also has the highest cap at 1200-1300GW by 2030, but GBA is committed to shutting proportion of imported clean energy among regions in China, down one-thirds of its coal power plants during the same period. thanks to proximity to Southwest China (Yunnan) and future access to Tibetan hydropower. GBA also has the best access Hong Kong's progress on air quality/carbon reduction: The HK to offshore wind on the Guangdong coastline and the highest government has initiated two public consultations, one in June 2019 penetration of nuclear power, as home to China's first com- on Hong Kong's 2050 decarbonization strategy and one in July 2019 mercial nuclear station.