China Wind Sector

China Utilities 21 January 2016

China Wind Sector

Initiation: Less is more

 We see multi-year headwinds for the China Wind Sector, including worsening curtailment, tariff cuts, and slowing capacity addition

 Wind IPPs with large existing capacities and fewer pipeline projects in Zones I and II should fare best; valuations look to be at trough levels Dennis Ip, CFA (852) 2848 4068  We prefer balanced play Huadian Fuxin and scaled play Longyuan; [email protected] wind equipment and small grid-curtailed IPPs are likely to suffer Scott Chui

(852) 2848 4443 [email protected]

See important disclosures, including any required research certifications, beginning on page 127

China Wind Sector: 21 January 2016

Table of contents

Investment thesis ...... 6 Daiwa’s 1T4C approach ...... 6 Less is more ...... 7 What to expect in each of the next 3 years ...... 8 Fuxin and Longyuan are our preferred picks ...... 9 China Wind Sector outlook — 1T4C...... 10 FiT cut should enhance market efficiency ...... 10 Installation costs ...... 17 Grid curtailment: moderating in 2017E, but probably not eliminated until 2020E ...... 21 Capacity additions: more about the quality than quantity ...... 32 Repair and maintenance costs ...... 34 IRR sensitivity analysis ...... 36 Valuation and risks ...... 38 Fuxin looks the most attractive vs. growth outlook ...... 38 Main risk: local utilisation protection measures ...... 42 Appendix I: UHV transmission network ...... 43 Appendix II: Wind curtailment map (1H15) ...... 49 Appendix III: Wind project IRR analysis ...... 50

Company Section China Longyuan Power ...... 51 Huadian Fuxin Energy ...... 73 CGN New Energy Holdings...... 77 China Suntien Green Energy ...... 81 China High Speed Transmission ...... 101 Henan Pinggao Electric ...... 107 XJ Electric ...... 115

China Utilities 21 January 2016

China Wind Sector

Initiation: Less is more

 We see multi-year headwinds for the China Wind Sector, including worsening curtailment, tariff cuts, and slowing capacity addition

(852) 2848 4443 [email protected]

Investment case: We believe the China Wind Sector faces multi-year Key stock calls challenges: the National Development and Reform Commission (NDRC) is New Prev. cutting tariffs every 2 years, IRRs on new projects look set to decline on China Longyuan Power (916 HK) Rating Outperform stable construction costs, and wind curtailment will likely remain an issue Target 5.30 even after ultra-high-voltage (UHV) lines are built. In this report, we Upside p 13.7% highlight the main headwinds using our proprietary “1T4C” assessment. Huadian Fuxin Energy (816 HK) Rating Outperform Outperform Equity IRR of new wind farms to decline. We expect new wind projects’ Target 1.75 1.75 profitability to decline on the 2016/18 tariff cuts, with equity IRRs going from Upside p 7.4% 11-17% beforehand to 9-16% in 2016E and 10-14% in 2018E. In turn, we CGN New Energy Holdings (1811 HK) Rating Hold Hold foresee relatively sluggish wind capacity additions of 21GW/23GW in Target 1.45 1.45 2016/17E (2015E: 25GW). Upside p 3.6% China Suntien Green Energy (956 HK) UHV lines to partly relieve wind curtailment in 2H17E. The rapid growth Rating Hold Hold in wind capacity during 2014/15 looks set to exacerbate the issue of wind Target 1.10 1.65 Upside p 2.8% curtailment, ie, electricity wasted after generation, which we see rising from 8% in 2014 to 16%/18% in 2015/16E, respectively. In our view, there is too Source: Daiwa forecasts much wind power in total for local utilisation protection to be viable, and we expect a meaningful improvement in curtailment to start only in 2H17, after the commissioning of UHV transmission lines. However, we do not foresee wind curtailment being completely resolved by the UHV network. We estimate that equity IRRs for Zone I wind farms could fall from 14% in 2015 to 9% by 2018E in the event that utilisation remains at 1,900 hours.

Less is more is our investment theme for 2016, and we prefer companies with defensive earnings profiles, ie, those with: 1) smaller proportions of new capacity coming on stream after tariff cuts, and 2) fewer pipeline projects in Zones I and II. Equipment makers will likely suffer as they look the most susceptible to our expected decline in wind power installation in 2016E, both in terms of volume contraction and margin compression.

Catalysts: The main near-term share-price catalyst for the sector should be the regulator’s upward revision of wind capacity targets for 2020. Longer term, we would view intensifying wind curtailment as a key catalyst.

Recommendations: Fundamental weakness is almost priced in, in our view, after a 50%-plus decline in share prices for the wind IPP names over the past 6 months. We see investment value in large-scale player China Longyuan (916 HK, HKD4.66, Outperform [2] and diversified player Huadian Fuxin (816 HK, HKD1.63, Outperform [2]).

Risks: The major risk to our Negative sector rating would be stronger-than- expected utilisation protection measures for wind farms in the northwest.

See important disclosures, including any required research certifications, beginning on page 127

China Wind Sector: 21 January 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook China Wind Sector: grid-connected capacity additions We expect China’s wind power installation to face a (GW) temporary slowdown after the rush installations seen in 30 40% 25 25 24 2015, under which completions targeted for 2016 were 25 23 30% 21 22 brought forward. In turn, we forecast a 16% YoY drop in 20 20 17 20% 15 wind capacity additions, from 25GW for 2015E to 21GW in 14 14 2016E. 15 10% 10 0% We expect wind capacity addition to recover in 2017E, 5 (10%) driven by a slight easing of wind curtailment issues 0 (20%) following the commissioning of the UHV transmission 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E network and the scheduled cut in the on-grid tariff in Newly connected capacity YoY growth - RHS

2018E. Source: NEA, Daiwa forecasts

Valuation China Wind Sector: 2016E ROE vs. 2016E PBR On the basis of 2016E ROE vs. PBR, Fuxin and CGN New 20% Energy look to be the most undervalued stocks in our 18% coverage universe. While we are arguably being prudent in 16% Fuxin Goldwind - H our 2016E EPS forecast for Fuxin (10% below the 14% CGNNE 12% HNR consensus forecast), we see uncertainty over CGN New 10% Longyuan

Energy’s planned asset injections given its weak valuation. 8% CHST 2016E 2016E ROE 6% Suntien Among the wind equipment manufacturers, we believe 4% Datang RE CHST has a better risk-reward profile than Goldwind 2% despite having a lower 2016E ROE. Trading at a 1.5x 0% 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 2016E PBR, Goldwind looks at risk of a share-price 2016E PBR correction if the wind equipment sector suffers a demand Source: Daiwa forecasts, Bloomberg consensus for non-rated companies shock, in our view. Note: Pricing as of 19 Jan 2016

Earnings revisions China Wind Sector: Bloomberg consensus 2016E EPS revisions The Bloomberg consensus earnings forecasts for the wind Rebased at 100 farm operators have been on a downtrend since early 120 2015, driven by the worsening curtailment issue (and 110 100 hence lower utilisation rate), despite improving wind 90 speeds. 80 70 Longyuan is the one exception to this trend, likely because 60 the market is more positive on the sustainability of the 50

company’s profitability due to the favourable geographical

Jul-15

Apr-15 Oct-15

Jan-15 Jun-15 Jan-16

Feb-15 Mar-15

Nov-15 Dec-15 Aug-15 Sep-15 distribution of its wind farms, which we think should see its May-15 grid curtailment fall below the peer average in 2015E. Longyuan Huadian Fuxin Suntien CGN New Energy Source: Bloomberg

China Wind Sector: 21 January 2016

Sector stocks: key indicators

EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg CGN New Energy Holdings 1811 HK 1.40 Hold Hold 1.45 1.45 0.0% 0.023 0.023 0.0% 0.028 0.028 0.0% China Longyuan Power 916 HK 4.66 Outperform 5.30 0.364 0.468 China Suntien Green Energy 956 HK 1.07 Hold Hold 1.10 1.65 (33.3%) 0.092 0.100 (7.3%) 0.100 0.116 (14.0%) Huadian Fuxin Energy 816 HK 1.63 Outperform Outperform 1.75 1.75 0.0% 0.250 0.250 0.0% 0.304 0.304 0.0% Source: Bloomberg, Daiwa forecasts

China Wind Sector: key assumptions 2013 2014 2015E 2016E 2017E 2014 2015E 2016E 2017E YoY Wind farm capacity addition (MW) - Fuxin 784 1,389 1,500 1,000 1,000 77% 8% -33% 0% - Longyuan 1,366 1,633 2,222 1,800 2,000 20% 36% -19% 11% - CGNNE - - 1,402 1,500 - n.a. n.a. 7% -100% - Suntien 99 252 382 400 450 154% 52% 5% 13% Wind farm installed capacity (MW) - Fuxin 3,501 4,889 6,389 7,389 8,389 40% 31% 16% 14% - Longyuan 11,910 13,543 15,765 17,565 19,565 14% 16% 11% 11% - CGNNE - - 1,402 2,902 2,902 n.a. n.a. 107% 0% - Suntien 1,445 1,697 2,079 2,479 2,929 17% 23% 19% 18% Wind utilisation (hours) - Fuxin 2,030 1,888 1,812 1,776 1,803 -7% -4% -2% 1% - Longyuan 2,111 1,980 1,900 1,880 1,974 -6% -4% -1% 5% - CGNNE - - 1,683 1,782 1,782 n.a. n.a. 6% 0% - Suntien 2,312 1,996 1,900 2,002 1,980 -14% -5% 5% -1% Net-debt-to-equity gearing (%) - Fuxin 358% 323% 297% 300% 295% -35pp -26pp 3pp -5pp - Longyuan 176% 203% 206% 206% 197% 27pp 3pp 0pp -9pp - CGNNE 321% 156% 361% 521% 431% -166pp 205pp 161pp -90pp - Suntien 121% 107% 148% 181% 211% -14pp 41pp 33pp 30pp

Source: Company, Daiwa forecasts

China Wind Sector: 21 January 2016

Investment thesis

We initiate coverage on the China Wind Sector with a Negative stance, as we believe the sector faces multi-year challenges – the NDRC is cutting wind tariffs every 2 years, IRRs on new wind projects look set to decline on stable construction costs, and wind curtailment will likely remain an issue even after the UHV transmission lines are built.

A mooted local utilisation protection scheme, which could be fully implemented in 2017, would not completely offset the earnings impact on wind farms of severe curtailment in the 3 northwest provinces, based on our conclusion that these regions could reach a 15-20% power mix from wind if the curtailment rate were capped at 15% in 2016, with some of the wind power being deemed “competitive volume” and therefore earning a much lower on- grid tariff.

Daiwa’s 1T4C approach Based on our 1T4C We analyse the sector using our proprietary 1T4C approach, whereby we assess the analysis, we expect industry from 5 perspectives: wind on-grid tariff, installation cost, wind curtailment, capacity equity IRRs on new wind growth, and maintenance cost. On our reading, these 5 factors combined paint a farms to decline and the discouraging picture for the sector for the next few years. UHV network to partly relieve the curtailment issue 1T4C components One ”T” Four “C” Tariff Installation cost Curtailment Capacity growth Maintenance cost

Source: Daiwa

China Wind Sector: 1T4C analysis 2016 2017 2018

Tariff  -  Installation cost    Curtailment    Capacity growth  -  Maintenance cost   - WTG   

Source: Daiwa

Based on our assessment summarised in the table above, we highlight 2 trends that we expect to play out in the sector in the coming years:

 Equity IRRs of new wind farms should decline. In its wind tariff plans, announced in December 2015, the NDRC stipulated that wind tariffs should be cut every 2 years, ie, in 2016 and 2018. All 4 of China’s wind resources zones will be subject to cumulative tariff cuts ranging from 4.9% to 10.2%. As a result, we expect new wind projects’ profitability to decline, with their average IRRs falling from 11-17% before the tariff cuts to only 9-16%/10-14% after the cuts in 2016/18E. This decline in profitability will, in our view, lead to sluggish wind capacity additions of 21GW/23GW in 2016/17E, respectively.

 UHV lines to partly relieve wind curtailment issue in 2H17E. The rapid wind capacity growth experienced during 2014/15 is likely to intensify wind curtailment. Our forecasts have wind curtailment rising from 8% in 2014 to 16%/18% in 2015/16E, respectively, due primarily to limited transmission capacity. We expect a slight improvement in wind curtailment starting in 2H17E, after at least 8 UHV transmission

China Wind Sector: 21 January 2016

lines have been commissioned over 2016-17E. However, we do not see wind curtailment being resolved completely by the UHV network, given our outlook for weak power demand growth in coastal China.

Less is more Following from the NDRC’s proposal for progressive tariff cuts starting in 2016, we see 2 key trends playing out in the sector in the coming years: 1) a less profitable environment for China’s wind farm operators, whereby the later a wind project is completed, the lower its IRR will be, and 2) we expect steeper tariff cuts in Zones I and II relative to Zones III and IV to constrain capacity growth in these regions, as some projects would become less profitable following the cuts.

Based on these 2 trends, our investment theme “less is more”, as IPPs with the smallest proportions of new capacity and pipeline projects in Zones I and II should ultimately be the most profitable, in our view.

Small proportions of new capacity We prefer wind IPPs with We prefer China wind IPPs with relatively small proportions of new wind capacity, ie, those relatively small with large wind project portfolios prior to the tariff cuts and prudent new capacity expansion proportions of new wind plans. Older projects are entitled to a fixed wind tariff that is higher than the tariff for new capacity, on which IRRs wind farms, and we expect these established projects should still yield 16-18% equity would be relatively low IRRs, vs. 13-14% for new wind farms. Hence, it follows that the smaller the proportion of new capacity that a wind farm IPP has, the greater its overall profitability should be (see also page 51 in the company section on China Longyuan).

Meanwhile, comparing the IRRs on wind power to those on other energy sources, we can see wind power losing competitiveness, particularly to solar. While both clean energy sources will see tariff cuts starting in 2016, we believe that ongoing reductions in the installation cost for solar energy will cancel out the impact of tariff cuts. As such, we prefer solar to wind within the China renewable energy space.

Alternative energy sources: equity IRR comparison 17%

16%

15%

14%

13%

12%

11%

10% Wind (base) Wind (after Wind (after Solar (base) Solar (after Nuclear Coal Hydro 2016E) 2018E) 2016E) Source: Daiwa forecasts

Small proportions of pipeline projects in Zones I and II We prefer wind IPPs with We also prefer China wind IPPs with relatively small proportions of pipeline projects in small proportions of Zones I and II. In our view, the NDRC’s proposal for progressive tariff cuts sends a strong pipeline projects in signal to the wind power industry that the regulator intends to restrict wind power Zones I and II, where installation in Zones I and II, as evidenced by the relatively steep tariff cuts scheduled for tariff cuts are greatest 2016-18 (Zones I and II: a 9.6-10.2% cumulative tariff reduction, vs. Zones III and IV: 4.9- 8.9%).

China Wind Sector: 21 January 2016

China: the NDRC’s proposed wind tariff cuts for 2016-18 (CNY per kWh) 0.7 12%

0.6 10% 0.5 8% 0.4 6% 0.3 4% 0.2 0.1 2% 0.0 0% Zone I Zone II Zone III Zone IV Current 2016 2018 Cumulative tariff cut - RHS

Source: NDRC, Daiwa

After the tariff cuts, we expect more projects in Zones I and II to become unprofitable as a result of the steeper wind tariff cuts relative to Zones III and IV, and it follows that we will see more projects being cancelled in Zones I and II. Hence, we prefer the China wind IPPs with relatively small project pipelines in Zones I and II, since they should be less affected by the tariff cuts and see greater capacity growth.

Implications for equipment makers We expect the wind We see 2016 being a challenging year for the wind equipment makers, including the wind equipment producers to turbine manufacturers and wind gearbox manufacturers, as we expect China’s wind power suffer in 2016E industry to face a temporary slowdown in project completions after the flurry of installations in 2015. On our reading, the equipment makers will be affected by a decline in volumes and a contraction in margins, since they will likely have to lower their prices to compete for limited downstream demand.

Against this backdrop, we think there is likely to be further industry consolidation for the wind turbine generator (WTG) business in 2016, as declining WTG prices could squeeze out marginal or foreign players. Existing cost leaders, such as Xinjiang Goldwind, should fare better on possible market-share gains, in our view.

What to expect in each of the next 3 years Given the above outlook, we present below our year-by-year assessment of key trends for the China wind IPPs and wind equipment makers:

2016: After the announcement of the wind on-grid tariff cut, effective from January 2016, we saw a surge in wind project deployment (reflected in our estimate that a record 25GW of new capacity was installed in 2015). Given this front-end loaded wind installation, we estimate that wind power installation in China will likely slow in the current year, most notably for projects in Zones I and II. As a result of this expected slowdown, together with our view of worsening wind curtailment following the rush installations of 2015, some projects in Zones I and II are likely to become unprofitable, as reflected in our conservative capacity growth forecast of 21GW for 2016E. By extension, we think the WTG makers will be hit hard, experiencing both volume declines and margin squeezes due to overcapacity. The utilisation protection scheme will start a trial run in the northwest.

2017: We look for a mild recovery in wind power installation in 2017E. Also, we expect a slight rush of installations ahead of the on-grid tariff cut scheduled for 2018. Wind project economics should improve during the year, since we expect a gradual easing of wind curtailment upon the commissioning of the 8 UHV transmission lines connecting Western China to the coastal regions in addition to the full implementation of the utilisation protection scheme. That said, we believe wind curtailment will remain the biggest problem for the industry, as we do not foresee the UHV transmission network completely resolving the problem amid sluggish power demand growth in China.

China Wind Sector: 21 January 2016

2018 and beyond: Wind capacity growth in China post-2017E should remain relatively stable, in our view, with a gradual geographical shift in wind installation from Zones I and II (good wind resources but heavy curtailment) to Zones III and IV (less substantial wind resources but few if any curtailment issues). The slowdown in wind capacity growth that we expect for 2016-17E, as well as completion of the UHV transmission network, should steadily alleviate the grid congestion issues for wind power. Nevertheless, under the progressive wind tariff reduction mechanism proposed by the NDRC, steep tariff cuts every 2 years are likely to weigh on the project IRRs of newly built wind farms. On our forecasts, IRRs for these projects would fall from their current average of 11-17% to 10-14% by 2018E.

Fuxin and Longyuan are our preferred picks We prefer the We prefer the downstream wind farm operators over the upstream wind equipment downstream wind farm manufacturers, as we believe the potential slowdown in wind power installation in China developers over the could lead to a demand shock for WTG as well as components such as wind gearboxes in equipment makers 2016E. Given that the wind equipment names are delta plays that depend on wind installation growth rates, a slowdown in wind installation could be accompanied by reduced shipment volumes and narrower margins. We are therefore cautious on the wind equipment manufacturers, and view companies focused solely in China as especially vulnerable to the potential slowdown in wind power installation in 2016E.

By contrast, we expect the downstream wind farm operators to continue to offer stable earnings growth over the next few years, driven mainly by capacity additions. Despite our view of worsening wind curtailment during 2016E, we believe the likely decline in the profitability of wind farms would only partly offset the extra revenue from the aggressive capacity addition undertaken during 2014-15. The result should be sustainable net profit growth for the China wind IPPs, in our view. We especially prefer wind farm operators with balanced portfolios and large existing capacities prior to the expected tariff cut.

Huadian Fuxin (816 HK, HKD1.63, Outperform [2]) is our preferred pick, given its balanced power generation portfolio, a 58% CAGR in 2015-17E associate income from its 39% stake in Fuqing Nuclear, and appealing valuation (0.6x 2016E PBR). We also like China Longyuan (916 HK, HKD4.66, Outperform [2]), which has established wind farms across China with a total wind installed capacity of 15.8GW by 2015E. Also, the company has relatively low exposure to heavily curtailed regions such as Inner Mongolia and the northeastern China (2015E: 51%, versus Huaneng Renewable Energy’s (HNR) 43%, CGNNE’s 60%, Fuxin’s 75% and Datang RE’s 76%), and hence we believe its earnings quality will be the least affected by the deteriorating wind curtailment that we expect in 2016E.

China wind: 2016E ROE vs. 2016E PBR China wind: 2015-17E vs. 2016E PER

20% 70% 18% 60% Datang RE 16% Fuxin Goldwind - H 14% CGNNE 50% 12% HNR 40% 10% Longyuan

8% CHST 30% 2016E 2016E ROE

17E 17E EPSCAGR HNR - 6% Longyuan Suntien 20%

2015 Suntien 4% Fuxin CGNNE Datang RE 10% 2% CHST Goldwind - H 0% 0% 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 0 2 4 6 8 10 12 14 2016E PBR 2016E PER Source: Daiwa forecasts, Bloomberg consensus for non-rated companies Source: Daiwa forecasts, Bloomberg consensus for non-rated companies Note: Pricing as of 19 Jan 2016 Note: Pricing as of 19 Jan 2016

China Wind Sector: 21 January 2016

China Wind Sector outlook — 1T4C FiT cut should enhance market efficiency Proposed wind tariff cut could lead to slowdown in wind capacity additions in Zones I and II On 29 October 2015, the NDRC circulated a proposed wind power on-grid tariff cut plan at its internal meeting, in which it suggested that the wind feed-in tariff (FiT) be cut in a smaller, more gradual manner from 2016-20, as opposed to the large single tariff cuts done every 2 to 3 years previously. By 2020, the NDRC targeted to align the on-grid tariff for wind power to that for coal-fired power, making wind power competitive with other power generation sources.

China: originally proposed wind tariff cuts Benchmark on-grid tariff (CNY/KWh, VAT incl.) Utility Initial FiT effective Changes Proposed tariff cut YoY % Cumulative % zone Regions policy 1 Jan 2016 (%) 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 2018 2020 Inner Mongolia: All except those included in Type II Type I 0.51 0.49 -3.9% 0.47 0.45 0.43 0.41 0.38 -4.1% -4.3% -4.4% -4.7% -7.3% -12.2% -22.4% Xinjiang: Urumqi, Yili, Changji, Klamyi, Shihezi Hebei: Zhangjiakou, Chengde Inner Mongolia: Chifeng, Tongliao, Type II 0.54 0.52 -3.7% 0.49 0.47 0.45 0.43 0.40 -5.8% -4.1% -4.3% -4.4% -7.0% -13.5% -23.1% Xing'anmeng, Hulun Buir Gansu: Zhangye, Jiayuguan, Jiuquan Jilin: Baicheng, Songyuan Heilongjiang: Jixi, Shuangya, Qitaihe, Suihua, Yichun, Daxing'an Mountain Type III 0.58 0.56 -3.4% 0.54 0.52 0.50 0.48 0.45 -3.6% -3.7% -3.8% -4.0% -6.2% -10.7% -19.6% Gansu: All except those included in Type II Xinjiang: All except those included in Type I Ningjia: All All except those included in Type I, Type II or Type IV 0.61 0.61 0.0% 0.59 0.58 0.57 0.56 0.52 -3.3% -1.7% -1.7% -1.8% -7.1% -6.6% -14.8% Type III

Source: NDRC, Daiwa

The initially proposed cuts, at 3-5% per year, seemed quite aggressive to us, as compared with the proposed solar power tariff cuts of 2-3% YoY over the same period (2016-20), especially when we see very limited scope for construction cost reductions for wind farm projects as compared with solar farm projects.

The revised tariff In December, the National Energy Administration (NEA) and the Price Bureau of the NDRC reduction plan called for undertook a review of the proposed tariff reduction plan for wind power. Compared with the more moderate cuts originally proposed tariff reduction plan, the revised plan called for more moderate cuts to the tariffs for wind power. The highlights:  Tariff cut every 2 years, rather than sequential annual cut: Unlike the solar tariff reduction plan, the revised wind tariff cut plan is more moderate than the previous one, with the cuts in Zones II and IV being one cent less for 2016, and the cuts in Zones I and III unchanged. Also, instead of yearly cuts, the revised plan calls for a tariff cut every 2 years and further proposes the actual tariff cuts for both 2016 and 2018.  Milder cut for 2016: The proposed tariff cuts for Zones I and III are unchanged from the prior proposal, with tariffs in Zone I decreasing from CNY0.49/kWh to CNY0.47/kWh in 2016 (a 4.1% cut), and Zone III decreasing from CNY0.56/kWh to CNY0.54/kWh (a 3.6% cut). On the other hand, Zones II and IV now see milder cuts, with the tariff in Zone II decreasing from CNY0.52/kWh to CNY0.50/kWh (a 3.8% cut versus CNY0.49/kWh previously), and Zone IV decreasing from CNY0.61/kWh to CNY0.60/kWh (a 1.6% cut versus CNY0.59/kWh previously).  Next cut in 2018, rather than 2017: The proposed follow-on tariff cut is planned for 2018 instead of 2017. Another CNY2 to 3 cent reduction is proposed, or a cut of 3-6%, which again is milder than the original proposal.

China Wind Sector: 21 January 2016

China: revised wind tariff reduction plan Benchmark on-grid tariff (CNY/KWh, VAT incl.) Cumulative FiT Proposed tariff YoY % Utility Initial effective 1 Changes % zone Regions policy Jan 2016 (%) 2016 2018 2016 2018 2018 Inner Mongolia: All except those included in Type II Type I 0.51 0.49 -3.9% 0.47 0.44 -4.1% -6.4% -10.2% Xinjiang: Urumqi, Yili, Changji, Klamyi, Shihezi Hebei: Zhangjiakou, Chengde Inner Mongolia: Chifeng, Tongliao, Type II 0.54 0.52 -3.7% 0.50 0.47 -3.8% -6.0% -9.6% Xing'anmeng, Hulun Buir Gansu: Zhangye, Jiayuguan, Jiuquan Jilin: Baicheng, Songyuan Heilongjiang: Jixi, Shuangya, Qitaihe, Suihua, Yichun, Daxing'an moutain Gansu: All except those included in Type III 0.58 0.56 -3.4% 0.54 0.51 -3.6% -5.6% -8.9% Type II Xinjiang: All except those included in Type I Ningjia: All All except those included in Type I, Type IV 0.61 0.61 0.0% 0.60 0.58 -1.6% -3.3% -4.9% Type II or Type III

Source: NDRC, Daiwa

Wind tariff cut plan signals government’s concern over grid curtailment in Zones I and II The revised tariff The revised plan suggests to us that the government is increasingly concerned about the reduction plan should overcapacity of wind power in some regions, especially Zones I and II, which has led to lead to a slowdown in serious grid curtailment issues in recent years. As such, we believe the proposal for a big capacity expansion in reduction in tariffs in Zones I and II will likely force wind farm developers, such as China Zones I and II Longyuan, HNR, and Fuxin to slow down their capacity expansion plans in these regions, since some projects will be unprofitable after the tariff cuts.

As such, we believe the wind farm developers will likely be affected in 2 ways: 1) the proposed benchmark wind power tariff cuts in 2016 and 2018 will likely bring down wind project IRRs, and given our expectation of stable wind farm unit construction costs, this might affect the wind IPPs’ future capacity additions, especially in Zones I and II, and 2) the average wind tariff for the wind IPPs will decline slightly YoY, due to the new capacity that is subject to reduced wind power tariffs coming on line post-2016.

Background to wind FiT In August 2009, the NDRC adopted a 4-tier on-grid wind power tariff system, with tariffs in the 4 utilities zones ranging from CNY0.51-0.61/kWh. Following the decline in wind farm construction costs, the NDRC issued a wind tariff cut notice in January 2015, with Zone I/II/III tariffs being cut by CNY0.02 to CNY0.49/CNY0.52/CNY0.56 per kWh (inclusive of VAT), respectively, and the on-grid tariff for Zone IV unchanged at CNY0.61 per kWh (inclusive of VAT).

The tariff cut applied to new onshore wind farms approved after 1 January 2015, as well as wind farms approved before 1 January 2015 but commissioned after 1 January 2016.

China Wind Sector: 21 January 2016

China: wind tariff adjustment issued in January 2015 Benchmark on-grid tariff (CNY/KWh, VAT incl.) Utility zone Regions New policy Current policy Changes (%) Inner Mongolia: All except those included in Type II Type I 0.49 0.51 -3.9% Xinjiang: Urumqi, Yili, Changji, Klamyi, Shihezi Hebei: Zhangjiakou, Chengde Type II Inner Mongolia: Chifeng, Tongliao, Xing'anmeng, Hulun Buir 0.52 0.54 -3.7% Gansu: Zhangye, Jiayuguan, Jiuquan Jilin: Baicheng, Songyuan Heilongjiang: Jixi, Shuangya, Qitaihe, Suihua, Yichun, Daxing'an mountain Type III 0.56 0.58 -3.4% Gansu: All except those included in Type II Xinjiang: All except those included in Type I Ningjia: All Type IV All except those included in Type I, Type II or Type III 0.61 0.61 0.0%

Source: NDRC, Daiwa

Impact Front-loaded orders in The tariff cut that came into effect in January 2016 triggered rush installations across 2015 will likely lead to a Zones I to III in 2015. Thus, we estimate China added some 25GW of new wind connected temporary capacity capacity in 2015, the highest annual figure for any country on record, with its cumulative addition slowdown in wind power connected capacity reaching 120GW by year-end — exceeding the 12th FYP 2016E capacity target of 100GW by 20%.

However, we forecast wind installations to slump to 21GW in 2016E, considering the impact of the front-loaded orders ahead of the tariff cut. According to our checks with various wind operators, most companies plan to add new capacity only in Zones III and IV and acknowledge that the boost in the capacity in 2015 was essentially a one-off.

Indeed, it is not unusual to experience a slowdown in capacity growth following a cut in the FiT. Apart from the FiT cut for wind power (implemented in 2016), the FiT was adjusted down for solar energy in 2013. In that case, the tariff cut announced by the NDRC in August 2013 applied to solar projects approved after 1 September 2013 or commissioned after 1 January 2014.

China: solar feed-in tariffs (September 2013) Applicable for solar projects approved after 1st Sep 2013, or commissioned after 1st Jan 2014 Utility zone Regions Benchmark on-grid tariff (CNY/KWh, VAT incl.) New policy Previous policy Changes Ningxia Qinghai: Haixi Type I Gansu: Jiayuguan, Wuwei, Zhangye, Jiuquan, Dunhuang, Jinchang 0.90 1.00 -10.0% Xinjiang: Hami, Tacheng, Altay, Karamay Inner Mongolia: All except those included in Type II Beijing Tianjin Heilongjiang Jilin Liaoning Sichuan Yunnan Type II 0.95 1.00 -5.0% Inner Mongolia: Chifeng, Tongliao, Xing'anmeng, Hulunbeier Hebei: Chengde, Zhangjiakou, Tangshan, Qinhuangdao Shanxi: Datong, Shuzhou, Xinzhou Shaanxi: Yulin, Yan'an Qinghai: All except those included in Type I Gansu: All except those included in Type I Xinjiang: All except those included in Type I Type III All except those included in Type I or Type II 1.00 1.00 1.00 Subsidy of CNY0.42/KWh for self consumption Distributed - Extra electricity shall be acquired at local thermal on-grid tariff level by the grid companies

China Wind Sector: 21 January 2016

Progressive cuts likely to drag down capacity However, we believe the decline in overall installations in 2016 will be partly offset by an acceleration in installations in Zone IV triggered by the progressive tariff cuts planned for 2016-18. In December 2015, the NDRC’ s Pricing Bureau issued a notice outlining cuts in the FiT for wind projects to be approved in 2016 and 2018 (cuts of 2-4% for 2016 and 3- 6% for 2018). Under this plan, Zone IV no longer avoids the tariff adjustments, and after the rush installations in Zones I through III, we believe that operators’ front-loaded project pipelines likely won’t be able to support another round of aggressive capacity additions in Zones I to III.

In our view, the planned progressive cuts make sense, since both the ongoing electricity reforms and over-supply of electricity capacity call for an efficient supply of electricity. The China government is keen to boost the economy through electricity tariff cuts for power plants, and reducing electricity production costs should help to boost the efficiency of the whole industry chain. Reducing on-grid tariffs for wind projects should not only filter out low-quality wind projects for which costs are high and operating efficiency low, but also lessen the burden of the renewable energy surcharge borne by retail customers.

1. Filtering out low-quality wind projects We analyse the potential As the on-grid tariff is the major source of revenue for wind projects, tariff cuts should IRR changes by province largely impact the profitability of wind projects. Based on the reported number of utilisation hours and the provincial-level approved tariffs, we have sought to show the differences in returns across various locations. Note that we do not make differentiated forecasts in terms of the capital cost per MW and we assume flat 70% debt financing. Our IRR calculations are based on the following key assumptions:  On-grid tariff: unchanged for 20 years  Utilisation hours: the average reported utilisation hours for 2013-14, which we think is a fair basis given our view that severe curtailment issues are unlikely to be resolved until 2020E  Interest cost: 5% pa  Tax rate: free for 3 years, a 50% discount for the next 3 years, and a 25% corporate tax rate thereafter  VAT: 100% VAT rebate on domestic wind turbine purchases and a 50% VAT rebate on power tariffs earned

Factoring in the progressive tariff cuts from 2016 to 2020, we find the equity IRRs of China’s new wind farms would fall from 15.7% in 2015E to 13.1% in 2018E and 11.6% in 2020E. The results differ among provinces, with southeast regions generally faring better than northwest regions. Provinces such as Yunnan, Beijing and Shanghai show relatively high returns. Meanwhile, given poor utilisation, Gansu, Guangdong and Heilongjiang should see low returns.

Using an investment IRR criteria of 12% to select projects, we find that projects in only half the provinces are likely to remain profitable through to 2020E.

China Wind Sector: 21 January 2016

China: provincial equity IRR based on our calculation (based on new proposal) Province Zone Current 2016E 2018E 2020E Beijing Zone IV Profitable Profitable Profitable Profitable Tianjin Zone IV Profitable Profitable Profitable Profitable Hebei Zone II & IV Profitable Profitable Profitable Not profitable Shanxi Zone IV Profitable Profitable Profitable Profitable Shandong Zone IV Profitable Profitable Profitable Profitable Inner Mongolia Zone I & II Profitable Profitable Not profitable Not profitable Liaoning Zone IV Profitable Profitable Not profitable Not profitable Jilin Zone III & IV Not profitable Not profitable Not profitable Not profitable Heilongjiang Zone III & IV Profitable Not profitable Not profitable Not profitable Shanghai Zone IV Profitable Profitable Profitable Profitable Jiangsu Zone IV Profitable Profitable Profitable Profitable Zhejiang Zone IV Profitable Profitable Profitable Profitable Anhui Zone IV Profitable Profitable Profitable Profitable Fujian Zone IV Profitable Profitable Profitable Profitable Jiangxi Zone IV Profitable Profitable Profitable Profitable Henan Zone IV Profitable Profitable Profitable Profitable Hubei Zone IV Profitable Profitable Profitable Profitable Hunan Zone IV Profitable Profitable Profitable Profitable Chongqing Zone IV Profitable Profitable Profitable Profitable Sichuan Zone IV Profitable Profitable Profitable Profitable Shaanxi Zone IV Profitable Profitable Profitable Profitable Gansu Zone II & III Not profitable Not profitable Not profitable Not profitable Qinghai Zone IV Profitable Profitable Profitable Not profitable Ningxia Zone III Profitable Profitable Profitable Not profitable Xinjiang Zone I & III Not profitable Not profitable Not profitable Not profitable Guangdong Zone IV Profitable Profitable Profitable Profitable Guangxi Zone IV Profitable Profitable Profitable Profitable Hainan Zone IV Profitable Profitable Profitable Profitable Guizhou Zone IV Profitable Profitable Profitable Profitable Yunnan Zone IV Profitable Profitable Profitable Profitable

Source: NEA, Daiwa estimates Note: The year indicates when the project obtains approval; 2020E on-grid tariff cut is assumed to be similar to 2016/18 Note: Profitability IRR benchmark is 12%

China: provincial equity IRR (based on current policy effective 2016) 40% 35% 30% 25% 20% 15% 10% 5%

Jilin

Anhui

Hubei Hebei

Fujian

Tianjin Henan Hunan Gansu

Beijing

Shanxi

Jiangxi

Hainan

Ningxia

Yunnan Jiangsu Qinghai

Xinjiang

Sichuan Shaanxi

Guizhou Guangxi

Liaoning

Zhejiang

Shanghai

Shandong

Chongqing

Guangdong Heilongjiang

Inner Mongolia Source: NEA, Daiwa forecasts Note: The year indicates when the project obtains approval

China: provincial equity IRR (based on current policy effective 2018) 40% 35% 30% 25% 20% 15% 10% 5%

Jilin

Anhui

Hubei Hebei

Fujian

Tianjin Gansu Henan Hunan

Beijing

Shanxi

Jiangxi

Hainan

Ningxia

Qinghai Yunnan Jiangsu

Xinjiang

Shaanxi Sichuan

Guangxi Guizhou

Liaoning

Zhejiang

Shanghai

Shandong

Chongqing

Guangdong Heilongjiang

Inner Mongolia Source: NEA, Daiwa forecasts Note: The year indicates the when the project obtains approval

China Wind Sector: 21 January 2016

We believe that the The proposed wind power tariff cut schedule suggests that tariff cuts will be implemented earlier the operators can every 2 years, which means that the earlier the operators can complete projects, the better complete projects, the their returns will be. However, the proposed benchmark wind power tariff cut every 2 years better their returns will will likely reduce the IRRs on wind projects, and given our expectation of stable wind farm be unit construction costs, this might affect wind operators’ future capacity additions, as part of their pipeline of wind projects may be deemed unprofitable following the tariff cuts. The lower returns could therefore be expected to reduce new installations.

We note that the size of tariff cut in Zone IV is milder than for Zones I to III. In our view, the proposed tariff policy is designed to keep investors’ focusing on Zone IV, especially non- curtailed areas. Since curtailment leads to electricity being wasted, reducing curtailment can improve the overall efficiency of wind power in China.

China: provincial equity IRR (2015E) China: provincial equity IRR (2016E)

Heilongjiang Heilongjiang 12% 11%

Jilin Jilin 3% 3% Liaoning Liaoning 13% Xinjiang Inner Mongolia 13% Xinjiang Inner Mongolia 10% 14% Beijing 21% 9% 13% Beijing 20% Tianjin 24% Tianjin 25% Hebei Hebei Ningxia Ningxia Shanxi 15% Shanxi 15% 15% 16% 21% Shandong 19% 20% Shandong 19% Qinghai Qinghai 14% Gansu 13% Gansu Jiangsu 20% Henan Jiangsu 21% Shaanxi Henan 8% Shaanxi 7% 22% 20% 23% Anhui Shanghai Tibet 20% Anhui Shanghai Tibet Hubei 16% 25% n.a. 16% 24% n.a. Chongqing Hubei Chongqing Sichuan Zhejiang Sichuan 19% Zhejiang 21% 19% 20% 27% 22% 26% Jiangxi 21% Jiangxi Hunan Hunan 25% 25% 17% Guizhou 18% Fujian Guizhou Fujian 20% 38% 19% 37% <12% Yunnan <12% Yunnan 32% Guangxi Guangdong 31% Guangxi Guangdong 12-18% 17% 16% 12-18% 17% 15% >18% >18%

Hainan Hainan 21% 20%

Source: Daiwa Source: Daiwa Note: Unprofitable regions (< 12% equity IRR) are highlighted in red Note: Unprofitable regions (< 12% equity IRR) are highlighted in red

China: provincial equity IRR (2018E) China: provincial equity IRR (2020E)

Heilongjiang Heilongjiang 10% 8%

Jilin Jilin 2% 1% Liaoning Liaoning Xinjiang Inner Mongolia 12% Xinjiang Inner Mongolia 11% 7% 11% Beijing 19% 6% 10% Beijing 18% Tianjin 23% Tianjin 21% Hebei Hebei Ningxia Ningxia Shanxi 13% Shanxi 12% 13% 19% Shandong 17% 11% 18% Shandong 16% Qinghai Qinghai Gansu 12% Gansu Henan Jiangsu 19% 11% Henan Jiangsu 17% Shaanxi 5% Shaanxi 6% 21% 20% Tibet 18% Anhui Shanghai Tibet 17% Anhui Shanghai Hubei 14% 23% Hubei 13% 21% n.a. Chongqing n.a. Chongqing Sichuan 17% Zhejiang Sichuan 16% Zhejiang 19% 17% 24% 20% 23% Jiangxi 19% Hunan Jiangxi Hunan 23% 21% Guizhou 16% Fujian Guizhou 15% Fujian 18% 35% 17% 33% <12% Yunnan <12% Yunnan 29% Guangxi Guangdong 27% Guangxi Guangdong 12-18% 15% 14% 12-18% 14% 13% >18% >18%

Hainan Hainan 19% 18%

Source: Daiwa Source: Daiwa Note: Unprofitable regions (< 12% equity IRR) are highlighted in red Note: Unprofitable regions (< 12% equity IRR) are highlighted in red

China Wind Sector: 21 January 2016

2: Lowering the burden of the renewable energy surcharge Tariff cuts could lower The renewable energy FiT can be broken into 2 parts, namely the local coal-fired on-grid the renewable energy tariff and the subsidy, which is the difference between the FiT and the local coal-fired on- deficit grid tariff. The grid companies settle the coal-fired on-grid tariff with the renewable energy project owners, whereas the Ministry of Finance (MoF) pays for the spread through the Renewable Energy Development Fund. The renewable fund recorded a cumulative shortfall of around CNY14bn as at end-2014, and we estimate the shortfall expanded to CNY50bn as at end-2015E. Even though only around 30% of the wind FiT comes from subsidies (solar: 51-58%, biomass 33%), wind still consumes most of the subsidies (49% versus 28% for solar in 2015E) due to its large installed base.

China: wind power on-grid tariff China: Renewable Energy Development Fund usage 100% 100% 9% 21% 22% 23% 80% 34% 35% 80% 42% 49% 53% 16% 72% 67% 28% 60% 60% 21% 91% 40% 40% 79% 66% 58% 62% 51% 47% 49% 20% 20% 43% 28% 33%

0% 0% Solar (utility-scale) Solar (DG) Wind Biomass 2009 2010 2011 2012 2013 2014 2015E Subsidy Coal-fired on-grid tariff Wind Solar Other renewable energies

Source: NDRC Source: Daiwa

The shortfalls in the renewable fund have led to lagged subsidy payments from the government to the operators, putting companies’ cash flows and profitability under stress. According to our research in the market, some downstream renewable energy operators have only received the coal-fired on-grid tariff portion of the subsidy. We believe the renewable fund has not been able to support new project development since it was established in 2013, and we expect the cumulative shortfall to grow from CNY14bn as at end-2014 to CNY50bn by end-2015E assuming the renewable energy surcharge is unchanged.

Since 2006, the MoF has imposed a surcharge on retail electricity sales. The surcharge is mainly used to pay for the subsidy portion of the on-grid tariff. Given the rapid development of renewable energy in China, the surcharge has been revised several times, from CNY0.2 cents in 2006 to CNY1.9 cents starting in January 2016, and its size as a proportion of residential and industrial electricity tariffs has increased from 0.2%/0.2% to 3.6%/2.4% following the renewable surcharge hike in December 2015.

China: renewable energy surcharge China: renewable energy surch arge to benchmark tariff (CNY per kWh) 4.0% 0.020 3.5% 3.0% 0.015 2.5% 2.0% 0.010 1.5% 1.0% 0.005 0.5% 0.0%

0.000

Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-15 Jul-14

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-14 Jan-15 Jan-13

Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-06 % to residential tariff % to industrial tariff

Source: NDRC Source: CEIC, Daiwa

China Wind Sector: 21 January 2016

Renewable energy Arguably the most straightforward solution to the issue of the fund deficit would be to surcharge hike would increase the renewable energy surcharge. However, a hike in the surcharge would further pressure the profitability affect the profitability of power-intensive industries (such as basic materials and of power-intensive manufacturing industries), most of which are already facing with thin margins amid industries overcapacity. Alternatively, a cut in the FiT would effectively reduce the pressure on the renewable fund, while improving the operating efficiency of the renewable energy operators through accelerated subsidy payments, which would enhance the operators’ cash flow and potentially lead to better investor sentiment towards renewable energy projects.

China: accounts receivable days of renewable energy operators 300

250

200

150

100

0 1H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 Longyuan Huaneng RE Datang RE China Power New Energy

Source: Companies, Daiwa

Installation costs Cost assessment Like other renewable energy technologies, wind power is capital-intensive but has no fuel costs. The key parameters determining the economics of wind power are: 1) investment costs (including those associated with project financing), 2) operation and maintenance costs (fixed and variable), 3) capacity factor (based on wind speeds and turbine availability factor), 4) economic lifetime, and 5) the cost of capital.

It is generally accepted that cuts in the FiT should be most correlated with the reduction in capacity installation costs, since for new projects there would no significant change in the other parameters over time. Hence, we assess the scope for a reduction in capacity installation costs in order to analyse the profitability of future wind projects facing tariff cuts.

Wind farm construction cost components Similar to other renewable technologies, the high upfront costs of wind power can be a barrier to their uptake, despite there being no fuel cost risks once the wind farm has been built. The construction costs of a wind power project can be broken down into the following major categories:  Wind turbine cost: including blades, turbine generators, towers and transformers, which on aggregate account for around 64% of total wind farm construction costs  Land cost and civil works: including site preparation and the foundations for the towers, accounting for around 17% of total construction costs  Balance of system cost: accounts for roughly 9% of total wind farm construction costs, and comprises grid connection, building construction, control systems, project consultancy, etc.

China Wind Sector: 21 January 2016

Wind farm construction cost breakdown Planning & others, 8% 100% Civil works, 7% 90% Others 80% Land Transformer acquisition, 10% 70% Generator 60% Power converter WTG, 51% 50% Gearbox Grid connection, 40% Rotor blades 11% Tower, 30% 13% 20% 10% Tower 0%

Source: Daiwa

WTGs account for WTGs are the major cost component for a wind farm. Besides WTGs, grid connections around 51% of the total account for roughly 11% of the cost, tower foundation 7%, and land 10%. Wind farms wind farm construction constructed on mountain ground feature higher costs. For the turbine, the largest cost cost components are the rotor blades, tower and gearbox, which together account for around 60% of the turbine cost. The generator, transformer and power converter account for about 13% of the turbine cost, with the remainder being comprised of miscellaneous costs associated with the tower, such as the rotor hub, cabling and rotor shaft.

China: wind farm construction cost breakdown (CNY per W) Cost breakdown Proportion (%) Equipment WTG 4.0 51% Tower 1.0 13% Wind turbine total 5.0 64% Balance of system (BOS) Grid connection 0.9 11% Land acquisition 0.8 10% Civil works and foundation 0.5 7% Planning and others 0.6 8% BOS total 2.8 36% Total 7.8 100%

Source: Daiwa

Still room for a reduction in construction cost? To answer the question, we analyse the future construction cost trends for wind projects in China. We break down our cost assessment into 3 parts: 1) wind turbine costs (including tower), 2) civil works and land costs, and 3) balance of system (BOS) cost.

1) Wind turbine costs The wind turbine is the largest single cost component of the total installed cost of a wind farm, within which the main components are the wind turbine generators (including blades and generators, or WTGs) and the towers.

WTG ASP price trend WTG prices have been flat since 2013, with the bidding prices for domestic 1.5-2.5MW has been fairly stable, turbines driven largely by market supply and demand conditions. As a result of the with no meaningful cost increased competition among wind turbine manufacturers, as well as lower commodity reductions prices for steel, copper and cement, the per-unit ASP for a WTG has declined 10-15% since 2010.

In 2014, the per-unit ASP for WTG rose amid increased bidding prices ahead of the rush installations experienced in 2015. The average wind turbine bidding price then softened in 2015.

China Wind Sector: 21 January 2016

Wind turbine price Market price for steel, copper and cement (CNY/W) Rebased to 1.00 5.0 in Jan 2009 3.0 4.6 2.5 2.0 4.2 1.5 3.8 1.0 0.5 3.4 0.0

3.0

Jan-09 Jan-11 Jan-12 Jan-13 Jan-15 Jan-10 Jan-14

Sep-09 Sep-10 Sep-11 Sep-13 Sep-14 Sep-15 Sep-12

May-09 May-10 May-12 May-13 May-14 May-15 May-11

Oct-11 Oct-12 Oct-13 Oct-14 Oct-10

Jun-11 Jun-12 Jun-13 Jun-14

Jun-10 Cement Steel Copper

Feb-12 Feb-13 Feb-14 Feb-15 Feb-11 Source: Goldwind Source: Price Monitoring Center, NDRC

Inside a wind turbine, the 2 most expensive components are the towers and rotor blades, which together account for around half of the total cost. After these 2 components, the next largest cost component is the gearbox. Although not the most expensive component, the gearbox can be considered the most important component. The gears increase the low rotational speed of the rotor shaft in several stages to the high speed needed to drive the generator, and the gearbox is an important component of the O&M costs as it requires extensive maintenance.

Gross margins for wind operators increasing While the wind turbine ASP has stabilised in recent years, the cost of manufacture has actually declined due to the benefits of large-scale production and the falling prices of steel, copper and cement. For example, Goldwind’s gross margin on WTG manufacturing increased by 14.3pp to 25.4% in 1H15 vs. its lowest level of 11.1% in 1H12, and was 6.1pp higher than the average level of 19.3% in 2013. The company’s gross margin improved in 2013 and remained at an elevated level throughout 2014, backed by the increasing scale of newly installed capacity. The improved margin has also resulted from the market consolidation that followed the fierce competition of 2012, with the top-10 players now accounting for nearly 80% of the market.

Goldwind: WTG gross profit margin Wind turbine market bidding size 30% (GW) 12 10.2 25% Front loaded order after proposed tariff cut 10 8.4 plan released in Sep 2014 20% 8 6.8 6.4 5.5 5.8 15% 6 4.8 4.8 4.7 4.3 3.9 3.8 4 3.7 4 3 10% 2.2 2.3 2.5 1.4 2 5% 0

1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 2Q13 3Q13 4Q13 1H10 2H10 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 1Q13 Source: Goldwind Source: Goldwind

We note the average bidding size started to trend down in 2015, likely because of the front-loaded orders in 4Q14. We suspect the WTG manufacturers’ wide gross margins will come under pressure if, as we expect, their order books decline in 2016. However, the more consolidated nature of the market may offer some protection to margins, in our view.

China Wind Sector: 21 January 2016

2) Land acquisition and civil works This includes the cost of land acquisition, transportation and installation of wind turbines and the tower, construction of the wind turbine foundation (tower), and construction of access roads and other related infrastructure needed for the wind farm. Foundations are materials-intensive, with 45% to 50% of the cost of monopile foundations being attributable to the steel required. Since foundation costs only constitute 15-18% of the total cost of construction for a wind farm, we believe that swings in the steel/copper transaction prices should not have a significant impact on total wind farm construction costs.

Market price for steel and copper Rebased to 1.00 in Jan 2009 3.0

2.5

2.0

1.5

1.0

0.5

0.0

Jul-09 Jul-12 Jul-13 Jul-10 Jul-11 Jul-14 Jul-15

Oct-09 Oct-10 Apr-11 Apr-12 Oct-13 Apr-15 Apr-09 Apr-10 Oct-11 Oct-12 Apr-13 Apr-14 Oct-14

Jan-11 Jan-14 Jan-15 Jan-09 Jan-10 Jan-12 Jan-13

Steel Copper Source: Price Monitoring Center, NDRC

Land costs are more The transportation and installation of wind turbines and towers are also a major cost expensive in the component. As installations are shifting to non-curtailed areas in the southeast, building in southeast of China than densely populated and generally more-developed coastal areas with rising land values can in the north lead to higher installation costs. Moreover, unlike the northwest, where wind farms are mostly built on flat areas, site selection in the southeast is limited to hilly land, which is also more expensive to build on (higher transportation costs and in general the cost of land in the southeast is higher).

However, to offset some of the higher construction costs associated with building in the southeast, the wind energy operators opt to build large single wind turbines (which leads to a lower per Watt land cost as the big turbines generate more power than the smaller ones).

3) Balance of system cost The balance of system cost (BOS) includes a range of construction costs other than foundation costs and wind turbine costs, such as the construction of buildings, control systems, project consultancy costs, and grid connection costs.

BOS costs vary widely across the world, and even across regions in China, depending on a number of factors, such as location of the project, distance from the grid, labour wage level, and the competitive landscape in the engineering, procurement, and construction (EPC) segment. As with the foundation cost, the BOS cost is also higher in southeast areas due to the higher labour costs associated with the area’s more developed economy, as well as a scarcity of flat land suitable for wind farm development.

Conclusion We expect a flat wind From the above analysis, we conclude that wind farm construction costs should remain construction cost trend stable at CNY7.5-8.2 per W over 2016-18, for the following reasons: 1) limited downside to over our forecast period the manufacturing cost of a WTG, 2) land and civil work costs likely to be flat or slightly higher, given more wind farms in southeast China going forward, and 3) BOS costs to remain flat going forward.

According to our discussions with the wind turbine operators, unlike solar installation costs which have typically fallen by 3-5% each year for the past 5 years, there is little scope for a further reduction in the manufacturing cost of a WTG.

China Wind Sector: 21 January 2016

Grid curtailment: moderating in 2017E, but probably not eliminated until 2020E We expect China’s grid curtailment issue to remain elevated for another year, after the surge in the curtailment rate in 1H15 (2014: 8.0%; 1H15: 15.2%) and possibly 2H15. In our view, wind utilisation fundamentals are deteriorating, given: 1) weakening electricity demand in coastal China, 2) accelerated wind capacity additions in 2014 and 2015E, and 3) sustained capacity growth in competing power generation sources, such as coal-fired power and nuclear power.

Further ahead, we expect a slight improvement in grid congestion issues in 2017E, mainly driven by the planned commissioning of the UHV transmission lines from end-2016E to 2017E. It is important to note that we do not see the UHV transmission lines as a silver bullet for wind curtailment, meaning that even after the large-scale commissioning of UHV transmission lines post-2017E, we think the curtailment issues will only be partly resolved.

In May 2015, the government published policies to regulate the market, including one whereby provinces with grid curtailment exceeding 20% will not be permitted to build new wind farms. In 1H15, most provinces in northeast China, along with Gansu and Xinjiang, reported curtailment in excess of 20% (Xinjiang even reported 0% wind power output for winter 2015), and in March 2015, when the government announced approvals for wind projects totalling 34GW, these provinces did not receive any new approvals.

Curtailment set to worsen in 2015-16E We forecast China’s curtailed wind power to reach 35bn kWh in 2015E, more than double the 2014 level of 13.3bn kWh, and implying a grid curtailment ratio of ~16%. Heading into 2016E, we look for this trend to continue, with the curtailment rate likely to edge up further to 18-20%. The factors below underline our bearish view:

Softening power demand in China China’s power intensity The moderation in China’s electricity consumption for 2014 and 2015 can be attributed to has been declining as its the following 2 factors. First, China’s real GDP growth has declined to around 7% pa over GDP has been shifting, the past 2 years, from its recent peak of 10.6% in 2010 on massive infrastructure as China moves towards investment. Second, the components of China’s GDP have gradually been shifting from a service-led economy heavy industry to tertiary industry, which has capped the growth in power demand in recent years.

The GDP chart below shows the gradual divergence of GDP growth and power consumption growth in China. While in earlier years (2002-13) we saw a close correlation between the 2 indicators (with the power demand coefficient fluctuating around the 1.0 level), we started to see power demand growth lag GDP growth starting in 2014, with the power coefficient falling to ~0.5, and further to just ~0.1 in 10M15.

China: GDP growth vs. electricity consumption growth China: power consumption growth for heavy industries 20% 2.0 25%

15% 15% 1.5 5% 10% 1.0 (5%) 5% 0.5 (15%)

0% 0.0 (25%)

2002 2004 2005 2006 2008 2009 2011 2012 2013 2014 2003 2007 2010

Jul-11 Jul-12 Jul-13 Jul-14 Jul-15

10M15

Apr-11 Oct-11 Oct-12 Apr-13 Oct-13 Apr-14 Apr-15 Apr-12 Oct-14

Jan-11 Jan-12 Jan-13 Jan-15 Jan-14 Power demand growth GDP growth Chemical Cement Non-ferrous metal Power demand coefficient - RHS Ferrous metal 4 Majors Source: NDRC, Daiwa Source: China Electricity Council, Daiwa Note: GDP number for 2015 represents 3Q15 numbers

China Wind Sector: 21 January 2016

Power consumption Assuming the credibility of China’s announced GDP numbers, we think the main reason for proportion by heavy the divergence between GDP growth and power consumption growth from 2014 onwards industries has declined (as shown in the left-hand chart above) is the declining growth of power consumption by in recent years heavy industries. The growth of the 4 major heavy industries that we identify (chemical, cement, non-ferrous metals, and ferrous metals) largely moderated from a high single-digit percentage towards a negative level in 2015. This moderation also led to the proportion of heavy industries’ consumption as a percentage of total power consumption declining to 58% for 10M15 from 61% for 2009-11 (see the lower chart on the left).

While this phenomenon is just an eventual outcome of China’s economy transitioning to becoming a more developed country, it will also inevitably lead to more moderated power demand growth.

China: power consumption breakdown by industry China: power consumption breakdown by industry (10M15) 100% 12% 12% 12% 13% 13% 13% 13% Primary, 2% Residential, Secondary - 13% 80% 11% 11% 11% 11% 12% 12% 13% light, 12%

60% Tertiary, 13% 61% 61% 61% 60% 60% 60% 40% 58% Secondary - 20% others, 1% 12% 13% 12% 12% 12% 12% 12% Secondary - 0% heavy, 58% 2009 2010 2011 2012 2013 2014 10M15 Primary Secondary - light Secondary - heavy Secondary - others Tertiary Residential

Source: NDRC, Daiwa Source: NDRC, Daiwa

Even since the Renewable Energy Law was implemented in 2006, stating that clean energy, including hydro, wind, solar and nuclear has priority of dispatch over coal-fired power, the curtailment issues have persisted, especially in the provinces that lack local power demand and rely heavily on electricity exports.

Inter-regional electricity export volume growth (YoY) (% ) 60

(10) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2013 2014 2015

Source: Wind

Accelerated wind power installations in 2014 to 2015E Apart from the distressed power demand outlook in China, we don’t think the supply side is helping the situation. In 2014, a record 19.8GW of new wind capacity was connected to the grid, surging 37% YoY from 2013 and exceeding the 2011 peak of 16.5GW by 20%. For 2015E, we estimate that China’s wind power installations surpassed the 2014 record, by connecting 25GW of wind turbines to the grid, representing 26% wind installation growth from 2014.

Improving wind We attribute the booming wind installations in 2014-15 mainly to: 1) improving wind power utilisation in 2013-14 led fundamentals (on improving grid conditions in 2013-14, with grid curtailment dropping to 11% to booming wind and 8%, respectively from a high teens percentage in 2011-12), and 2) rush installations installation in 2014-15 ahead of the wind on-grid tariff cut starting in January 2016, as previously discussed.

China Wind Sector: 21 January 2016

Since the curtailment data was announced in 2011, we have observed a strong correlation between wind-power installations and the curtailment ratio in subsequent years in China. In 2012, the grid curtailment ratio rose to 17% after the wind power installation boom in 2010- 11 (18.9GW and 17.6GW capacity additions for 2010 and 2011, respectively). The worsening curtailment problem forced many wind farm developers to slow their pace of capacity expansion in 2012-13 (at 13.0GW and 16.1GW in 2012 and 2013, respectively), which successfully resulted in less wind curtailment for 2013-14 (curtailment dropped by 6pp to 10.7% in 2013 and to 8% in 2014). See the following 2 charts that compare the grid curtailment ratio with wind power installations.

China: grid curtailment vs. installation China: grid curtailment vs. capacity growth (GW) 80% 20% 73% 30 20% 18% 70% 17% 16% 25 60% 15% 15% 15% 50% 14% 20 11% 40% 10% 15 10% 30% 39% 8%

10 20% 25% 24% 5% 5% 21% 21% 10% 16% 5 0% 0% 0 0% 2011 2012 2013 2014 2015E 2016E 2017E 2011 2012 2013 2014 2015E 2016E 2017E Wind power installation YoY growth (1-year lag) - LHS Wind power installation (1-year lag) Wind curtailment - RHS Wind curtailment - RHS Source: NEA, Daiwa forecasts Source: NEA, Daiwa forecasts

With this strong correlation, and coupled with the rush installations seen in 2014-15 (wind capacity additions amounted to 23.2GW in 2014 and we expect 28GW to be installed for 2015E), China’s grid curtailment ratio rose from 8% in 2014 (or 8.5% in 1H14) to 15.2% in 1H15, and we estimate the curtailment rates for 2015 and 2016E to stay elevated at 16% and 18%, respectively.

Still, a lot of the new Another reason supporting our argument of worsening grid curtailment in 2H15E to 2016E capacity in 2014-15 was is that newly connected wind farms were still largely concentrated in the heavily curtailment built in areas with heavy regions. In 2014 and 1H15, 53% and 34% of the newly built wind farms were still located in wind curtailment provinces with serious grid curtailment issues, respectively, including 15%/15% of newly built wind farms being located in Gansu (curtailment: 31%), 8%/10% in Inner Mongolia (curtailment: 20% in west Inner Mongolia and 14% in east Inner Mongolia), and 15%/4% in Xinjiang (curtailment: 29%) for 2014 and 1H15, respectively. See the following charts and tables for more details, and also refer to Appendix I for a map outlining China’s wind curtailments.

China: wind capacity additions by province (2014) New capacity of provinces with heavy grid curtailment (1H15) Province Capacity additions (MW) Proportion Grid curtailment 1H15 Gansu 1,348 15% 31.0% Inner Mongolia 876 10% 17.0% Gansu, 15% Xinjiang 398 4% 28.8% Others, 22% Liaoning 176 2% 17.5% Heilongjiang, Hebei 146 2% 13.9% 3% Xinjiang, 15% Heilongjiang 109 1% 22.7% Guizhou, 5% Jilin 99 1% 43.0% Total 3,151 34% Yunnan, 5% 2014 Inner Mongolia, Ningxia, 6% Gansu 3,048 15% 11.0% 8% Shandong, 6% Shanxi, 7% Inner Mongolia 1,667 8% 9.0% Hebei, 7% Xinjiang 3,033 15% 15.0% Liaoning 450 2% 6.0% Hebei 1,377 7% 12.0% Heilongjiang 616 3% 12.0% Jilin 306 2% 15.0% Total 10,495 53%

Source: NEA, Daiwa Source: NEA, Daiwa

China Wind Sector: 21 January 2016

China: wind curtailment rates by province 2011 2012 2013 2014 1H12 1H13 1H14 1H15 Beijing 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.7% 4.4% Tianjin 0.0% 0.0% 1.7% 1.0% 0.0% 0.0% 2.0% 5.3% Hebei 3.1% 12.5% 16.6% 12.0% 6.1% 20.2% 14.6% 13.9% Shanxi 0.0% 0.6% 0.0% 0.0% 0.6% 0.7% 0.4% 3.8% Shandong 0.0% 0.0% 0.0% 1.0% 0.0% 0.0% 1.2% 1.1% Inner Mongolia 20.3% 30.2% 15.9% 9.0% 17.7% 11.1% 10.8% 17.0% Liaoning 8.9% 12.5% 5.0% 6.0% 13.6% 13.0% 7.9% 17.5% Jilin 20.5% 32.2% 21.8% 15.0% 28.1% 17.6% 19.8% 43.0% Heilongjiang 14.5% 17.4% 14.6% 12.0% 16.5% 21.6% 15.5% 22.7% Shaanxi 0.0% 0.0% 3.0% 2.0% 0.0% 0.0% 1.8% 0.0% Gansu 17.0% 24.3% 20.7% 11.0% 18.4% 11.7% 5.7% 31.0% Ningxia 0.6% 1.2% 0.7% 0.0% 0.8% 3.0% 0.4% 2.7% Xinjiang 3.2% 4.3% 5.2% 15.0% 7.4% 5.2% 17.3% 28.8% Yunnan 0.0% 0.0% 3.7% 4.0% 0.0% 3.4% 1.5% 0.8% National average 15.0% 17.0% 11.0% 8.0% 11.8% 10.0% 8.5% 15.2% Source: NEA

Alternative power-generating sources also rushing in Apart from the reasons stated above, the supply of other sources of electricity generation, such as thermal power plants, hydroelectric power plants, and nuclear power plants, will continue to expand over the next few years, based on the current commissioning schedule, which, in our view, should worsen the current excess supply condition.

Thermal power: excessive approvals since 2014 As at August 2015, capacity under construction for thermal power plants had reached 87.6GW, with the accumulated approved capacity expansion pipeline at over 150GW. Given the construction period for thermal power plants of 3-5 years, we expect accelerated capacity growth for thermal power over the next few years. The major reasons for the continuing capacity expansion despite weak demand growth are two-fold: 1. The provincial governments, after being delegated with approval rights for thermal power projects since 2014, have a strong incentive to accelerate approvals in order to boost provincial-level GDP growth and tax revenue. 2. The low coal price has made thermal power generation very profitable, encouraging further capacity expansion. Also, coal miners such as China Shenhua (1088 HK, not rated) have expanded their business to the downstream coal-fired IPP segment to maintain profitability.

China has a target for Hydro power: stable 10GW pa capacity growth until 2020E 360GW of hydro power For hydro power, according to the China Electricity Council, China’s hydro power capacity by 2020 target should reach 360GW by 2020. In 2014, China experienced a boom in terms of hydro installations (+8% YoY) and generation (+20% YoY), due mainly to the higher-than-average discharge of water flow in the country’s major rivers and as the peak in hydro investment was in 2012. Although we do not expect capacity growth to continue at a similar pace, given the decreasing number of both new installations and newly launched projects in 1H15, the exploitation rate of hydro power is still relatively low (~50% in 2014 vs. US ~80%). Being clean and renewable, and with low variable costs and stable output, hydro power is still the biggest substitute for thermal power in the eyes of the Chinese government, in our view. Should China achieve its hydro power target of 360GW by 2020, we estimate this could still translate into 10GW pa capacity growth for 2015-20.

China Wind Sector: 21 January 2016

Nuclear power: demand from coastal regions could be absorbed Nuclear power capacity Due to the long planning-approval-construction period, nuclear power capacity expansion additions still likely to is more predictable than all other types of power generation. Currently, there are 24 concentrate on the nuclear reactors under construction, with total capacity of 24.5GW expected to be added coastal regions by 2020E on our forecasts. Under our bull-case scenario (if the planned projects are approved and finished 1 year earlier than our current forecasts), there could be 39.6GW of capacity added between the present time and the end of 2020E. And although the capacity expansion appears to be moderate, we would note that all nuclear power plants under construction are located in China’s coastal regions, meaning that nuclear power could still threaten the supply-demand situation of these provinces.

China: total capacity forecasts by generation type China: capacity-addition forecasts by generation type (GW) (GW) 2,000 15% 140 120 1,500 11 16 10% 100 3 11 18 17 3 15 20 25 17 1,000 80 2 15 2 5 21 - 10 23 60 6 5% 45 8 59 51 500 40 51 46 48 40 20 0 0% 30 22 17 16 16 10 10 2011 2012 2013 2014 2015E 2016E 2017E 0 2011 2012 2013 2014 2015E 2016E 2017E Hydro Coal-fired Nuclear Wind Solar Others Hydro Coal-fired Nuclear Wind Solar Others Capacity growth - RHS Power demand growth - RHS Source: CEC, NEA, Daiwa forecasts Source: CEC, NEA, Daiwa forecasts

Government encourages local consumption in heavy curtailed area On 8 October 2015, the NEA released a policy to Encourage the local consumption of renewable energy (Chinese-language only), and carried out a local consumption trial in Gansu and Inner Mongolia. As at end-1H15, Gansu and Inner Mongolia accounted for 31% of the total connected wind capacity in China. The 2 regions rely heavily on electricity exports. In 2014, the electricity output in Gansu and Mongolia accounted for 2.2%/6.8% of the total for the country, while electricity consumption was only 2.0%/4.4%, respectively. Curtailments in Gansu and Inner Mongolia surged dramatically to 28.82% and 19.92%, respectively, in 1H15.

Since 2008, the Central government has made plans to take a more centralised approach in planning for future wind capacity. At the end of 2008, China launched a plan to build 6 land-based 10GW wind-power bases in northern China, which is rich in wind resources. The government instructed the state grid corporation to construct corresponding auxiliary grid infrastructure for electricity transmission. The blueprint indicates that China’s future wind power will be characterised by large-scale, centralised production and long-distance transmission.

However, the delayed transmission-line development and poor local consumption ability have led to heavy curtailment at the wind-power bases. In view of this, the NDRC has suspended new wind approvals in curtailed areas for the past 3 years, shifting capacity to the non-curtailed southeast area, close to the power consumption centre.

China Wind Sector: 21 January 2016

China: 2014 yearly sufficient rate China Wind Sector: location of the mega-watt wind farms

North North East South North Central 80% East West 60% 40% 20% 0% (20%) (40%) (60%)

(80%)

Jilin

Anhui

Hebei Hubei

Fujian

Tianjin

Gansu Hunan Henan

Beijing

Shanxi

Jiangxi

Hainan

Ningxia

Jiangsu Qinghai

Yunnan

Xinjiang

Shaanxi Sichuan

Guangxi Guizhou

Liaoning

Zhejiang

Shanghai

Shandong

Chongqing

Guangdong Heilongjiang

InnerMongolia

Source: NEA, Daiwa Source: NEA, Daiwa Note: Positive means generation > consumption

The NDRC has called for With no major power transmission line plans in 2015, and weak inter-regional exports due increasing local to weak power-demand growth, the NDRC has been forced to call for increasing local consumption by the consumption by the wind-power bases. The notice specified 3 areas of attention: 1) a focus wind-power bases on regional grid consumption and decreased reliance on inter-regional exports, 2) clear instructions to encourage the direct supply of renewable electricity, 3) priority for electricity dispatches, and compensation for thermal power plants for reducing utilisation hours, and 4) allowing thermal power plants to take responsibility for variable load power, increasing the loading capacity of renewable energy in the grid system.

Considering the severe grid congestion in the western parts of China, the country has an aggressive plan to invest heavily in the construction of ultra-high-voltage transmission lines to bring power from the west to the coast over 12th FYP and 13th FYP at least. The staged growth of power demand could narrow the gap between local power production and consumption in coastal areas.

Additionally, accepting imported clean electricity could bring pressure to the utilisation of local coal-fired power plants. Local governments, in our view, also intend to protect thermal power plants in their provinces by reducing clean power imports. Local power plants contribute to the local government’s GDP investment and tax revenue, and over 61% of the power capacity in China is developed and operated by central state-owned enterprises. In a slowing growth environment, even small monetary contributions are valuable to the local governments’ financials, and we believe governments will be reluctant to cut the local supply of thermal electricity.

YoY changes in power shortage in coastal areas 40% 30% 20% 10% 0% (10%) (20%) (30%) (40%) (50%) (60%) Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2013 2014 2015

Source: National Bureau of Statistics Note: Coastal provinces including Shandong, Shanghai, Jiangsu, Zhejiang, Beijing and Tianjin

China Wind Sector: 21 January 2016

Some wind operators With diminishing external demand, wind-farm operators are actively seeking alternative have been forced to ways to improve local consumption. Some operators have tried to enter into direct-power- compete with thermal sales (DPS) agreements with industry users to improve utilisation hours. Since such power to gain more measures place wind-farm operators in competition with thermal electricity producers, they utilisation hours are forced to supply at ~CNY0.4/kWh, close to the benchmark tariff, and sometimes as low as the marginal variable cost at ~CNY0.2/kWh.

In Inner Mongolia, where power reforms on the sale of electricity were introduced in 2015, HNR conducted a trial to directly supply 100m kWh of wind electricity at CNY0.4466/kWh in 1H15. The supply amount is relatively small, only less than 6% of HNR’s total output in Inner Mongolia, and ~1% of the total in 1H15, which should not have a significant impact on improving utilisation hours, in our view. We see it an inspiring trial, but operators are not well-protected by the compulsory on-grid law, and so they have to seek ways to improve utilisation hours. HNR achieved a 10.93% improvement to 1,177h in utilisation hours in west Inner Mongolia, and 32.1% to 860h in east Inner Mongolia.

There’s an industry rule that wind operators should only supply excess electricity – that generated beyond the critical utilisation hours (1,400-1,800h) – through a contract at a price lower than the on-grid tariff to avoid distortion in the market. However, some operators have been forced to sell more.

Specifically, the document came out with the idea to allow thermal power plants to be the “peaker” for the first time; to increase the loading capacity of renewable energy in the grid system by offering shaving for unstable wind power. However, we are worried as to whether surging coal-fired capacity could really be the “peaker” for variable load power, or the “robber” as it would steal utilisation hours from clean energy operators.

Coal-fired capacity: “peaker” or “robber”? Despite the slow power demand growth, newly installed coal-fired power capacity increased by 40% YoY for 11M15.

Cumulative installed coal-fired capacity (GW) 50

0 Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2013 2014 2015

Source: CEC

We still saw accelerating We believe the build-out of coal-fired power plants will make it more difficult for clean coal-fired capacity power sources to take market share from coal-fired generation, especially when coal-fired additions in 2015, IPPs usually have: 1) guaranteed utilisation hours under minimum offtake arrangements, despite the overcapacity or 2) direct supply contracts with industrial users. The implementation of direct-power-sales of coal-fired power could lock up the power demand from the large power users, and take market share of the wind operators.

Most coal-fired IPPs make power purchase agreements (PPA) with local governments to ensure its profitability. There are generally 3 types of offtake arrangement; the annual allocation arrangement is the most common, wherein the power plant negotiates the annual output amount on an annual basis.

China Wind Sector: 21 January 2016

China: types of offtake arrangements Type Term Explanation Minimum take arrangement 20-25 years Offtakers purchase a defined minimum volume of electricity generated, and the tariffs for the sale of electricity are reviewed and determined by the relevant authorities from time to time. Capacity charge arrangement 20-25 years In addition to the payment received for electricity purchased, defined payments are also made based on the capacity available for dispatch, regardless of actual generation, and where the tariffs for the sale of electricity are determined based on various factors such as construction costs, tax rates, financing costs and producer price indices. Annual allocation arrangement 1 year An output volume is agreed upon with the local power grid or regulatory authorities, on an annual basis, and the tariffs for the sale of electricity are reviewed and determined by the relevant authorities from time to time. Source: Daiwa

The accelerated investment in coal fired IPPs is likely to be the consequence of: 1) ongoing weakness in the thermal market increasing the profitability of coal-fired IPPs, 2) the dispatch of approval rights of thermal IPPs from the national to provincial level since November 2014, and 3) coal miners such as China Shenhua (1088 HK, not rated) expanding their business to the downstream coal-fired IPP area to remain profitable.

2017: UHV transmission lines to improve grid curtailment slightly Going into 2017, we see improving grid conditions in China. Apart from the fact that most of the leading wind operators have claimed that they would not add any new capacity in provinces with heavy wind curtailment until the curtailment issue is resolved, we expect the UHV transmission power network to expand from 2H16E, on the completion of several UHV transmission lines connecting western provinces to the power demand centres in southern and eastern China. In addition, given our view of declining wind-power deployment after 2015E, we look for an easing of pressure on the wind-power generators from the curtailed grid infrastructure going into 2H17E.

Accelerated UHV transmission network construction in 2015 China’s power market is characterised by a supply-demand mismatch between the west and the east. While western China has abundant electricity supply competing for limited electricity consumption, power demand centres in eastern China suffer from electricity shortages, especially during the peak season in summer.

Construction of UHV To relieve this supply-demand mismatch, China has been, over the past few years, lines has been behind planning the construction of a UHV transmission network linking the west and the east of the SGCC’s original the country. However, due to continual debate over the safety and economic efficiency of schedule such an UHV transmission network, China’s UHV transmission network development has been delayed over the past few years, with only 9 UHV transmission lines in operation by end-2015, despite the construction of China’s first transmission line taking place in 2006

China: UHV transmission lines in operation and their sources of electricity Name Supply Demand DC/AC Voltage (KV) Capacity (GW) Construction Commission date Length Power type Jindongnan - Jingmen Shanxi Hubei AC 1,000 5 Aug-06 Aug-08 640 Thermal Xiangjiaba - Shanghai Sichuan Shanghai DC 800 6 Dec-07 Jul-10 1,907 Hydro Yunnan – Guangdong Yunnan Guangdong DC 800 5 Dec- 08 Dec-09 1,438 Hydro Jinping - Sunan Guizhou Jiangsu DC 800 7 Nov-08 Dec-12 2,059 Hydro Huainan - Zhebei - Shanghai Anhui Shanghai AC 1000 7 Oct-11 Sep-13 2*649 Thermal Nuozhadu - Guangdong Yunnan Guangdong DC 800 8 Oct-11 Sep-13 1,413 Hydro Haminan- Zhenzhou Xinjiang Henan DC 800 8 May-12 Jan-14 2,192 Thermal, wind Xiluodu - Zhejiangxi Sichuan Zhejiang DC 800 8 Jul-13 Jul-14 1,680 Hydro Zhebei – Fuzhou Fujian Zhejiang AC 1000 7 Apr-13 Dec-14 2*603 Hydro, nuclear Source: SGCC, Daiwa

In May 2014, in response to the central government’s “Action Plan for Air Pollution Prevention and Control”, the SGCC and NEA planned to start the construction of 12 transmission lines linking western China to the coastal regions (including 4 UHVAC lines, 5 UHVDC lines, and 3 high-voltage 500kV transmission lines). According to the plan, all 9 UHV lines are scheduled to commence operations before end-2017.

China Wind Sector: 21 January 2016

Despite such an ambitious plan, only 3 lines (1 DC and 2 AC lines) actually started construction in 2014, significantly behind the original target. This, coupled with about a 2- year construction period for UHV transmission lines, led to no UHV transmission lines commencing operations in 2015.

We began to see accelerated construction of UHV transmission lines in 2015, with SGCC starting the construction of 6 UHV transmission lines during the year (4 DC and 2 AC lines, of which 5 lines were among the 12 lines previously planned), boosting the number of UHV transmission lines under construction to 9 by end-January 2016.

China: 9 UHV transmission lines under construction Name DC/AC From To Voltage (kV) Length (km) Capacity (GW) Power type Construction date Commencement date Ningdong - Zhejiang DC Ningxia Zhejiang 800 1720 8 Thermal, wind Nov-14 2016Q4 Huainan - Nanjing - Shanghai AC Anhui Shanghai 1000 2*780 7 Thermal Nov-14 2016YE Ximeng - Shandong AC Inner Mongolia Shandong 1000 2*730 9 Thermal, wind Nov-14 2016Q3 Mengxi - Tianjinnan AC Inner Mongolia Tianjin 1000 2*608 5 Thermal, wind Mar-15 2016E Yuheng - Weifang AC Shaanxi Shandong 1000 2*1049 8 Thermal May-15 2017E Jiuquan - Xiangtan DC Gansu Hunan 800 2383 8 Thermal, wind Jun-15 2017Q1 Jinbei - Nanjing DC Shanxi Jiangsu 800 1119 8 Thermal Jun-15 2017E Ximeng - Jiangsu DC Inner Mongolia Jiangsu 800 1620 10 Thermal, wind Dec-15 2017E Shanghaimiao - Shandong DC Inner Mongolia Shandong 800 1300 8 Thermal, wind Dec-15 2017E Total 71

Source: SGCC, Daiwa

China: 9 UHV transmission lines in the planning stage Length Name DC/AC From To Voltage (kV) (km) Capacity (GW) Commencement date Dianxibei - Guangdong DC Yunnan Guangdong 800 2,000 5 end-2017E Zhundong - Easter China DC Xinjiang Anhui 1,100 3,340 13 2018E Mengxi - Changsha, Jinmen - Wuhan, Changsha - Nanchang AC Inner Mongolia Hunan 1,000 12 2018E Zhangbei - Nanchang, Jindongnan - Yubei, Nanyang - Zhumadian AC Hebei 10 2018E Nanjing - Xuzhou - Lianyungang - Taizhou AC Jiangsu 10 2018E Jinan - Zaozhuang - Linyi - Weifang AC Shandong 10 2018E Humeng - Qingzhou DC Inner Mongolia Shandong 10 2018E Mengxi - Wuhan DC Inner Mongolia Hubei 10 2018E Zhundong - Chengdu DC Xinjiang Sichuan 12 2018E Total 100

Source: SGCC, Daiwa

The construction start of 6 UHV lines, however, was still lagging in the SGCC’s original 2015 plan of 14 (6 AC and 8 DC). The SGCC expects construction of the remaining 8 planned UHV lines to start in 2016E, and commence operations by end-2018 at the earliest.

We remain cautious on the UHV’s contribution to resolving the wind curtailment problems But even after the commissioning of the 9 (still being built) UHV lines in 2016-17E, will the western provinces be able to eradicate wind curtailment issues completely? We doubt it, for 2 reasons: 1) UHV lines can only transmit 10-20% of the electricity derived from renewable energy, and 2) the planning of UHV transmission lines is likely to encourage wind power installation along the transmission path.

UHV lines can’t transmit 100% wind power at a time Only 1 out of 9 operating As opposed to industry expectations that UHV transmission lines can greatly contribute to lines transmits wind wind power transmission, the history of the 9 UHV transmission lines currently in operation power tell us a different story – only 1 of 9 operating UHV transmission lines (Haminan- Zhengzhou) actually transmits wind power. These UHV transmission lines are used by many other sources of electricity generation, such as coal-fired power and hydro power. This is especially true in southern and central China, where there are abundant hydro resources and rich coal supply.

Currently, the only UHV transmission line that transmits electricity for wind power is the South Hami-Zhengzhou project, due to its proximity to 2 of the 9 major wind power bases in China, namely the Hami wind power base in Xinjiang and the Jiuquan wind power base in Gansu.

China Wind Sector: 21 January 2016

China: UHV transmission lines in operation and their sources of electricity

Heilongjiang

Jilin Inner Mongolia Liaoning Xinjiang Beijing Tianjin Shanxi Hebei Shandong Qinghai Ningxia Gansu Jiangsu Shaanxi Henan Tibet Shanghai Hubei Anhui Sichuan Zhejiang Jiangxi Hunan Curtailment 1H15 (%) Fujian Hydropower 0 Guizhou 0 - 2 Wind power Guangdong Taiwan 2 – 10 Yunnan Coal fired Guangxi 10 – 20 Hong Kong Nuclear power > 20% Macau

Hainan

Source: SGCC, Daiwa

China: UHV transmission lines in operation and their sources of electricity Name Supply Demand DC/AC Voltage (KV) Capacity (GW) Construction Commission date Length Power type Jindongnan – Jingmen Shanxi Hubei AC 1,000 5 Aug-06 Aug-08 640 Thermal Xiangjiaba – Shanghai Sichuan Shanghai DC 800 6 Dec-07 Jul-10 1,907 Hydro Yunnan – Guangdong Yunnan Guangdong DC 800 5 Dec- 08 Dec-09 1,438 Hydro Jinping – Sunan Guizhou Jiangsu DC 800 7 Nov-08 Dec-12 2,059 Hydro Huainan - Zhebei - Shanghai Anhui Shanghai AC 1000 7 Oct-11 Sep-13 2*649 Thermal Nuozhadu - Guangdong Yunnan Guangdong DC 800 8 Oct-11 Sep-13 1,413 Hydro Haminan- Zhenzhou Xinjiang Henan DC 800 8 May-12 Jan-14 2,192 Thermal, wind Xiluodu – Zhejiangxi Sichuan Zhejiang DC 800 8 Jul-13 Jul-14 1,680 Hydro Zhebei – Fuzhou Fujian Zhejiang AC 1000 7 Apr-13 Dec-14 2*603 Hydro, nuclear Source: SGCC, Daiwa

Only 20% of the Even if the UHV transmission line is designed for transmitting wind power, usually only 10- transmission capacity 20% of the total transmission capacity can be allocated to it, for 2 reasons: can be allocated to wind power 1) The Intermittent nature of renewable energy, especially wind power, requires a certain proportion of conventional power generation to ensure stable electricity transmission. Take the case of the Hami-Zhengzhou UHV transmission line, the line has transmitted around 40% of electricity sourced from renewable energy such as wind and solar since it started operations, but our market research shows that the operation has not been very successful. Having operated for 2 years since January 2014, the line was under repair and maintenance half of the time in 2015, given the damage caused by huge load fluctuations. 2) Competition from coal-fired power: Most of the western provinces don’t just suffer from overwhelming wind power supply, but also from the large-scale commissioning of coal-fired power plants. Take the Ximeng-Shandong UHV transmission line as an example, this line is designed to transmit less than 10% in wind power, with the rest of its capacity reserved for the coal-fired power plants, as Ximeng is one of the planned thermal power plant bases in China, and is scheduled to commission 8.6GW of thermal power plant over the next few years.

China Wind Sector: 21 January 2016

The NEA has estimated Overall, considering that wind power could account for only 10-20% of the UHV that the enhanced grid transmission capacity, and UHV capacity is designed on the basis of thermal utilisation could only absorb an hours (wind utilisation hours is usually half of that for thermal power), around c.30% of the additional 15-20GW of designed capacity could be allocated to wind power. We estimate that the 9 UHV clean energy at most transmission lines still being built, coupled with the 2 additional lines that have obtained NDRC approval, could absorb ~15GW of extra renewable energy capacity in the grid- curtailed provinces, beginning 2H16E at the earliest. This 15GW, by 2017, of extra capacity, in our view, could also be split between wind power and solar energy. Even taking into account other short-distance transmission lines (other than UHV lines), the enhanced grid infrastructure could only absorb an additional 15-20GW of clean energy at most, according to the NEA.

China: additional capacity for clean energy provided by UHV transmission lines Name DC/AC From To Voltage (kV) Length Capacity (GW) Capacity for clean energy (GW) Construction date Commencement date Ningdong - Zhejiang DC Ningxia Zhejiang 800 1,720 8.0 2.4 Nov-14 4Q16 Huainan - Nanjing - Shanghai AC Anhui Shanghai 1000 2*780 7.0 - Nov-14 end-2016 Ximeng - Shandong AC Inner Mongolia Shandong 1000 2*730 9.0 2.7 Nov-14 3Q16 Mengxi - Tianjinnan AC Inner Mongolia Tianjin 1000 2*608 5.0 1.5 Mar-15 4Q16 Yuheng – Weifang AC Shaanxi Shandong 1000 2*1049 8.0 - May-15 1Q17 Jiuquan – Xiangtan DC Gansu Hunan 800 2,383 8.0 2.4 Jun-15 1Q17 Jinbei – Nanjing DC Shanxi Jiangsu 800 1,119 8.0 - Jun-15 2017 Ximeng – Jiangsu DC Inner Mongolia Jiangsu 800 1,620 10.0 3.0 Dec-15 2017 Shanghaimiao - Shandong DC Inner Mongolia Shandong 800 1,300 8.0 2.4 Dec-15 2017 Dianxibei - Guangdong DC Yunnan Guangdong 800 2,000 5.0 - 2016(E) 2018E Zhundong - Easter China DC Xinjiang Anhui 1100 3,324 12.0 3.6 2016(E) 2017/19E Total 76.0 14.4

Source: SGCC, Daiwa forecasts

Commissioning of UHV lines would boost capacity installations Another factor that might limit any reduction in wind curtailment would be an accelerated pace of wind installations along the UHV transmission lines. Given that building a UHV transmission line could take 2 years to design and approve, and then another 2 years to build, many wind farm operators have in the past decided to seize the opportunity and rush to obtain development rights in the regions planning to build UHV transmission lines.

For instance, new wind capacity in Xinjiang increased from 990MW, or 8% of new installations in 2012, to 3,146MW in 2013 or 20% of new installations, following the commissioning of the Hami- Zhengzhou UHV line in January 2014. The rush by the wind operators to get approval to build new wind farm projects next to new UHV lines in Xinjiang, as a result, led to Xinjiang’s wind curtailment rate increasing to 15% in 2014, from 5% in 2013, due to overcapacity in the region, while the national average actually dropped by 2.7pp over the same period.

China Wind Sector: 21 January 2016

Capacity additions: more about the quality than quantity With the declining wind tariff outlook that we see for the next few years, as well as the wind curtailment issues remaining unresolved, wind project deployment in China is set to moderate over 2016-17E. Peaking at 25GW in 2015E, we estimate China’s newly connected wind capacity to drop to 21GW in 2016E, and recover slightly to 23GW in 2017E.

China: newly connected capacity growth (GW) 30 40% 25 25 24 25 23 30% 21 22 20 20 17 20% 15 14 14 15 10%

10 0%

5 -10%

0 -20% 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E Newly connected capacity YoY growth - RHS

Source: NEA, Daiwa forecasts

China: newly installed capacity vs. annual connection rate China: cumulative installed capacity vs. % grid-connected (MW) (MW) 25,000 140% 140,000 120% 120% 120,000 20,000 100% 100% 100,000 80% 15,000 80% 80,000 60% 10,000 60% 60,000 40% 40% 40,000 5,000 20% 20,000 20% 0 0% 0 0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Newly installed capacity Newly connected capacity Total installed capacity Total connected capacity Annual connection rate Total connection rate

Source: CWEA, NEA, Daiwa Source: CWEA, NEA, Daiwa

We expect a 16% YoY 2016E: The 16% YoY decline in newly connected wind capacity that we forecast is based decline in wind capacity on the impact of a wind on-grid tariff cut this year, effective in January 2016. The threat of additions in 2016E this wind tariff cut, in our view, led to many wind farms being completed earlier than expected, in 2015, boosting China’s wind farm installations in 2015 to a record high of 25GW. The size of the average China wind turbine tender was also showing the same trend, with wind turbine tenders surging sharply during 4Q14, and returning to normal after, suggesting robust wind farm commissioning in 4Q15 (around a 1-year construction period for wind-farm projects), but that the commissioning of the wind farms is likely to stay muted going into 2016E. Consequently, we expect a temporary slowdown in wind-farm completions shortly after the tariff cut in 2016.

China Wind Sector: 21 January 2016

China: wind-turbine quarterly tendering volume (GW) 12 Front-loaded order flow after the proposed tariff cut plan was released in Sep 2014 10

0 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15

Source: Goldwind, Daiwa

We are still long-term 2017E and after: Given our expectation of limited cost reductions for the wind farm positive on China’s wind projects despite the relatively aggressive tariff cuts proposed by the NDRC, we look for power development some marginally profitable pipeline projects to be rendered unfeasible (IRR would become too low, and the operators would stop building). This, coupled with the NDRC’s explicit initiatives to discourage new wind farms being built in Zones I and II (as evidenced by the sharper wind tariff cuts there than in Zones III and IV), leads us to believe that wind farm development in China will be more rational in the future, which also means it is unlikely that China’s wind installations will be restored to or exceed the 2015 peak anytime soon.

Having said that, we are still long-term positive on China’s wind-power development. As we expect more disciplined wind project deployment over the next few years, we look for long- term sustainable capacity growth in China’s wind power sector.

In terms of the 13th FYP capacity target for wind power, we see a high chance that the 12th FYP capacity target for 2020 of 200GW will be surpassed in 2019E. As a result, it is very likely that the NDRC will revise up the 2020 wind capacity target in the 13th FYP, and according to our forecast, by 20% to 240GW (actual target likely to be issued in 1H16).

China: grid-connected wind capacity vs. 2020 capacity targets (GW) 300

250

200

150

100

0 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E Grid-connected capacity 2020 capacity target under the 12th FYP Revised 2020 capacity target (Daiwa) Source: NEA, Daiwa forecasts

China Wind Sector: 21 January 2016

Repair and maintenance costs The market expects China’s wind farm operators to see their repair and maintenance (R&M) costs rise over 2016-17E, given that a higher proportion of their installed wind capacity is now out of the warranty period. Having said that, we do not expect the R&M cost increase to be an issue for the operators moving forward, as: 1) we anticipate a moderating increase in R&M costs only, as the pullback in wind capacity additions in 2011- 13 should result in a slowdown in WTG warranties expiring over 2015-17, and 2) the R&M cost usually accounts for only 3-5% of the overall operating cost of a wind-farm operator, which is unlikely to have a huge impact on their profitability.

Out-of-warranty wind capacity to moderate WTGs in China are sold In China, wind turbine generators (WTG) are usually sold with a 3-5-year warranty, during with 3-5-year warranties which the WTG manufacturers will bear the R&M costs for their WTGs sold. Therefore, companies operating with newer WTGs are likely to enjoy an initially lower R&M cost, but these should rise once the warranty expires.

Given that China only started large-scale wind power deployment in 2010, most wind farm developers experienced exceptionally low R&M costs for the period up to end-2014, since when their R&M costs began rocketing.

Going into 2016-17E, however, we expect the number of WTG warranty expirations to stabilise as a result of a slowdown in wind-power installations in 2012-13 (from 16GW in 2011 to ~14GW in 2012-13), given the deteriorating wind curtailment situation and serious WTG technical issues. Considering this, we expect a moderating increase in the number of WTG warranties expiring in China in 2016-17E, reaching respective 49% & 53% of China’s total wind capacity being out of warranty, compared with ~46% in 2015E.

China: wind capacity where the WTG is out of warranty (GW) 180 60% 160 53% 49% 50% 140 46% 120 41% 40% 100 32% 30% 80 24% 60 19% 20% 40 13% 11% 10% 20 0 0% 2009 2010 2011 2012 2013 2014 2015E 2016E 2017E Total grid-connected wind capacity Wind capacity out-of-warranty Out-of-warranty % - RHS

Source: NEA, Daiwa forecasts

R&M cost accounts for only 3-5% of wind-farm operating costs We expect only a limited impact on the wind-farm operators’ profitability as a result of rising R&M costs, based on our analysis that R&M costs account usually for only 3-5% of a wind farm’s operating costs.

Given the capital-intensive nature of the wind farm operating business, depreciation and finance costs usually account for a significant proportion of a wind farm’s operating costs, which we estimate to be 64% and 21%, respectively. On the other hand, repair and maintenance usually cost only around CNY0.8-1.6cents per kWh, or 3-5% of total operating costs.

We have cross-checked our estimates with the financials of the 3 major Hong Kong-listed wind farm operators, namely Longyuan, Huaneng Renewables, and Datang Renewable, which also have similar cost structures, ie, R&M costs account for only 3-5% of their total operating costs (see the following charts).

China Wind Sector: 21 January 2016

China Wind Sector: R&M cost as a % of total operating costs China Wind Sector: operating cost breakdown 4.0% Repair and Others, 4% maintenance, 3.5% 3% 3.0% Labour cost, 3% Material cost, 2.5% 5% 2.0% 1.5% Finance cost, 21% Depreciation, 1.0% 64% 0.5% 0.0% 2012 2013 2014 Longyuan Datang RE Huaneng RE

Source: Company, Daiwa Source: Companies, Daiwa estimates Note: Averages for the 3 wind operators listed in Hong Kong

R&M costs can be split What’s more, according to the WTG manufacturers, the repair and maintenance (R&M) into 2 parts: WTG R&M cost of a WTG only constitutes around 50% of a wind-farm’s total R&M cost, with the cost and wind farm R&M remainder being wind-farm operating costs, which are always borne by the wind-farm cost operators themselves. After the WTG warranty expires, the wind-farm operators need to bear a WTG R&M cost of CNY30/kW per year (higher than CNY20/kW per year if the maintenance is done by the manufacturers for WTGs under warranty, and this is on top of a CNY30/kW cost for wind-farm R&M). As such, we estimate that only ~1.5% of a wind- farm’s operating costs would rise when the WTG warranty expires.

China Wind Sector: operating cost breakdown (current)

R&M cost - WTG 1.5% R&M cost - wind farm 1.5% Others 4%

Labour cost 3%

Material cost 5%

Finance cost 21% Depreciation 64%

Source: Companies, Daiwa estimates

China Wind Sector: 21 January 2016

IRR sensitivity analysis The wind curtailment We have calculated the IRRs for China’s wind-farm projects by assuming a change in the rate is one of the most curtailment rate. Assuming an average wind utilisation of 2,000 hours a year, as well as an sensitive factors for average wind on-grid tariff of CNY0.56/kWh, we estimate that the equity IRR of a wind wind farm IRRs project would be ~15.7%. Based on this, each CNY0.025 drop in the on-grid tariff would lead to a wind project IRR shrinking by ~1.6pp, assuming utilisation is unchanged.

On the other hand, if we assume the same tariff assumption, we estimate that a 200-hour pa decline in utilisation hours (or ~10% drop) would lead to the wind project equity IRR falling by 3.4pp (see the following IRR sensitivity table).

China Wind Sector: equity IRR sensitivity Utilisation rate (hours) 2,600 2,400 2,200 2,000 1,800 1,600 1,400 0.61 31.50% 27.10% 22.90% 18.90% 15.10% 11.50% 8.10% 0.585 29.00% 24.90% 21.00% 17.30% 13.70% 10.40% 7.10%

0.56 26.60% 22.80% 19.20% 15.70% 12.30% 9.20% 6.10% 0.535 24.30% 20.70% 17.30% 14.10% 11.00% 8.00% 5.20%

0.51 22.00% 18.70% 15.60% 12.60% 9.70% 6.90% 4.20%

grid(CNYtariff - per kWh) per 0.485 19.80% 16.70% 13.80% 11.00% 8.40% 5.80% 3.20% 0.46 17.60% 14.80% 12.20% 9.60% 7.10% 4.60% 2.30%

Wind on Wind 0.435 15.50% 13.00% 10.50% 8.10% 5.80% 3.50% 1.30%

Source: NDRC, Daiwa estimates

China Wind Sector: IRR sensitivity for 2015 wind tariffs China Wind Sector: IRR sensitivity for 2016 wind tariffs Utilisation rate (hours) Utilisation rate (hours) 2,600 2,500 2,400 2,300 2,200 2,100 2,000 1,900 1,800 2,600 2,500 2,400 2,300 2,200 2,100 2,000 1,900 1,800 Zone I 23% 21% 19% 18% 16% 14% 13% 11% 10% Zone I 21% 19% 18% 16% 15% 13% 12% 10% 9% Zone II 25% 23% 22% 20% 18% 16% 15% 13% 12% Zone II 23% 22% 20% 18% 17% 15% 14% 12% 11% Zone III 29% 27% 25% 23% 21% 19% 17% 16% 14% Zone III 27% 25% 23% 21% 20% 18% 16% 14% 13% Zone IV 34% 32% 29% 27% 25% 23% 21% 19% 17% Zone IV 33% 31% 28% 26% 24% 22% 20% 18% 16% Offshore 15% 12% 10% 8% 5% 3% 1% -1% 0% Offshore 15% 12% 10% 8% 5% 3% 1% -1% 0%

Source: Daiwa estimates Source: Daiwa estimates Note: Gold highlights: without curtailment; blue highlights with curtailment(base case) Note: Gold highlights: without curtailment; blue highlights with curtailment(base case)

China Wind Sector: IRR sensitivity for 2018 wind tariffs China Wind Sector: IRR sensitivity for 2020 wind tariffs Utilisation rate (hours) Utilisation rate (hours) 2,600 2,500 2,400 2,300 2,200 2,100 2,000 1,900 1,800 2,600 2,500 2,400 2,300 2,200 2,100 2,000 1,900 1,800 Zone I 18% 17% 15% 14% 13% 11% 10% 9% 7% Zone I 16% 14% 13% 12% 11% 9% 8% 7% 6% Zone II 21% 19% 18% 16% 15% 13% 12% 10% 9% Zone II 18% 17% 15% 14% 13% 11% 10% 9% 7% Zone III 24% 23% 21% 19% 17% 16% 14% 13% 11% Zone III 22% 20% 18% 17% 15% 14% 12% 11% 9% Zone IV 31% 29% 27% 25% 23% 21% 19% 17% 15% Zone IV 29% 27% 25% 23% 21% 19% 17% 16% 14% Offshore 13% 11% 8% 6% 4% 2% 0% -2% 0% Offshore 13% 11% 8% 6% 4% 2% 0% -2% 0%

Source: Daiwa estimates Source: NDRC, Daiwa estimates Note: Gold highlights: without curtailment; blue highlights with curtailment (base case) Note: Gold highlights: without curtailment; blue highlights with curtailment (base case)

As a consequence, we estimate that China’s average wind-farm equity IRR would fall from ~16% currently, to only ~13% in 2018E, marginally meeting the 12% equity IRR threshold set by most of the wind-farm developers.

This leads us to our conclusion that more of China's wind-farm projects will become unprofitable by 2020E, assuming no change in wind-farm construction costs (refer to the previous section on our wind-farm construction cost outlook). Of course, we should emphasise that the above estimated equity IRRs are only an average, and there are still be some provinces (the majority located in the Southeast China) where wind-farm projects are very profitable (see our equity IRR forecasts by province in the following below).

China Wind Sector: 21 January 2016

China Wind Sector: equity IRR forecasts by province Province Zone Curtailment 2014 utilisation Initial 2015E 2016E 2018E 2020E Beijing Zone IV 4% 2,114 21% 21% 20% 19% 18% Tianjin Zone IV 5% 2,298 25% 25% 24% 23% 21% Hebei Zone II & IV 14% 1,927 16% 15% 15% 13% 12% Shanxi Zone IV 4% 2,084 21% 21% 20% 19% 17% Shandong Zone IV 1% 1,951 19% 19% 19% 17% 16% Inner Mongolia Zone I & II 17% 1,914 15% 14% 13% 11% 9% Liaoning Zone IV 17% 1,801 13% 13% 13% 12% 11% Jilin Zone III & IV 43% 1,548 4% 3% 3% 2% 1% Heilongjiang Zone III & IV 23% 1,873 13% 12% 11% 10% 8% Shanghai Zone IV 0% 2,200 25% 25% 24% 23% 21% Jiangsu Zone IV 0% 2,005 21% 21% 20% 19% 17% Zhejiang Zone IV 0% 2,062 22% 22% 21% 20% 18% Anhui Zone IV 0% 1,772 16% 16% 16% 14% 13% Fujian Zone IV 0% 2,761 38% 38% 37% 35% 32% Jiangxi Zone IV 0% 2,205 25% 25% 24% 23% 21% Henan Zone IV 0% 2,118 23% 23% 22% 21% 20% Hubei Zone IV 1% 1,944 19% 19% 19% 17% 16% Hunan Zone IV 0% 1,867 18% 18% 17% 16% 15% Chongqing Zone IV 0% 2,001 21% 21% 20% 19% 17% Sichuan Zone IV 0% 2,276 27% 27% 26% 24% 23% Shaanxi Zone IV 0% 1,957 20% 20% 20% 18% 17% Gansu Zone II & III 31% 1,718 9% 8% 7% 6% 5% Qinghai Zone IV 0% 1,650 14% 14% 13% 12% 11% Ningxia Zone III 3% 1,968 17% 16% 15% 13% 11% Xinjiang Zone I & III 29% 2,361 11% 10% 9% 7% 6% Guangdong Zone IV 0% 1,750 16% 16% 15% 14% 13% Guangxi Zone IV 0% 1,819 17% 17% 17% 15% 14% Hainan Zone IV 0% 1,966 21% 21% 20% 19% 18% Guizhou Zone IV 1% 1,984 20% 20% 19% 18% 17% Yunnan Zone IV 1% 2,474 32% 32% 31% 29% 27%

Source: Daiwa Note: Assuming utilisation unchanged for full-year 2014

China Wind Sector: 21 January 2016

Valuation and risks Fuxin looks the most attractive vs. growth outlook We see Fuxin as being The 4 wind stocks that we cover are trading at low valuations, all below 1x 2016E PBR and overly punished by the at or below 9x 2016E PER, due to the ongoing market sell-off as well as the weak investor recent wind sector sell- sentiment towards the wind sector. Of our 4 stocks, Fuxin and Suntien have the most off undemanding valuations. Fuxin has the lowest one-year forward PER (4.5x 2016E PER, 2SD below its past-3.5-year-average 12-month forward PER of 8.9x), whereas Suntien has the lowest one-year forward PBR (0.4x 2016E PBR, 1.8SD below its past-5-year-average 12-month forward PBR of 0.9x).

When comparing their PBRs to ROEs, Fuxin appears to be the most attractive, as it is trading currently at 0.6x 2016E PBR. We believe the market is overly punishing Fuxin, and the fact it is now trading at a trough valuation suggests a trading opportunity. Although Fuxin is still facing challenges, such as wind curtailment issues and difficulties with its coal- fired business, we believe it will be able to deliver an 17% EPS CAGR over 2015-17E, backed by earnings growth at subsidiary Fuqing Nuclear and its moderately growing wind- power business.

Although Suntien has the lowest 2016E PBR, of 0.4x, as well as a low 2016E PER of 9.0x, the stock is trading in line (in terms of both PER vs. EPS CAGR and PBR vs. ROE) with its wind IPP and downstream gas peers. But its risk-reward does not look that attractive due to challenges in its natural gas business given the currently weak gas demand and lack of business growth opportunities, despite an expected improvement in its wind business.

China Wind Sector: 2016E PER vs. 2015-17E EPS CAGR China Wind Sector: 2016E PBR vs 2016E ROE

70% 20% 18% 60% Datang RE 16% Fuxin Goldwind - H 50% 14% CGNNE 12% HNR 40% 10% Longyuan 30% 8% CHST Longyuan 2016E ROE

17E 17E EPSCAGR HNR - 6% 20% Fuxin Suntien 2015 CGNNE Suntien 4% 10% Datang RE CHST 2% Goldwind - H 0% 0% 0 2 4 6 8 10 12 14 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 2016E PBR 2016E PER Source: Bloomberg, Daiwa forecasts for covered companies Source: Bloomberg, Daiwa forecasts for covered companies Note: Pricing as of 19 Jan 2016 Note: Pricing as of 19 Jan 2016

Fuxin: share price vs. 1-year-forward PER bands Fuxin: 1-year-forward PER bands (HKD) (x) 7 16 6 14 13.7x Avg+2SD 5 12 11.3x Avg+1SD 4 10 3 8.9x Avg 8 2 6.5x Avg-1SD 6 1 4.0x Avg-2SD 0 4

Jul-12 Jul-13 Jul-14 Jul-15

Jan-14 Jan-13 Jan-15 Jan-16

Mar-13 Mar-14 Mar-15

Sep-13 Nov-15 Sep-12 Nov-12 Nov-13 Sep-14 Nov-14 Sep-15

May-14 May-15 May-13 0

Price 5x PER 7x PER

Jul-12 Jul-13 Jul-14 Jul-15

Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15

Jan-14 Jan-15 Jan-16 9x PER 11x PER 13x PER Jan-13 Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

China Wind Sector: 21 January 2016

Fuxin: share price vs. 1-year-forward PBR bands Fuxin: 1-year-forward PBR bands (HKD) (x) 6 2.5 5 2.0 1.9x Avg+2SD 4 1.6x Avg+1SD 3 1.5 2 1.2x Avg 1.0 1 0.9x Avg-1SD

0 0.5 0.6x Avg-2SD

Jul-15 Jul-12 Jul-13 Jul-14

Jan-14 Jan-15 Jan-16

Jan-13 0.0

Mar-13 Mar-14 Mar-15

Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 Sep-15 Nov-15

May-13 May-14 May-15

Price 0.6x PBR 0.9x PBR

Jul-12 Jul-13 Jul-14 Jul-15

Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15

Jan-13 Jan-14 Jan-15 Jan-16 1.2x PBR 1.5x PBR 1.8x PBR Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

Longyuan: share price vs. 1-year-forward PER bands Longyuan: 1-year-forward PER bands (HKD) (x) 26 24x Avg+2SD 11 24 22 20.5x Avg+1SD 8 20 18 17.8x Avg 5 16 14 14.4x Avg-1SD 12 2 11.0x Avg-2SD

Jul-12 Jul-13 Jul-14 Jul-15

Jul-11 8

Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Price 10x PER 14x PER

Jan-11 Jan-16 Jan-12 Jan-13 Jan-14 Jan-15

Sep-12 Sep-11 Sep-13 Sep-14 Sep-15

May-12 May-13 May-14 May-15 18x PER 22x PER 26x PER May-11 Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

Longyuan: share price vs. 1-year-forward PBR bands Longyuan: 1-year-forward PBR bands (HKD) (x) 12 2.3 2.1 10 2.0x Avg+2SD 1.9 8 1.7 1.7x Avg+1SD 1.5 6 1.5x Avg 1.3 1.2x Avg-1SD 4 1.1 0.9 1.0x Avg-2SD 2

0.7

Jul-12 Jul-13 Jul-14 Jul-15

Jul-11 0.5

Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Price 1x PBR 1.2x PBR

Jan-16 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

Sep-11 Sep-12 Sep-13 Sep-14 Sep-15

May-12 May-13 May-14 May-15 1.5x PBR 1.8x PBR 2x PBR May-11 Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

CGNNE: share price vs. 1-year-forward PER bands CGNNE: 1-year-forward PER bands (HKD) (x) 3.5 17 16.7x Avg+2SD

3.0 15 14.0x Avg+1SD 2.5 13 2.0 11.3x Avg 11 1.5

1.0 9 8.7x Avg-1SD

Jul-15 6.0x Avg-2SD

Oct-14 Apr-15 Oct-15

Jan-15 Jun-15 Jan-16

Feb-15 Mar-15

Nov-14 Dec-14 Aug-15 Sep-15 Nov-15 Dec-15 May-15 Price 6x PER 8x PER 5 10x PER 12x PER 14x PER Oct-14 Feb-15 Jun-15 Oct-15 Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

China Wind Sector: 21 January 2016

CGNNE: share price vs. 1-year-forward PBR bands CGNNE: 1-year-forward PBR bands (HKD) (x) 4.0 2.3 2.2x Avg+2SD 3.5 2.1 3.0 1.9 1.9x Avg+1SD 2.5 1.7 2.0 1.5 1.5x Avg 1.5 1.3 1.2x Avg-1SD 1.0 1.1 0.9

0.8x Avg-2SD

Jul-15

Oct-14 Apr-15 Oct-15

Jan-15 Jun-15 Jan-16

Mar-15

Feb-15

Nov-14 Dec-14 Aug-15 Sep-15 Nov-15 Dec-15

May-15 0.7 Price 1.2x PBR 1.4x PBR 0.5 1.6x PBR 1.9x PBR 2.2x PBR Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

Suntien: share price vs. 1-year-forward PER bands Suntien: 1-year-forward PER bands (HKD) (x) 5 30 28.5x Avg+2SD 4 25 21.9x Avg+1SD 3 20

2 15 15.3 Avg

1 10 8.7x Avg-1SD 0 5

2.1x Avg-2SD

Jul-14 Jul-11 Jul-12 Jul-13 Jul-15

Oct-11 Oct-15 Oct-10 Apr-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15

Jan-13 Jan-12 Jan-14 Jan-15 Jan-11 0

Price 3x PER 9x PER

Jul-12

Oct-10 Apr-14

Jun-15

Feb-13

Nov-14 Dec-11 Sep-13 15x PER 24x PER 33x PER May-11 Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

Suntien: share price vs. 1-year-forward PBR bands Suntien: 1-year-forward PBR bands (HKD) (x) 4 1.5 1.4x Avg+2SD 1.3 3 1.1 1.1x Avg+1SD 2 0.9 0.9x Avg 1 0.7 0.6x Avg-1SD 0 0.5 0.4x Avg-2SD

0.3

Jul-11 Jul-12 Jul-13 Jul-14 Jul-15

Oct-14 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Apr-15 Oct-15

Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

Price 0.4x PBR 0.7x PBR

Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Oct-10 1x PBR 1.3x PBR 1.6x PBR Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts

China Wind Sector: 21 January 2016

China Wind Sector: Valuation comparison (1) Target Market Daily trade EPS CAGR Company name Bloomberg Rating Share price price Upside cap vol (3M) Free float PER (x) PBR (x) ROE (%) (%) code (local curr.) (local curr.) (%) (USDm) (USDm) (%) 2015E 2016E 2017E 2015E 2016E 2017E 2015E 2016E 2017E 2015-17E Wind IPPs Huadian Fuxin Energy 816 HK Outperform 1.63 1.75 7% 1,636 5.6 37% 5.5 4.5 4.0 0.7 0.6 0.5 13% 14% 14% 16.7% China Longyuan Power 916 HK Outperform 4.66 5.30 14% 4,629 16.3 42% 10.8 8.4 7.0 0.9 0.8 0.7 9% 10% 11% 23.7% China Suntien Green Energy 956 HK Hold 1.07 1.10 3% 480 0.7 50% 9.8 9.0 7.5 0.4 0.4 0.4 5% 5% 6% 13.7% CGN New Energy Holdings 1811 HK Hold 1.40 1.45 4% 687 1.4 28% 7.6 6.5 5.5 1.0 0.9 0.8 13% 14% 15% 18.3% JNCEC-H 579 HK NR 2.28 n.a. n.a. 1,891 2.3 87% 6.6 5.9 5.0 0.9 0.8 0.7 15% 15% 16% 14.1% HUANENG RENEWA-H 958 HK NR 1.72 n.a. n.a. 1,980 9.0 82% 8.0 6.4 5.3 0.8 0.7 0.6 10% 11% 12% 22.8% CHINA DATANG C-H 1798 HK NR 0.79 n.a. n.a. 717 0.3 86% 20.8 12.1 8.1 0.4 0.4 0.4 2% 4% 5% 60.1% Simple average 1,717 9.9 7.6 6.1 0.7 0.7 0.6 10% 11% 11% 24.2% Weighted average 9.3 7.3 6.0 0.8 0.7 0.7 10% 11% 12% 22.5% Wind equipment CHINA HIGH-SPEED 658 HK NR 5.80 n.a. n.a. 1,199 6.0 58% 8.2 7.6 7.9 0.8 0.8 0.7 10% 10% 9% 2.2% XINJIANG GOLD-H 2208 HK NR 11.80 n.a. n.a. 6,859 13.8 89% 8.9 8.7 8.2 1.6 1.5 1.4 18% 17% 17% 4.2% Simple average 4,029 8.6 8.2 8.0 1.2 1.1 1.0 14% 13% 13% 3.2% Weighted average 8.8 8.5 8.1 1.5 1.4 1.3 17% 16% 16% 3.9% Source: Bloomberg, Daiwa forecasts for covered companies Note: Prices as at 19 Jan 2016

China Wind Sector: Valuation comparison (2) Company name Bloomberg Rating Div yield (%) EV/EBITDA (x) Net debt-to-equity (%) EBITDA margin (%) Net margin (%) code 2015E 2016E 2017E 2015E 2016E 2017E 2015E 2016E 2017E 2015E 2016E 2017E 2015E 2016E 2017E Wind IPPs Huadian Fuxin Energy 816 HK Outperform 3.5% 4.3% 4.8% 7.1 6.9 6.8 292% 295% 289% 63% 67% 69% 15% 16% 17% China Longyuan Power 916 HK Outperform 2.2% 2.4% 2.8% 8.5 7.8 7.3 206% 207% 198% 66% 68% 70% 15% 17% 19% China Suntien Green Energy 956 HK Hold 2.5% 3.8% 4.6% 8.8 8.9 8.8 148% 181% 211% 39% 46% 49% 8% 9% 9% CGN New Energy Holdings 1811 HK Hold 2.0% 2.3% 2.7% 12.4 13.3 9.3 361% 521% 431% 25% 30% 36% 9% 9% 9% JNCEC-H 579 HK NR 3.6% 4.0% 4.7% 7.9 6.9 6.0 193% 155% 122% 32% 34% 34% 14% 14% 15% HUANENG RENEWA-H 958 HK NR 2.1% 2.7% 3.4% 8.3 6.7 5.7 294% 309% 319% 89% 89% 89% 22% 23% 23% CHINA DATANG C-H 1798 HK NR 0.5% 0.8% 1.1% 10.1 8.8 7.7 399% 415% 423% 83% 83% 84% 4% 6% 8% Simple average 2.3% 2.9% 3.4% 9.0 8.5 7.4 270% 297% 285% 57% 60% 62% 12% 13% 14% Weighted average 2.5% 2.9% 3.4% 8.5 7.8 7.0 248% 257% 245% 62% 64% 65% 15% 16% 17% Wind equipment CHINA HIGH-SPEED 658 HK NR 2.0% 2.5% 2.0% 6.1 6.1 6.0 62% 47% 34% 24% 23% 23% 10% 10% 10% XINJIANG GOLD-H 2208 HK NR 5.7% 5.9% 6.3% 14.0 12.5 10.6 38% 48% 54% 17% 18% 19% 12% 12% 12% Simple average 3.9% 4.2% 4.1% 10.0 9.3 8.3 50% 48% 44% 21% 21% 21% 11% 11% 11% Weighted average 5.2% 5.4% 5.6% 12.8 11.5 9.9 42% 48% 51% 18% 19% 20% 12% 11% 11% Source: Bloomberg, Daiwa forecasts for covered companies Note: Prices as at 19 Jan 2016

China Wind Sector: 21 January 2016

Main risk: local utilisation protection measures The major risk to our call China failed to deliver on expectations that it would implement a Renewable Energy for the sector would be if Portfolio Standard (RPS) in 2014, a measure that was expected to be the strongest policy a utilization protection measure to force grid companies to respect the Renewable Energy Law. scheme were introduced soon In the draft version of the RPS, the NEA divided 31 provinces into 4 tiers in order to implement a quota system. The policy set targets for local grids and governments for the generation, dispatch and consumption of a certain percentage of power generated by renewable energy sources, particularly wind and solar.

Possible new proposal for a protection scheme for renewable energy In December 2015, local media reported that the National Energy Bureau had drafted a protection purchase scheme for renewable energy, similar to the RPS, to guarantee the purchase of renewable energies (ie, guaranteeing utilisation hours. The draft document revealed by the local media said that renewable energy electricity generated would be classified as either protected volume or competitive volume. The protected volume would be given priority in the country’s annual power generation planning, with an offtake contract to ensure it is all purchased, while the competitive volume would mostly compete with coal- fired power (CNY0.25-0.30/kWh for Inner Mongolia, Gansu and Xinjiang vs. wind power on-grid tariff of CNY0.47-0.50/kWh) but would receive preferential dispatch rights. If the protected volume were not fully purchased, the gap would be filled with other fuel types.

The proposal aims to eradicate the curtailment issues, but given that the current curtailment rate is 30% for the provinces that account for the most wind power (ie, the 3 in the northwest; see the table below), we don’t think full implementation is possible in 2016. However, we do think the curtailment rate could fall to 15%, with the grid getting 15-20% of power from wind farms, assuming no contributions from new solar and wind capacity additions in the affected regions, and all renewable utilisation protection is focused on wind power only. If this were to happen, this could lead to the wind operators’ profitability improving.

We expect the protection scheme to be fully implemented in 2017 following a trial run sometime in 2H16.

China wind: percentage of wind power to total power generation Total power 2015 Target Improved wind Installed capacity 2016E Wind % of total in 2015 Wind generation generation % of total curtailment curtailment output (2015E) power generation 2016 (bn kWh) (bn kWh) (m kWh) (GW) Inner Mongolia 38.80 365.40 10.6% 30 15 5.82 23.82 52.65 14.3% Liaoning 10.64 162.31 6.6% 25 15 1.06 6.57 12.64 7.7% Jilin 5.47 76.15 7.2% 50 15 1.92 4.32 7.83 10.2% Heilongjiang 7.34 88.28 8.3% 30 15 1.10 5.23 9.72 10.9% Hebei 16.80 251.77 6.7% 25 15 1.68 9.17 18.56 7.3% Gansu 12.63 114.12 11.1% 40 15 3.16 12.02 18.84 16.3% Xinjiang 14.55 191.13 7.6% 40 15 3.64 16.91 38.24 19.8%

Source: NEA, Daiwa forecasts Note: Highlighted provinces are located in Northwest with severe curtailment issues Note: assume no contribution from solar and wind capacities addition in 2016E Note: Assuming 1% YoY total power generation growth in 2014-16E Note: assume all renewable protection is focused on wind power

China Wind Sector: 21 January 2016

Appendix I: UHV transmission network

UHV lines: on the fast track The UHV development To reduce the geographical mismatch between electricity demand and supply, China set a plan has been goal of having a UHV system (for a description of what UHV lines are, see page 48). But, postponed given due to continuing debates on the safety of the transmission lines, especially the ongoing debate over vulnerability of such a broad network to system-wide curtailment issues, the development UHV safety plan had been postponed for many years. The China government finally decided to accelerate UHV construction in 1H14, as pollution has been getting worse and a significant number of energy power sources (hydro, wind, solar and coal-fired) are rapidly popping up in the western regions.

To implement the country’s Action Plan for Air Pollution Prevention and Control released in mid-2014, 12 transmission lines are planned, including 4 AC and 5 DC UHV projects, to connect the energy-rich inland with the heavily industrialised coastal areas. These 9 UHV lines (of which 8 are under construction) have been designed to relocate power plants from populated areas near Beijing, Shanghai and Guangzhou to remote inland areas, while utilising the rich renewable energy in those areas.

9 UHV lines under the air-pollution prevention plan Construction Commission Supply Demand DC/AC date date Status Ningdong – Zhejiang Ningxia Zhejiang DC Nov-14 4Q16 Under Construction Huainan - Nanjing – Shanghai Anhui Shanghai AC Nov-14 2016YE Under Construction Ximeng – Shandong Inner Mongolia Shandong AC Nov-14 3Q16 Under Construction Mengxi – Tianjinnan Inner Mongolia Tianjin AC Mar-15 2016E Under Construction Yuheng – Weifang Shaanxi Shandong AC May-15 2017E Under Construction Jinbei – Nanjing Shanxi Jiangsu DC Jun-15 2017E Under Construction Shanghaimiao – Shandong Inner Mongolia Shandong DC Dec-15 2017E Under Construction Ximeng – Jiangsu Inner Mongolia Jiangsu DC Dec-15 2017E Under Construction Dianxibei – Guangdong (CSG) Yunnan Guangdong DC 2016E 2018E NDRC Approved Source: SGCC, Daiwa

As of 18 January 2016, construction of 8 of the 9 lines has started, and the Dianxibei- Guangdong line is the only one pending the start of construction under CSG. Construction of 3 of the UHV lines included in the air pollution prevention plan started in 2014, while construction on a further 3 started in 1H15. And construction of the Shanghaimiao- Shandong line and the Ximeng-Jiangsu line started in December 2015.

We think the government has made enhancing the grid network one of its key focus areas after air pollution prevention became a priority following a series of smog incidents. At a working meeting in 2015, SGCC announced a more ambitious plan, whereby it would start the construction of “six AC, eight DC”, meaning a total of 14 lines in 2015; construction of 6 lines began in 2015 (including the 5 shown in the table above).

China Wind Sector: 21 January 2016

UHV segment: planned UHV lines for 2015 1Q15 - two AC one DC Type Air pollution plan Planned Actual Mengxi-Tianjinnan AC Yes 1Q15 Mar-15 Yuheng-Weifang AC Yes 1Q15 May-15 Jiuquan-Xiangtan DC 1Q15 Jun-15 2Q 15 - three DC Ximeng-Jiangsu DC Yes 2Q15 Dec-15 Jinbei-Nanjing DC Yes 2Q15 Jun-15 Shanghaimiao-Shandong DC Yes 2Q15 Dec-15 2H15 - four AC four DC Mengxi-Changsha, Jinmen-Wuhan, Changsha-Nanchang AC 2H15 Zhangbei-Nanchang, Jindongnan-Yubei, Nanyang-Zhumadian AC 2H15 Nanjing-Xuzhou-Lianyungang-Taizhou AC 2H15 Jinan-Zaozhuang-Linyi-Weifang AC 2H15 Humeng-Qingzhou DC 2H15 Mengxi-Wuhan DC 2H15 Zhundong-Chengdu DC 2H15 Zhundong-Wannan DC 2H15 Source: SGCC, Daiwa

62% CAGR for UHV equipment demand during 2014-18 According to media reports, SGCC has a 3-phase target for UHV construction under the 13th FYP period: 1) accelerating the construction of “six AC eight DC” lines, which were planned for 2015, 2) the start of the construction of “ten AC two DC” lines before 2018, and 3) additional lines to strengthen the UHV network

UHV construction Considering that the average investment per DC line is CNY25bn, and CNY20bn for an AC should lead to line, the 16 AC and 10 DC lines in the 3-stage plan should involve a total investment of cumulative equipment CNY570bn. And considering that construction of some of the lines commenced in 2014 demand of about and are still under construction, the total investment in UHV lines over 2016-20 should be CNY200bn over CNY600bn. We estimate that this will lead to cumulative equipment demand of about CNY200bn, implying a 78% UHV equipment demand CAGR over 2014-18.

UHV segment: investment (CNYbn) (CNYbn) (#) 140 12

120 10 100 8 80 6 60 4 40 20 2 0 0 2010 2011 2012 2013 2014 2015 2016E 2017E Total investment # of lines under construction

Source: SGCC, Daiwa forecasts

UHV equipment demand (CNYbn) (CNYbn) 35 30 25 20 15 10 5 0 2010 2011 2012 2013 2014 2017E

Source: SGCC, Daiwa forecasts

China Wind Sector: 21 January 2016

Capex breakdown of DC UHV lines Capex breakdown of AC UHV lines

Converter Valve, 6% Converter transformer, GIS, 16% 11% C&P system, AC 1% Transformer, 7% Others, 75% DC field Reactor, 3% equipment, 7% Others, 75%

Source: NEA Source: NEA

Construction schedule for UHV lines AC/DC Capacity (GW) Investment (CNY bn) 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Jinping - Sunan DC 7 22 Nuozhadu - Guangdong DC 5 16.5 Huainan - Zhebei - Shanghai AC 7 18.5 Haminan- Zhenzhou DC 8 25.4 Xiluodu - Zhejiangxi DC 8 23.8 Zhebei - Fuzhou AC 7 18 Ningdong - Zhejiang DC 8 23.7 Huainan - Nanjing - Shanghai AC 7 26.8 Ximeng - Shandong AC 9 17.8 Mengxi - Tianjinnan AC 5 17.5 Yuheng - Weifang AC 8 24.2 Jiuquan - Xiangtan DC 8 26.2 Jinbei - Nanjing DC 8 16.2 Ximeng - Jiangsu DC 10 25.4 Shanghaimiao - Shandong DC 8 22.1 Dianxibei - Guangdong DC 5 22.2 Zhundong - Easter China DC 12 40.7 2 DC lines approved in 2016 DC 50 3 AC lines approved in 2016 AC 60 2 DC lines approved in 2017 DC 50 4 AC lines approved in 2017 AC 80 1 DC lines approved in 2018 DC 25 4 AC lines approved in 2018 AC 80 3 AC lines approved in 2019 AC 60 Total investment 5.4 8.4 37.5 48.0 21.8 56.8 101.6 123.9 139.1 131.1 82.5 # of lines under construction 1 3 5 5 6 7 10 10 6 5 3 Operating lines Under construction Obtain NDRC approval Assumption Source: SGCC, Daiwa forecasts

UHV-equipment supply structure favours existing players China’s UHV industry is China’s UHV market is a highly fragmented one, with a limited number of qualified highly fragmented, with domestic players with a stable market share. UHV equipment R&D is capital-intensive and only one purchaser, the the State Grid is the only purchaser. Equipment providers need to obtain an offer through State Grid private negotiations and public tenders, both with and via the State Grid, while the key equipment makers are the State Grid’s subsidiaries (XJ, Nari, Pinggao, etc). Considering the high entry barriers, we expect the current competitive landscape to remain as it is.

Moreover, we think the existing market shares of the foreign players might be acquired by domestic players in the near term. After years of the adoption, research and testing of demonstration projects, China’s UHV transmission technology is comparable with that of its global peers. And for strategic and national security reasons, the China government wants to build power transmission lines with the core technology provided by the domestic companies.

China Wind Sector: 21 January 2016

UHV sector: competitive landscape of the UHV equipment suppliers 100%

80%

60%

40%

20%

0% GIS AC Transformer Reactor Converter Valve Converter Transformer XD Pinggao NHVS TBEA TWBB XJ SF ABB C-EPRI SPECO

Source: Companies, SGCC, Daiwa

AC lines: players benefiting from the value chain DC lines: players benefiting from the value chain Market share in total AC UHV investment Market share in total DC UHV investment 8% 6% 7% 5% 6% 4% 5% 4% 3% 3% 2% 2% 1% 1% 0% 0% XD TBEA TWBB XJ C-EPRI XD Pinggao NHVS TBEA TWBB SPECO Source: SGCC, Daiwa Source: SGCC, Daiwa

AC equipment producers benefiting the most AC line development is Government approval of AC lines has been put on hold for many years, due to continuous still being debated due safety and economic debate on the following: 1) using AC lines to connect the regional to safety issues and the power networks will increase the risk of system failure, compared with DC lines, and 2) the higher costs of building unit construction cost of AC lines will exceed DC lines for longer transmission distances. them

China Wind Sector: 21 January 2016

UHV lines: construction cost comparison of AC vs. DC Total AC Cost (8) Total DC Cost (9) Cost

Approx. 450km

DC losses (7)

AC losses (6)

DC line cost (5) Shunt capacity cost (4)

AC line cost (3) DC Terminal cost (2)

AC Terminal cost (1)

SC Distance Source: HVDC Transmission – Power Conversion Applications in Power Systems, 2009, by CK Kim, VK Sood, GS Jang, SJ Lim, and SJ Lee Note: (1) Initial cost of AC power transmission line (2) The initial cost of DC power transmission lines, which is greater due to the higher valve costs used for DC transmission (3) Construction cost for AC transmission line (4) A shunt capacitor must be installed, typically every 100km or 200km, because of an AC line’s electrostatic capacity. In other words, the increase in the total cost for AC power transmission lines is accompanied by the additional cost of shunt capacitors. (5)Construction cost for a DC transmission line, which is lower than for an AC line (6) Power losses of an AC transmission line (7) Power losses of a DC transmission line

We think the accelerated Compared with DC lines, AC lines also offer the following benefits: 1) AC lines are more pace of AC-line flexible when it comes to transmission: DC lines can only carry electricity from a start point approvals since 2014 to an end point, while AC lines can output and input electricity along the line, 2) DC-line has benefited the AC electricity cannot be utilised directly by end users. It needs different voltages to be built into equipment producers power inverter stations to convert DC power to AC.

We think the acceleration in the pace of AC-line approvals since 2014 should primarily benefit the AC equipment producers over the DC players.

Approved AC/DC lines 7

0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E AC DC

Source: SGCC, Daiwa

China Wind Sector: 21 January 2016

So what are UHV lines? Ultra-high voltage (UHV) lines are transmission facilities that have a DC (direct current) voltage that is greater than ±800kv, and an AC (alternating current) voltage that is greater than 1,000kv.

Theoretical rule of thumb: Power transmission at higher voltages can enhance efficiency over longer transmission distances. Over certain distances, it is more economical to use UHVDC than UHVAC.

China: classification of power voltages Voltage level Kv range Low <1.5kv Medium 1.5-35kv High 110-330kv Ultra-high voltage AC/DC (UHVAC/DC) >1,000/>800 Source: Daiwa

Illustration of electrical power equation (simplified version for DC) Power P = I x V = R x I2 = V2/R, where power P is in Watts, voltage V is in volts, resistance R is ohms, and current I is in amperes (DC); as for AC, the power factor is more complicated.

UHV: line power loss comparison at certain distances UHV: construction cost comparison at certain distances

25% HVDC 500kV 600 UHVDC 800kV UHVDC 800kV 20% UHVDC 1,000kV Cost UHVDC 1000kV savings 500

15% yr

10%

Line Line loss (%) RMB/kW RMB/kW Lowest line loss if 400 5% Construction cost of UHVDC1,000kV UHVDC1,000kV lines lines is lower than 800kV lines when are constructed 0% distance exceeds 2,500km 1000 1400 1800 2200 2600 3000 3400 3800 300 1500 2500 3500 4500 Transmission distance (km) Transmission distance (km)

Source: NEA Source: NEA

China Wind Sector: 21 January 2016

Appendix II: Wind curtailment map (1H15)

China: wind curtailment map (1H15)

Heilongjiang 23%

Jilin Inner Mongolia 43% 17% Liaoning Xinjiang 14% 29% Beijing 4% Tianjin 5% Hebei Shanxi 14% Shandong Ningxia 4% Qinghai 3% 1% Gansu Jiangsu 31% Shaanxi Henan Tibet Shanghai Hubei Anhui Sichuan 1% Zhejiang Jiangxi Hunan Western Route Guizhou Fujian 1% Curtailment (Twh per year) Yunnan Guangdong Taiwan 0 1% Guangxi 0 - 2 Hong Kong 2 – 10 Macau 10 – 20 > 20% Hainan

Source: NEA, Daiwa

China Wind Sector: 21 January 2016

Appendix III: Wind project IRR analysis

China wind project: IRR analysis Constructi on Period Operating Period (CNYm) Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 … Year 20 Gross electricity generated (m kWh) - 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Electricity self-consumed (mn kWh) - (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) (4.0) Net electricity generated (mn kWh) - 96.0 96.0 96.0 96.0 96.0 96.0 96.0 96.0 96.0 96.0 96.0 96.0 … 96.0

Income statement (CNYm) Revenue Electricity income (ex VAT) 45.9 45.9 45.9 45.9 45.9 45.9 45.9 45.9 45.9 45.9 45.9 45.9 45.9 VAT rebate (equipment) 7.8 7.8 7.8 7.8 7.8 7.8 7.8 VAT rebate (electricity) 3.9 3.9 3.9 3.9 3.9 3.9 Total 53.8 53.8 53.8 53.8 53.8 53.8 53.8 49.9 49.9 49.9 49.9 49.9 … 49.9 Cost Depreciation (19.5) (19.5) (19.5) (19.5) (19.5) (19.5) (19.5) (19.5) (19.5) (19.5) (19.5) (19.5) (19.5) O&M (1.4) (1.4) (1.4) (1.4) (1.4) (1.6) (1.6) (1.6) (1.6) (1.6) (1.6) (1.6) (1.6) Labour cost (1.0) (1.0) (1.0) (1.0) (1.0) (1.0) (1.0) (1.0) (1.0) (1.0) (1.0) (1.0) (1.0) EBIT 31.9 31.9 31.9 31.9 31.9 31.7 31.7 27.8 27.8 27.8 27.8 27.8 27.8 EBIT margin (%) 59% 59% 59% 59% 59% 59% 59% 56% 56% 56% 56% 56% 56%

Interest expense (13.1) (11.9) (10.8) (9.7) (8.5) (7.4) (6.3) (5.1) (4.0) (2.8) (1.7) (0.6) - Profit before tax 18.8 19.9 21.1 22.2 23.3 24.3 25.5 22.7 23.8 25.0 26.1 27.2 27.8 Income tax - - - (2.8) (2.9) (3.0) (6.4) (5.7) (6.0) (6.2) (6.5) (6.8) (7.0) Effective tax rate(%) 0.0% 0.0% 0.0% 12.5% 12.5% 12.5% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% Net profit 18.8 19.9 21.1 19.4 20.4 21.3 19.1 17.0 17.9 18.7 19.6 20.4 … 20.9 Net margin (%) 34.9% 37.0% 39.2% 36.1% 38.0% 39.6% 35.5% 34.1% 35.8% 37.6% 39.3% 41.0% 41.8%

PBT 18.8 19.9 21.1 22.2 23.3 24.3 25.5 22.7 23.8 25.0 26.1 27.2 27.8 +Depreciation 19.5 19.5 19.5 19.5 19.5 19.5 19.5 19.5 19.5 19.5 19.5 19.5 19.5 -Tax - - - (2.8) (2.9) (3.0) (6.4) (5.7) (6.0) (6.2) (6.5) (6.8) (7.0) +interest expense 13.1 11.9 10.8 9.7 8.5 7.4 6.3 5.1 4.0 2.8 1.7 0.6 - Capex (390) ------FCF-Project (390) 51.4 51.4 51.4 48.6 48.4 48.2 44.9 41.6 41.4 41.1 40.8 40.5 … 40.4 -interest expense (13.1) (11.9) (10.8) (9.7) (8.5) (7.4) (6.3) (5.1) (4.0) (2.8) (1.7) (0.6) - -Debt repayment (22.8) (22.8) (22.8) (22.8) (22.8) (22.8) (22.8) (22.8) (22.8) (22.8) (22.8) (22.8) - FCF-Equity (117) 15.5 16.7 17.8 16.2 17.2 18.0 15.8 13.8 14.6 15.5 16.3 17.2 … 40.4 Project IRR 10.0% Equity IRR 15.7%

Source: Daiwa estimates

China wind projects: Daiwa’s key assumptions for wind project IRR Assumptions Capacity (MW) 50 Operation (Years) 20 Unit-capex (including VAT) (CNY/W) 7.8 Unit-capex (excluding VAT) (CNY/W) 6.7 Total investments (including VAT) (CNYm) 390 Total investments (excluding VAT) (CNYm) 333 Tariff (including VAT) (CNY/kWh) 0.56 Tariff (excluding VAT) (CNY/kWh) 0.48 Utilization hours (hours) 2,000 Self-use rate (%) 0 Finance cost (%) 5% Payback period of debt (Years) 12 Tax rate (%) 25 O&M Per MWh (CNY k/kWh) 15 O&M growth after 5 years (%) 10% Labour cost per MWh (CNY k/kWh) 10 Debt (%) 70%

Source: Daiwa

China Utilities 21 January 2016

China Longyuan Power (916 HK)

China Pow

Target price: HKD5.30 Share price (19 Jan): HKD4.66 | Up/downside: +13.7%

Initiation: looking for more quality capacity growth Dennis Ip, CFA (852) 2848 4068  Largest wind project portfolio, cushioning it from likely future tariff cuts [email protected]  Expect less dilution with positive FCF in the near term Nicole Jiang (852) 2848 4469  Initiating with Outperform (2) rating and TP of HKD5.30; top sector pick [email protected]

Investment case: We initiate coverage of China Longyuan Power Group Share price performance

(Longyuan), China’s largest wind-farm operator in terms of consolidated (HKD) (%) capacity (15.7GW as at end-2015), with an Outperform (2) rating. We 11 120 forecast a net profit CAGR of 20% over 2014-17, driven by 1.8-2GW in new 9 105 capacity additions for 2016-17E. 7 90 6 75

4 60 More prudent capacity growth for 2016-17... We anticipate a decline in Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 capacity additions for 2016 after the front-loaded installations in 2015, and Longyuan P (LHS) Relative to HSI (RHS) heavy curtailments holding up the pipelines in China’s Zones I-II. As such, we are cautious on Longyuan’s capacity targets. In our model, we assume 12-month range 4.66-10.18 1.8GW and 2GW of capacity additions for 2016 and 2017, respectively, Market cap (USDbn) 4.78 representing 11% YoY growth in cumulative installed capacity per year, a 3m avg daily turnover (USDm) 16.44 slower pace than the 19% CAGR recorded for 2010-15. Shares outstanding (m) 8,036 Major shareholder Guodian Group (58.4%)

… but of a higher quality. We think Longyuan’s planned installations in areas Financial summary (CNY) with less curtailment issues (majority of curtailments are in Inner Mongolia, Year to 31 Dec 15E 16E 17E Jilin, Heilongjiang, Liaoning and Gansu) will drive its profitability in 2015-17, on Revenue (m) 19,446 21,729 23,962 the back of higher earnings visibility and lower magnitude of tariff cuts in these Operating profit (m) 7,499 8,811 10,039 Net profit (m) 2,922 3,758 4,471 areas (cuts of 9.6-10.2% for Zones I-II vs. 4.9-8.9% for Zones III-IV for 2016- Core EPS (fully-diluted) 0.364 0.468 0.556 18E, in the latest government plan). Of the 6.6GW in Longyuan’s pipeline (as EPS change (%) 14.2 28.6 19.0 at end-1H15), about 63.6% (4.2GW) of projects are in Zone IV, where there are Daiwa vs Cons. EPS (%) (15.6) (7.0) (4.7) no curtailment issues. We forecast Zone I-II wind capacity as a proportion of PER (x) 10.8 8.4 7.0 Dividend yield (%) 2.2 2.4 2.8 Longyuan’s overall capacity to fall from 41% at end-2015 to 39% for 2017E. DPS 0.088 0.092 0.109 PBR (x) 0.9 0.8 0.7 Lower dilution risk. Longyuan has the largest operating base of all of China’s EV/EBITDA (x) 8.5 7.8 7.3 ROE (%) 8.5 10.2 11.1 wind-farm operators, with the operating cash flow to support its annual capacity Source: FactSet, Daiwa forecasts additions. We think it offers the least dilution risk vs. peers with the lowest gearing ratio (1H15: 194% vs. peers’ 230-280%) and the highest operating cash flow (2014: CNY12bn vs. peers’ CNY5-7bn). If Longyuan is able to install 2GW of wind installations per year from 2016-20 (2016: 1.8GW), we estimate it could achieve positive free cash flow in 2017-18.

Catalysts: The following would be potential earnings catalysts: 1) better utilisation, especially in Zones I-II, 2) its FCF turning positive, and 3) offshore wind-farm capacity expansion (on-grid tariff is still CNY0.75/kWh).

Valuation: We initiate coverage with an Outperform (2) rating and SOTP- derived 12-month TP of HKD5.30, implying a 2016E PER of 9x. We see this as undemanding, given that it is 2.5SD below its past-5-year average. We expect its valuation discount to narrow if its curtailment rate improves.

Risks: The main risks to our view: 1) slower-than-expected capacity expansion and 2) weaker-than-expected utilisation hours.

See important disclosures, including any required research certifications, beginning on page 127

China Longyuan Power (916 HK): 21 January 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook Longyuan: net profit growth and wind capacity

We forecast Longyuan to post a net-profit CAGR of 20% (CNYm) (MW) over 2014-17, driven mainly by its wind-power business, 5,000 25,000 for which we forecast a 23% net-profit CAGR over the 4,000 20,000 same period. Meanwhile, we expect the coal-power 3,000 business to stay stable, accounting for 8% of Longyuan’s 15,000 2,000 net profit for 2015E. 10,000 1,000 We see Longyuan’s planned capacity expansion as its 0 5,000 main earnings-growth driver. We forecast a consolidated (1,000) 0 installed capacity CAGR of 9%, with wind capacity 2010 2011 2012 2013 2014 2015E 2016E 2017E expanding at 1.8-2GW p.a. over 2015-20E. Wind Coal-fired Others Consolidated installed capacity

Source: Company, Daiwa forecasts

Valuation China wind and clean energy operators: 1-year forward PER bands

Since 2011, Longyuan has traded at a 1-year forward PER (X) that has been 1SD above the average trading PER for the 35 China wind sector of 10x. We believe Longyuang warrants 30 25 a premium valuation because it is the largest wind-farm 20 operator in China, with its well-balanced portfolio, solid 15 track record, largest market cap, and low dilution risk vs. 10 peers. 5 0

Our target price implies a 2016E PER of 9x, which we see

Jul-13 Jul-14 Jul-15

Apr-14 Oct-15 Apr-13 Oct-13 Oct-14 Apr-15

Jan-13 Jan-14 Jan-15 Jan-16 as undemanding given it is 2.5SD below the stock’s past 5- Longyuan Huadian Fuxin HNR year average. We expect this valuation discount to narrow Suntien CGNNE Average if its curtailment rate improves. Source: Bloomberg Note: Prices as at 19 January 2016. For not-rated stocks (HNR), we use Bloomberg consensus earnings forecasts

Earnings revisions Longyuan: consensus EPS forecasts

In 2015, the Bloomberg consensus revised up its 2015 and (CNY) 2016 EPS forecasts for Longyuan by 3.7% and 4.2%, 0.800 respectively. This compares to respective cuts of 27.1% 0.700 and 31.8% for 2015 and 2016 forecasts made in 2014 on the weak 2013 results, which missed the consensus EPS 0.600 number by 30.8%. 0.500

Our EPS forecast for 2015 is 15.7% below consensus, 0.400 since we have factored in low power generation growth for 0.300 2015. Our 2016-17 EPS forecasts are 4.7-7.0% below Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 consensus, as we expect the curtailment effect of power 2015E EPS 2016E EPS 2017E EPS generation to barely improve until 2017. Source: Bloomberg

China Longyuan Power (916 HK): 21 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Consolidated capacity - Total (MW) 8,431 10,571 12,698 14,073 15,698 17,950 19,770 21,790 Consolidated capacity - wind (MW) 6,556 8,598 10,544 11,910 13,543 15,765 17,565 19,565 Wind power utilization hours (hours) 2,217 2,026 1,985 2,111 1,980 1,900 1,880 1,974 Consolidated wind power output (Million 9,442 13,061 16,027 20,565 22,131 24,900 29,524 34,232 Kwh) Unit fuel cost (CNY/MWh) 241 245 234 201 181 162 159 156 Average on-grid wind farm tariff 0.572 0.578 0.582 0.583 0.585 0.587 0.584 0.581

Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales of electricity 8,544 10,695 12,404 14,710 14,913 16,123 18,366 20,566 Service concession construction 1,450 793 519 667 228 257 288 316 revenue Other Revenue 4,223 5,096 4,365 3,770 3,066 3,066 3,075 3,080 Total Revenue 14,218 16,585 17,288 19,147 18,207 19,446 21,729 23,962 Other income 986 1,296 1,296 432 437 440 440 440 COGS (7,700) (8,302) (7,126) (6,672) (5,009) (4,899) (5,038) (5,155) SG&A (888) (1,113) (1,326) (1,515) (1,603) (1,604) (1,717) (1,923) Other op.expenses (2,543) (3,362) (4,086) (5,381) (5,474) (5,883) (6,603) (7,285) Operating profit 4,073 5,103 6,045 6,011 6,559 7,499 8,811 10,039 Net-interest inc./(exp.) (1,100) (1,638) (2,518) (2,538) (2,951) (3,421) (3,498) (3,805) Assoc/forex/extraord./others 228 60 140 60 454 499 493 485 Pre-tax profit 3,200 3,526 3,667 3,533 4,062 4,577 5,806 6,719 Tax (439) (305) (342) (561) (510) (654) (841) (947) Min. int./pref. div./others (748) (642) (732) (921) (993) (1,002) (1,206) (1,302) Net profit (reported) 2,013 2,578 2,593 2,052 2,558 2,922 3,758 4,471 Net profit (adjusted) 2,013 2,578 2,593 2,052 2,558 2,922 3,758 4,471 EPS (reported)(CNY) 0.270 0.345 0.347 0.255 0.318 0.364 0.468 0.556 EPS (adjusted)(CNY) 0.270 0.345 0.347 0.255 0.318 0.364 0.468 0.556 EPS (adjusted fully-diluted)(CNY) 0.270 0.345 0.347 0.255 0.318 0.364 0.468 0.556 DPS (CNY) 0.030 0.032 0.057 0.071 0.071 0.088 0.092 0.109 EBIT 4,073 5,103 6,045 6,011 6,559 7,499 8,811 10,039 EBITDA 6,310 8,101 9,742 10,412 11,559 12,871 14,831 16,671

Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 3,200 3,526 3,667 3,533 4,062 4,577 5,806 6,719 Depreciation and amortisation 2,237 2,998 3,697 4,401 5,001 5,371 6,020 6,632 Tax paid (439) (305) (342) (561) (510) (654) (841) (947) Change in working capital 0 (3,538) (3,051) 2,988 (2,759) (319) (1,549) (414) Other operational CF items (990) 2,961 3,027 3,250 7,075 5,768 1,860 3,761 Cash flow from operations 4,008 5,641 6,998 13,611 12,868 14,744 11,296 15,752 Capex (17,435) (14,505) (12,461) (11,534) (13,614) (16,647) (13,373) (14,750) Net (acquisitions)/disposals (3,990) 0 0 (175) (867) 0 0 0 Other investing CF items 3,725 (261) (1,656) 1,220 (6,366) 0 0 0 Cash flow from investing (17,700) (14,766) (14,117) (10,489) (20,848) (16,647) (13,373) (14,750) Change in debt 3,677 11,058 8,067 (1,112) 12,028 5,683 6,402 3,764 Net share issues/(repurchases) 0 0 2,295 0 0 0 0 0 Dividends paid (632) (403) (515) (512) (382) (548) (705) (839) Other financing CF items (1,732) (2,333) (992) (3,862) (3,992) (3,621) (3,620) (3,927) Cash flow from financing 1,313 8,322 8,856 (5,486) 7,655 1,513 2,077 (1,002) Forex effect/others (58) (13) (13) (15) (6) 0 0 0 Change in cash (12,437) (815) 1,723 (2,379) (330) (389) 0 0 Free cash flow (13,427) (8,863) (5,463) 2,077 (746) (1,902) (2,077) 1,002 Source: FactSet, Daiwa forecasts

China Longyuan Power (916 HK): 21 January 2016

Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 4,338 3,740 5,369 3,445 2,828 2,440 2,440 2,440 Inventory 636 926 816 753 1,017 860 818 733 Accounts receivable 3,496 5,430 7,998 6,710 6,411 7,522 8,680 9,297 Other current assets 1,921 3,377 3,603 2,899 4,497 4,161 4,450 4,369 Total current assets 10,392 13,473 17,786 13,807 14,753 14,982 16,388 16,838 Fixed assets 50,651 64,967 73,352 79,985 88,307 100,088 107,943 116,564 Goodwill & intangibles 7,673 8,174 8,333 8,697 8,541 8,106 7,671 7,235 Other non-current assets 5,959 8,010 8,368 8,618 11,917 12,346 12,772 13,190 Total assets 74,675 94,624 107,840 111,106 123,518 135,522 144,773 153,827 Short-term debt 17,200 19,078 26,170 24,697 36,070 37,495 39,035 39,115 Accounts payable 1,515 1,597 1,261 2,142 1,021 1,319 1,176 1,213 Other current liabilities 6,230 9,161 8,644 9,936 9,157 11,804 10,537 10,857 Total current liabilities 24,945 29,836 36,075 36,775 46,248 50,618 50,748 51,184 Long-term debt 19,975 31,828 32,482 33,205 33,762 38,020 42,881 46,565 Other non-current liabilities 2,330 2,634 2,861 2,997 2,658 2,658 2,658 2,658 Total liabilities 47,250 64,299 71,418 72,977 82,668 91,297 96,288 100,408 Share capital 7,464 7,464 8,036 8,036 8,036 8,036 8,036 8,036 Reserves/R.E./others 15,817 18,444 21,393 22,917 25,021 27,395 30,448 34,081 Shareholders' equity 23,281 25,909 29,429 30,954 33,057 35,431 38,485 42,117 Minority interests 4,144 4,417 6,992 7,176 7,792 8,794 10,000 11,302 Total equity & liabilities 74,675 94,624 107,840 111,106 123,518 135,522 144,773 153,827 EV 67,172 81,534 89,654 90,842 102,699 109,273 116,388 120,968 Net debt/(cash) 32,836 47,166 53,283 54,457 67,003 73,075 79,477 83,241 BVPS (CNY) 3.119 3.471 3.662 3.852 4.113 4.409 4.789 5.241

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) n.a. 16.6 4.2 10.7 (4.9) 6.8 11.7 10.3 EBITDA (YoY) n.a. 28.4 20.3 6.9 11.0 11.3 15.2 12.4 Operating profit (YoY) n.a. 25.3 18.5 (0.6) 9.1 14.3 17.5 13.9 Net profit (YoY) n.a. 28.1 0.6 (20.9) 24.7 14.2 28.6 19.0 Core EPS (fully-diluted) (YoY) n.a. 28.1 0.3 (26.3) 24.7 14.2 28.6 19.0 Gross-profit margin 45.8 49.9 58.8 65.2 72.5 74.8 76.8 78.5 EBITDA margin 44.4 48.8 56.3 54.4 63.5 66.2 68.3 69.6 Operating-profit margin 28.6 30.8 35.0 31.4 36.0 38.6 40.5 41.9 Net profit margin 14.2 15.5 15.0 10.7 14.0 15.0 17.3 18.7 ROAE n.a. 10.5 9.4 6.8 8.0 8.5 10.2 11.1 ROAA n.a. 3.0 2.6 1.9 2.2 2.3 2.7 3.0 ROCE n.a. 7.0 6.9 6.3 6.3 6.5 7.0 7.5 ROIC 5.8 6.8 6.6 5.5 5.7 5.7 6.1 6.5 Net debt to equity 141.0 182.0 181.1 175.9 202.7 206.2 206.5 197.6 Effective tax rate 13.7 8.7 9.3 15.9 12.6 14.3 14.5 14.1 Accounts receivable (days) n.a. 98.2 141.7 140.2 131.5 130.8 136.1 136.9 Current ratio (x) 0.4 0.5 0.5 0.4 0.3 0.3 0.3 0.3 Net interest cover (x) 3.7 3.1 2.4 2.4 2.2 2.2 2.5 2.6 Net dividend payout 11.1 9.4 16.4 27.7 22.3 24.1 19.7 19.6 Free cash flow yield n.a. n.a. n.a. 6.6 n.a. n.a. n.a. 3.2 Source: FactSet, Daiwa forecasts

Company profile

Listed in December 2009, China Longyuan Power is Asia's largest and the world's second-largest wind-farm operator, with total operational experience of 22 years. Total attributable capacity of wind farms reached 15,765 MW as of 2015YE. The group has developed projects across 23 provinces and autonomous regions in China and overseas. China Guodian Group, one of the big-five independent power producer groups, is the company's largest shareholder.

China Longyuan Power (916 HK): 21 January 2016

Looking for more quality capacity growth Investment case Proxy for the sector Longyuan is the largest wind IPP in China and in Asia, and the second in the world in terms of capacity. At the end of 2015, it had 15,765MW of consolidated installed wind capacity, and about a 13% share of the market in terms of operating wind capacity as at the end of 2015. Meanwhile, it also operates other power projects (ie, coal, solar, biomass, tidal and geothermal power).

Longyuan: installed capacity by segment and wind-power market share in China (MW) 25,000 30%

25.5% 25% 20,000 22.2% 20.9% 20.9% 18.0% 20% 15,000 16.8% 15.4% 14.1% 12.3% 15% 13.0% 11.8% 10,000 10%

5,000 5%

0 0% 2007 2008 2009 2010 2011 2012 2013 2014 2015E 2016E 2017E Wind power installed capacity Coal power installed capacity Other renewable energy % market share

Source: Company, NEA, Daiwa research

Capacity boost in 2015 The company added Longyuan added 2.2GW of wind-power capacity in 2015, bringing its cumulative installed 2.2GW of wind-power capacity to 15.7GW. This accounted for ~9% of China’s newly connected total on-grid wind capacity in 2015, capacity in 2015. Management initially guided for 1.8-2.2GW of new capacity additions in bringing its cumulative 2015, then raised the target to 2-2.6GW in August 2015. While 2.2GW was completed in installed capacity to 2015, the remaining 0.4GW should commence operation in 1H16. Despite the rush in 15.7GW wind-farm construction in 2015, Longyuan maintains its 2GW per annual growth target for 2016-20.

However, we are more conservative than management on the company’s capacity targets, as we anticipate a decline in both capacity additions and capacity growth in 2016 after the front-loaded orders in 2015. But we see a rebound in 2017. In our model, we assume 1.8GW of capacity additions for 2016 and 2GW for 2017, representing 11% YoY growth in cumulative installed wind capacity. This suggests a slower pace than the 20% CAGR recorded for 2010-15.

China Longyuan Power (916 HK): 21 January 2016

Longyuan: consolidated installed capacity by province (MW) New capacity Installed capacity (MW) Dec-13 Jun-14 Dec-14 Jun-15 Dec -15 added in 2015 Heilongjiang 1,137 1,137 1,186 1,235 1,235 48 Jilin 349 349 448 448 448 - Liaoning 1,003 1,003 1,003 1,003 1,003 - Inner Mongolia 2,285 2,285 2,384 2,384 2,586 202 Jiangsu 1,057 1,057 1,244 1,578 1,678 435 Zhejiang 138 138 163 212 228 65 Fujian 506 506 506 506 522 16 Hainan 99 99 99 99 99 - Gansu 1,039 1,039 1,140 1,290 1,290 150 Xinjiang 1,091 1,091 1,292 1,292 1,391 100 Hebei 971 971 1,070 1,070 1,170 100 Yunnan 528 528 570 620 620 50 Anhui 396 396 539 588 588 50 Shandong 99 99 245 295 339 94 Tianjin 132 132 132 132 132 - Shanxi 399 399 548 597 647 99 Ningxia 278 278 278 377 725 447 Guizhou 248 248 343 442 538 195 Shaanxi 149 149 198 198 198 - Tibet 8 8 8 8 8 - Chongqing 0 0 50 50 150 100 Shanghai 0 0 0 48 48 48 Guangdong 0 0 0 0 26 26 Canada 0 0 99 99 99 - Wind total 11,910 11,910 13,543 14,568 15,765 2,197 Source: Company

Longyuan: consolidated installed capacity by division (China) 2008 2009 2010 2011 2012 2013 2014 2015 Capacity Zone 1 985 1,243 1,835 2,375 2,920 3,376 3,676 3,977 Zone 2 258 830 1,481 1,829 2,010 2,010 2,210 2,460 Zone 3 464 1,060 1,252 1,450 1,548 1,764 1,912 2,407 Zone 4 796 1,372 1,989 2,945 4,066 4,760 5,646 6,822 Total 2,503 4,504 6,556 8,598 10,544 11,910 13,444 15,666 Proportion Zone 1 39.3% 27.6% 28.0% 27.6% 27.7% 28.3% 27.3% 25.4% Zone 2 10.3% 18.4% 22.6% 21.3% 19.1% 16.9% 16.4% 15.7% Zone 3 18.5% 23.5% 19.1% 16.9% 14.7% 14.8% 14.2% 15.4% Zone 4 31.8% 30.5% 30.3% 34.2% 38.6% 40.0% 42.0% 43.5% Source: Company Note: see sector section for a detailed breakdown of each zone

A more conservative capacity addition plan would lower the risk of equity dilution and achieve positive FCF in 2017/18E By adding 2GW of wind The government’s proposed implementation of a reduction in the feed-in tariff (FIT) for capacity per year, the onshore wind projects suggests that it is increasingly concerned about overcapacity of company could achieve wind power in some regions, especially those in Zones I-II, where it has led to serious grid FCF by 2017/18 curtailment issues in the past few years. As such, we believe the significant reduction in tariffs in Zones I-II proposed by the government would force wind-farm developers to slow down their capacity expansion plans in those regions, as some of the projects located there would be rendered unprofitable after the tariff cuts.

The proposed benchmark wind-power tariff cut would likely reduce wind project IRRs, and given our projection of stable wind-farm unit construction costs over 2015-20, this tariff reduction might impact Longyuan’s future capacity additions plan, especially in Zones I-II.

We estimate that Longyuan’s current operating cash flow could support at most ~1.8- 2.1GW wind capacity expenditure without increasing the company’s current net debt-to- equity ratio of 206%. If Longyuan is to install 2GW per year from 2016-20, we estimate the company could achieve positive FCF by 2017/18. If Longyuan were to adjust down its annual capacity addition from 2GW per year to 1.5-1.7GW, we estimate the resulting declining net debt-to-equity ratio would help clear any doubt over the near-term equity dilution risks, and the company could achieve FCF ahead of schedule in 2016/17. If Longyuan is aggressive in capacity additions, its net gearing should still be far below its threshold level of ~240%, according to our calculations.

China Longyuan Power (916 HK): 21 January 2016

Longyuan: net gearing sensitivity to annual capacity additions Longyuan: free cash flow sensitivity to annual capacity in 2016-20 addition in 2016-20

250% (CNY mn) 10,000

200% 5,000

0 150%

-5,000 100% 2014 2015E 2016E 2017E 2018E 2019E 2020E -10,000 1.4GW 1.7GW 2014 2015E 2016E 2017E 2018E 2019E 2020E 2.0GW 2.4GW 1.4GW 1.7GW 2.0GW 2.8GW 3.2GW Max net gearing (240%) 2.3GW 2.6GW 2.9GW

Source: Company, Daiwa estimates Source: Company, Daiwa estimates

Longyuan has the largest operating base among China’s wind-farm operators, while its operating cash flow supports its annual capacity additions. Longyuan has the lowest gearing ratio among the wind-farm operators we cover in China.

Net gearing comparison of major wind-farm developers Consolidated capacity growth for wind operators (MW) Longyuan HNR DTR Suntien Fuxin 350% 2007 712 na

300% 2008 1,205 273 173

250% 2009 2,001 1,148 852 263 471 200% 2010 2,053 1,973 1,408 358 862.8 150% 2011 2,042 1,382 1,231 346 837.5 100% 2012 1,945 554 512 145 545.5 2013 1,366 1,094 199 99 784 50% 2014 1,633 976 197 252 1388.5 0% 2015 2,222 2,145 1,180 380 1,500 2011 2012 2013 2014 1H15

2016E 2,000 1,000-1,500 1,000 400 1,000 Longyuan HNR DTR Fuxin Suntien

Source: Company, Daiwa estimates Source: Company, Daiwa estimates Note: E=Company Guidance

Diversifying to non-curtailed areas should help improve earnings visibility Installations in non- The power curtailment issue has been the most unstable factor affecting the profitability of curtailed areas should the wind-farm operators since 2011 – most severely in the northeast and northwest regions. lead to capacity growth Wind-farm operators prefer new capacity in the southern regions, despite the area’s inferior in 2015-17 natural wind speeds. As discussed in the sector section of the report, we believe installations in non-curtailed areas (that is, provinces other than Inner Mongolia, Jilin, Heilongjiang, Liaoning and Gansu) will lead the capacity growth in 2015-17, resulting in higher earnings visibility and the wind-farm operators becoming less sensitive to tariff cuts.

We estimate that 49% of Longyuan’s operational consolidated capacity was located in mildly curtailed or non-curtailed areas as at end-2015, versus 39% at the end of 2012. Capacity in heavily curtailed Xinjiang, Gansu and northeast China dropped to 27.7% at end-2015, from 38.2% at end-2010. We believe the ratio will continue to trend down, considering that 63.6% of Longyuan’s pipeline is in the non-curtailed Zone IV area. Including approved offshore wind-power projects, Longyuan accounted for 8.74% of the total capacity of projects approved by the NEA up to end-2015, ranking it top among its peers. Of the 6.6GW in Longyuan’s pipeline, about 63.6% (4.2GW) of the projects are located in Zone IV where there are no grid curtailment problems. Moreover, 4GW of Longyuan’s projects included in the national plan require approval from the NEA at the provincial level to be executed.

China Longyuan Power (916 HK): 21 January 2016

Longyuan: locations of operating wind farms Longyuan: proportions of newly installed capacity (MW) (MW) 16,000 100% 14,000 90% 12,000 80% 70% 10,000 60% 8,000 50% 6,000 40% 4,000 30% 2,000 20% 10% 0 0% 2009 2010 2011 2012 2013 2014 2015 2009 2010 2011 2012 2013 2014 2015 Strong curtailment Mild curtailment Small curtailment Strong curtailment Mild curtailment Small curtailment

Source: Company Source: Company Note: Strong curtailment : 1H15 curtailment > 15%, mild curtailment: 1H15 curtailment >2%, Note: Strong curtailment : 1H15 curtailment > 15%, mild curtailment: 1H15 curtailment >2%, and <15%, no curtailment: 1H15 curtailment ≤ 2% and <15%, no curtailment: 1H15 curtailment ≤ 2%

Longyuan: locations of newly installed capacity Longyuan: locations of pipeline capacity (6.6GW as of 6M15) (MW) 2,500

2,000 Zone I-III 1,500 36%

1,000 Zone IV 64% 500

0 2009 2010 2011 2012 2013 2014 2015 Strong curtailment Mild curtailment Small curtailment

Source: Company Source: Company Note: Strong curtailment : 1H15 curtailment > 15%, mild curtailment: 1H15 curtailment >2%, and <15%, no curtailment: 1H15 curtailment ≤ 2%

Possible improvement in curtailment of legacy projects provides earnings upside We expect grid We expect China’s grid curtailment issue to remain elevated for another year, after the congestion issues to surging curtailment rate in 1H15 and further worsening in 2H15-2016. Further ahead, as ease slightly in 2017, the major listed wind-farm operators have committed to suspend or slow down their suggesting earnings installation plans in Zone I during 2016, and with the commissioning of the UHV upside for projects transmission lines by end-2016 to 2017, we expect the grid congestion issues to ease located in curtailed slightly in 2017. areas Longyuan has around 41% of total wind capacity (as at end-2015) located in Zones I-II. We estimate that if Longyuan improves its utilisation hours in Zones I-II by 5%, its gross electricity generated would increase by 2%, which would result in a ~2pp upward lift in its net profit margin.

Longyuan: decline in utilisation hours in heavily curtailed areas Capacity 2015 1H15 utilization hours 1H14 utilization hours 1H13 utilization hours 1H15 vs. 1H14 1H15 vs. 1H13 (MW) (hours) (hours) (hours) Inner Mongolia 2,586 1,115 1,014 1,103 10% 1% Gansu 1,290 770 903 842 -15% -9% Xinjiang 1,391 997 1,180 1,361 -16% -27% Wind total 15,765 1,085 1,036 1,104 5% -2% Source: Company

China Longyuan Power (916 HK): 21 January 2016

Net profit to rise at a CAGR of 20% from 2014-17E Unlike previous years, when new capacity installations had been concentrated in 2H to capture the strong wind in 4Q and 1Q of the following year, Longyuan added 1.0GW of wind farms in 1H15, seeing an immediate profit contribution in 2H15.

In 1H15, due to the rebound in wind resources brought about by increased periods of strong wind, Longyuan’s wind-power generation rose by 22.09% YoY (2014: up 5.28% YoY, 1H14: up 5.1% YoY). This was faster than its capacity growth: its wind capacity increased by 13.7% YoY for 1H15. However, for the whole of 2015, the company’s wind- power generation growth slowed to 11.4% YoY (2H15: up 1% YoY), due to the likelihood of weak utilisation hours in 2H15 (~815 hours, down 14% YoY) and the rebound in wind- power generation in 4Q14 providing a strong base (~565 hours, up 2.5% YoY). We estimate the company’s wind-farm utilisation rate declined by 4% to 1,900h for 2015 (2014: 1,980h), and decline further to 1,880h in 2016 considering the likelihood of more severe curtailments during the year.

We forecast Longyuan’s net profit to rise at a 20% CAGR from 2014-17, driven by 1.8/2GW in capacity additions in 2016/17E and a gradual improvement in utilisation in 2017.

Longyuan: net profit and total consolidated installed capacity (CNYm) (MW) 5,000 25,000

4,000 20,000 3,000 15,000 2,000 10,000 1,000

0 5,000

(1,000) 0 2010 2011 2012 2013 2014 2015E 2016E 2017E Wind Coal-fired Others Consolidated installed capacity

Source: Company, Daiwa

Overseas expansion Expanding overseas Longyuan has been active over the past few years in seeking overseas opportunities. Its brings geographical first overseas project, the Canadian Dufferin 100MW project, started operation at the end diversity to Longyuan’s of 2014 and recorded 1,471 average utilisation hours in 1H15, benefiting from the good wind-farm business wind resources. The Canadian project tender features a 20-year power purchase agreement, and first-year tariff of CAD0.135/kWh (with further adjustments subject to CPI increases, VAT inclusive).

In addition, the company has started construction of the 100MW wind-power project in South Africa. Longyuan won 2 bids (for 100MW and 144MW) back on 29 October 2013. The 2 South Africa tenders have guaranteed tariffs of ZAR0.86-0.81/kWh, respectively. Longyuan expects to maintain a 15% equity IRR benchmark in selecting overseas projects, which it anticipates these 2 projects reaching. According to management, the first 100MW of projects are scheduled to be operational by end-2016 or 2017.

Longyuan signed both of these South African projects in 2013, when capacity growth in China had slowed, impeded by the prevailing curtailment. Expanding overseas brings geographical diversity to Longyuan’s wind-farm business, and should create more project opportunities for Longyuan, fuelling its future business growth.

China Longyuan Power (916 HK): 21 January 2016

Leading the offshore market Longyuan aims to add 100-300MW in offshore wind capacity in 2016, followed by 500- 600MW in 2017, bringing its total offshore wind capacity to 2GW by 2018, and 3GW by 2020. In 2015, Longyuan added 152MW of offshore projects, bringing its total offshore wind capacity to 496MW, accounting for more than half of the total installed offshore wind capacity in China. Its Rudong project and its expansion projects are one of the few large- scale offshore wind-farm projects in China. Its offshore wind farms put into operation after Some 9 of Longyuan’s projects with an aggregate capacity of 2,049MW were included in 2016 should depend on the National Offshore Wind Power Development and Construction Plan (2014-16), future tariff policies representing 19% of the total capacity of the plan. Longyuan maintains its leadership as China’s largest offshore wind-farm operator, and we believe the company’s early entry and track record in offshore wind-farm development will help it capture policy opportunities in the future.

In 2014, the NDRC set the FiT for intertidal wind projects at CNY0.75/kWh, and CNY0.85/kWh for offshore wind projects commissioned before December 2016. We believe Longyuan will remain flexible in terms of adjusting its number of annual installations in order to reap the best economic benefits, and because its offshore wind farms put into operation after 2016 will depend on future tariff policies.

Operations Declining market share in new approvals In the fifth batch of the Wind Power Projects Approval Plan promulgated by the NEA in 1H15, Longyuan obtained 28 projects with a gross capacity of 1,557MW, constituting 4.6% of the total 34GW approved. Excluding the latest offer, Longyuan obtained wind projects totalling 10.2GW from the 4 batches on the approval list, accounting for 8.7% of the total offered amount (excluding cancelled projects from the first batch, and offshore wind capacity).

Longyuan: wind projects approved in the 5 batches announced Longyuan: % of wind projects approved by NEA by the NDRC (GW) Time NEA batch of approval Longyuan No-curtail Total % 40 14% (MW) No. (MW) 35 12% 2011 1 3,530 49% 26,839 13.2% 30 2012 2 2,825 50 89.4% 25,263 11.2% 10% Supplemented approved plans 249 25 8% 2013 3 2,270 33 98% 28,729 7.9% 20 2014 4 1,543 28 94% 27,600 5.6% 6% 15 2015 5 1,557 28 97% 34,000 4.6%

10 4% 5 2% 0 0% 1st batch 2nd batch 3rd batch 4th batch 5th batch 08 - 2011 03 - 2012 03 - 2013 02 - 2014 04 - 2015 CLPG Total CLPG market share

Source: NDRC, Daiwa Source: NDRC, Daiwa

Starting from the fourth batch of wind approvals of 27.6GW issued in February 2014, we note that the leading wind-farm operators, including Longyuan, HNR and DTR, all started facing declining market share. We believe the major reason for this was the project selection rights shifting to provincial governments from mid-2013. The NDRC will only review the annual wind installation targets submitted by each province at the beginning of the year, while approval for a single project is at the disposal of the local government. As such, more market-oriented wind operators gained market share in the last 2 batches, such as CGN and CR Power.

China Longyuan Power (916 HK): 21 January 2016

Wind operators’ market share in approvals Increasing market share of local SOEs, and more market- oriented wind operators 100% 1-3 batch Mkt share 4th batch Mkt share 5th batch Market share CRP 3,213 4.0% 1,479 5.4% 2,600 7.6% 80% Goldwind 2,609 3.2% 487 1.8% 1,080 3.2% CGN 4,452 5.5% 1,848 6.7% 2,746 8.1% Suntien 1,740 2.2% 485 1.8% 460 1.4% 60% Total 12,014 14.9% 4,299 15.6% 6,886 20.3%

40%

20%

0% 1 2 3 4 5 Central SOE Local SOE Private/ Foregin and others

Source: NDRC, Daiwa Source: NDRC, Daiwa

Market share of the Thanks to the high number of approvals accumulated in the past few years, as of 6M15, leading wind-farm Longyuan had 6.1GW in approved pipeline projects, and we estimate it held 7.5GW at the operators, including end of 2015, the largest approval size among its peers and providing over 3 years of Longyuan, HNR and development pipeline. Starting from 2015, Longyuan also cooperated with local authorities DTR, had started to expand into unfamiliar provinces – in 1H15, Longyuan set up the first batch of provincial- declining in 2014 level investment platforms for cooperative development in Chongqing and Guangdong to cover all of its wind-power projects in relevant provinces.

Relying on its strong parent, Guodian Group, Longyuan continues to actively promote the cooperation with other branches and subsidiaries of Guodian, and signed new cooperation agreements with subsidiaries of Guodian Group in regions such as Gansu, Hainan, Jiangxi and Guizhou.

Longyuan: project pipelines Approved In national plan Long Accum but not yet into but not yet approved, Time Batch Longyuan No-curtail Total yuan approved operation or operation As of (MW) No. (MW) % (MW) (MW) (MW) 2011 1 3,530 26,839 13.2% 3,530 2 2,825 50 89.4% 25,263 11.2% 6,355 >3,000 2012YE 2012 Supplemented 249 approved plans 2013 3 2,270 33 28,729 7.9% 8,874 4,700 5,800 2013YE 2014 4 1,543 28 >90% 27,600 5.6% 10,417 6,500 9,600 2014YE 2015 5 1,557 28 97% 34,000 4.6% 11,974 6,100 10,600 1H15 7,500(E) 2015YE Source: NDRC, Daiwa

Maintenance costs likely rose in 2015, but should stabilise thereafter As of 6M15, 5,717 (6,922MW) of Longyuan’s wind turbines had exceeded their warranty period (47.5% of the total capacity). In 1H15 alone, 330 turbines (495MW) exceeded their warranty (2014: 222 units), and the company expects the full-year number to have exceeded 2GW. Because of the lag effect in terms of the repair and maintenance costs for a WTG, we expect Longyuan’s repair and maintenance costs to rise by 21% YoY to CNY593m for 2016 (the 2016 number is a reflection of 2015) with 80% (CNY496m) in the wind segment and the remainder in the coal-fired segment.

We expect Longyuan’s unit maintenance cost to stay flat over the next few years. Management guides for a 2015 unit O&M cost of CNY15/MWh, while it managed CNY12/MWh in 1H15 (2014: CNY15/MWh) thanks to the recovery of wind speeds and careful management by Longyuan. More than half of Longyuan’s total wind turbines likely exceeded their warranty by the end of 2015, and we expect the expiration rate to slow down in 2016-17, due mainly to: 1) Longyuan having slowed down its installations to 1.6GW p.a. on average in 2011-14, while wind turbines usually have warranty period of 3-5 years, and 2) Longyuan continuing to enlarge its operating base. The new installations in 2015 of 2.2GW, together with the 0.4GW to be completed soon, should provide a sound cushion. We project the warranties of about 54% and 56% of the company’s turbines to expire in 2016-17.

China Longyuan Power (916 HK): 21 January 2016

After the surge in 2015, Currently, Longyuan has its own R&M team to provide turbine maintenance services, the expiration rate without relying on third parties. By gaining more experience, the company should be able should slow in 2016-17 to maintain its O&M cost at a reasonable level over 2016-18E. We assume a flat unit O&M cost for the corresponding period in our model.

Longyuan: capacity of expired warranties (MW) 14,000 60%

12,000 55% 10,000 50% 8,000 45% 6,000 40% 4,000 2,000 35% 0 30% 2012 2013 2014 1H15 2015E 2016E 2017E 2018E

Warranty expired % of total

Source: Company, Daiwa estimates

In our forecasts, we assume 9%/21% YoY increases in repair and maintenance costs for 2015/16, as a result of capacity expansion. Even though repair and maintenance costs account for only 3% of Longyuan’s wind-power unit operating cost, the impact on net profit is much greater. We estimate such a cost will be 10% of Longyuan’s PBT in 2016, and in our sensitivity analysis, we calculate that every additional CNY1/MWh hike in the unit O&M cost would have a 0.5% impact on Longyuan’s 2016E net profit.

Sensitivity analysis of Longyuan’s change in unit O&M cost on Sensitivity analysis of Longyuan’s change in unit O&M cost on its operating results its operating results (relative to base case) Change in unit O&M costs 2016 net profit 2016 ROE 2014-17 CAGR TP Change in unit O&M costs 2016 net profit 2016 ROE 2014-17 CAGR TP (CNY/MWh) (HKD) (CNY/MWh) (HKD) (4.0) 3,829 10.35% 21.24% 5.71 (4.0) 1.9% 0.18ppt 0.79ppt 7.7% (3.0) 3,811 10.31% 21.05% 5.61 (3.0) 1.4% 0.14ppt 0.59ppt 5.8% (2.0) 3,794 10.26% 20.85% 5.51 (2.0) 0.9% 0.09ppt 0.40ppt 3.9% (1.0) 3,776 10.21% 20.65% 5.40 (1.0) 0.5% 0.05ppt 0.20ppt 1.9% - 3,758 10.17% 20.46% 5.30 - 0.0% 0.00ppt 0.00ppt 0.0% 1.0 3,741 10.12% 20.26% 5.20 1.0 -0.5% -0.05ppt -0.20ppt -1.9% 2.0 3,723 10.08% 20.06% 5.10 2.0 -0.9% -0.09ppt -0.40ppt -3.9% 3.0 3,705 10.03% 19.86% 4.99 3.0 -1.4% -0.14ppt -0.60ppt -5.8% 4.0 3,687 9.99% 19.66% 4.89 4.0 -1.9% -0.18ppt -0.80ppt -7.7%

Source: Daiwa estimates Source: Daiwa estimates

Wind-farm construction costs Wind turbine generator (WTGs) expenses constitute nearly half of total wind-farm construction costs. Longyuan benefits from economies of scale in this area by centralising its procurement of wind-power equipment, which is carried out 1 year in advance to fix the price. The average price of the WTGs procured during 2015 was around CNY4,100/kW (including VAT), flat from 2014’s 4,160/kW. Wind-farm construction costs were CNY7.8/W in 1H15, up 2.3% from CNY7.6/W for 2014.

We estimate Longyuan’s wind-farm construction costs to rise slightly to around 8/W in 2016-17, to compensate for the extra cost incurred for infrastructure spending in non- curtailed areas. Wind farms in non-curtailed provinces are usually located in hilly areas to avoid high-population density areas, while the construction costs for wind farms located on slopes are generally around 10-20% higher than those located on flat ground. Management expects turbine prices to rise slightly in the near term, since the company is adopting more 2MW models, which is more suitable for low wind-speed areas. In 2015, 0.86GW (33%) of the 2.6GW additions (2.2GW completed in 2015, 0.4GW to be completed in 2016) came from curtailed northern China, while the remaining 67% was from the non-curtailed south.

China Longyuan Power (916 HK): 21 January 2016

Given the favourable VAT tax policy and that domestic manufacturers have adopted foreign advanced technology, all of Longyuan’s wind turbines are manufactured domestically. More than 90% of its current WTGs were procured from domestic suppliers, such as United Power (UL), Goldwind (2208 HK, not rated) and Envision Energy (UL), while the remaining <10% (mainly offshore type wind turbines) came from foreign suppliers manufacturing in China: Gamesa (GAM SM), General Electric (GE US), and Vestas (VWS DC). Currently, about 80% of the company’s turbines under operation were sourced from domestic suppliers.

Other potential earnings sources In 1H15, Longyuan signed carbon trading agreements with a number of parties in several Expects to benefit from carbon markets in China, covering 2 of its wind farms (100MW), for an aggregate 220k the potential booming of tonnes of China Certified Emissions Reduction (CCER) credits and at the average 1H15 the CCER market trading price of CNY10/tonne. In 2015, Longyuan applied for 20 of its qualified projects to be issued with CCERs. According to management, even though the current trading price of CCDRs is relatively low, compared with credit prices under the former Clean Development Mechanism (CDM) regime (Euro11-12/tonne), they are seeing increasing demand driving up prices as the government plans to fully implement carbon trading in China from 2017-20.

In October 2011, the NDRC approved the setup of carbon trading trial markets in Beijing, Tianjin, Shanghai, Chongqing, Hubei, Guangdong and Shenzhen. The government plans to consolidate these trial markets into a national carbon market by end-2016 or early 2017, and fully implement carbon trading in China sometime between 2017 and 2020. In January 2015, China launched the CCER programme, allowing emitters the option of trading carbon offsets in the form of CCERs, which are issued by the NDRC. For wind operators, the NDRC allows existing projects registered with the UN’s CDM to register as CCER projects.

Longyuan has the longest track record in the wind industry in China (since 1993), and is the only operator in China that has its own team of experts in every core area of wind-farm development: resource investigation, design & planning, CDM application and operation monitoring. Longyuan has historically led the wind operators by registering up to 181 CDM projects, with 9,660MW cumulative installed wind capacity as at end-2012 (92% of total cumulative installed wind capacity). Since projects registered with the CDM are immediately qualified for CCERs, we believe Longyuan will still lead the registrations with the expansion of the domestic carbon trading market in China. We do not assume any CDM income in our model, given the lack of visibility in terms of the programme’s implementation.

No plan to expand into other clean energy areas Longyuan also operates other power projects, such as coal, solar, biomass, tidal and geothermal power. At end-2014, it had 159.7MW of solar capacity (0.9% of total), 114MW of biomass capacity (0.6% of total), tidal power generation projects of 3.9MW and geothermal power generation projects of 2.0MW. Longyuan has to date been focused on the development of wind farms, which has led to the other clean energy segment accounting for a declining portion of its capacity.

China Longyuan Power (916 HK): 21 January 2016

Longyuan: installed capacity breakdown 100%

80%

60%

40%

20%

0% 2007 2008 2009 2010 2011 2012 2013 2014 2015E 2016E 2017E Wind power installed capacity Coal power installed capacity Other renewable energy

Source: Company

Longyuan added only 30MW of solar capacity in 2015, considering urgent construction of wind capacity constrains cash flow. At the end of 2015, Longyuan had a rich pipeline comprising more than 3,000MW of solar projects, spread across Gansu, Inner Mongolia, Qinghai, Xinjiang and other regions. However, the company has no specific installation target for solar capacity.

After the disposal of the 30MW Liaocheng biomass project in August 2014, Longyuan then put up for sale its equity interest as well as corporate loan in the Jiansanjiang and Tangyuan biomass projects, and only kept one biomass plant of 30MW. The biomass assets have experienced continual losses before being listed for disposal. Longyuan is only keeping one biomass project and waiting for the operating environment to improve, without developing new projects.

Under the current Longyuan also has 2 pilot projects, namely the 3.9MW tidal power project in Zhejiang, development plan, which began operating in 1980, and the 2MW geothermal power project in Tibet. Longyuan management has does not have any expansion plans for these 2 projects. Though it expects to achieve free committed to focus its cash flow in 2017/18 at the earliest, under the current development plan, management has investments on wind- committed to focus its investments on wind-farm projects over the next 5 years, without farm projects over the considering any other clean energy investment field. next 5 years Coal-fired With the continuous weak coal prices, the coal-fired power assets owned by Longyuan provide strong cash flow to support its rapid growth of renewable energy development. Longyuan has 2 coal-fired power subsidiaries, both located in Jiangsu Province, namely 1,215MW Jiangyin Sulong (27% stake) and 660MW Tianshenggang (31.94% stake), accounting for 15% of the company’s consolidated installed capacity (1,875MW) and 14% of its operating profit in 1H15 (2014: 12%).

With the government’s stricter emissions standards, in mid-2014, Longyuan completed the transformation of its 2 coal-fired generating units into ultra-low emissions units and officially put them into operation as its first “ultra-low emission” environmentally-friendly transformed units, investing an aggregate CNY20m. A subsequent emissions test conducted by the Jiangsu Environmental Monitoring Center indicated that the emissions concentration of dust, SO2 and NOx, at the 2 newly transformed units satisfied the requirements for the ultraclean combustion of coal, and were below the emissions limits set for gas turbine units.

The Jiangyin Sulong plant also sources part of its fuel from its wholly owned subsidiary, Jiangsu Sulong Energy. The coal sales segment provided a good hedge for Longyuan’s coal-fired IPP business when coal prices increased more than 150% over 2006-08. The coal segment contributed 20-41% of adjusted operating profit during 2012-14. Nevertheless, the contribution of staged capacity additions has been declining over the past 5 years and, as such, we do not expect much impact on the company’s financials from any potential tariff cut.

China Longyuan Power (916 HK): 21 January 2016

Longyuan: EBIT contribution breakdown 100%

80%

60%

40%

20%

(20%) 2010 2011 2012 2013 2014 2015E 2016E 2017E Wind Coal-fired Others

Source: Company, Daiwa estimates

Coal-fired plants provide A new plant jointly managed by Longyuan and Huaneng Group with 2GW of installed a stable earnings stream capacity (Longyuan’s stake: 16%) became operational in 1Q14, and is expected to have made a full contribution in 2015. The plant is managed by Longyuan’s Nantong subsidiary, which also helps generate additional maintenance and repair service revenue. The JV contributed CNY330m in net profit in 2014, and 8% of PBT, and we estimate its contribution to increase by 10% YoY for 2015 (8% of 2015E PBT).

Longyuan built the new plant to replace its previous retired small unit, under the government plan to substitute small-sized thermoelectricity units with high energy consuming plants. The company has no plans for further investment in thermal power projects.

Less affected by national level coal-fired utilisation hour decline Despite the decline in national-level coal-fired plant utilisation hours in 2015, Longyuan believes its coal-fired plants were less affected, since they are cogeneration plants by nature, and have more favourable locations than most other coal-fired plants in the country.

All of Longyuan’s coal-fired plants are located in Jiangsu Province, which features leading GDP growth and electricity consumption demand. Moreover, these plants are designed as cogeneration plants, whose utilisation hours are protected, especially during winter heating seasons. Note that the decline in 2014 was partially due to the suspension of operations to carry out ultra-low emissions transmission work.

Longyuan: operating hours of coal-fired plants Power demand growth in Jiangsu Province compared with national growth 7,000 20% 6,000 15%

5,000 10% 5% 4,000 0% 3,000 (5%)

2,000 (10%)

1,000

3Q2013 1Q2014 1Q2011 3Q2011 1Q2012 3Q2012 1Q2013 3Q2014 1Q2015 3Q2015 0 YoY national growth YoY growth in Jiangsu 2012 2013 2014 1H14 1H15

Source: Daiwa estimates Source: Daiwa estimates

China Longyuan Power (916 HK): 21 January 2016

Risks Exposure to foreign exchange Longyuan’s wind and coal power plants are principally located in China; less than 1% of its total capacity is in Canada. While most of its revenue comes from China, the company has ~CNY1.7bn of bank borrowings in USD, as well as 3 outstanding corporate/perpetual bonds that are USD denominated and amount to ~USD1.2bn.

Since its USD400m perpetual note features a 5.25% coupon, Longyuan announced the redemption of the debt on 8 December 2015, immediately after it became callable on 7 December 2015, and replaced it with CNY borrowing in China. Longyuan’s USD300m bond is set to expire in August 2016. Thereafter, we expect Longyuan’s exposure to USD- denominated borrowing to fall from 8% of its total debt to 5%. Considering that the coupon on the USD500m bond maturing in 2017 is relatively low, at 2.88%, and given the company’s robust cash flow, we think Longyuan may not consider retiring the bond early. As of end-1H15, Longyuan had CNY2.8bn in cash (around USD450m) on its balance sheet.

Longyuan: USD-dominated perpetual/ corporate bond Issuance Amount Type Expiration Term Coupon Effective interest rate Note (USDm) (Years) 7 -Dec-12 400 Senior perpetual note Already redeemed 5.25% Under Hero Asia 12-Aug-13 300 Corporate bond 12-Aug-16 Three 3.25% 3.61% Investment Limited, a 3-Oct-14 500 Corporate bond 3-Oct-17 Three 2.88% 3.32% subsidiary of Longyuan Source: Company

Longyuan is keen to Mindful of the risk of further CNY depreciation, Longyuan is keen to replace its existing replace its existing USD loans with the goal of managing its interest expenses. The company’s USD/HKD- loans in light of the dominated debt decreased from CNY10.4bn at end-2014 to CNY6.5bn as of end-1H15. depreciating CNY Net of the effects of CNY depreciation, Longyuan replaced 38% of its USD/HKD debt in 1H15; and we expect it to retire a further 20% of its USD/HKD debt in 2016.

Longyuan: debt currency breakdown Total debt balance (CNYm) Proportion (%) Dec-15E Dec-16 E Dec-15 E Dec-16 E Foreign currency borrowings - USD 1,251 1,000 1.7% 1.2% - Other currency 113 226 0.1% 0.3% Foreign currency bonds - USD 5,126 3,337 6.8% 4.1%

Foreign currency debt 6,489 4,563 8.6% 5.6% Local currency debt 69,026 77,353 91.4% 94.4% Total debt 75,515 81,916 100.0% 100.0%

Source: Company, Daiwa

In 2015, the CNY/USD exchange reference rate depreciated by 6% from 6.11 to 6.5. Daiwa’s Asia ex Japan economist Kevin Lai expects a further depreciation in the CNY/USD exchange rate to 7.50 by end-2016. Longyuan has an USD300m bond maturing in 2016. If it does not refinance with USD-denominated debt/bonds, Longyuan would have to pay more on the principal, equivalent to cash-based FX losses.

Factor in the 2015 CNY depreciation against USD, and our forecast for 2016E, we expect it to incur non-cash FX losses of CNY310m for 2015E and CNY650m for 2016E, respectively representing 7% and 11% of its PBT for those years. However, these FX losses would be non-cash in nature, and the actual increases in cash interest expenses and cash-based fair value loss would amount to CNY94m for 2015E and CNY230m for 2016E (2% and 4% of PBT, respectively), on our estimates.

China Longyuan Power (916 HK): 21 January 2016

Longyuan: FX loss Debt exposure Currency 2015E 2016E USD debts USD 252 150 2016 Corporate bond (3.25% coupon) USD 300 300 2017 Corporate bond (2.875% coupon) USD 500 500 Total 1,052 950 - plus perpetual bond (5.25% coupon) USD 400 0 Net USD/HKD exposure 1,452 950 Assumptions 2015E 2016E USD debt interest rate 3.5% 3.5% Daiwa USD/CNY forecasts or actual value (year-end) 6.5 7.5 Average USDCNY 6.35 7.00 FX loss on: - Interest expense USD (2.5) (5.1) - Principle payment USD (12.1) (27.7) - Fair value USD (47.6) (86.7) Total FX loss USD (62.2) (119.5) Proportion to PBT 2015E 2016E - Interest expense CNY (16.0) (35.5) 0.3% 0.6% - Principle payment CNY (78.4) (194.2) 1.7% 3.3% - Fair value CNY (309.7) (649.9) 6.8% 11.2% Total FX loss CNY (404.1) (879.6) 8.8% 15.1% Source: Daiwa

We believe Longyuan is well aware of the risks of CNY depreciation, and it has been actively using derivatives instruments to hedge its FX borrowing exposure in expectation of CNY depreciation in the near term, which we think may partly offset the FX loss.

Near-term equity dilution risks Net debt-to-equity On our estimates, Longyuan’s 2015 capex increased by 22% YoY to CNY17bn as a result expected to stay at of a rush of construction in 2015 (2014: 1.6GW vs. 2015: 2.2GW). Accordingly, we estimate above 200% in 2015-16 the company’s net debt-to-equity ratio could rise from 203% for 2014 to 206% for 2015E.

For Longyuan to achieve its target of 2GW of wind capacity additions annually over the next few years, we would expect its net debt-to-equity ratio to stay at 206% in 2016E. Although management has stated the company has no need for an equity issuance as long as its net debt-to-equity ratio is less than 250%, we do not rule out the possibility it will have to seek equity financing, potentially in 2016. However, on our reading, Longyuan still has the least dilution risk among its peers, given it has the lowest gearing ratio (194% versus peers’ 230-280% in 1H15) and the highest operating cash flow (CNY13bn versus peers’ CNY5-7bn in 2014).

Longyuan’s USD300m perpetual bond became callable after December 2015. The perpetual bond could improve the company’s net debt-to-equity ratio, since it was treated as a portion of equity in the company’s accounting. Prior to the retirement of the perpetual bond in December 2015, Longyuan issued corporate debt in CNY to repay the perpetual bond, leading to a rise in its net debt and net gearing.

Longyuan: net debt level and cash position (CNYm) (Gearing ratio %) 20,000 210%

0 200% 190% (20,000) 180% (40,000) 170% (60,000) 160% (80,000) 150% (100,000) 140% 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & cash equivalent Short-term debt Long-term debt Gearing (RHS)

Source: Company, Daiwa research

China Longyuan Power (916 HK): 21 January 2016

In December 2012 Since its listing in 2009, Longyuan has carried out only one share placement, in December Longyuan committed to 2012, and shortly thereafter committed to undertaking no equity issuance for 3 years. undertaking no equity Through its one placement to date, it strengthened its cash position by about HKD2.9bn issuance for 3 years (7.7% of its enlarged share count), which it used to finance its rapid expansion in 2009-13. Given the rush expansion undertaken in 2014-15, we see net-debt-to-equity levels rising and note that the period for which it committed to no placements is now coming to an end.

China Longyuan Power (916 HK): 21 January 2016

Valuation We initiate coverage of Longyuan with an Outperform (2) rating and an SOTP-derived 12- Coverage initiated with month target price of HKD5.3, representing 14% upside potential from the current share an Outperform (2) rating price. We derive our target price using SOTP methodology, which we consider to be the and SOTP-derived 12- most appropriate given the different potential earnings growth and risk profiles of the month target price of company’s wind-farm and coal-fired IPP operations. HKD5.3

Longyuan: SOTP valuation Valuation Total gross value % Value Total gross value HKD/share (CNYm) (HKDm) Wind -power and other clean energies DCF at 8.6% 99,235 87% 120,035 14.94 Coal-fired power DCF at 9.1% 15,462 13% 18,702 2.33 Corporate value 114,697 100% 138,738 17.3 Net cash/ (debt) (79,477) (96,135) (12.0) NAV 35,220 42,603 5.30 Source: Daiwa forecasts

For the wind-farm business, we use a DCF-based valuation, applying a WACC of 8.6% and assuming a beta of 0.8 and terminal growth rate of 2%.

Longyuan: wind-farm free cash flow valuation Forecast 12 mths to 31 Dec (CNYm) 2016E 2017E 2018E 2019E 2020E 2021E 2022E … 2025E Terminal

Valuation Date 20-Jan-16 11-Jul-16 30-Jun-17 30-Jun-18 30-Jun-19 30-Jun-20 30-Jun-21 30-Jun-22 … 30-Jun -25 30-Jun -25 Next Balance Date 31-Dec-16 First Year Cash Flow Adjustment 0.95

Free Cash Flow EBITDA 13,434 15,320 17,002 18,703 20,426 22,282 24,180 30,127

Less: Other Non Cash (1,223) 309 (85) (83) (81) (4) (4) (4)

Less: Cash Tax Payable on EBIT (555) (665) (841) (960) (1,105) (1,368) (1,584) (2,562)

Plus: Decrease in Working Capital (1,487) (400) (1,190) (1,231) (1,247) (1,375) (1,404) (1,492)

Less: Capital Expenditure (13,373) (14,750) (14,845) (14,940) (14,940) (14,940) (14,940) (14,940)

Free Cash Flow (3,203.6) (186.0) 40.9 1,488.7 3,052.1 4,594.3 6,247.1 11,129.6 11,352.2

Free Cash Flow for Valuation Purposes (3,203.6) (186.0) 40.9 1,488.7 3,052.1 4,594.3 6,247.1 11,129.6 11,352.2

WACC 1 8.6% 8.6% 8.6% 8.6% 8.6% 8.6% 8.6% 8.6% 8.6% 8.6%

NPV of Free Cash Flow (3,080.6) (165.0) 33.5 1,120.0 2,113.6 2,929.3 3,667.1 5,097.6 78,609 Source: Daiwa forecasts

Longyuan: wind-farm DCF calculation Target gearing (debt/capital) (%) 25% Market risk premium (%) 10.00% Risk-free rate (%) 2.50% Cost of debt (%) 3.50% Cost of equity (%) 10.52% WACC (%) 8.6%

Terminal Value Terminal Growth Rate 2.00% Terminal WACC 8.61% Estimated Terminal Free Cash Flow 11,352.19 NPV of Terminal Value (as at 30 June 2025) 171,627.26 NPV of Terminal Value (as at 20 Jan 2016) 78,609.14 DCF Valuation NPV of Forecasts (CNYm) 20,626.34 NPV of Terminal Value (CNYm) 78,609.14 Enterprise Value (CNYm) 99,235.49 Source: Daiwa forecasts

For the coal-fired IPP business, we also use a DCF-based valuation, applying a WACC of 9.1% and assuming a beta of 0.9 and terminal growth rate of 0%.

China Longyuan Power (916 HK): 21 January 2016

Longyuan: coal-fired IPP free cash flow valuation 12 mths to 31 Dec (CNYm) 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E Terminal Valuation Date 20-Jan-16 11-Jul-16 30-Jun-17 30-Jun-18 30-Jun-19 30-Jun-20 30-Jun-21 30-Jun-22 30-Jun-23 30-Jun-24 30-Jun-24 Next Balance Date 31-Dec-16 First Year Cash Flow Adjustment 0.95 Free Cash Flow EBITDA 1,397 1,351 1,333 1,317 1,304 1,317 1,332 1,348 1,366 Less: Other Non Cash (44) 11 (3) (3) (3) (0) (0) (0) (0) Less: Cash Tax Payable on EBIT (287) (282) (286) (291) (298) (310) (322) (339) (363) Plus: Decrease in Working Capital (61) (14) (38) (34) (31) (30) (27) (25) (22) Less: Capital Expenditure 0 0 0 0 0 0 0 0 0 Free Cash Flow 1,005.1 1,065.5 1,005.7 988.9 972.7 976.7 982.6 984.1 979.9 979.9 Free Cash Flow for Valuation Purposes 1,005.1 1,065.5 1,005.7 988.9 972.7 976.7 982.6 984.1 979.9 979.9 WACC2 9.1% 9.1% 9.1% 9.1% 9.1% 9.1% 9.1% 9.1% 9.1% 9.1%

NPV of Free Cash Flow 964.4 939.7 813.0 732.7 660.5 607.9 560.6 514.6 469.6 5,162.3 Source: Daiwa forecasts

Longyuan: coal-fired IPP DCF calculation Target gearing (debt/capital) (%) 25% Market risk premium (%) 10.00% Risk-free rate (%) 2.50% Cost of debt (%) 3.50% Cost of equity (%) 11.16% WACC (%) 9.10%

Terminal Value Terminal Growth Rate 0.00% Terminal WACC 9.10% Estimated Terminal Free Cash Flow 979.88 NPV of Terminal Value (as at 30 June 2024) 10,772.30 NPV of Terminal Value (as at 20 Jan 2016) 5,162.28 DCF Valuation NPV of Forecasts (CNYm) 6,262.87 NPV of Terminal Value (CNYm) 5,162.28 Add: Market value of stakes in Associates #1 4,036 Associate #2 - - Associate #3 - - Enterprise Value (CNYm) 15,461.56 Source: Daiwa forecasts

Our target price implies We cross-check our target price with the implied PER. Our target price implies a 2016E a 2016E PER of 9x, on a PER of 9x, on a par with the multiples of its China wind operator peers, which we see as par with its China wind appropriate given many investors treat Longyuan as a proxy for the wind IPP sector value operator peers chain due to its large market cap.

Longyuan: 1-year forward PER vs. peers (X) 35 30 25 20 15 10 5

Jul-13 Jul-14 Jul-15

Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15

Jan-13 Jan-14 Jan-15 Jan-16

Longyuan Huadian Fuxin HNR Suntien CGNNE Average

Source: Bloomberg

China Longyuan Power (916 HK): 21 January 2016

Longyuan: free cash flow and NPV of free cash flow Longyuan: DPS and payout ratio

(CNYm) (CNY) 8,000 0.10 21%

6,000 0.08 20% 4,000 20% 0.06 2,000 19% 0.04 0 19% 0.02 (2,000) 18%

(4,000) 0.00 18% 2016 2017 2018 2019 2020 2021 2022 2010 2011 2012 2013 2014 2015E 2016E Free Cash Flow NPV of FCF DPS Payout Ratio

Source: Company, Daiwa estimates Source: Daiwa estimates

China Longyuan Power (916 HK): 21 January 2016

China Utilities 21 January 2016

(816 HK) Huadian Fuxin Energy Huadian F uxin Energy

Target price: HKD1.75 (from HKD1.75) Share price (19 Jan): HKD1.63 | Up/downside: +7.3%

Recovery in sight Dennis Ip, CFA (852) 2848 4068  Still expecting resilient net profit growth in wind power business [email protected]  Nuclear profit contribution should more than double by 2017E Scott Chui (852) 2848 4443  4.5x 2016E PER appeals vs. expected 17% 2015-17E EPS CAGR [email protected]

What's new: We expect Fuxin’s net profit growth to be resilient, at Forecast revisions (%) 21%/12% for 2016/17E, respectively. Despite our view of a likely worsening Year to 31 Dec 15E 16E 17E of wind curtailment in China, which could weigh on wind utilisation, we Revenue change - - - Net profit change - - - expect capacity-driven net profit growth for Fuxin’s wind power business. Core EPS (FD) change - - - Furthermore, we see another earnings driver from Fuxin’s nuclear power Source: Daiwa forecasts business, driven by the commissioning of Fuqing Nuclear Units 2-4 from 4Q15 to 2017. Also see our full report on Fuxin, published on 20 January Share price performance

2016: Huadian Fuxin Energy: Recovery in sight. (HKD) (%) 4.8 120 What's the impact: Wind to maintain its capacity-driven growth. We 3.9 103 expect Fuxin’s wind farms to be impacted by the deteriorating wind 3.1 85 2.3 68 curtailment that we expect in 2016E, given that 80% of Fuxin’s wind farms 1.5 50 were in northern China provinces (such as Gansu, Inner Mongolia, Jan-15 Apr-15 Jul-15 Oct-15 Jan-16

Xinjiang, and northeast China) as of 1H15, which have experienced serious Huadian Fu (LHS) Relative to HSI (RHS) wind curtailment. Also, the wind tariff cuts starting in January 2016 may lead to a moderating pace of wind capacity expansion for Fuxin. 12-month range 1.62-4.72 Market cap (USDbn) 1.75 Nevertheless, we expect the company to add 1.0-1.5GW of wind power pa 3m avg daily turnover (USDm) 5.66 Shares outstanding (m) 8,408 over 2015-17E. Also, with our expectation that grid curtailment issues will Major shareholder Huadian Group (62.8%) stop worsening by 2H17, we look for Fuxin to deliver a 41% net profit CAGR over 2015-17E for its wind power business. Financial summary (CNY) Year to 31 Dec 15E 16E 17E Nuclear profit contribution to more than double by 2017E. With the Revenue (m) 14,465 15,509 16,524 scheduled commissioning of Fuqing Units 2-4 in October 2015, February Operating profit (m) 5,557 6,153 6,600 Net profit (m) 2,104 2,555 2,865 2016, and 1Q17, respectively, we expect net profit from the nuclear power Core EPS (fully-diluted) 0.250 0.304 0.341 business to surge over the next 2 years, from CNY450m in 2015 to over EPS change (%) 6.9 21.4 12.2 CNY1.1bn in 2017 (a 58% net profit CAGR). Also, we think capital raising Daiwa vs Cons. EPS (%) (7.7) (10.1) (15.6) needs should be limited as most of the capex for Unit 3-4 has been PER (x) 5.5 4.5 4.0 Dividend yield (%) 3.5 4.3 4.8 completed previously. DPS 0.048 0.059 0.066 PBR (x) 0.7 0.6 0.5 What we recommend: We reaffirm our Outperform (2) rating on Fuxin, EV/EBITDA (x) 7.1 6.9 6.8 ROE (%) 13.2 14.3 14.2 with an SOTP-based 12-month target price of HKD1.75. Fuxin’s current Source: FactSet, Daiwa forecasts valuation is around the stock’s past-3-year lows of 4.5x 2016E PER and 0.6x 2016E PBR, and we believe the shares have been overly punished by weak sentiment on the wind sector. However, because Fuxin is a balanced clean-energy operator, we see limited downside risk, as its profitability should be protected by a growing nuclear profit contribution.

How we differ: Our 2015-17E EPS forecasts are 7-16% below the Bloomberg consensus, due mainly to our more cautious outlook on Fuxin’s coal-fired business.

See important disclosures, including any required research certifications, beginning on page 127

Huadian Fuxin Energy (816 HK): 21 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Fuxin: net-profit forecasts (excl. preferred dividends) We forecast a 17% net profit CAGR over 2015-17, mainly 3,500 driven by: 1) capacity-driven growth in the wind power 3,000 business, with 1.5GW/1.0GW/1.0GW new capacity coming 2,500 on line over 2015-17 leading to an 41% net profit CAGR for 2,000 the wind business; and 2) the net profit contribution from 1,500 Fuqing Nuclear rising from CNY450m to CNY1.1bn 1,000 following the commissioning of Fuqing Unit 2 in October 500 2015, as well as Fuqing Unit 3, scheduled to commence 0 operation in February 2016. (500) 2010 2011 2012 2013 2014 2015E 2016E 2017E This, coupled with the declining profitability of Fuxin’s coal- Hydro Wind Coal-fired Other clean energies Nuclear fired power business, should shift the company’s net profit Source: Company, Daiwa forecasts drivers from traditional coal-fired power and hydro power businesses, to wind power and nuclear power.  Valuation Fuxin: rolling 1-year forward PER chart Fuxin is trading currently at a 4.3x 2016E PER, (x) representing its trough valuation, or 1.7SD below its past 3- 16 year average since mid-2012. Despite Fuxin’s coal-fired business likely to be challenging, as well as wind 12 curtailment unlikely to be resolved within the near term, we believe the company will still be able to deliver a 16% EPS 8 CAGR over 2015-17, backed by a 58% net profit CAGR from Fuqing Nuclear (with Unit 2-4 commissioning), as well

as moderate profit growth from its wind power business. 4

Jul-13 Jul-14 Jul-15

Jul-12

Jan-14 Jan-13 Jan-15 Jan-16

Mar-15 Mar-13 Mar-14

Sep-12 Nov-12 Sep-13 Nov-13 Sep-14 Nov-14 Sep-15 Nov-15

May-13 May-14 May-15 Our target price of HKD1.75 represents a 5.0x 2016E PER, PER (x) Avg+1SD Average Avg-1SD still 1SD below its past 3-year trading average. Source: Bloomberg, Daiwa forecasts

Earnings revisions Fuxin: Bloomberg consensus EPS revisions The Bloomberg-consensus earnings forecasts for Fuxin (CNY) have been declining moderately since March 2015, due we 0.6 believe to the company’s disappointing full-year 2014 0.5 results, while the 2015 interim results were roughly in line. Since then, the consensus EPS has been revised down 0.4 consistently, due largely to deteriorating wind curtailment issues in 2015, as well as poor rainfall in 1H15. 0.3

0.2

Jul-14 Jul-15

Apr-14 Oct-14 Apr-15 Oct-15

Jan-14 Jun-14 Jan-15 Jun-15

Feb-14 Mar-14 Feb-15 Mar-15

Dec-14 Aug-14 Sep-14 Nov-14 Aug-15 Sep-15 Nov-15

May-14 May-15 2015 EPS 2016 EPS 2017 EPS

Source: Bloomberg

Huadian Fuxin Energy (816 HK): 21 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Consolidated installed coal-fired power 2,650 2,050 2,650 3,850 3,850 3,850 3,850 3,850 capacity at year end (MW) Coal-fired power average utilization 4,467 6,045 5,191 5,919 5,018 4,215 4,004 3,884 hours Consolidated installed hydropower 2,199 2,223 2,223 2,457 2,457 2,567 2,567 2,567 capacity at year end (MW) Hydropower average utilization hours 4,015 2,583 4,065 3,438 3,649 3,540 3,610 3,646 Consolidated installed wind power 1,334 2,171 2,717 3,501 4,889 6,389 7,389 8,389 capacity at year end (MW) Wind power average utilization hours 2,232 2,072 1,923 2,030 1,888 1,812 1,776 1,803 Total electricity sales (GWh) 20,835 16,187 24,677 33,324 35,239 35,675 38,027 40,136 Nuclear installed capacity n.a. n.a. n.a. n.a. 1,000 2,000 3,000 4,000

Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales of electricity 8,165 7,119 10,867 12,847 13,544 14,105 15,143 16,154 Service concession construction 193 44 277 81 27 35 41 45 revenue Other Revenue 40 116 208 314 325 325 325 325 Total Revenue 8,398 7,278 11,352 13,242 13,895 14,465 15,509 16,524 Other income 236 310 443 61 237 148 108 108 COGS (4,958) (3,939) (5,515) (5,897) (5,750) (4,653) (4,355) (4,266) SG&A (197) (226) (430) (415) (405) (422) (529) (564) Other op.expenses (1,581) (1,478) (2,372) (2,595) (3,036) (3,981) (4,581) (5,202) Operating profit 1,899 1,945 3,478 4,397 4,942 5,557 6,153 6,600 Net-interest inc./(exp.) (954) (1,201) (1,905) (2,305) (2,344) (2,548) (3,020) (3,178) Assoc/forex/extraord./others 12 3 43 94 84 518 985 1,208 Pre-tax profit 956 748 1,616 2,185 2,681 3,527 4,119 4,631 Tax (158) (95) (261) (484) (534) (482) (478) (520) Min. int./pref. div./others (277) (87) (262) (233) (280) (941) (1,087) (1,246) Net profit (reported) 521 566 1,093 1,468 1,867 2,104 2,555 2,865 Net profit (adjusted) 521 566 1,093 1,468 1,867 2,104 2,555 2,865 EPS (reported)(CNY) 0.087 0.094 0.160 0.193 0.234 0.250 0.304 0.341 EPS (adjusted)(CNY) 0.087 0.094 0.160 0.193 0.234 0.250 0.304 0.341 EPS (adjusted fully-diluted)(CNY) 0.087 0.094 0.160 0.193 0.234 0.250 0.304 0.341 DPS (CNY) 0.000 0.000 0.032 0.040 0.046 0.048 0.059 0.066 EBIT 1,899 1,945 3,478 4,397 4,942 5,557 6,153 6,600 EBITDA 3,037 3,188 5,276 6,572 7,609 9,175 10,341 11,381

Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 956 748 1,616 2,185 2,681 3,527 4,119 4,631 Depreciation and amortisation 1,139 1,244 1,798 2,175 2,667 3,618 4,188 4,781 Tax paid (158) (95) (261) (484) (534) (482) (478) (520) Change in working capital (74) (1,959) (441) 457 300 (877) (530) (456) Other operational CF items 1,152 1,532 1,964 2,288 2,060 1,829 1,834 1,768 Cash flow from operations 3,015 1,469 4,677 6,622 7,175 7,616 9,133 10,205 Capex (8,500) (7,217) (6,701) (6,579) (15,734) (13,360) (12,100) (12,035) Net (acquisitions)/disposals (1,703) (274) (3,308) (1,547) (378) 0 0 0 Other investing CF items 2,259 1,161 2,358 (431) (421) (403) (427) (388) Cash flow from investing (7,945) (6,330) (7,651) (8,557) (16,533) (13,763) (12,527) (12,423) Change in debt 5,904 4,898 3,016 5,006 9,322 5,995 7,017 6,043 Net share issues/(repurchases) 0 0 2,118 0 2,244 0 0 0 Dividends paid (96) (182) (338) (377) (498) (406) (496) (554) Other financing CF items 292 (1,015) (998) (3,489) (2,732) (733) (3,127) (3,271) Cash flow from financing 6,100 3,702 3,798 1,139 8,337 4,856 3,395 2,218 Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 1,170 (1,160) 823 (796) (1,022) (1,291) 0 0 Free cash flow (5,485) (5,749) (2,025) 43 (8,559) (5,744) (2,967) (1,829) Source: FactSet, Daiwa forecasts

Huadian Fuxin Energy (816 HK): 21 January 2016

Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 3,690 2,968 4,153 3,243 5,145 3,733 3,861 3,985 Inventory 216 764 342 412 427 306 273 254 Accounts receivable 1,381 2,198 2,866 3,049 3,492 3,406 3,657 3,901 Other current assets 135 218 249 267 686 686 686 686 Total current assets 5,422 6,148 7,612 6,970 9,749 8,130 8,476 8,825 Fixed assets 35,967 41,699 46,639 52,265 66,074 75,870 83,837 91,146 Goodwill & intangibles 610 700 970 1,096 1,100 1,067 1,035 1,002 Other non-current assets 3,712 5,261 6,119 7,345 9,012 9,545 10,958 13,050 Total assets 45,711 53,808 61,341 67,676 85,935 94,613 104,306 114,023 Short-term debt 7,040 10,141 9,709 11,716 12,061 12,061 12,061 12,061 Accounts payable 1,377 1,000 1,172 1,777 2,915 1,711 1,526 1,420 Other current liabilities 6,300 8,033 7,887 8,323 11,602 6,955 6,244 5,833 Total current liabilities 14,717 19,174 18,767 21,816 26,579 20,727 19,831 19,314 Long-term debt 21,970 24,531 29,042 31,047 40,508 46,503 53,520 59,563 Other non-current liabilities 554 734 823 1,103 1,190 5,091 5,518 6,151 Total liabilities 37,241 44,439 48,632 53,966 68,277 72,321 78,869 85,029 Share capital 5,089 6,000 7,623 7,623 8,408 10,402 10,402 10,402 Reserves/R.E./others 1,751 1,564 2,952 3,588 6,605 8,383 10,556 12,982 Shareholders' equity 6,840 7,564 10,574 11,211 15,013 18,785 20,958 23,384 Minority interests 1,630 1,805 2,135 2,500 2,646 3,507 4,479 5,611 Total equity & liabilities 45,711 53,808 61,341 67,676 85,935 94,613 104,306 114,023 EV 37,045 42,993 45,594 50,004 57,166 64,916 71,793 77,635 Net debt/(cash) 25,320 31,704 34,597 39,520 47,424 54,831 61,721 67,640 BVPS (CNY) 1.140 1.261 1.387 1.471 1.881 1.997 2.255 2.544

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 14.3 (13.3) 56.0 16.7 4.9 4.1 7.2 6.5 EBITDA (YoY) 23.0 5.0 65.5 24.6 15.8 20.6 12.7 10.1 Operating profit (YoY) 27.3 2.4 78.8 26.4 12.4 12.5 10.7 7.3 Net profit (YoY) 35.6 8.6 93.2 34.3 27.2 12.7 21.4 12.2 Core EPS (fully-diluted) (YoY) 35.6 8.6 69.9 20.2 21.5 6.9 21.4 12.2 Gross-profit margin 41.0 45.9 51.4 55.5 58.6 67.8 71.9 74.2 EBITDA margin 36.2 43.8 46.5 49.6 54.8 63.4 66.7 68.9 Operating-profit margin 22.6 26.7 30.6 33.2 35.6 38.4 39.7 39.9 Net profit margin 6.2 7.8 9.6 11.1 13.4 14.5 16.5 17.3 ROAE 9.4 7.9 12.1 13.5 14.2 13.2 14.3 14.2 ROAA 1.3 1.1 1.9 2.3 2.4 2.3 2.6 2.6 ROCE 5.8 4.8 7.3 8.1 7.8 7.4 7.2 6.9 ROIC 5.3 4.5 6.6 6.8 6.7 6.7 6.6 6.4 Net debt to equity 370.2 419.2 327.2 352.5 315.9 291.9 294.5 289.3 Effective tax rate 16.5 12.7 16.1 22.1 19.9 13.7 11.6 11.2 Accounts receivable (days) 53.0 89.7 81.4 81.5 85.9 87.0 83.1 83.5 Current ratio (x) 0.4 0.3 0.4 0.3 0.4 0.4 0.4 0.5 Net interest cover (x) 2.0 1.6 1.8 1.9 2.1 2.2 2.0 2.1 Net dividend payout 0.0 0.0 20.2 20.8 19.6 19.3 19.4 19.3 Free cash flow yield n.a. n.a. n.a. 0.4 n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts

Company profile

Huadian Fuxin Energy Corporation Limited (Fuxin) is a diversified clean-energy company in China. It engages in the development, management and operation of hydropower and coal-fired power plants in Fujian Province, and wind power and other clean-energy projects throughout China. The company also owns a 39% stake in a 4GW nuclear-power project in Fujian.

China Utilities 21 January 2016

(1811 HK) CGN New Energy Holdings CGN New Energy Hol dings

Target price: HKD1.45 (from HKD1.45) Share price (19 Jan): HKD1.40 | Up/downside: +3.5%

More difficulties likely on planned asset injection Dennis Ip, CFA (852) 2848 4068  Poor quality of first batch of assets has hit valuations [email protected]  Direct swap involving Korea power assets could be the solution Nicole Jiang (852) 2848 4469  Maintain Hold (3) rating on uncertainty over second asset injection [email protected]

What's new: CGN New Energy (CGNNE, formerly CGN Meiya) shares Forecast revisions (%) have fallen by 50%-plus since the asset injection in June 2015, on Year to 31 Dec 15E 16E 17E concerns over the near-term profitability of the acquired wind assets, Revenue change - - - Net profit change - - - derating of the wind farm operators on deteriorating wind curtailment issues Core EPS (FD) change - - - and a potential 5-10% wind on-grid tariff cut in 2016-18E. Weak valuations Source: Daiwa forecasts argue against further injections in the near term, though we think CGNNE could consider exchanging its Korea power assets for parent CGNPC’s Share price performance clean energy assets. (HKD) (%) 3.5 145 What's the impact: In June 2015, CGNNE announced plans to acquire 2.9 126 2.3 108 wind (1,221MW) and solar power (180.8MW) assets from CGNPC. More 1.6 89 than 50% of the wind capacity is in Gansu, where the market expected 1.0 70 wind curtailment to have exceeded 40% in 2015. In response to the poor Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 quality of this injection, its forward PBR has gone from 1.8x to 0.9x. CGN New En (LHS) Relative to HSI (RHS)

Valuations raise uncertainty over end-2016E schedule for second 12-month range 1.34-3.49 injection. Since the next batch of injected assets should be priced at more Market cap (USDbn) 0.76 than 1x PBR, CGNPC may have to wait for valuations to recover before 3m avg daily turnover (USDm) 1.39 Shares outstanding (m) 4,291 proceeding. Plus, additional injections may not be value accretive if Major shareholder CGNPC (72.3%) CGNNE continues to trade at c.1.0x PBR. Financial summary (USD) Direct swap could be a solution. We believe management is considering Year to 31 Dec 15E 16E 17E a complementary equity placement to raise funds for the second injection, Revenue (m) 1,161 1,341 1,544 either to CGNPC or other strategic investors. Since a placement would Operating profit (m) 173 244 338 Net profit (m) 101 118 141 dilute the EPS enhancement from the injection, we believe it would be in Core EPS (fully-diluted) 0.023 0.028 0.033 CGNNE’s best interest to exchange its Korea power assets for the clean EPS change (%) (6.8) 17.4 19.2 energy assets of CGNPC. While this would mean the loss of earnings from Daiwa vs Cons. EPS (%) (2.3) (5.1) (3.5) PER (x) 7.6 6.5 5.5 the Korean assets, we think the financial cost savings would partly offset Dividend yield (%) 2.0 2.3 2.7 the impact. Given CGNNE’s weak PBR of 0.9x, a direct swap of the Korea DPS 0.004 0.004 0.005 assets with the wind/solar assets could be a roundabout way of achieving PBR (x) 1.0 0.9 0.8 its goal. Also, we believe a direct asset swap could keep CGNNE’s net EV/EBITDA (x) 12.4 13.3 9.3 ROE (%) 13.4 14.0 14.7 debt-to-equity ratio below the 360% threshold. Source: FactSet, Daiwa forecasts

What we recommend: We have a Hold (3) rating on CGNNE and DCF- based 12-month TP of HKD1.45, implying a 6.8x 2016E PER. The main downside risk: asset injections not following the announced schedule; the main upside risk: improvement in utilisation.

How we differ: Our 2015-17E EPS forecasts are 2.3%/5.1%/3.5% below the Bloomberg consensus, which we attribute to our lower utilisation hour estimates for the injected wind-power asset, and as we incorporate into our forecasts the impact of the KRW and CNY deprecation in 2015.

See important disclosures, including any required research certifications, beginning on page 127

CGN New Energy Holdings (1811 HK): 21 January 2016

How do we justify our view? Growth outlook Valuation Earnings revisions

Growth outlook CGNPC: available clean energy assets for injection (March 2015) We forecast CGNNE to register an 18% net profit CAGR (MW) over 2015-17E, backed by its first asset injection of 1.4GW 14,000 2,949 12,941 of renewable power assets (completed in November 2015) 12,000 2,333 and a second asset injection of 1.5GW (scheduled to be 10,000 completed by end-2016E). We believe CGNNE’s 8,000 7,659 diversified portfolio with decent profitability currently 6,000 provides steady cash flow for future acquisitions, but we 4,000 forecast its net debt to equity to rise to 360% for 2015 after 1,402 2,000 the first injection (USD1.9bn). 2,868 0 CGNNE In operation Construction Pipeline Total CGNNE targets to acquire 3-5GW of clean and renewable under CGNPC under CGNPC under CGNPC under CGNPC Wind Solar Hydro power generation assets from its parent, CGNPC, over the Source: Company next 4 years. In our model, we build in assumptions for Note: CGNPC’s assets excludes the first batch of assets for injection only the first and second round of injections. Valuation CGNNE: rolling 1-year forward PER chart

CGNNE is currently trading at a 6.5x 2016E PER, (x) representing its trough valuation, or 1.8SD below its 17 16.6x Avg+2SD historical average since listing (October 2014). 15

13.9x Avg+1SD CGNNE’s share price has retreated by 50%-plus from its 13 peak in June 2015, and is currently trading at a 0.9x 2016E 11 11.3x Avg PBR, on our forecasts. Since the next batch of injected assets should be priced at more than 1.0x PBR in order to 9 8.7x Avg-1SD avoid suggestions that state assets are being undervalued, 7 CGNPC may have to postpone the planned injection until 6.0x Avg-2SD its valuation improves. 5 Oct-14 Feb-15 Jun-15 Oct-15 Source: Bloomberg, Daiwa forecasts

Earnings revisions CGNNE: Bloomberg-consensus EPS forecasts

The Bloomberg-consensus EPS forecasts for 2015-17E (USD) have risen by 9%/11%/21% since the company announced 0.040 the asset injection plan on June 2015: 1) as some analysts’ 0.035 estimates did not factor in earnings contributions from the first and/or second asset injections, and 2) given the larger- 0.030 than-expected size of the first injection. 0.025

However, our 2015-17E EPS forecasts are 0.020 2.3%/5.1%/3.5% below the consensus numbers, likely as 0.015 we have lower utilisation hour estimates for the injected Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 wind-power asset, and as we incorporate into our forecasts 2015E EPS 2016E EPS 2017E EPS the impact of the KRW and CNY deprecation in 2015. Source: Bloomberg

CGN New Energy Holdings (1811 HK): 21 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E EOY Attributable installed clean and n.a. 944 944 1,578 1,890 1,810 1,810 1,810 renewable energy capacity (MW) EOY Attributable installed conventional n.a. 1,439 1,436 1,436 1,770 1,770 1,770 1,770 energy capacity (MW) EOY Attributable clean-energy capacity n.a. 0 0 0 0 1,402 2,902 2,902 from asset injection (MW) EOY Attributable installed capacity n.a. 2,383 2,380 3,014 3,660 4,981 6,481 6,481 (MW)

Profit and loss (USDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Retained business n.a. 755 932 1,037 1,370 1,134 1,174 1,172 Asset injection n.a. 0 0 0 0 27 166 372 Other Revenue n.a. 0 0 0 0 0 (0) 0 Total Revenue n.a. 755 932 1,037 1,370 1,161 1,341 1,544 Other income n.a. 6 11 9 9 3 3 4 COGS n.a. (548) (706) (759) (1,014) (985) (1,043) (1,046) SG&A n.a. (34) (39) (43) (59) (40) (50) (62) Other op.expenses n.a. (95) (108) (120) (147) 34 (7) (101) Operating profit n.a. 84 91 124 159 173 244 338 Net-interest inc./(exp.) n.a. (41) (38) (48) (60) (91) (145) (202) Assoc/forex/extraord./others n.a. (10) 12 33 38 60 67 67 Pre-tax profit n.a. 33 65 110 138 143 166 203 Tax n.a. (14) (27) (40) (37) (23) (26) (35) Min. int./pref. div./others n.a. (8) (9) (14) (16) (19) (22) (27) Net profit (reported) n.a. 11 29 55 85 101 118 141 Net profit (adjusted) n.a. 11 29 55 85 101 118 141 EPS (reported)(USD) n.a. 0.004 0.009 0.018 0.025 0.023 0.028 0.033 EPS (adjusted)(USD) n.a. 0.004 0.009 0.018 0.025 0.023 0.028 0.033 EPS (adjusted fully-diluted)(USD) n.a. 0.004 0.009 0.018 0.025 0.023 0.028 0.033 DPS (USD) n.a. 0.000 0.000 0.000 0.000 0.004 0.004 0.005 EBIT n.a. 84 91 124 159 173 244 338 EBITDA n.a. 139 150 193 253 289 407 553

Cash flow (USDm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax n.a. 33 65 110 138 143 166 203 Depreciation and amortisation n.a. 54 59 69 93 116 163 215 Tax paid n.a. (14) (27) (40) (37) (23) (26) (35) Change in working capital n.a. 0 (161) (45) 97 19 (11) (24) Other operational CF items n.a. 12 209 92 (84) 95 149 208 Cash flow from operations n.a. 85 145 185 207 349 442 567 Capex n.a. 0 (491) (331) (195) (46) (54) (46) Net (acquisitions)/disposals n.a. 0 (12) (43) 6 (1,952) (2,024) 0 Other investing CF items n.a. (140) (69) 88 (63) 0 0 0 Cash flow from investing n.a. (140) (572) (286) (252) (1,999) (2,077) (46) Change in debt n.a. 0 486 356 (265) 1,700 1,769 (45) Net share issues/(repurchases) n.a. 0 0 0 262 0 0 0 Dividends paid n.a. 0 0 0 0 (15) (18) (21) Other financing CF items n.a. 79 (89) (522) 177 (95) (149) (208) Cash flow from financing n.a. 79 397 182 174 1,590 1,602 (274) Forex effect/others n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Change in cash n.a. 24 (30) 81 129 (59) (33) 246 Free cash flow n.a. 85 (358) (189) 18 (1,649) (1,635) 521 Source: FactSet, Daiwa forecasts

CGN New Energy Holdings (1811 HK): 21 January 2016

Financial summary continued … Balance sheet (USDm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment n.a. 113 84 168 285 225 192 439 Inventory n.a. 29 26 28 31 30 32 31 Accounts receivable n.a. 132 126 97 158 134 155 178 Other current assets n.a. 245 495 415 314 313 314 315 Total current assets n.a. 519 730 708 787 702 692 963 Fixed assets n.a. 751 1,183 1,445 1,483 3,366 5,281 5,112 Goodwill & intangibles n.a. 0 0 0 0 0 0 0 Other non-current assets n.a. 163 171 219 216 216 216 216 Total assets n.a. 1,433 2,084 2,373 2,487 4,284 6,189 6,291 Short-term debt n.a. 49 126 28 203 527 865 856 Accounts payable n.a. 106 129 105 157 152 161 160 Other current liabilities n.a. 150 207 79 86 83 87 88 Total current liabilities n.a. 305 462 212 445 762 1,113 1,105 Long-term debt n.a. 764 1,172 1,385 1,187 2,563 3,994 3,958 Other non-current liabilities n.a. 30 32 283 38 38 38 38 Total liabilities n.a. 1,099 1,666 1,879 1,671 3,363 5,145 5,101 Share capital n.a. 0 0 0 0 0 0 0 Reserves/R.E./others n.a. 240 311 387 709 0 0 0 Shareholders' equity n.a. 240 312 387 709 795 895 1,015 Minority interests n.a. 94 107 107 107 126 149 176 Total equity & liabilities n.a. 1,433 2,084 2,373 2,487 4,284 6,189 6,291 EV n.a. 1,442 1,959 1,945 1,812 3,591 5,415 5,151 Net debt/(cash) n.a. 700 1,215 1,245 1,105 2,865 4,667 4,375 BVPS (USD) n.a. 0.077 0.100 0.125 0.165 0.185 0.209 0.236

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) n.a. n.a. 23.5 11.3 32.1 (15.3) 15.5 15.1 EBITDA (YoY) n.a. n.a. 8.0 28.5 31.1 14.2 41.1 35.8 Operating profit (YoY) n.a. n.a. 7.7 36.4 28.3 8.6 41.3 38.3 Net profit (YoY) n.a. n.a. 156.6 90.6 54.1 18.1 17.4 19.2 Core EPS (fully-diluted) (YoY) n.a. n.a. 156.6 90.6 41.2 (6.8) 17.4 19.2 Gross-profit margin n.a. 27.4 24.3 26.8 26.0 15.2 22.2 32.2 EBITDA margin n.a. 18.4 16.1 18.6 18.4 24.9 30.4 35.8 Operating-profit margin n.a. 11.2 9.8 12.0 11.6 14.9 18.2 21.9 Net profit margin n.a. 1.5 3.1 5.3 6.2 8.7 8.8 9.1 ROAE n.a. 9.4 10.5 15.8 15.5 13.4 14.0 14.7 ROAA n.a. 1.6 1.6 2.5 3.5 3.0 2.3 2.3 ROCE n.a. 14.7 6.4 6.9 7.7 5.6 4.9 5.7 ROIC n.a. 5.2 3.4 3.3 4.4 4.4 3.8 4.4 Net debt to equity n.a. 291.1 389.9 321.4 155.8 360.5 521.5 431.2 Effective tax rate n.a. 36.4 49.6 55.5 50.0 28.0 26.0 26.0 Accounts receivable (days) n.a. 32.0 50.5 39.2 34.0 45.9 39.3 39.3 Current ratio (x) n.a. 1.7 1.6 3.3 1.8 0.9 0.6 0.9 Net interest cover (x) n.a. 2.0 2.4 2.6 2.7 1.9 1.7 1.7 Net dividend payout n.a. 0.0 0.0 0.0 0.0 15.0 15.0 15.0 Free cash flow yield n.a. 11.1 n.a. n.a. 2.4 n.a. n.a. 67.8 Source: FactSet, Daiwa forecasts

Company profile

CGN New Energy (CGNNE), established in 1995, is a diversified Asia IPP investor in terms of fuel type and geography. Positioned as CGN’s sole global platform for clean and renewable power, CGNNE targets to selectively acquire 3-5GW (1.4GW acquired in 2015) clean and renewable power generation assets from CGN in 2015-18.

China Utilities 21 January 2016

(956 HK) China Suntien Green Energy China Sunti en Gr een Energ y

Target price: HKD1.10 (from HKD1.65) Share price (19 Jan): HKD1.07 | Up/downside: +2.8%

Value play or value trap? Scott Chui (852) 2848 4443  Wind capacity expansion on track, with utilisation set to improve [email protected]  Natural-gas sales likely to continue to struggle on weak glass industry Dennis Ip, CFA (852) 2848 4068  Cheap valuation comes with higher risks; maintain Hold (3) [email protected]

What's new: After declining by 30% since mid-October, in line with the sell- Forecast revisions (%) off in the rest of the wind sector, Suntien is now trading at an 0.4x 2016E Year to 31 Dec 15E 16E 17E PBR, a past 5-year trough. Nevertheless, we see a balanced risk-reward Revenue change (12.9) (23.6) (24.5) profile as any fundamental improvement in the utilisation hours for its wind Net profit change (7.3) (14.0) (26.8) Core EPS (FD) change (7.3) (14.0) (26.8) business would likely be offset by prolonged challenges for its natural-gas Source: Daiwa forecasts business. This note marks a transfer of analyst coverage.

Share price performance What's the impact: Suntien’s high geographical concentration in Hebei (HKD) (%) Province is a double-edged sword for its business: while the company’s 2.3 110 wind curtailment eased in 1H15 due to improving grid connections in Hebei 1.9 99 when the national average deteriorated, its gas business suffered the most 1.6 88 in 1H15 among the gas distributors due to its heavy exposure to industrial 1.3 76 1.0 65 users, or more specifically, glass manufacturers in Shahe County. Jan-15 Apr-15 Jul-15 Oct-15 Jan-16

Ch Suntien (LHS) Relative to HSI (RHS) Wind farms less exposed to heavily curtailed regions. Given that 90% of Suntien’s operating wind farms are in Hebei, the company has effectively avoided rapidly worsening curtailment issues in northwest China (where the 12-month range 1.07-2.21 Market cap (USDbn) 0.50 curtailment rate dropped to 9.7% in 1H15 from 12% in 2014, while the 3m avg daily turnover (USDm) 0.66 national average rose to 15.2% from 8%). Referring to the company’s Shares outstanding (m) 3,679 project pipeline, we expect it to maintain its geographical concentration in Major shareholder Hebei Const & Inv (50.5%) Hebei for the next 2-3 years, suggesting more steady profitability than its peers on: 1) less severe grid congestion problems in Hebei, and 2) its wind Financial summary (CNY) farms’ proximity to Beijing and Tianjin. Year to 31 Dec 15E 16E 17E Revenue (m) 4,355 4,331 4,852 Operating profit (m) 886 1,149 1,345 Natural-gas business woes. Following the c.55% gas sales volume Net profit (m) 343 371 443 decline in 2015E, a meaningful pick-up in sales volume in 2016 looks Core EPS (fully-diluted) 0.092 0.100 0.119 unlikely, curbed by Suntien’s 50% demand exposure to the glass- EPS change (%) (7.4) 8.2 19.5 Daiwa vs Cons. EPS (%) (16.1) (26.1) (26.8) manufacturing city of Shahe in 2015 (the glass industry is still consolidating PER (x) 9.8 9.0 7.5 amid overcapacity). Suntien needs new customers to revitalise its retail Dividend yield (%) 2.5 3.8 4.6 business, but its remaining projects are mostly greenfield or at the county DPS 0.022 0.034 0.041 level, with limited near-term profit contributions. In addition, we forecast a PBR (x) 0.4 0.4 0.4 EV/EBITDA (x) 8.8 8.9 8.8 bad debt provision of ~CNY100m (or net profit of CNY243m incl. ROE (%) 4.6 4.9 5.6 provisions) on slower-than-expected cash collection. Source: FactSet, Daiwa forecasts

What we recommend: We maintain our Hold (3) rating and cut our SOTP- based 12-month TP to HKD1.10 from HKD1.65. We cut our earnings forecasts by 7-26% over 2015-17, reflecting our expectation of prolonged weakness in Suntien’s retail gas sales. While we see limited downside for Suntien’s share price at the current valuation, we think the stock lacks rerating catalysts. We also see a likely 2015 earnings disappointment as a near-term overhang, and as such would stay on the sidelines for now.

How we differ: Our 2016-17E EPS are about 26% below consensus, as we are more conservative on Suntien’s gas volume recovery in 2016-17.

See important disclosures, including any required research certifications, beginning on page 127

China Suntien Green Energy (956 HK): 21 January 2016

How do we justify our view?

Growth outlook Valuation Earnings revisions

Growth outlook Suntien: gross profit by segment outlook Impaired by weak industrial demand in China, Suntien’s (CNYm) natural-gas business profit is likely to remain largely flat 1,800 50% 1,600 over the next couple of years despite its expanded pipeline 40% 1,400 30% coverage in Central Hebei. 1,200 1,000 20% We see brighter prospects for the company’s wind power 800 10% 600 business, and forecast a 19% installed capacity CAGR 0% over 2015-17, as well as a slight improvement in utilisation 400 200 (10%) to ~2,000 hours from 1,900 for the next 2 years as wind 0 (20%) resources normalise, while wind curtailment might edge up 2011 2012 2013 2014 2015E 2016E 2017E by 1-2pp due to limited transmission capacity. All in all, we Natural gas Wind and solar power YoY growth - RHS look for improving profitability for Suntien’s wind farms, with Source: Company, Daiwa forecasts its wind gross margin rising by 1pp per year for 2016-17E.

Valuation Suntien: 1-year forward PER We see value emerging after the recent sell-off, as the (x) 30 stock has fallen to a 9.0x 2016E PER and 0.4x 2016E 28.5x Avg+2SD PBR, both at past 5-year trough valuations. As we see it, 25 the stock does not look especially appealing vis-à-vis its 21.9x Avg+1SD 20 wind and gas peers, in terms of both PBR vs. ROE and PER vs. EPS CAGR. 15 15.3 Avg 10 8.7x Avg-1SD As such, we look for a mean reversion only if: 1) Suntien’s 5 natural-gas business earnings bottom out, which we expect 2.1x Avg-2SD to occur at least by 2017, and 2) the stock market becomes 0

more rational. Jul-12

Oct-10 Apr-14

Jun-15

Feb-13

Nov-14 Dec-11 Sep-13 May-11 Source: Company, Daiwa forecasts

Earnings revisions Suntien: Bloomberg consensus earnings revisions The Bloomberg-consensus EPS forecasts for 2015-17 (CNY) have experienced a sustained decline since the beginning 0.20 of 2015, which we attribute to: 1) disappointing natural-gas 0.18 sales, and 2) worries about intensifying wind curtailment 0.16 issues in China. From September, we note a more stable consensus revisions trend, as most of the bad news seems 0.14 to have come out already. Having said that, our 2015-17 0.12 EPS forecasts are still 16-27% below consensus, as we 0.10 expect a bad debt provision of CNY100m (~24% of Suntien 0.08 net profit) for 2015, and slower gas volume recovery for Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 2016-17. 2015E EPS 2016E EPS 2017E EPS

Source: Bloomberg

China Suntien Green Energy (956 HK): 21 January 2016

Financial summary Key assumptions Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Natural gas sales volume (mn m3) 935 1,213 1,246 1,484 1,523 1,130 1,185 1,279 Wholesales gas proportion (%) 68 61 56 51 55 70 71 70 Gas ASP, excl tax (CNY/m3) 1.79 1.93 1.97 2.16 2.44 2.29 2.07 2.07 Gas cost, excl tax (CNY/m3) 1.43 1.57 1.50 1.68 2.00 2.03 1.60 1.60 Consolidated installed wind power 855 1,201 1,346 1,445 1,697 2,079 2,479 2,929 capacity (MW) Wind utilisation (hours) 0 2,048 2,290 2,312 1,996 1,900 2,002 1,980

Profit and loss (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Natural gas 1,726 2,405 2,569 3,327 3,903 2,952 2,541 2,725 Wind power 516 765 1,133 1,333 1,246 1,403 1,790 2,127 Other Revenue 0 0 0 0 0 (0) 0 0 Total Revenue 2,242 3,170 3,702 4,661 5,149 4,355 4,331 4,852 Other income 84 135 78 31 56 64 44 44 COGS (1,581) (2,257) (2,464) (3,202) (3,854) (3,171) (2,941) (3,238) SG&A (101) (153) (195) (240) (256) (257) (281) (309) Other op.expenses (38) (22) (54) (34) (4) (104) (4) (4) Operating profit 607 873 1,067 1,216 1,093 886 1,149 1,345 Net-interest inc./(exp.) (168) (245) (354) (424) (487) (589) (684) (785) Assoc/forex/extraord./others 50 73 90 40 69 69 84 85 Pre-tax profit 489 701 803 832 675 366 549 645 Tax (58) (82) (7) (158) (176) (54) (84) (103) Min. int./pref. div./others (152) (170) (246) (215) (163) (69) (94) (98) Net profit (reported) 279 449 550 460 335 243 371 443 Net profit (adjusted) 279 449 550 460 366 343 371 443 EPS (reported)(CNY) 0.124 0.139 0.170 0.142 0.091 0.065 0.100 0.119 EPS (adjusted)(CNY) 0.124 0.139 0.170 0.142 0.100 0.092 0.100 0.119 EPS (adjusted fully-diluted)(CNY) 0.124 0.139 0.170 0.142 0.100 0.092 0.100 0.119 DPS (CNY) 0.045 0.058 0.020 0.053 0.031 0.022 0.034 0.041 EBIT 607 873 1,067 1,216 1,093 986 1,149 1,345 EBITDA 844 1,243 1,535 1,767 1,690 1,692 2,011 2,381

Cash flow (CNYm) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Profit before tax 489 701 803 832 675 366 549 645 Depreciation and amortisation 237 370 468 550 598 706 862 1,036 Tax paid (58) (82) (7) (158) (176) (54) (84) (103) Change in working capital 153 (331) (618) 205 (197) (71) (60) (88) Other operational CF items (167) 209 584 167 (13) 520 600 700 Cash flow from operations 654 866 1,230 1,597 885 1,467 1,867 2,190 Capex (1,918) (3,172) (1,413) (1,536) (2,446) (3,680) (3,970) (4,150) Net (acquisitions)/disposals (1) (2) (1) (2) (3) 0 0 0 Other investing CF items (1,542) (703) 86 268 116 40 40 40 Cash flow from investing (3,461) (3,877) (1,329) (1,270) (2,333) (3,640) (3,930) (4,110) Change in debt 2,002 1,645 694 1,398 2,067 2,075 2,979 2,984 Net share issues/(repurchases) 2,722 0 0 0 1,256 0 0 0 Dividends paid (245) (146) (272) (94) (248) (152) (232) (278) Other financing CF items 504 (232) (427) (576) (465) (589) (684) (785) Cash flow from financing 4,982 1,267 (5) 728 2,610 1,334 2,063 1,921 Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 2,176 (1,743) (104) 1,055 1,162 (839) 0 0 Free cash flow (1,263) (2,306) (183) 61 (1,561) (2,213) (2,103) (1,960) Source: FactSet, Daiwa forecasts

China Suntien Green Energy (956 HK): 21 January 2016

Financial summary continued … Balance sheet (CNYm) As at 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Cash & short-term investment 2,475 920 758 1,670 3,198 2,000 2,000 2,000 Inventory 25 25 30 43 43 58 50 51 Accounts receivable 189 396 843 846 1,402 1,562 1,428 1,509 Other current assets 222 622 601 565 689 1,013 654 858 Total current assets 2,911 1,962 2,231 3,123 5,331 4,633 4,132 4,418 Fixed assets 6,079 7,713 8,602 10,180 11,731 14,817 18,030 21,245 Goodwill & intangibles 1,423 2,458 2,357 2,256 2,198 2,172 2,068 1,969 Other non-current assets 1,298 1,925 2,072 1,855 2,350 2,409 2,927 3,004 Total assets 11,712 14,059 15,263 17,414 21,610 24,031 27,157 30,637 Short-term debt 1,443 636 971 1,359 1,730 1,730 1,730 1,730 Accounts payable 326 125 197 224 437 481 419 423 Other current liabilities 927 1,062 928 1,162 1,364 1,376 1,197 1,211 Total current liabilities 2,696 1,824 2,096 2,744 3,531 3,587 3,346 3,364 Long-term debt 3,576 6,114 6,529 7,545 9,296 11,371 14,351 17,334 Other non-current liabilities 1 26 15 19 21 113 121 185 Total liabilities 6,274 7,964 8,640 10,307 12,848 15,072 17,817 20,883 Share capital 3,238 3,238 3,238 3,238 3,715 3,715 3,715 3,715 Reserves/R.E./others 1,572 1,967 2,329 2,727 3,644 3,772 4,059 4,375 Shareholders' equity 4,811 5,206 5,568 5,966 7,360 7,487 7,774 8,090 Minority interests 628 889 1,055 1,141 1,403 1,472 1,566 1,664 Total equity & liabilities 11,712 14,059 15,263 17,414 21,610 24,031 27,157 30,637 EV 6,135 9,648 10,696 11,312 11,619 14,892 17,881 20,878 Net debt/(cash) 2,544 5,831 6,742 7,234 7,828 11,101 14,081 17,064 BVPS (CNY) 2.133 1.608 1.719 1.842 2.001 2.035 2.113 2.199

Key ratios (%) Year to 31 Dec 2010 2011 2012 2013 2014 2015E 2016E 2017E Sales (YoY) 47.8 41.4 16.8 25.9 10.5 (15.4) (0.6) 12.0 EBITDA (YoY) 50.9 47.3 23.5 15.1 (4.3) 0.1 18.9 18.4 Operating profit (YoY) 48.9 43.8 22.2 14.0 (10.2) (9.7) 16.5 17.1 Net profit (YoY) 68.2 60.8 22.5 (16.4) (20.3) (6.4) 8.2 19.5 Core EPS (fully-diluted) (YoY) 48.8 12.0 22.5 (16.4) (29.8) (7.4) 8.2 19.5 Gross-profit margin 29.5 28.8 33.5 31.3 25.2 27.2 32.1 33.3 EBITDA margin 37.6 39.2 41.5 37.9 32.8 38.9 46.4 49.1 Operating-profit margin 27.1 27.5 28.8 26.1 21.2 22.6 26.5 27.7 Net profit margin 12.5 14.2 14.8 9.9 7.1 7.9 8.6 9.1 ROAE 9.1 9.0 10.2 8.0 5.5 4.6 4.9 5.6 ROAA 3.2 3.5 3.7 2.8 1.9 1.5 1.4 1.5 ROCE 7.9 7.5 7.9 8.1 6.1 4.7 4.8 5.0 ROIC 8.5 7.7 8.4 7.1 5.2 4.1 4.5 4.5 Net debt to equity 52.9 112.0 121.1 121.3 106.4 148.3 181.1 210.9 Effective tax rate 11.9 11.7 0.9 18.9 26.1 14.8 15.3 16.0 Accounts receivable (days) 22.3 33.7 61.1 66.1 79.6 124.2 126.0 110.5 Current ratio (x) 1.1 1.1 1.1 1.1 1.5 1.3 1.2 1.3 Net interest cover (x) 3.6 3.6 3.0 2.9 2.2 1.7 1.7 1.7 Net dividend payout 36.1 41.8 11.8 37.2 34.4 34.4 34.5 34.5 Free cash flow yield n.a. n.a. n.a. 1.8 n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts

Company profile

China Suntien Green Energy is a clean-energy enterprise controlled by the Hebei Construction & Investment Group. Its main businesses include the investment, construction and operation of wind farms, as well as the transmission and distribution of natural gas and compressed natural gas (CNG).

China Suntien Green Energy (956 HK): 21 January 2016

Value play or value trap?

We see a balanced risk- After declining by 30% since the middle of October on the heels of the sell-off in the wind reward profile for sector, Suntien stock is now trading at a 0.4x 2016E PBR, a past-5-year trough. With that Suntien despite the 30% said, we see a balanced risk-reward profile as any fundamental improvement in its wind drop in share price business would likely be offset by what we see as prolonged challenges for its natural-gas business.

We are 16% below We also believe the Bloomberg consensus has yet to factor in poor wind resources in consensus for 2015E, or November and December 2015, as well as Suntien’s bad debt provision for 2015, which 41% taking into account we estimate could amount to CNY100m, or 25% of its net profit for 2015. As such, we see AR provisions an overhang for Suntien’s share price as its earnings for 2015 might miss the consensus forecasts. Our 2015E earnings are 16% below consensus on a recurring basis, or 41% below including the accounts receivable provisions.

Wind: capacity-based growth still robust Further relief of wind Suntien’s wind-power business has experienced improving fundamentals over the past few curtailment in Hebei years, thanks to the improving grid infrastructure in Hebei Province as characterised by the looks limited “Three Transformer Substations, Four Transmission Lines” project in Zhangjiakou. With the wind-curtailment rate dropping to 8% in 2015E, however, we believe further relief of wind curtailment will be limited in the near future, due mainly to: 1) the still limited transmission capacity to send wind power from remote areas to Beijing and Tianjin, 2) aggressive wind power deployment in Hebei ahead of tariff cuts, with substantial approved wind capacities. That said, given the low-base wind utilisation rate in 2015E, we still look for a mild 2-3% utilisation improvement over the next few years.

On the capacity side, Suntien added total capacity of 393MW in 2015, which comprised 382MW of wind farms and 11MW of solar projects. As at end-2015E, the company had total wind installed capacity of 2.1GW. Looking ahead, Suntien’s strong order backlog of ~1.4GW approved projects should facilitate capacity growth over next 2-3 years.

Suntien: installed capacity Suntien: wind utilisation (MW) (hours) 3,500 45% 2,400 15% 40% 2,300 3,000 10% 35% 2,500 2,200 30% 5% 2,100 2,000 25% 2,000 0% 1,500 20% 1,900 15% -5% 1,000 10% 1,800 -10% 500 5% 1,700 0 0% 1,600 -15% 2011 2012 2013 2014 2015E 2016E 2017E 2011 2012 2013 2014 2015E 2016E 2017E Installed capacity (MW) YoY growth - RHS Utilisation YoY change - RHS

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

Geographical concentration in Hebei Province As opposed to other wind-farm operators with over 50% of wind projects located in northwest China, 88% of Suntien’s operating wind farms were located in Hebei as at end- 2015E.

China Suntien Green Energy (956 HK): 21 January 2016

Suntien: wind installed capacity by location (end-2015E) Suntien: proportion of wind installed capacity by location Xinjiang 100MW 100% 7% 7% 9% 12%

Shanxi 149MW 80%

60%

Hebei, within 93% 93% 91% 88% Zhangjiakou 40% 1,002MW Hebei, outside Zhangjiakou 20% 828MW 0% 2012 2013 2014 2015E Within Hebei Outside Hebei

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

Suntien’s wind business Referring to the company’s project pipeline shown below, which shows 89% of its 1.4GW has a high geographical of pipeline projects are still located within Hebei Province, we expect its geographical concentration in Hebei concentration to remain at over 85% for the next 2-3 years.

We believe this high location concentration helped Suntien dodge the rapidly worsening curtailment issues in northwest China during 2015 (when the curtailment rate dropped to 9.7% in 1H15, from 10.3% in 2014, while the national average increased to 15.2% in 1H15 from 8% in 2014), and therefore the company was able to maintain a relatively lower curtailment rate last year than its wind IPP peers. According to management’s preliminary statistics, Suntien’s curtailment rate dropped to 8% in 2015, while we estimate the national average probably worsened over the same period given the deteriorating grid congestion in the northwest provinces (refer to the below curtailment rate chart).

Suntien: curtailment rate Suntien: geographical distribution of pipeline projects 18% Inner Mongolia Shangdong 3% 16% 4% 14% Guangxi 4% 12% 10% 8% 6% 4% 2% Hebei 89% 0% 2011 2012 2013 2014 2015E Suntien Hebei average National average

Source: NEA, Company, Daiwa forecasts Source: Company, Daiwa forecasts

Proximity to Beijing and Tianjin guarantees strong electricity demand Another apparent advantage of developing wind projects in Hebei is proximity to power demand centres such as Beijing and Tianjin, suggesting that electricity produced by clean energy sources could be well absorbed. Second, the heavy air pollution in the Beijing- Tianjin-Hebei regions has prompted the government to support clean energy development within these regions, including stringent control over clean energy dispatch, more ambitious renewable energy targets, etc.

Wind curtailment may rebound over 2016-17, due to rising wind curtailment in Zhangjiakou Power transmission Notwithstanding the above benefits of Suntien focusing its wind project development in bottlenecking may Hebei, we expect the company’s average wind curtailment to rebound slightly to 9%/10% intensify in Zhangjiakou in 2016-17, from 8% in 2015, due mainly to the intensifying transmission bottlenecking in in 2016-17 Zhangjiakou region. That said, as the company is diversifying its wind projects outside Zhangjiakou, with no new wind farms being constructed within the region, we look for its exposure to Zhangjiakou to decline from 48% as of end-2015, to 34% as of 2017.

China Suntien Green Energy (956 HK): 21 January 2016

Also, considering that the company, along with all other wind-farm operators in China, went through 2 years of poor wind resources in 2014 and 2015, Suntien’s utilisation level is currently sitting at a very low base, ie, 2,200/2,065 full-load utilisation (theoretical utilisation rate barring the electricity output being curtailed) in Hebei Province, we still foresee slightly higher utilisation hours for 2016-17, at 2,002 and 1,980 hours, respectively, compared with 1,900 hours in 2015, despite a modestly rebounding curtailment rate.

“Three Transformer Substations, Four Transmission Lines” project The high curtailment in Hebei Province in past years was due mainly to the lagged grid infrastructure construction as compared to the construction pace of the province’s wind- farm projects in Zhangjiakou, which limited the transmission capacity of its wind farms to the Hebei Grid. According to the China Electricity Council (CEC), Zhangjiakou’s grid- connected wind-power capacity was 5.8GW at end-2014, while there were only 2 x 500kV transmission lines providing ~3GW of transmission capacity from Zhangjiakou to the Hebei Grid, resulting in the severe wind curtailment in the region.

“Three Transformer We started to see substantial easing of grid curtailment issues following the completion of Substations, Four the “Three Transformer Substations, Four Transmission Lines” project in April 2015. The Transmission Lines” project included the construction of 3 x 500kV transformer substations in Zhangbei, project” was the main Shangyi and Kangbao, as well as 4 comprehensive 500kV transmission lines including the driver for the reduced Kangbao-Zhangbei line, Shangyi-Zhangbei line, and 2 x Zhangbei to Zhangnan lines. The wind curtailment in contribution of this project was apparent in 2015, as it provided the third transmission route Hebei during 2014-15 for Zhangbei’s wind projects, in addition to the existing 2 transmission lines in Guyuan and Wanquan. This new project, according to the State Grid, should add an additional 1.55GW of transmission capacity for Zhangjiakou’s wind power (or support 2.2GW of wind projects assuming 70% efficiency).

To our knowledge, 2 more 500kV transmission projects are currently in the preparatory stage, ie, the Zhangnan-Changping project and the Beijing Fangshan-Tianjin Nancai project, as part of the Beijing-Tianjin-Hebei grid integration plan. In addition, the UHV line linking Zhangbei and Nanchang, which we expect to be completed by 2018, should add ~3GW of wind transmission capacity, by when we expect the transmission bottleneck in Zhangjiakou to be largely resolved.

“Three Transformer Substations, Four Transmission Lines” and Zhangbei-Nanchang UHV line

Kangbao Zhangjiakou 500kV Three-Substation-Four-Line Zhangnan- Changping 500kV

Baituyao Fangshan- Nancai 500kV Zhangjiakou – Nanchang 1,000kV AC UHV UHV aggregation station Zhangbei Beijing 500kV city grid Shangyi Zhangjiakou

Beijing Changping

Zhangnan Tangshan

Fangshan Nancai

Tianjin To Nanchang, Jiangxi To

Source: Daiwa

China Suntien Green Energy (956 HK): 21 January 2016

Zhangjiakou’s transmission bottlenecking could emerge again To quantify the benefits of the “Three Transformer Substations, Four Transmission Lines” project, we compare Zhangjiakou’s transmission capacity versus its wind installed capacity. Referring to the chart below, the blue triangular points represent the wind capacity in Zhangjiakou, whereas the area chart in grey represents the wind absorption ability (domestic consumption plus transmission capacity). The orange line shows the surplus wind capacity that cannot be absorbed by the current infrastructure.

Gap between wind The gap between wind capacity and wind absorption ability significantly narrowed in 2015, capacity and thanks to “Three Transformer Substations, Four Transmission Lines” providing additional transmission capacity is transmission capacity to Zhangjiakou. This also pulled the surplus wind capacity to 26%, set to enlarge until UHV from over 80% in 2014 according to our calculation. This result coincides with the situation lines are built of Suntien’s wind farms in Zhangbei. According to the company, its 3 wind farms located in Zhangei, with an installed capacity of 300MW, were only allowed a maximum output of 90MW in 2014 (~70% curtailment), which was lifted to 150MW (~50% curtailment) after the project is completed.

Zhangjiakou: transmission capacity vs. grid-connected wind capacity (GW) 12 100%

10 80%

8 60%

6 40%

4 20%

2 0%

0 -20% 2011 2012 2013 2014 2015E 2016E 2017E 2018E Transmission capacity (GW) Domestic wind absorption (GW) Grid-connected capacity (GW) % wind to transmission surplus Source: Hebei Government, Daiwa forecasts

So is this pointing to a bright future for 2016-17? We doubt it. Referring to the above chart, we expect little improvement in either Zhangjiakou’s power demand or its grid infrastructure over the next 2 years, based on the lack of new transmission lines to be completed during this period. On the other hand, the city still has an aggressive capacity expansion plan until 2020, with Zhangjiakou’s wind power set to reach 13GW by 2020, from 6.6GW in 2014, representing an annual growth rate of 12%. Even if we conservatively assume a capacity growth rate of 10%, we still forecast the transmission surplus to climb to 44% by 2017, reflecting a possible increase in wind curtailment in the region over 2016-17.

We expect Zhangjiakou’s transmission capacity to witness some meaningful improvement until 2018, but such an improvement will largely depend on the timely completion of the 1,000kV AC UHV transmission Line from Zhangbei to Nanchang (Jiangxi Province).

Strong wind project backlog to support rapid capacity growth Suntien’s wind capacity Suntien has abundant approved pipeline projects for its development over the next 2-3 growth is slated to years, with total approved capacity reaching 1.6GW as of June 2015, or 93% of its accelerate on its 1.4GW installed capacity at 1.7GW by then. Comparing this ratio with that for its peers, which approved capacity mainly ranges from 21-70%, Suntien would see the highest growth rate over the next few years should all the approved projects be completed. Suntien’s approved projects dropped to 1.4GW at end-2015, or 67% of its installed capacity at end-2015. We believe the slight decline was normal as wind-farm completions are usually concentrated in 4Q, and even considering this, the ratio of 67% was still at the top end among its peers.

Next, we compare Suntien’s 2016 capacity addition target of 400-500MW with its approved projects of 1.6GW at June 2015, which shows a healthy capacity addition coverage of 3.5x (or 3.1x for Suntien’s year-end approved capacity of 1.4GW). This coverage ratio tells us

China Suntien Green Energy (956 HK): 21 January 2016

that even if only 1 out of 3.5 projects were able to be completed by end-2016, Suntien would still be able to achieve the midpoint of its 2016 capacity addition target of 450MW. Again, this coverage ratio of 3.5x is the highest among its peers, whose ratios range between 1.4x and 5.5x.

Suntien: approved wind projects versus peers (1H15) Suntien: % of 2016 capacity additions covered by approvals (MW) (MW) 16,000 100% 7,000 6.0 14,000 6,000 5.0 80% 12,000 5,000 4.0 10,000 60% 4,000 3.0 8,000 3,000 40% 2.0 6,000 2,000 4,000 20% 1,000 1.0 2,000 0 - 0 0% Suntien Longyuan Huaneng RE Datang RE Fuxin Suntien Longyuan Huaneng RE Datang RE Fuxin Approved projects 2016 capacity additions target Approved projects Installed capacity % of approved projects - RHS Capacity additions coverage - RHS

Source: Companies, Daiwa Source: Companies, Daiwa

Suntien’s 400-500 p.a. With the above analysis, and coupled with the fact that 89% of Suntien’s pipeline projects capacity addition target are located in Hebei where the company has much experience and strong relationships, looks achievable we are comfortable with the company achieving its 2016 or even 2017 capacity addition targets of 400-500MW.

With respect to longer-term development, Suntien has ample resources of wind-farm reserves, just as other wind-farm developers in China. As at end-2015, the company had over 21GW of wind-farm reserves, more than 10x its installed capacity of 2.1GW.

Natural-gas business: the pain is not over yet Suntien’s late entry into In contrast to other listed gas distributors which usually have diversified footprints across the downstream gas China, Suntien’s natural-gas business is concentrated only in Hebei Province. The market led to its company originated its natural-gas business by operating a mid-stream natural-gas difficulty in acquiring transmission pipeline, and later on developed city gas projects along the cities its pipeline quality city gas projects covered. Being the latecomer in downstream gas distribution, the company was unable to bid for quality city gas projects except for a few, such as Shahe.

Reliance on glass Against this backdrop, Suntien’s development in the retail gas market (downstream gas manufacturers still high, distribution) has been slow, with Shahe the only project contributing to meaningful volume with 50% of retail gas or gross profit within the retail segment. This, however, has caused a substantially high demand coming from geographical exposure of its retail segment in Shahe (the project accounted for over 80% Shahe in 2015E of Suntien’s retail sales in 2014, and 50% in 2015E due to a drastic volume decline). Furthermore, Shahe’s singular industry focus on glass manufacturing induced an abrupt decline in gas demand in 2015E, following the industry entering a consolidation stage amid overcapacity and poor construction demand.

As such, while the wholesale gas business (midstream natural-gas transmission) should continue to post stable growth in the future, Suntien’s retail segment, which we estimate to account for 61%/36% of the company’s gas sales gross profit in 2014/15, looks likely to witness another difficult year in 2016.

China Suntien Green Energy (956 HK): 21 January 2016

Suntien: natural-gas sales volume Suntien: gross profit trend by customer segment (mn m3) (CNYm) 1,600 15% 800 40% 1,400 700 30% 10% 1,200 600 20% 1,000 500 5% 10% 800 400 0% 600 0% 300 400 200 -10% -5% 200 100 -20% 0 -10% 0 -30% 2012 2013 2014 2015E 2016E 2017E 2012 2013 2014 2015E 2016E 2017E Wholesales Retail CNG YoY growth - RHS Wholesales Retail CNG YoY growth - RHS

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

Glass industry consolidation ongoing Gas demand from glass Given that the glass industry is still in a consolidation stage amid overcapacity and the produce may continue to depressed construction sector outlook, we foresee more inefficient glass manufacturers shrink on poor glass being squeezed out over 2016, while some of the surviving players might consider demand, or converting to heavy fuel oil to save fuel costs. We therefore forecast Suntien’s C&I gas manufacturers shifting sales volume to decline by 5% for 2016, after which sales volume should resume 15% YoY to cheaper fuels growth for 2017.

We see the construction sector in China remaining sluggish over the next few years, affected by the overbuilding of residential and commercial buildings. The new construction starts began to slow in 2011, with growth falling further into negative territory in 2012. Construction starts recovered slightly in 2013, and subsequently declined for 2 consecutive years in 2014-15. This has induced a deceleration in the pace of growth in areas that are still being built as well, with the growth rate already pointing towards nil for end-2015.

Given that construction is one of the key demand sources for float glass, the sustained weakness in the construction sector has led to weak demand for float glass. Looking at Hebei specifically, a slowdown in flat glass production in 2015 was evident, with production volume declining by 10% YoY.

Property new starts and under construction data Hebei: Flat glass production volume 50% (mn weight boxes) 40% 160 50% 30% 140 40% 120 30% 20% 100 20% 10% 10% 80 0% 0% 60 -10% 40 -20% (10%) 20 -30% (20%) 0 -40%

2008 2009 2010 2011 2012 2013 2014 11M15

2006 2013 1997 1998 1999 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2014 New-started areas YoY growth 2015E Production volume YoY growth - RHS Under-construction areas YoY growth Source: CEIC, Daiwa Source: WIND, Daiwa forecasts Note: flat glass production volume is annualized from 10M15 data

The float glass overcapacity problem has complicated the situation, with the glass industry witnessing sustained price competition since 2011. According to WIND, the average selling price of float glass declined from CNY74 per weight box in 2011 to the sub-CNY50 level by end-2015, despite a slight seasonal strengthening towards the year-end.

China Suntien Green Energy (956 HK): 21 January 2016

Hebei: flat glass production volume Suntien: C&I gas sales volume forecasts vs. Hebei flat glass production (CNY/weight 80% box) 60% 80 75 40% 70 20% 65 0% 60 55 (20%) 50 (40%) 45 (60%) 40

(80%)

Jul-11 Jul-13 Jul-14 Jul-15

Jul-12 2010 2011 2012 2013 2014 2015E 2016E 2017E

Apr-12 Oct-15 Apr-11 Oct-11 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15

Jan-15 Jan-11 Jan-12 Jan-13 Jan-14 4mm 5mm 6mm Hebei glass production Suntien - C&I gas sales volume

Source: WIND, Daiwa forecasts Source: Company, WIND, Daiwa forecasts Note: flat glass production volume is annualized from 10M15 data Note: flat glass production volume is annualized from 10M15 data

Suntien could struggle With the glass industry’s unexciting outlook, our base-case scenario suggests another 5% to secure new industrial gas sales volume decline for Suntien’s C&I sector for 2016. Currently, the company only customers during the supplies natural gas to 2 glass manufacturers in Shahe, down from a mid-teens number of glass industry’s cyclical manufacturers in 2013-14. While we do not expect these 2 remaining customers to either downturn convert to heavy fuel oil or shut down their operations any time soon, we see them encountering difficulties in increasing production, or Suntien securing additional key customers during the cyclical trough.

Slight margin squeeze possible We foresee a slight dollar margin squeeze for Suntien’s natural-gas sales, driven by: 1) a CNY0.02/m3 dollar margin squeeze for industrial users in order boost natural-gas demand, 2) a CNY0.06/m3 dollar margin expansion for residential users following the implementation of a progressive tariff mechanism, and 3) normalisation of CNG margins.

Suntien: natural-gas dollar margins by segment 2012 2013 2014 2015E 2016E 2017E - Wholesales 0.29 0.25 0.25 0.29 0.27 0.26 - Retail 0.70 0.73 0.67 0.73 0.76 0.78 - CNG 0.66 0.68 0.81 1.02 0.89 0.89 Overall dollar margin 0.47 0.48 0.44 0.44 0.42 0.42

Source: Company, Daiwa forecasts

We expect the margins Downstream gas distributors are usually protected by stable dollar margins regardless of on Suntien’s gas sales to how natural-gas prices are adjusted, as the distributors can pass on the changes to end come under pressure if it users by applying to the government. For 2016, however, we think it will be relatively attempts to incentivise difficult for Suntien to maintain its industrial gas dollar margins owing to the depressed natural-gas usage glass industry, and envisage the company possibly lowering its gas selling point slightly in order to lure new customers, or promote oil-to-gas conversion. As such, we expect a slight CNY0.02/m3 dollar margin compression for its C&I business.

That said, we think any slight margin squeeze would be mitigated by margin expansion in the residential segment. In July 2014, the Hebei Price Bureau of the Province DRC released a notice urging the implementation of a progressive natural-gas tariff mechanism for all cities in Hebei within 2015, which clearly stated that residential tariffs would be segregated into 3 brackets, with higher-consuming households (Brackets II & III) being charged higher natural gas tariffs than those in Bracket I (see the table below).

Hebei: progressive gas tariff mechanism for residential segment Gas tariff multiple Coverage Bracket I 1x Covers 80% of total households Bracket II 1.2x Covers 95% of total households Bracket III 1.5x Covers 100% of total households

Source: Hebei DRC

China Suntien Green Energy (956 HK): 21 January 2016

Even though we have observed some delays in actual implementation by some cities, most of the big cities, such as Handan, Baoding, Shijiazhuang and Xingtai, have already announced policies. As a consequence, some of Suntien’s city gas projects started implementing residential progressive pricing at the end of 2015, and we therefore look for a CNY0.06/m3 dollar margin improvement per year in the residential segment over 2016-17.

Financials Heavy capex requirements over 2016-17, positive FCF looks remote Suntien’s future capex On our estimates, Suntien’s capital needs over the next few years will be substantial, should mainly focus on which we mainly attribute to its rapidly developing wind-farm portfolio. wind capacity expansion Capex for wind power business We believe Suntien is still in the midst of a high capex period for its wind-power business, and expect 400-500MW of new wind capacity additions over the next few years, translating into CNY3-4bn of capex per year over 2016-17E (assuming unit capex for wind farms is CNY7,500-7,700/kW). This pace, as we discussed in the previous section, should be well- supported by its 1.4GW of approved wind projects at end-2015.

Capex for natural-gas business For the natural-gas business, capex requirements should be mild. After completing the “Pipeline for Ten Counties in Central Hebei (Phase 1)” project in 1H15, the company plans to focus on developing the “Pipeline for Ten Counties in Central Hebei (Phase 2)” project, as well as ramp up its city gas projects. Overall, we look for yearly capex of CNY550m/ CNY650m over 2016-17.

With the heavy capex requirement, as stated above, and coupled with our estimates for cash flow from operations of only CNY1.8-2.5bn over 2016-18, we foresee only a remote chance of Suntien achieving positive free cash flow over the next few years, indicating that the company would still need to rely on external financing (either debt or equity) channels for expansion.

Suntien: free cash flow estimates (CNYm) 3,000 2,000 1,000 0 (1,000) (2,000) (3,000) (4,000) (5,000) 2012 2013 2014 2015E 2016E 2017E 2018E Capex - wind power Capex - natural gas Operating cash flow Free cash flow

Source: Company, Daiwa forecasts

Balance sheet to gear up sharply, but still within Suntien’s comfort level Suntien’s comfort Owing to the company’s huge capex requirements, we investigated the room for Suntien to gearing level is 75% total further borrow by looking at its gearing level. We expect a steeply increasing net gearing liabilities to total assets level from 2015 onwards, with net gearing reaching 180% in 2016E and 208% in 2017E, should the company meet its wind capacity additions target, in contrast with the moderate gearing level in 2014 of 107%.

We attribute this sharp increase to 2 reasons: 1) Suntien’s natural-gas business, which has been its major cash flow generator, remaining sluggish over the next 2-3 years after the steep decline in sales volume in 2015E, and 2) the wind power business is a capital intensive business, which requires huge upfront investment, and as such the 400-500MW capacity additions target is likely to require significant capex.

China Suntien Green Energy (956 HK): 21 January 2016

Suntien: net debt and net-debt-to-equity gearing Suntien: total liabilities to total assets level (CNYm) 80% 25,000 250% 75% 20,000 200% 70% 15,000 150% 65%

10,000 100% 60%

5,000 50% 55%

0 0% 50% 2012 2013 2014 2015E 2016E 2017E 2018E 2012 2013 2014 2015E 2016E 2017E 2018E Net debt % net debt to equity - RHS % Total liabilities to total assets Suntien's comfort level

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

The company’s surging net debt/equity gearing level to over 200% could be a concern, but in our view it is a common and inevitable evil for China’s wind-farm operators, especially during the initial stage of capacity expansion when operating cash flow is still negligible compared with the massive upfront investment costs incurred.

In fact, it’s a common scenario that pure wind-farm operators would have 200%+ net gearing. Referring to the below chart, the 4 major H-share listed wind IPPs have a net gearing range of 197-416%, with China Longyuan (916 HK, HKD4.66, Outperform [2]), which is the most moderately geared, still having a gearing level of close to 200%.

Wind farm operators: net gearing level comparison 500%

400%

300%

200%

100%

0% 1H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 China Suntien China Longyuan Huaneng RE Datang RE Huadian Fuxin

Source: Bloomberg, Daiwa

Looking further into Suntien’s projected total liabilities/total assets ratio, we also believe that the company’s total liabilities/total assets ratio should still be within its comfort level at 75% over our forecast period, implying that it has no urgency to restructure its balance sheet, in terms of gearing.

Equity placement unlikely at current share-price level An equity placement Of course, Suntien might still seek to replenish its equity from time to time, in order for its looks unlikely at any balance sheet to stay healthy. Recall that Suntien completed an equity placement in price below HKD2.46 January 2014, raising CNY1.3bn by issuing 477m shares at HKD3.35; as such, we believe further equity financing might be possible.

That said, according to the State Council and the SASAC, China’s SOEs are not permitted to undertake equity financing at a valuation below a 1.0x PBR, and therefore we believe Suntien would be unlikely to carry out an equity placement at a price below HKD2.46/share, assuming a 2015E BVPS of CNY2.06/share. Hence, we expect the most likely way for Suntien to replenish equity would be in the form of a CB or perpetual bond issuance.

China Suntien Green Energy (956 HK): 21 January 2016

Valuation and risks Maintain Hold (3), with SOTP-based valuation of HKD1.10 We lower our TP to We maintain our Hold (3) rating for Suntien, and cut our 12-month SOTP-based target HKD1.10 from HKD1.60 price to HKD1.10, from HKD1.65, representing 3% upside potential from its current share price. We derive our target price using an SOTP valuation methodology, based on the different risk reward profiles of Suntien’s 2 major business segments: 1) natural-gas business and 2) wind and solar power business.

Suntien: SOTP valuation (CNY mn) Methodology Valuation % of value Natural gas business DCF 1,483 42% Wind and solar power business DCF 2,038 58% Equity value 3,521

No. of shares (mn) 3,715 CNYHKD FX 1.16

Fair value per share (HKD) 1.10

Source: Daiwa forecasts

Natural-gas business We apply a 7.5% WACC We value the company’s natural-gas business by discounting its free cash flow for the next to the natural-gas 10 years, with a terminal growth rate of 1%. Our calculated WACC for the natural-gas business business is 7.5%, which assumes a risk-free rate of 2.9%, a target gearing of 60%, and an equity beta of 0.9.

Suntien: free cash flow calculations for natural-gas business 12 mths to 31 Dec, All figures in CNYm 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Valuation Date 20-Jan-16 Next Balance Date 31-Dec-16 First Year Cash Flow Adjustment 0.95

Free Cash Flow EBITDA 454 495 543 581 608 636 668 700 731 762 Less: Other Non Cash (92) (97) (106) (116) (123) (132) (141) (151) (160) (169) Less: Cash Tax Payable on EBIT (65) (73) (81) (87) (92) (97) (103) (108) (114) (120) Plus: Decrease in Working Capital (30) (44) (45) (57) (61) (39) (23) (18) (3) (3) Less: Capital Expenditure (550) (400) (400) (100) (100) (100) (100) (100) (100) (100) Free Cash Flow (283) (119) (89) 221 232 269 301 323 354 370

Free Cash Flow for Valuation Purposes (283) (119) (89) 221 232 269 301 323 354 370

WACC 7.5% 7.5% 7.5% 7.5% 7.5% 7.5% 7.5% 7.5% 7.5% 7.5% 7.5%

NPV of Free Cash Flow (273) (107) (74) 172 168 181 188 188 191 186

Source: Daiwa forecasts

China Suntien Green Energy (956 HK): 21 January 2016

Suntien: DCF calculations for natural-gas business Terminal Value Terminal Growth Rate 1.0% Terminal WACC 7.5% Estimated Terminal Free Cash Flow 370 NPV of Terminal Value (as at 30 Jun 2025) 5,652 NPV of Terminal Value (as at 20 Jan 2016) 2,843

DCF Valuation NPV of Forecasts 821 NPV of Terminal Value 2,843 Add: Market value of stakes in Associates #1 437 Associate #2 Associate #3 Enterprise Value 4,101 Less: Net Debt (as at 20 Jan 2016) (2,621) Equity Value 1,480

No. Shares (millions) 3,715

Per Share Equity Value HK$0.45

Source: Daiwa forecasts

Suntien: DCF sensitivity for natural-gas business Discount NPV of Term Val. PV of Enterprise Equity Per Share Rate FCF at 2025 Term Val. Value Value (HK$) 5.0% 1,022 9,148 5,747 7,206 4,585 1.40 5.5% 979 8,141 4,890 6,306 3,685 1.12 6.0% 937 7,334 4,213 5,586 2,965 0.90 6.5% 897 6,672 3,666 4,999 2,378 0.72 7.0% 858 6,120 3,217 4,512 1,891 0.58 7.5% 821 5,652 2,843 4,101 1,480 0.45 8.0% 785 5,251 2,528 3,750 1,129 0.34 8.5% 750 4,903 2,260 3,447 826 0.25 9.0% 717 4,598 2,029 3,183 562 0.17 9.5% 685 4,329 1,830 2,952 331 0.10 10.0% 655 4,090 1,656 2,747 126 0.04

Source: Daiwa forecasts

Wind and solar power business We apply an 8.3% WACC For the wind and solar power business, our valuation is arrived at by discounting its free to the wind and solar cash flow until 2039, given the usual estimated life of a wind and solar farm of 20 years, as business well as our assumption of no capacity growth beyond 2020. Thus, we allocate zero terminal value to the wind and solar business. Regarding our WACC assumptions, we assume a risk-free rate of 2.9%, a target gearing of 70%, and an equity beta of 1.4, which results in a WACC of 8.3%.

Suntien: free cash flow calculations for wind and solar business 12 mths to 31 Dec, All figures in CNYm 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 … 2039

Valuation Date 20-Jan-16 Next Balance Date 31-Dec-16 First Year Cash Flow Adjustment 0.95

Free Cash Flow EBITDA 1,557 1,886 2,332 2,790 3,203 3,293 3,478 3,487 3,495 3,503 3,512 3,521 … 620 Less: Other Non Cash (2) (2) (1) (1) (1) (0) (0) (0) (0) (0) (0) (0) (0) Less: Cash Tax Payable on EBIT (89) (122) (175) (237) (313) (352) (415) (449) (483) (518) (520) (523) (97) Plus: Decrease in Working Capital (30) (44) (45) (57) (61) (39) (23) (18) (3) (3) (4) (4) 49 Less: Capital Expenditure (3,420) (3,750) (3,700) (3,650) 0 0 0 0 0 0 0 0 0 Free Cash Flow (1,984) (2,031) (1,589) (1,155) 2,829 2,902 3,039 3,019 3,008 2,982 2,988 2,994 … 572

Free Cash Flow for Valuation Purposes (1,984) (2,031) (1,589) (1,155) 2,829 2,902 3,039 3,019 3,008 2,982 2,988 2,994 … 572

WACC 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% 8.3%

NPV of Free Cash Flow (1,910) (1,810) (1,307) (877) 1,984 1,879 1,817 1,666 1,532 1,403 1,297 1,200 … 88

Source: Daiwa forecasts

China Suntien Green Energy (956 HK): 21 January 2016

Suntien: DCF calculations for wind and solar business Terminal Value Terminal Growth Rate 0.0% Terminal WACC 8.3% Estimated Terminal Free Cash Flow 0 NPV of Terminal Value (as at 30 Jun 2040) 0 NPV of Terminal Value (as at 20 Jan 2016) 0

DCF Valuation NPV of Forecasts 13,185 NPV of Terminal Value 0 Add: Market value of stakes in Associates #1 401 Associate #2 Associate #3 Enterprise Value 13,586 Less: Net Debt (as at 20 Jan 2016) (11,460) Equity Value 2,126

No. Shares (millions) 3,715

Per Share Equity Value HK$0.65

Source: Daiwa forecasts

Suntien: DCF sensitivity for wind and solar business Discount NPV of Term Val. PV of Enterprise Equity Per Share Rate FCF at 2025 Term Val. Value Value (HK$) 5.8% 18,382 0 0 18,783 7,323 2.23 6.3% 17,207 0 0 17,608 6,148 1.87 6.8% 16,108 0 0 16,509 5,050 1.54 7.3% 15,082 0 0 15,483 4,023 1.23 7.8% 14,121 0 0 14,522 3,062 0.93 8.3% 13,221 0 0 13,622 2,162 0.66 8.8% 12,377 0 0 12,778 1,319 0.40 9.3% 11,586 0 0 11,987 528 0.16 9.8% 10,844 0 0 11,245 (215) -0.07 10.3% 10,147 0 0 10,548 (912) -0.28 10.8% 9,491 0 0 9,892 (1,567) -0.48

Source: Daiwa forecasts

Stock likely oversold, but risk-reward still looks unattractive Near-term risks still Suntien’s share price has fallen to a 9.0x 2016E PER and 0.4x 2016E PBR, both at past-5- significant despite cheap year trough valuations, which might attract investors to bottom-fish. While the stock is not valuation, in our view expensive, we think risks could arise if: 1) Suntien’s natural-gas business remains sluggish for a prolonged period before bottoming out, 2) further provisions are needed if glass manufacturers default or close down, and 3) a further sell-off occurs as a result of disappointing 2015 results. As such, we would advise investors to stay on the sidelines until the above risks are at least partially mitigated.

Suntien: 1-year forward PER Suntien: 1-year forward PBR (x) (x) 30 1.5 28.5x Avg+2SD 1.4x Avg+2SD 25 1.3 21.9x Avg+1SD 20 1.1 1.1x Avg+1SD

15 15.3 Avg 0.9 0.9x Avg

10 0.7 8.7x Avg-1SD 0.6x Avg-1SD 5 0.5 2.1x Avg-2SD 0.4x Avg-2SD

0 0.3

Jul-12

Oct-12 Oct-10 Apr-11 Oct-11 Apr-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15

Oct-10 Apr-14

Jun-15

Feb-13

Nov-14 Dec-11 Sep-13 May-11 Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

China Suntien Green Energy (956 HK): 21 January 2016

We expect consensus Comparing Suntien’s current valuation to its wind IPP and downstream gas peers, we estimates to fall over the believe Suntien’s valuation is not appealing based on our forecasts, on either a PER vs. next 12 months EPS CAGR or a PBR vs. ROE basis. Based on consensus earnings, however, the stock is trading in line, but we expect consensus forecasts for 2016-17 to come down over the next 12 months, and believe the stock may turn out to be less attractive than it might seem.

Suntien: 2016E PER to 2015-17E EPS CAGR comparison with Suntien: 2016E PBR to 2016E ROE comparison with peers peers 70% 25% ENN 60% Datang RE 20% China Gas 50% CR Gas Fuxin CGNNE 40% 15% HNR BEH 30% Huaneng RE TCCL

17E 17E EPSCAGR 10%

Longyuan 2016E ROE - Longyuan 20% Kunlun 2015 Fuxin CGNNE Suntien 5% Suntien 10% Datang RE 0% 0% - 2.0 4.0 6.0 8.0 10.0 12.0 14.0 - 0.5 1.0 1.5 2.0 2.5 2016E PER 2016E PBR Source: Bloomberg, Daiwa forecasts Source: Bloomberg, Daiwa forecasts Note: Pricing as of 19 Jan 2016. Daiwa estimates for covered companies Note: Pricing as of 19 Jan 2016. Daiwa estimates for covered companies

Key investment risks Industrial gas demand Industrial-gas demand As 70% of Suntien’s retail gas sales volume is derived from industrial gas sales, its gas could further weaken on sales revenue is highly dependent on China’s overall industrial gas demand, which would depressed oil prices be negatively affected if the price competitiveness of gas is further reduced due to low oil prices. Should the WTI oil price drop from the current USD32/barrel level, the price of refinery oil products in China may decline accordingly, while the city-gate tariff would remain unchanged until the next city-gate tariff cut. This could negatively affect Suntien’s gas sales volume in 2016.

Moreover, the continuing slowdown in industrial production would hinder the growth of industrial gas demand directly. For example, most of Suntien’s gas customers are glass producers in Hebei, and a decline in demand for glass in China would negatively affect Suntien’s industrial gas sales, as glass manufacturers would reduce their production. Those factories and plants that are surviving on low profit margins may turn idle or close down, while the remaining ones may also turn to more economical fuels such as heavy oil. Therefore, the macroeconomic slowdown could have a significant negative impact on Suntien’s revenue and earnings.

Wind curtailment Hebei’s wind curtailment Since wind power accounted for 34% of Suntien’s revenue in 2015E, severe wind could worsen more than curtailment would hinder the company’s overall revenue, and thus hurt its earnings. Most we expect on larger of Suntien’s wind farms are located in Hebei Province, where wind curtailment is relatively overcapacity moderate compared to other provinces in China (Suntien: 8% vs. Hebei: 13.9% vs. the national average: 15.2% in 1H15). More severe wind curtailment problems may arise with: 1) weaker-than-expected overall power demand due to the slowdown in GDP growth, sluggish industrial production and higher energy efficiency, 2) a delay in the completion of the UHV transmission lines (in particular the Zhangbei-Nanchang AC line) due to a delay in construction and government approval, or 3) larger overcapacity in the wind power sector due to continued rush installations in 2015 and 2016.

China Suntien Green Energy (956 HK): 21 January 2016

Appendix I: wind project details

Suntien: wind and solar project list Project name Type Installed capacity Ownership Attributable capacity Location Province Date of completion Kangbao Wolongshan Wind Farm Wind 30.0 100.0% 30.0 Kangbao County, Zhangjiakou Hebei Nov-06 Guyuan Langweibashan Wind Farm Wind 30.6 100.0% 30.6 Guyuan County, Zhangjiakou Hebei Oct-07 Kangbao Sanxiatian Wind Farm Wind 49.5 100.0% 49.5 Kangbao County, Zhangjiakou Hebei Jan-10 Guyuan Wuhuaping Wind Farm Wind 49.5 100.0% 49.5 Guyuan County, Zhangjiakou Hebei Jan-10 Guyuan Dongxinying Wind Farm Wind 199.5 100.0% 199.5 Guyuan County, Zhangjiakou Hebei Oct-10 Chongli Qingsanying Wind Farm Phase I Wind 49.3 50.0% 24.7 Chongli County, Zhangjiakou Hebei Nov-08 Chongli Qingsanying Wind Farm Phase II Wind 49.3 51.0% 25.1 Chongli County, Zhangjiakou Hebei Jun-09 Chongli Jiaocheshan Wind Farm Wind 49.3 51.0% 25.1 Chongli County, Zhangjiakou Hebei Mar-12 Zhangbei Caoniangou Wind Farm Wind 49.5 49.0% 24.3 Zhangbei County, Zhangjiakou Hebei Dec-10 Zhangbei Daxishan Wind Farm Wind 49.5 51.0% 25.2 Zhangbei County, Zhangjiakou Hebei Mar-12 Yuxian Kongzhong Caoyuan Wind Farm Phase I Wind 49.5 55.9% 27.7 Yuxian, Zhangjiakou Hebei Jan-09 Yuxian Kongzhong Caoyuan Wind Farm Phase II Wind 49.5 55.9% 27.7 Yuxian, Zhangjiakou Hebei Nov-09 Yuxian Baiyantuo Wind Farm Wind 49.3 55.9% 27.6 Yuxian, Zhangjiakou Hebei Dec-10 Yuxian Dongdianziliang Wind Farm Wind 49.5 55.9% 27.7 Yuxian, Zhangjiakou Hebei Jan-12 Yuxian Chashan Wind Farm Wind 49.5 100.0% 49.5 Yuxian, Zhangjiakou Hebei Feb-12 Yuxian Yongshengzhuang Wind Farm Wind 49.5 100.0% 49.5 Yuxian, Zhangjiakou Hebei Mar-12 Yuxian Lihuajian Wind Farm Wind 49.5 100.0% 49.5 Yuxian, Zhangjiakou Hebei 2012 Yuxian Dongxinghe Wind Farm Wind 49.5 100.0% 49.5 Yuxian, Zhangjiakou Hebei 2013 Lingqiu Hanfengling Wind Farm Wind 49.5 55.0% 27.2 Lingqiu County, Shanxi Shanxi Mar-12 Lingqiu Baicaowan Wind Farm Wind 49.5 55.0% 27.2 Lingqiu County, Shanxi Shanxi Mar-12 Weichang Yudaokou Muchang Wind Farm Wind 150.0 100.0% 150.0 Weichang County, Chengde Hebei Nov-10 Haixing Wind Farm Wind 49.5 70.0% 34.7 Haixing County, Cangzhou Hebei Sep-08 Laiyuan Dongtuanpu Wind Farm Wind 49.5 100.0% 49.5 Laiyuan County, Baoding Hebei 2012 Laiyuan Huanghualiang Wind Farm Wind 49.5 100.0% 49.5 Laiyuan County, Baoding Hebei 2014 Weichang Ruyihe Wind Farm Wind 199.5 100.0% 199.5 Weichang County, Chengde Hebei 2014 Ruoqiang Luobuzhuang Phase I Wind 50.0 100.0% 50.0 Ruoqiang, Xinjiang Xinjiang 2014 Changli Datan Wind Farm Wind 48.0 100.0% 48.0 Changli County, Qinhuangdao Hebei 2014 Weichang Zhangjiawan Wind Farm Wind 49.5 50.0% 24.8 Weichang County, Chengde Hebei Jan-10 Weichang Guangfayong Wind Farm Wind 49.5 45.0% 22.3 Weichang County, Chengde Hebei Jan-10 Weichang Shanwanzi Wind Farm Wind 49.5 50.0% 24.8 Weichang County, Chengde Hebei Feb-10 Weichang Zhuzixia Wind Farm Wind 49.5 45.0% 22.3 Weichang County, Chengde Hebei Feb-10 Weichang Dishuihu Wind Farm Wind 49.5 45.0% 22.3 Weichang County, Chengde Hebei Dec-10 Heibei Laiyuan Zhoucun Photovoltaic Power Generation Project Solar 1.0 100.0% 1.0 Laiyuan County, Baoding Hebei 2012 Xinjiang Hejing Photovoltaic Power Generation Project Solar 20.0 100.0% 20.0 Hejing County, Xinjiang Xinjiang 2013 Hebei Laiyuan Jinjiajing Photovoltaic Power Generation Project Solar 10.0 100.0% 10.0 Laiyuan County, Baoding Hebei 2014

Source: Company, Daiwa

Suntien: wind farm map (1H15)

Source: Company

China Suntien Green Energy (956 HK): 21 January 2016

Appendix II: map of natural-gas operations

Suntien: natural-gas project map (1H15)

Source: Company

China Suntien Green Energy (956 HK): 21 January 2016

100

China Industrials 21 January 2016

China High Speed Transmission (658 HK)

China High Speed Transmissi on

Target price: n.a.

Share price (19 Jan): HKD5.80 | Up/downside: -

Restructuring in progress Dennis Ip, CFA (852) 2848 4068  Leading wind gearbox player, with 60% domestic market share [email protected]  Continuing to streamline its business, avoiding further investment Nicole Jiang (852) 2848 4469  Seeking overseas expansion in the wind gearbox market [email protected]

Background: CHST is a leading supplier of wind gear transmission Share price performance equipment in China, with a domestic market share of around 60%. The (HKD) (%) company derives around 80% of its revenue from wind gearbox sales. 8.5 185 7.5 161

6.5 138

Highlights: Continuing to streamline its business, avoiding further 5.5 114 investment. Having stretched its balance sheet with its earlier 4.5 90 diversification strategy, CHST is streamlining its business to focus on wind Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 China HST (LHS) Relative to HSI (RHS) gear boxes, industrial gearboxes and sapphires. Following the disposal of its steel plant and coal -mining machinery businesses in 2014 and 2015, respectively, CHST aims to dispose the CNC machine tool product and sell 12-month range 4.72-8.15 down some of its stake in its marine gear transmission equipment business Market cap (USDbn) 1.21 3m avg daily turnover (USDm) 6.00 (inviting investment funds to become shareholders), with a view to raise Source: FactSet, Daiwa forecasts cash/reduce gearing and avoid further investment.

Dominant in domestic gearbox market, seeking overseas expansion. In 2014, CHST delivered around 10.3GW of wind gearboxes, and is targeting sales of around 14.5GW in 2015 and 17GW in 2016. It expects to export 4GW of wind gearboxes in 2015 and 5-5.5GW in 2016. Currently, more than 95% of its export products are supplied to GE Energy. CHST aims to maintain its domestic market share while expanding its overseas customer base to drive growth in the wind gearbox business.

Targeting high-end customers for industrial gearbox business. Faced with the current overcapacity in the industrial equipment industry, the company adjusted its development strategy by targeting sales to the high-end market and seeks to realise export sales, with the goal of replicating its success in the wind gearbox business. In 2014, its industrial gearboxes registered revenue of ~CNY900m (not including the sapphire business); management expects a slight decline in such revenue to CNY700-800m for 2015.

Paying down debt. CHST is committed to reducing its debt (as of end- 2014, its total bank debt, excluding double-counted back-to-back financing debt, was CNY9.8bn). The company repaid CNY2bn in 1H15, and repaid another CNY1.5-1.6bn in 2H15. As a result of cuts in the benchmark rate in China, CHST expects to realise material finance cost savings in 2015.

Valuation: CHST is trading at PERs of 38x for 2014 and 8x for 2015E (based on the Bloomberg-consensus EPS forecast). Investor concerns over a slowdown in domestic orders in 2016 due to the installation rush in 2015, and heavy curtailment in the northwest areas, have weighed on share-price performances in the wind equipment segment.

See important disclosures, including any required research certifications, beginning on page 127

China High Speed Transmission (658 HK): 21 January 2016

Restructuring in progress

Benefiting from an Even though we forecast growth in newly connected wind capacity in China to slow, from expansion in overseas 20GW in 2014 and 25GW in 2015E to 21GW in 2016E, management expects CHST to orders benefit from an expansion in overseas orders over 2016-17, and for its stretched balance- sheet position to improve through debt reduction and the disposal of loss-making ventures.

Wind gearboxes Having stretched its balance sheet with its earlier diversification strategy, CHST has been streamlining its business to focus on wind gearboxes, industrial gearboxes and sapphires.

Wind gear transmission equipment is a major product for the company, accounting for 71% of total sales in 2014 and 79% in 1H15. In 2014, CHST delivered around 10.3GW of wind gearboxes, and the company is targeting sales of around 14.5GW in 2015 and around 17GW in 2016. It supplies its major products – 1.5MW, 2MW and 3MW wind power gear transmission equipment – to domestic and overseas customers in bulk. Furthermore, the company has successfully developed 5MW and 6MW wind power gearbox transmission equipment for the development of offshore wind turbines for the mass market. Currently, most developers source offshore wind gear equipment from overseas suppliers.

CHST is a leading supplier of wind gear transmission equipment in China, with a domestic market share of around 60%. Its major competitors, Chongqing Gearbox and Ningbo Gearbox, each have market shares of about 10%. CHST’s customers include international wind turbine manufacturers such as GE Energy, Vestas and Gamesa. The company has guided that it exported 4GW of wind gearboxes in 2015 and it targets 5-5.5GW for 2016. Currently, more than 95% of its export products are supplied to GE Energy.

CHST: wind gearboxes sales volume CHST: market share in China 12,000 120% CHST market share in China (2014) (GW) 100% Total wind capacity installed 23.35 10,000 Goldwind (direct drive) 4.43 80% Xiangtan (direct drive) 1.78 8,000 60% Other direct drive supplier 3 Gearbox demand 14.14 6,000 40% CHST 8.1 20% CHST market share in 2014 57% 4,000 0% 2,000 -20% 0 -40% 2008 2009 2010 2011 2012 2013 2014 Domestic Export YoY Growth

Source: Company Source: Daiwa, Company

Global: new wind installations China: new wind installations and connections (MW) (MW) 60,000 25,000

50,000 20,000

40,000 15,000

30,000 10,000 20,000 5,000 10,000 0 0 2006 2007 2008 2009 2010 2011 2012 2013 2014

New installation New connection

1997 1998 1999 2001 2002 2003 2004 2005 2007 2008 2009 2010 2012 2013 2014 2006 2011 2000 Source: GWEC Source: CWEA

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China High Speed Transmission (658 HK): 21 January 2016

Industrial gearboxes In addition to enhancing its wind power equipment business, the company has shifted its focus back to the industrial gear transmission equipment segment. It sought to optimise the allocation of resources through the divestment of the steel plant and coal mining machinery businesses by way of spin-off and disposal.

CHST’s industrial gear transmission equipment products are mainly supplied to customers in industries such as metallurgy, construction materials, traffic, transportation, petrochemical, aerospace and mining. Among these products, transmission equipment for high-speed locomotives, metros and urban light rail systems carry gross margins of around 35%, according to the company, above its average gross margin of 25% in recent years.

Targeting sales to high- Facing overcapacity in the industrial equipment industry, the company has adjusted its end market and aiming development strategy by targeting sales to the high-end segment and seeking export to replicate its success sales. In March 2015, CHST received a quality certification from the American Petroleum with wind gearboxes Institute (API), which CHST believes will enhance its export competitiveness for gearboxes, especially for shale gas products. The company has also obtained International Railway Industry Standard (IRIS) certificate for its rail transportation products, which should help its rail transportation products expand into high-end international railway markets.

CHST: industrial gearbox market segments revenue breakdown CHST: gross margins on industrial gearboxes in 1H15 (%) 2010 2011 2012 2013 2014 1H14 1H15 Construction Materials, 19% Construction Materials 33.5 32.6 32.6 19.1 9.5 17.1 16.7 Bar-rolling, Wire-rolling and Plate- 25.8 5.3 8.9 8.6 -5.7 8.1 1.0 rolling Mills Other products, Bar-rolling, High-speed Locomotives, Metros and 28.6 29.4 40.1 33.2 37.6 36.5 39.0 46% Wire-rolling and Urban Light Rails Plate-rolling General Purpose Gear Transmission 42.7 38.8 37.3 9.3 -18.4 8.5 7.6 Mills, 19% Equipment High-speed Heavy-load 65.4 40.4 37.8 20.4 18.8 18.6 23.6 Other products 32.5 17.2 20.8 23.6 8.5 18.1 20.2

High-speed High-speed Heavy-load , 1% General Locomotives, Purpose Gear Metros and Transmission Urban Light Equipment, 4% Rails, 11% Source: Company Source: Company Note: 90% of other products are for the sapphire business

In 2014, CHST’s industrial gearboxes registered revenue of ~CNY900m (not including the sapphire business), and management expects a slight decline to CNY700-800m in 2015. According to the company, the high-end traditional gearbox segment in China is dominated by imported products, with leading player SEW-Eurodrive, a German company, recording revenue of around CNY6bn in China for 2014. CHST expects to benefit from its strategy of targeting high-end customers.

Streamlining other businesses Shifting its focus back to Going back to 2010, CHST’s earlier diversification investment strategy stretched its wind gearboxes and balance sheet and most of the new investments were loss making. Following the disposal traditional gearboxes, of the steel equipment ventures in 2014, CHST entered into an agreement to dispose of its while streamlining other coal mining machinery business in January 2015. The company continues to focus on wind businesses and traditional gearboxes while streamlining other businesses.

Marine gear transmission equipment CHST is seeking to leverage its capacity for innovation by launching more high-end products. Currently, most of its marine gearboxes are for sale domestically. The company expects to see mid- to long-term growth opportunities for the marine business in international markets, and in 1H15 it received export orders for the supply of propellers for ten ships.

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China High Speed Transmission (658 HK): 21 January 2016

To further streamline its business, the management aims to sell down some of its stake in its marine gear equipment business and invite investment funds to become shareholders. Its intention is to retain operational control while being a significant minority shareholder. Management expects this approach to relieve the company’s balance sheet through a reduced capex burden, while still allowing it to realise returns from these businesses.

CNC machine tool product In 2014, the CNC business marginally reached break even overall. The company is considering disposing of its operation in the CNC machine tool segment to third parties, and it expects to realise a disposal gain upon completion. In 1H15, the segment contributed only around 1.5% of total revenue; the NAV of the segment is around CNY500m.

Light-emitting diode (LED) sapphire substrates CHST has an upstream value chain through its wholly owned subsidiary, Nanjing J-Crystal Photoelectric Science & Technology. The subsidiary’s operations include crystal growing, slicing, lapping and polishing. Currently, most of its sales are to LED customers with lighting needs, though management believes it may be able to tap demand from mobile phone players in the future. The subsidiary focuses on large-size crystal-growing machines, which it regards as more efficient in producing large-size wafers. Apple currently uses sapphire displays in its Apple Watch, and management believes handset makers could follow this trend.

To reduce its exposure to further investment, management is considering cooperating with investment funds to expand its sapphire operation, once it receives large orders that will require it to expand capacity. Similar to the strategy it has planned for the marine gear equipment business, CHST intends to retain operational control while being a significant minority shareholder.

CHST: revenue breakdown CHST: gross margin by business segment (CNYm) 40% 10,000 30% 8,000 20% 6,000

4,000 10%

2,000 0%

0 (10%) 2010 2011 2012 2013 2014 1H15 2010 2011 2012 2013 2014 1H15 Wind gear transmission equipment Industrial gear transmission equipment Wind gearbox Industrial gearbox Marine gear transmission equipment CNC machine tool product Marine equipment CNC machine tool product Diesel Engine Products Diesel Engine Products

Source: Company Source: Company

CHST: cash position (CNYm) 5,000 4,000

3,000 2,124 2,175 2,405 2,235 2,000 1,665 1,833 1,000 0 (1,000) (2,000) (3,000) 2010 2011 2012 2013 2014 1H15 Net cash from operation Net cash from investments Net cash from financing

Cash at beginning of year Cash balance Source: Company

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China High Speed Transmission (658 HK): 21 January 2016

CHST: segment breakdown (CNY m) 2010 2011 2012 2013 2014 1H15 REVENUE 7,393 7,121 6,369 6,539 8,147 4,751 YoY Growth% -4% -11% 3% 25% Gear segment 7,094 6,546 5,761 5,779 7,420 4,469 Wind gear transmission equipment 5,458 4,770 3,952 4,140 5,802 3,745 Industrial gear transmission equipment 1,636 1,777 1,809 1,639 1,618 724 - Gear Transmission Equipment for Construction Materials 668 701 474 363 328 135 - Gear Transmission Equipment for Bar-rolling, Wire-rolling and Plate-rolling Mills 551 400 541 456 277 138 - Transmission Equipment for High-speed Locomotives, Metros and Urban Light Rails 36 51 80 106 158 82 - General Purpose Gear Transmission Equipment 145 135 91 64 63 30 - High-speed Heavy-load Gear Transmission Equipment 25 23 8 11 15 7 - Other products 211 466 615 640 777 334 Marine gear transmission equipment 234 254 251 341 350 146 CNC machine tool product 46 61 181 238 225 74 Diesel Engine Products 19 259 176 181 152 63 GPM 29.9% 25.5% 24.4% 24.9% 24.8% 29.6% Gear segment Wind gear transmission equipment 29.6% 27.2% 26.8% 29.4% 31.3% 35.3% Industrial gear transmission equipment 32.0% 22.9% 22.1% 18.5% 8.1% 17.5% - Gear Transmission Equipment for Construction Materials 33.5% 32.6% 32.6% 19.1% 9.5% 16.7% - Gear Transmission Equipment for Bar-rolling, Wire-rolling and Plate-rolling Mills 25.8% 5.3% 8.9% 8.6% -5.7% 1.0% - Transmission Equipment for High-speed Locomotives, Metros and Urban Light Rails 28.6% 29.4% 40.1% 33.2% 37.6% 39.0% - General Purpose Gear Transmission Equipment 42.7% 38.8% 37.3% 9.3% -18.4% 7.6% - High-speed Heavy-load Gear Transmission Equipment 65.4% 40.4% 37.8% 20.4% 18.8% 23.6% - Other products 32.5% 17.2% 20.8% 23.6% 8.5% 20.2% Marine gear transmission equipment 23.6% 23.8% 11.1% 10.7% 8.2% 7.1% CNC machine tool product 23.0% 17.9% 22.2% 20.7% 20.9% 22.6% Diesel Engine Products 17.3% 17.3% 15.1% 13.1% 5.3% -8.2% Source: Company

CHST: income statement (CNY m) 2010 2011 2012 2013 2014 1H15 Revenue 7,393 7,121 6,369 6,539 8,147 4,751 Cost of sales (5,180) (5,302) (4,815) (4,908) (6,127) (3,343) Gross profit 2,213 1,819 1,553 1,631 2,020 1,408 Other income 200 232 215 334 400 77 Other gains and loss 111 (70) (2) 13 (160) 32 Distribution and selling costs (201) (254) (279) (281) (304) (139) Administrative expenses (460) (527) (502) (613) (680) (292) Research and development costs (50) (83) (138) (139) (167) (74) Other expenses (57) (123) (89) (229) (84) (21) Finance costs (147) (323) (524) (564) (742) (317) Share of results of associates 0 1 (12) (8) (6) (8) Share of results of jointly controlled entities 41 25 (16) (54) 29 7 Profit before taxation 1,650 695 208 88 307 673 Taxation (257) (147) (79) (57) (131) (164) Profit for the year 1,393 548 128 31 176 509 Shareholder 1,384 557 138 65 208 524 Non-controlling interests 10 (9) (10) (33) (33) (15)

EPS Basic 1.08 0.41 0.10 0.05 0.13 0.32 Diluted 0.91 0.41 0.10 0.05 0.13 0.32 Source: Company

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China High Speed Transmission (658 HK): 21 January 2016

CHST: income statement (CNY m) 2010 2011 2012 2013 2014 1H15 Non-current Assets 6,789 8,148 9,069 9,337 7,640 8,147 PPE 4,870 5,589 6,238 6,633 5,940 5,655 Prepaid lease payments 399 609 938 1,034 597 586 Available-for-sale investments 149 363 307 165 136 214 Deposit for land lease 380 400 336 281 281 281 Prepayment for acquisition of PPE 59 31 90 124 116 303 Others 932 1,155 1,160 1,100 572 1,108 Current Assets 8,142 10,253 10,813 13,633 17,659 16,678 Inventories 1,258 1,799 1,781 2,390 2,275 2,101 Trade and other receivables 3,811 4,938 4,668 6,238 7,819 8,784 Pledged bank deposits 767 1,253 1,898 2,515 2,756 3,369 Bank balances and cash 2,124 2,175 2,405 2,235 1,650 1,817 Others 183 89 63 256 3,159 606 Total Assets 14,932 18,401 19,882 22,971 25,300 24,825

Current liabilities 5,226 7,998 10,645 11,509 13,186 12,309 Trade and other payables 2,554 2,826 2,945 3,986 4,279 5,659 Borrowings 1,209 4,991 7,449 7,109 7,971 5,087 Held-for-trading financial liabilities - - - - 327 1,177 Others 1,463 181 250 414 609 386 Non-current Liabilities 2,191 2,781 1,493 2,700 3,243 3,171 Borrowings 2,043 2,627 1,288 2,338 2,968 2,951 Others 148 154 205 362 275 220 Capital and Reserves 7,514 7,622 7,745 8,762 8,870 9,345 Share capital 103 103 103 119 119 119 Reserves 7,289 7,370 7,437 8,395 8,569 9,091 Equity attributable to owners of the Company 7,393 7,473 7,539 8,514 8,688 9,211 Non-controlling interests 122 149 205 248 182 134 Source: Company

CHST: key ratios 2010 2011 2012 2013 2014 1H15 Sales (YoY) 30.9% -3.7% -10.6% 2.7% 24.6% 20.4% Net profit (YoY) 43.2% -59.7% -75.1% -53.4% 222.8% 199% EPS (diluted) (YoY) 17.5% -55.1% -74.9% -53.9% 170.2% 200% Gross-profit margin 29.9% 25.5% 24.4% 24.9% 24.8% 29.6% Net profit margin 18.8% 7.7% 2.0% 0.5% 2.2% 10.7% Net-debt-to-equity ratio 13.1% 71.4% 81.8% 82.3% 104.7% 66.6% Effective tax rate 15.5% 21.2% 38.1% 64.8% 42.7% 24.3% Current ratio (x) 0.64 0.78 0.98 0.84 0.75 0.74 Net interest cover (x) 11.95 3.07 1.45 1.27 1.38 3.12 Net dividend payment (x) 36.5% 0.0% 0.0% 0.0% 0.0% 0.0% Source: Company

CHST: cash flow (CNY m) 2010 2011 2012 2013 2014 1H15 Operating cash flows before movements in working capital 2,019 1,756 1,376 1,593 1,910 (Increase) decrease in inventories 171.0 -561.4 -10.9 -832.2 -75.7 Increase in trade and other receivables (1,140) (1,175) 184 (1,710) (1,452) Other changes in working cashflow 784 148 146 1,034 269 Cash generated from operations 1,834 168 1,695 85 651 Income tax paid (200) (287) (153) (91) (170) Net cash from operation 1,634 (118) 1,542 (7) 481 2,815 Net cash from investments (2,031) (2,174) (1,923) (1,602) (1,819) (178) Purchase of property, plant and equipment (1,082) (1,002) (1,037) (883) (576) (27) Increase in pledged bank deposits (315) (486) (4,238) (4,497) (5,446) (5,256) Withdrawal in pledged bank deposits - - 3,593 3,880 5,185 4,643 Others (634) (686) (241) (103) (982) 462 Net cash from financing 2,050 2,343 612 1,439 767 (2,471) New bank borrowings raised 2,788 7,047 8,185 10,960 12,414 2,611 Gross proceeds on placement of shares 1,916 - - 856 - - (Repayment to) advance from a related party 1 (1) - - - (5,511) Repayment of bank borrowings (2,183) (2,705) (7,066) (10,240) (11,062) - Others (471) (1,997) (507) (136) (585) 430 Net change in cash 1,653 51 230 (169) (570) 167 Cash balance 2,124 2,175 2,405 2,235 1,665 1,833 Bank balances and cash of a disposal group classified as held for sale - - - - 16 16 Source: Company

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China Industrials 21 January 2016

Henan Pinggao Electric (600312 CH) Henan Pinggao Electric

Target price: n.a. Share price (19 Jan): CNY14.73 | Up/downside: -

Taking advantage of accelerated UHV construction Dennis Ip, CFA (852) 2848 4068  Pinggao provide GIS for UHV lines; has 40% market share [email protected]  Tianjin project has allowed it to enter the power distribution field Nicole Jiang (852) 2848 4469  Cooperating with SGCC to develop a grid maintenance business [email protected]

Background: Henan Pinggao Electric (Pinggao) is a power grid equipment Share price performance manufacturer focused on switchgear production for all voltage levels. (CNY) (%) Pinggao’s key customers are the 2 power grid companies in China: State 28 135 24 121 Grid Corporation of China (SGCC) and China Southern Power Grid (CSG). 20 108

The company says parental support gives it an edge in setting industry 16 94 standards and carrying out capital-intensive research, which means it can 12 80 win market share by offering new products and integrated services. Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Henan Ping (LHS) Relative to SHASHR Index (RHS) Highlights: Accelerated UHV construction a boon. Pinggao provides gas insulated switchgear (GIS) to AC UHV transmission lines, and currently 12-month range 14.00-27.54 has a 40% market share. Pinggao is one of only 3 suppliers of AC UHV Market cap (USDbn) 2.54 3m avg daily turnover (USDm) 45.64 GIS in China with a historically dominant market share. According to the Source: FactSet, Daiwa forecasts company, the competitive landscape is fairly stable and favourable for Pinggao, because: 1) it has the most advanced technology for switchgear, 2) as a subsidiary of SGCC, it can take part in setting standards and government-initiated research projects, and 3) it has a reliable track record in providing GIS products. Around 40% of Pinggao’s sales are exposed to UHV GIS, and as such, it benefits from accelerated UHV construction.

Exposure to power distribution. In October 2015, Pinggao placed 219m shares with 10 specific investors, at CNY22.33/share, and a lock-up period of 12 months. The proceeds are mainly being used to acquire mid-to-low voltage switchgear companies from Pinggao Group, and fund further working capital for the company’s Tianjin plant. The Tianjin plant started operating at end-2014, and has helped the company expand into the power distribution field, the market for which is highly fragmented and localised. Since these products are more customised with low technical barriers, regional players dominate the market. On the back of Pinggao’s strong support from SGCC and technological advantage, it expects to benefit from the centralised tendering process for power distribution equipment that started in 2014.

Has set up operations & maintenance (O&M) JV. Pinggao has set up a JV in the grid maintenance business, working with SGCC’s provincial subsidiaries. Pinggao provides the maintenance services, and supplies key components and equipment. Such a business model could provide more sustainable and recurring sales, according to the company.

Valuation: The stock is trading currently at a 2014E PER of 22x, and 19x for 2015E, based on the Bloomberg-consensus EPS forecasts.

See important disclosures, including any required research certifications, beginning on page 127

Henan Pinggao Electric (600312 CH): 21 January 2016

Taking advantage of increased UHV construction

Focused on switchgear Pinggao is a power grid equipment manufacturer that focuses on switchgear production for production for all all voltage levels. It was founded in 1970, and formerly known as Pingdingshan High voltage levels Voltage Switchgear Factory. Pinggao Electric was listed on 21 February 2001, and currently 38.51% of its shares are held by Pinggao Group. In 2010, Pinggao Group became a subsidiary of SGCC, meaning that Pinggao became an indirect subsidiary of SGCC. Pinggao’s key customers are the 2 power grid companies in China: SGCC and CSG.

Key products Pinggao has 4 major business lines, namely: 1) GIS, 2) open type SF6 circuit-breakers, 3) high-voltage (HV) switchgear and ground switches, and 4) others. Its GIS business is the core earnings growth driver, according to the company.

1) GIS: this type of switchgear integrates circuit breakers, switchgear and other electrical components in an airproof container that is insulated with sulphur hexafluoride (SF6) to protect them from the external environment. They can be further classified into ultra- high voltage (UHV) systems and regular voltage systems. UHV systems are used for UHV AC lines, and are one of the most important items in a UHV AC system, which means they must be extremely reliable. According to management, Pinggao has a leading market share of more than 40% of ultra-high voltage systems in China, and a 20% share of regular voltage GIS systems.

2) Open type SF6 circuit-breakers: SF6 gas has excellent dielectric and arc-quenching properties. After electrochemical contact separation, the current is carried through an arc and is interrupted when this arc is cooled by a gas blast of sufficient intensity.

3) High-voltage (HV) switchgear and ground switches: HV circuit-breakers are the main component of HV switchgear; hence, HV circuit breakers require special features to ensure safe and reliable operation. Most of the time, these circuit breakers remain in ON mode, and may be operated after a long period of time. So circuit-breakers must be reliable enough to ensure safe operation, when required.

Pinggao: 2014 revenue breakdown by segment and gross margin Business segment 2014 Revenue (CNYm) % of total GPM SF6 circuit breaker 394 8.6% 21.7% High voltage switchgear and ground switch 279 6.0% 12.9% Insulated switchgear 3,464 75.2% 30.1% Spare parts and others 333 7.2% 37.3% Core business 4,469 97.0% 28.9% Others 137 3.0% NM Source: Company

Leading market share in UHV AC investment 40% market share in Pinggao provides GIS for AC UHV lines in which it has a 40% market share. The GIS UHV GIS tenders market is largely split between Pinggao, XD (601179 CH, not rated) and New Northeast Electric Group High Voltage Switchgear Company (NHVS) (not listed), with Pinggao being the dominant player.

GIS are one of the most important items in a UHV AC system, and constitute more than half of the total equipment investment. According to media reports, SGCC has a 3-phase target for UHV construction under the 13th FYP period, in addition to accelerating the construction of “six AC eight DC” lines planned for 2015, SGCC also targets to start the construction of “ten AC two DC” lines before 2018. The planned AC lines during 2016-20 largely outweigh the DC lines. Considering that the average investment per AC line is CNY20bn, we estimate cumulative AC UHV equipment demand of about CNY80bn for the period. For DC UHV lines, GIS equipment is also required for DC-AC conversion, while the bidding amount is smaller for lower voltages.

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China: UHV AC investment China: UHV DC investment (CNYbn) (CNYbn) 20 25 18 16 20 14 12 15 10 8 10 6 4 5 2 0 0 2012 2013 2014 2015 2016E 2017E 2018E 2012 2013 2014 2015 2016E 2017E 2018E Source: SGCC, Daiwa forecasts Source: SGCC, Daiwa forecasts

Pinggao is one of only 3 suppliers in China of UHV GIS for AC with a historically dominant market share. According to the company, the competitive landscape is stable and remains favourable for Pinggao because: 1) it has the most advanced switchgear technology in China, 2) as a subsidiary of SGCC, it can take part in setting standards and government- initiated research projects, and 3) it has a reliable track record in providing GIS products.

Pinggao: GIS orders won in SGCC UHV bidding GIS orders Name Time of approval Number of bids (unit) Amount of bids (CNYbn) Delivery period UHV AC Huainan-Nanjing-Shanghai 2014 16 \ Oct-2014 after Ximeng-Shandong 2014 11 \ Dec-15 Mengxi-Tianjinnan Nov-15 17 1.57 Jul-16 Yuheng-Weifang May-15 12 1.11 Oct-16 UHV DC Ningdong-Zhejiang 2014 16 (750kV) \ Mar-15 Jinbei-Jiangsu Jun-15 19 (750kV) 0.44 May-17 Jiuquan-Hunan May-15 27(500kV) 0.13 Dec-16 Ximeng – Jiangsu 11(1000kV) 0.85 Shanghaimiao – Shandong Dec-15 14(500kV) 0.21 2017E Source: Company, Daiwa

High margins for UHV UHV GIS products also have a higher gross margin than that for mid- or low-voltage GIS products products. UHV GIS for DC lines have a gross margin of more than 50%, while that for AC UHV GIS products is more than 30%, higher than the 20% for conventional switchgear products.

Looking for sustainable growth after peaking UHV construction Private placement in October 2015 raised CNY4.9bn in proceeds, to acquire group assets and fund working capital In October 2015, Pinggao placed 219m shares with 10 specific investors, at CNY22.33/share. The lock-up period is 12 months. The proceeds are mainly being used to: 1) acquire mid-to-low voltage switchgear and other businesses from Pinggao Group (CNY3bn), and fund its CNY800m working capital needs. According to management, the guaranteed net profit for the acquired assets is CNY212.64m, CNY270.61m and CNY346.84m in 2016-18, and 2) invest CNY378m in the Pinggao Tianjin smart switchgear industrial park project and CNY676m in the company’s India plant. After the placement, the State Grid’s shareholding decreased from 45.94% to 38.51%.

Pinggao: 2015 acquired assets from Pinggao Group Company name Stake Major business Further funding (CNYm) 2014 revenue (CNYm) 2014 net profit (CNYm) Shanghai Tianling 90% Mid-to-low voltage switchgears 894.7 549.7 35.1 Pinggao Weihai 100% Regular voltage GIS (exports) 226.7 188.7 17.2 Pinggao Tongyong 100% Switchgears 974.9 907.3 43.5 Guoji Gongcheng 100% EPC, power distribution and transmission equipment exports 782.2 313.4 -2.2 Langfang Dongzhi 50% JV with Toshiba 138.7 180.5 15.4 Source: Company

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Tianjin Plant has helped Pinggao expand into the power distribution field Relying on Tianjin Including the recent injection, namely the CNY378m funded from the private placement in Project to expand into October 2015, Pinggao has invested a total of CNY1.4bn in its Tianjin plant, which the power distribution commenced operations at the end of 2014, and helped the company expand into the field power distribution field. The plant produces mid-voltage vacuum interrupters, pole vacuum switches, embedded poles, etc. Management expects sales of CNY200m from the Tianjin project in 2015, and CNY1bn in 2016. And when full utilisation is achieved, management projects sales of CNY3-4bn sales a year.

The market for power distribution equipment is highly fragmented and localised. Since these products are more customised and the segment has low technical barriers, regional players dominate the market in China. On the back of Pinggao’s strong State Grid support and technological advantage, the company expects to be benefit from the centralised tender process for power distribution equipment that started in 2014.

Compared with the US and Europe, the current stage of China’s smart grid plan appears to be more transmission-centric, mainly focusing on expanding electricity generation, and connecting new power generation to demand centres through electricity transmission and distribution systems. In China’s smart grid plan in 2015, it stated that it plans to start upgrading its grid automation, including: 1) completing construction reform for 30 core cities and 30 non-core city centres, 2) achieving 50% power distribution automation coverage in core cities, and 3) completing the integrated governance of low-voltage issue in rural areas

Has set up an O&M JV. Pinggao has set up JVs in the grid maintenance business, working with SGCC’s provincial subsidiaries. Pinggao provides the maintenance service, and supplies key components and equipment. This business model could provide more sustainable and recurring sales, according to the company.

Under the power reforms, China will eventually open up the competition among the power generation and retail businesses to allow the market to determine energy tariffs. SGCC has also been encouraged to let professional parties enter the grid maintenance business. Pinggao is currently working closely with local SGCC subsidiaries to develop this business model, according to management.

Pinggao:1-year forward PER Pinggao:1-year forward PBR

(x) (x) 50 5.0 45 4.5 40 4.0 35 34.7x Avg+2SD 3.7x Avg+2SD 3.5 30 28.0x Avg+1SD 3.0 3.1x Avg+1SD 25 21.1x Avg 2.5 20 2.5x Avg 15 14.3x Avg-1SD 2.0 1.9x Avg-1SD 10 1.5 7.5x Avg-2SD 1.3x Avg-2SD

5 1.0

Jul-15 Jul-12 Jul-13 Jul-14

Jul-12 Jul-13 Jul-14 Jul-15

Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15

Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Oct-14 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Apr-15 Oct-15

Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Source: Bloomberg Source: Bloomberg

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Pinggao: UHV GIS equipment Pinggao: UHV GIS equipment

Source: Company Source: Company

Pinggao: Circuit breakers Pinggao: Circuit breakers

Source: Company Source: Company

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Pinggao: income statement (CNYm) 2011 2012 2013 2014 9M15 Gross revenue 2,525 3,284 3,818 4,606 3,129 SF6 circuit breaker 152 167 437 394 High voltage isolation switch and earthing switch 194 167 289 279 Insulated switchgear 1,858 2,524 2,594 3,464 Spare parts and others 254 95 133 333 Core business 2,458 2,953 3,452 4,469 - Others 67 332 367 137 3,129 VAT (18) (14) (29) (36) (15) Net revenue 2,508 3,270 3,789 4,570 3,114 COGS (2,045) (2,614) (2,836) (3,276) (2,106) SF6 circuit breaker (169) (188) (360) (308) High voltage isolation switch and earthing switch (179) (170) (210) (243) Insulated switchgear (1,497) (1,921) (1,877) (2,420) Spare parts and others (156) (51) (76) (208) Core business (2,001) (2,330) (2,523) (3,179) - Others (43) (283) (313) (97) (2,106) Gross profit 463 657 953 1,294 1,008 SF6 circuit breaker (17) (21) 77 86 - High voltage isolation switch and earthing switches 16 (4) 78 36 - Insulated switchgear 361 603 717 1,044 - Spare parts and others 98 44 57 124 - Core business 457 622 929 1,290 - Others 24 48 53 40 1,023 Selling expense (212) (194) (243) (190) (116) Admin expense (189) (262) (214) (293) (209) Finance costs (income) (40) (47) (50) (18) (48) Others (18) (6) 9 0 (8) Operating income 4 148 454 793 627 EBIT 44 195 505 811 675 EBITDA 128 309 642 996 n.a. Non-operating income 36 5 10 34 30 Non-operating expense (8) (3) (0) (18) (10) PBT 31 150 464 809 646 Income tax (15) (14) (67) (106) (111) Non-controlling interests 1 (0) 1 (10) (26) Net profit 17 135 399 693 509 Recurring net profit 25 135 398 708 490 Gain / loss on disposal (7) 0 (15) 19 Adjusted EPS (fully-diluted) 0.02 0.17 0.49 0.66 0.45 Dividend - 41 57 569 Source: Company

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Pinggao: balance sheet (CNYm) 2011 2012 2013 2014 9M15 Non-current assets 1,814 2,049 2,782 3,412 3,534 Held-to-maturity investment Long-term equity investment 353 371 384 Fixed assets 680 865 1,416 1,669 1,757 Under construction 313 249 222 456 656 Intangible assets 293 339 495 680 688 Development cost 143 189 229 254 250 Long-term deferred expenses 1 1 3 1 0 Deferred tax assets 31 35 33 44 45 Others 308 137 Current assets 3,157 4,355 4,444 6,500 8,031 Inventories 680 1,061 969 1,309 2,127 Notes receivables 92 41 25 42 119 Accounts receivables 1,520 1,887 2,814 4,230 4,963 Prepayment 152 277 340 326 368 Dividend receivable Other receivables 40 34 52 35 46 Cash 674 1,055 245 558 407 Total asset 4,971 6,404 7,226 9,912 11,564 Non-current liabilities 138 489 432 10 558 Long-term borrowings 110 60 Bond 397 398 548 Salaries payable 0 0 0 Payable 28 32 33 Deferred income 0 Deferred tax liabilities 9 9 Current liabilities 2,094 3,041 2,980 3,813 4,962 Borrowings 274 156 661 799 1,280 Notes payable 321 688 462 617 899 Accounts payable 804 1,234 1,359 1,828 1,728 Accruals 168 390 259 364 864 Salaries payable 4 6 8 19 22 Tax payable (8) 43 150 139 (12) Interest payable 22 14 12 10 0 Dividend payable 3 3 3 3 3 Other payable 6 6 67 33 178 Others 500 500 Total liability 2,233 3,530 3,412 3,823 5,520 Share capital 819 819 819 1,137 1,137 Capital reserve 1,337 1,337 1,921 3,024 3,024 Earning reserve 137 150 192 255 255 Retained earnings 441 564 879 1,453 1,394 Non-controlling interests 4 4 3 220 236 Total equity 2,738 2,874 3,814 6,089 6,045 Source: Company

Pinggao: cash flow statement (CNYm) 2011 2012 2013 2014 9M15 Net cash from operations 43 471 (200) 276 (368) Net cash from investments (196) (250) (462) (694) (195) Purchase of PPE (227) (260) (462) (692) (222) Assets held for sale Investment in JV Acquisition of subsidiary Others 31 10 - (1) 27 Net cash from financing 53 (21) 9 689 369 Issuance of shares (421) (674) 3 1,335 Issuance of bonds 498 895 548 Borrowings (55) (498) 478 Others (24) (242) 61 (148) (657) Net change in cash (99) 200 (653) 271 (194) FX change (or restatement) (0) 0 1 (4) 1 Cash balance 543 743 90 357 164 Source: Company

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Pinggao: key business metrics 2011 2012 2013 2014 9M15 Sales (YoY) 21.7% 30.1% 16.3% 20.6% 25.8% EBITDA (YoY) 46.4% 142.0% 107.8% 55.1% n.a. Adjusted net profit (YoY) 519.4% 450.4% 194.2% 77.8% 15.7% Core EPS (fully diluted) (YoY) 384.1% 676.1% 194.4% 34.6% 19.7% Gross-profit margin 18.3% 20.0% 25.0% 28.1% 32.2% EBITDA margin 5.1% 9.4% 16.8% 21.6% n.a. Adjusted net profit margin 1.0% 4.1% 10.4% 15.4% 15.7% ROE 0.6% 4.7% 10.5% 11.8% 8.8% Net debt to equity 1.1% 8.6% 33.5% 14.6% 39.9% Effective tax rate 48.1% 9.6% 14.4% 13.1% 17.2% Current ratio (x) 1.51 1.43 1.49 1.70 1.62 Net interest cover (x) 1.092 4.155 10.047 44.184 18.617 Adjusted dividend payout 0.0% 30.2% 14.3% 80.3% 0.0% Source: Company

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China Industrials 21 January 2016

XJ Electric (000400 CH) XJ Electric

Target price: n.a. Share price (19 Jan): CNY15.51 | Up/downside: -

Beneficiary of UHV construction and the smart grid Dennis Ip, CFA (852) 2848 4068  15% of gross profit came from the UHV DC business in 2014 [email protected]  Top-tier grid dispatch automation system supplier in China Nicole Jiang (852) 2848 4469  Slowdown in grid investment in 1Q-3Q15 affected profit growth [email protected]

Background: XJ Electric (XJ) is a leading equipment supplier in the field of Share price performance power generation, transmission, distribution and consumption in China. XJ (CNY) (%) is among China’s top-tier high-voltage relay protection and surveillance 36 100 system providers. It has been involved in nearly all Ultra High Voltage 30 85 23 70

Direct Current (UHV DC) projects in China, and is a market leader in DC 17 55 converter valve tenders. In November 2013, XJ Group injected DC 10 40 transmission-related assets into XJ, making XJ an integrated UHV DC Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 XJ Electri (LHS) player with a comprehensive DC product line. In 2014, about 15% of XJ’s Relative to SZASHR Index (RHS) gross profit came from the UHV business. 12-month range 14.53-35.70 Highlights: Benefiting from faster DC UHV construction. In November Market cap (USDbn) 2.37 2013, XJ Group injected DC transmission-related assets, including Flexible 3m avg daily turnover (USDm) 47.31 Power Transmission Company, into XJ. After the asset injection, XJ Source: FactSet, Daiwa forecasts became an integrated DC transmission equipment maker with a comprehensive product line. Based on our supply chain analysis, XJ currently has around a 4% market share in China’s overall DC business, thanks to its dominant share in converter valve and converter transformer tendering, which comprises 20% of China’s total DC line investment, or 70% of the country’s UHV DC equipment investment. An aggregate number of 6 lines obtained NDRC approvals in 2015. Based on our analysis, investment in DC lines should boom in China over 2016-17.

Smart grid products for smart power networks. XJ is also among the top-tier grid dispatch automation system suppliers in China, with about a 14% market share currently in high-voltage relay protection and surveillance systems. According to management, the formation of a UHV power transmission network, ongoing urbanisation and a rising renewable energy contribution in China’s power mix suggest growing demand for XJ’s smart grid products. Leveraging on the strong support from its parent company, state-owned State Grid Corporation of China (SGCC), XJ expects to continue to win market share through new-product introductions and integrated services.

9M15 results. XJ’s net profit dropped sharply by 72% YoY for 9M15, attributable mainly to a 32% YoY decline in revenue. The company said the major reasons for the contraction in revenue were: 1) a slowdown in grid distribution investment in 1Q-3Q15 (it expects the rural grid network upgrade plan released in September 2015 to help recover the growth), and 2) a delay in the delivery of some major projects.

Valuation: XJ is trading currently at a PER of 15x for 2014, and 30x for 2015E based on the Bloomberg-consensus EPS forecast.

See important disclosures, including any required research certifications, beginning on page 127

XJ Electric (000400 CH): 21 January 2016

Beneficiary of UHV construction and smart grid

XJ is a leading equipment supplier in the field of power generation, transmission, distribution and consumption in China. It is among China’s top-tier high-voltage relay protection and surveillance system providers, and has been involved in nearly all UHV DC projects in China, being a market leader in DC converter valve tenders. In November 2013, XJ Group injected DC transmission-related assets into XJ, making XJ an integrated UHV DC player with a comprehensive DC product line.

In 2014, XJ register total revenue of CNY8.36bn, with CNY1.06bn net profit attributable to shareholders.

Major business XJ currently has 6 business lines. From an earnings contribution perspective, smart power transformation and distribution systems as well as direct current transmission systems are the core earning drivers, with a higher gross margin than that for its other businesses, according to management.

1) Smart power transformation and distribution systems: power grid dispatching automation, relay protection systems, power station monitoring systems, outdoor vacuum circuit breakers, plant protection systems, etc. 2) DC transmission systems: converter valve devices, UHV DC transmission control and protection systems, DC field equipment, flexible DC transmission devices, etc. 3) Smart medium-voltage electricity supply equipment: switches, transformers, reactors, arc suppression coil grounding devices, ring main units, comprehensive traction power supply automation systems, railway prefabricated electrical substations, rail switching equipment, etc. 4) Smart meters: smart watt-hour meters, smart terminals, and smart home systems. 5) Smart power sources and application systems: special power sources as well as military and electric vehicle charging equipment. 6) EMS and other processing services: structural component processing equipment and surface mounting devices.

XJ: 2014 revenue by segment and gross-profit margin Business segment 2014 Revenue (CNY m) % of total Gross margin Smart power transformation and distribution systems 3,288 39.6% 44.1% DC transmission systems 1,479 17.8% 41.7% Smart mid-voltage power supply 1,467 17.7% 22.6% Smart meters 1,151 13.9% 20.3% Smart power supply and application systems 670 8.1% 28.6% EMS processing services and others 251 3.0% 12.5% Source: Company

Beneficiary of accelerating DC UHV construction

Has a 4% market share In November 2013, XJ Group injected DC transmission-related assets, including Flexible in overall DC investment Power Transmission Company, into XJ. After the asset injection, XJ became an integrated in China, thanks to its DC transmission equipment maker with a comprehensive product line, which includes dominance in converter converter valves, UHV DC transmission control and protection systems, DC field valve tendering equipment and flexible DC transmission devices.

Based on our supply chain analysis, XJ currently has around a 4% market share in China’s overall DC business, thanks to its dominant share in converter valve and converter transformer tendering, which comprises 20% of China’s total DC line investment, or 70% of the country’s UHV DC equipment investment.

In 2015, 6 DC lines obtained NDRC approval and construction was started on 4 lines, exceeding the aggregate numbers in 2011-14. Based on our analysis, investment in DC lines in China is poised to boom in 2016, as well as in 2017.

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UHV DC lines: capex breakdown UHV DC: investment in 2012-17E (CNYbn) Converter Valve 90 6% Converter transformer 80 11% 70 C&P system 60 1% 50 DC field 40 equipment 30 7% Others 20 75% 10 0 2012 2013 2014 2015 2016E 2017E

Source: SGCC, Daiwa Research Source: SGCC, Daiwa forecasts

XJ: tender results for DC UHV lines approved after 2012 Project name Converter Valve (Set) C&I System Year of approval Hami-Zhengzhou XJ: 4 NARI 2012 XD: 2 C-EPRI: 2 Xiluodu - Zhejiangxi XJ: 2 XJ 2012 XD: 4 C-EPRI: 2 Ningdong - Zhejiang XJ: 4 NARI 2014 C-EPRI: 4 Jinbei - Nanjing XJ: 4 XJ 2015 SF ABB: 4 Jiuquan - Xiangtan XD: 4 NARI 2015 C-EPRI: 4 Ximeng – Jiangsu/ Shanghaimiao - Shandong XD:4 XJ:1 2015 XJ:4 NARI: 1 C-EPRI: 8 Source: Company

Smart grid upgrade XJ is also a top-tier grid XJ is also among the top-tier grid dispatch automation system suppliers in China, with a dispatch automation market share of about 14% currently in high-voltage relay protection and surveillance system supplier in China systems. According to management, the formation of the UHV power transmission network, ongoing urbanisation and a rising renewable energy contribution in China’s power mix suggest growing demand for XJ’s smart grid products. Leveraging on the strong support from its parent company, SGCC, XJ expects to continue to win market share through new-product introductions and integrated services.

Market share of relay protection and surveillance systems in Market share of relay protection and surveillance systems in recent tenders by SGCC (35-110kV) tenders by SGCC (110-220kV)

NARI, 14% NARI Relay, Others, 16% 20% Others, 30%

NARI Relay, Changyuan, 13% 10%

SF, 16% Wisdom NARI, 12% Nanjing System, 9% Automation, 8% Changyuan, 9% Nanjing SF, 8% XJ, 14% XJ, 9% Automation, 12% Source: SGCC Source: SGCC Note: tenders since first batch in 2014 Note: tenders since first batch in 2014

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Compared with the US and Europe, the current stage of China’s smart grid plan appears to be more transmission-centric, mainly focusing on expanding electricity generation, and connecting new power generation to demand centres through electricity transmission and distribution systems. In the State Grid’s distribution network construction plan for 2015-20, it stated that it plans to start upgrading its grid automation, including: 1) completing construction reform for 30 core cities and 30 non-core city centres, 2) achieving 50% power distribution automation coverage in core cities, and 3) completing the integrated governance of low-voltage issue in rural areas.

Zhuhai XJ, a key subsidiary of XJ, has been the leading provider of automation distribution equipment in China since 2010. SGCC floated the first centralised tender for automation distribution equipment in May 2014, and XJ has around a 30% market share currently, second only to NARI Group.

SGCC: market share in automation distribution system tenders Zhuhai XJ Electric: revenue and net profit of (2010-14) (CNYm) SF 2,500 40% 8% 35% 2,000 30% 25% XJ 1,500 27% 20% 1,000 15% 10% 500 NARI 5% 65% 0 0% 2010 2011 2012 2013 2014 Revenue Net profit NPM

Source: SGCC Source: Company

XJ: major businesses and subsidiaries Major businesses and subsidiaries Smart power distribution Zhuhai XJ Electric, Zhuhai Xujizhi Power Grid Automation Smart power transmission Plant Protection System, Smart Power Transmission DC transmission systems Flexible Transmission System (Converter Valve), DC Transmission Control and Protection System Smart mid-voltage power supply XJ Transformer, Smart mid-voltage Switcher Smart meters Henan XJ Instrument Smart power supply and application systems XJ Power Source: Company

XJ: 1-year-forward PER XJ: 1-year-forward PBR

(x) (x) 60 7.0 4.9x Avg+2SD 50 6.0 42.7x Avg+2SD 5.0 4.1x Avg+1SD 40 33.5x Avg+1SD 4.0 3.3x Avg 30 24.2x Avg 3.0 2.4x Avg-1SD 20 2.0 15.0x Avg-1SD 1.6x Avg-2SD 10 1.0 5.7x Avg-2SD

0 0.0

Jul-15 Jul-12 Jul-13 Jul-14

Jul-14 Jul-12 Jul-13 Jul-15

Oct-13 Apr-15 Apr-12 Oct-12 Apr-13 Apr-14 Oct-14 Oct-15

Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Oct-12 Apr-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15

Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Source: Bloomberg Source: Bloomberg

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XJ Electric (000400 CH): 21 January 2016

XJ: UHV DC transmission control and protection systems XJ: switchgear

Source: Daiwa Source: Daiwa

XJ: intelligent substation system XJ: smart metering devices

Source: Daiwa Source: Daiwa

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XJ: income statement (HKDm) 2011 2012 2013 2014 9M14 9M15 Gross revenue 4,362 6,612 7,155 8,359 5,015 3,428 Smart power transformation and distribution system 2,278 3,702 3,996 3,288 DC transmission system 115 1,079 778 1,479 Smart mid-voltage power supply 983 854 1,051 1,467 Smart meter 527 485 797 1,151 Smart power supply and application system - - - 670 EMS processing service and others 294 321 359 251 Core business 4,197 6,441 6,980 8,306 - Others 165 171 174 53 3,428 VAT (33) (65) (62) (57) (37) (16) Net revenue 4,330 6,547 7,093 8,302 4,979 3,412 COGS (2,935) (4,842) (5,236) (5,485) (3,439) (2,568) Smart power transformation and distribution system (1,406) (2,472) (2,665) (1,839) Direct current transmission system (55) (966) (649) (862) Smart mid-voltage power supply (689) (625) (834) (1,135) Smart electricity meter (420) (373) (640) (917) Smart power supply and application system - (479) EMS processing service and others (257) (285) (321) (220) Core business (2,826) (4,721) (5,110) (5,452) - - Others (109) (121) (126) (33) (3,439) (2,568) Gross profit 1,395 1,704 1,856 2,817 1,539 844 Smart power transformation and distribution system 872 1,230 1,330 1,449 Direct current transmission system 60 113 129 617 Smart mid-voltage power supply 294 229 217 332 Smart electricity meter 107 112 157 233 Smart power supply and application system - - - 192 EMS processing service and others 37 36 37 31 Core business 1,370 1,720 1,870 2,854 - - Others 57 50 48 20 (3,439) 860 Selling expense (419) (376) (450) (506) (318) (272) Admin expense (554) (651) (577) (786) (408) (379) Finance costs (income) (87) (92) (54) (47) (40) (35) Others (26) (50) (29) (157) 8 8 Operating income 309 536 746 1,321 782 166 EBIT 396 628 801 1,368 822 200 EBITDA 487 746 927 1,476 n.a. 200 Non-operating income 56 146 147 76 39 54 Non-operating expense (2) (9) (7) (2) (2) (1) PBT 364 672 886 1,395 819 218 Income tax (60) (103) (116) (106) (81) (34) Non-controlling interests (148) (238) (247) (227) (145) (19) Net profit 157 332 523 1,062 593 165 Adjusted EPS (fully-diluted) 0.41 0.68 1.06 1.06 593 0.16 Dividend 38 38 67 101 Source: Company

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XJ: balance sheet (HKDm) 2011 2012 2013 2014 9M15 Non-current assets 1,209 1,203 1,281 1,307 1,396 Held-to-maturity investment 11 Long-term equity investment 28 28 25 - Fixed assets 840 1,043 1,077 1,029 978 Under construction 234 58 101 140 227 Intangible assets 75 45 40 77 71 Development cost 61 Long-term deferred expenses 2 1 0 Deferred tax assets 20 29 36 60 59 Current assets 5,863 5,723 9,106 9,485 9,238.2 Inventories 1,417 1,475 2,133 1,856 2,255 Notes receivables 121 97 77 107 150 Accounts receivables 2,663 3,363 4,993 6,262 5,586 Prepayment 294 151 399 269 327 Dividend receivable 1 Other receivables 195 97 131 164 185 Cash 1,171 539 1,373 827 736 Total asset 7,072 6,926 10,387 10,792 10,634 Non-current liabilities 875 691 695 697 698 Long-term borrowings 185 Bond 690 691 692 694 695 Payable 3 3 3 Current liabilities 3,230 3,047 4,943 3,862 3,636 Borrowings 263 307 400 - Notes payable 8 47 84 Accounts payable 1,490 1,986 3,535 3,200 3,121 Accruals 689 486 802 390 362 Salaries payable 4 4 8 9 6 Tax payable 95 149 69 147 (41) Interest payable 4 4 4 4 39 Dividend payable 13 17 - 4 Other payable 162 94 118 61 63 Others 510 Total liability 4,105 3,738 5,638 4,558 4,334 Share capital 378 378 492 1,008 1,008 Capital reserve 594 596 633 829 830 Earning reserve 256 256 270 372 372 Retained earnings 1,297 1,574 2,769 3,461 3,525 Non-controlling interests 442 384 585 565 565 Total equity 2,967 3,187 4,749 6,234 6,300 Source: Company

XJ: cash flow statement (HKDm) 2011 2012 2013 2014 9M15 Net cash from operations 473 498 751 (208) 142 Net cash from investments (146) (56) (89) (119) (130) Purchase of PPE (157) (67) (107) (119) (130) Assets held for sale Investment in JV Acquisition of subsidiary Others 11 10 18 0 0 Net cash from financing (157) (1,073) (105) (252) (122) Issuance of shares Issuance of convertible bonds Issuance of bonds 690 Borrowings (651) (651) 93 (400) Others (195) (422) (198) 148 (122) Net change in cash 169 (632) 558 (580) (111) Fx change (or restatement) Cash balance 1,171 539 1,311 732 621 Source: Company

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XJ: key ratios 2011 2012 2013 2014 9M15 Sales (YoY) 13.1% 51.6% 8.2% 16.8% -31.7% EBITDA (YoY) 36.3% 53.0% 24.3% 59.2% n.a. Adjusted net profit (YoY) 6.7% 112.1% 57.5% 103.1% -72.2% Core EPS (fully diluted) (YoY) 5.8% 64.7% 57.5% -0.6% -72.4% Gross-profit margin 32.0% 25.8% 25.9% 33.7% 24.6% EBITDA margin 11.2% 11.3% 13.0% 17.7% n.a. Adjusted net profit margin 3.6% 5.0% 7.3% 12.7% 4.8% ROE 6.2% 11.8% 12.6% 18.7% 2.9% Net debt to equity Net cash 16.4% Net cash Net cash 0.8% Effective tax rate 16.4% 15.3% 13.1% 7.6% 15.5% Current ratio (x) 1.81 1.88 1.84 2.46 2.54 Net interest cover (x) 4.562 6.803 14.757 28.996 7.666 Adjusted dividend payout 24.2% 11.4% 12.9% 9.5% 0.0% Source: Company

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Daiwa’s Asia Pacific Research Directory HONG KONG SOUTH KOREA Takashi FUJIKURA (852) 2848 4051 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Research Head Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Kosuke MIZUNO (852) 2848 4949 / [email protected] Shipbuilding; Steel (852) 2773 8273 Mike OH (82) 2 787 9179 [email protected] Regional Research Co-head Banking; Capital Goods (Construction and Machinery) John HETHERINGTON (852) 2773 8787 [email protected] Iris PARK (82) 2 787 9165 [email protected] Regional Deputy Head of Asia Pacific Research Consumer/Retail Rohan DALZIELL (852) 2848 4938 [email protected] SK KIM (82) 2 787 9173 [email protected] Regional Head of Product Management IT/Electronics – Semiconductor/Display and Tech Hardware Kevin LAI (852) 2848 4926 [email protected] Thomas Y KWON (82) 2 787 9181 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional) Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game Junjie TANG (852) 2773 8736 [email protected] Kevin JIN (82) 2 787 9168 [email protected] Macro Economics (China) Small/Mid Cap Jonas KAN (852) 2848 4439 [email protected] Head of Hong Kong and China Property TAIWAN Cynthia CHAN (852) 2773 8243 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Property (China) Head of Regional Technology; Head of Taiwan Research; Semiconductor/IC Design Leon QI (852) 2532 4381 [email protected] (Regional) Banking (Hong Kong/China); Broker (China); Insurance (China) Christie CHIEN (886) 2 8758 6257 [email protected] Anson CHAN (852) 2532 4350 [email protected] Banking; Insurance (Taiwan); Macro Economics (Regional) Consumer (Hong Kong/China) Steven TSENG (886) 2 8758 6252 [email protected] Jamie SOO (852) 2773 8529 [email protected] IT/Technology Hardware (PC Hardware) Gaming and Leisure (Hong Kong/China) Christine WANG (886) 2 8758 6249 [email protected] Dennis IP (852) 2848 4068 [email protected] IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer Power; Utilities; Renewables and Environment (Hong Kong/China) Kylie HUANG (886) 2 8758 6248 [email protected] John CHOI (852) 2773 8730 [email protected] IT/Technology Hardware (Handsets and Components) Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Helen CHIEN (886) 2 8758 6254 [email protected] Kelvin LAU (852) 2848 4467 [email protected] Small/Mid Cap Head of Automobiles; Transportation and Industrial (Hong Kong/China) Brian LAM (852) 2532 4341 [email protected] INDIA Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Transportation – Railway; Construction and Engineering (China) Jibo MA (852) 2848 4489 [email protected] Head of India Research; Strategy; Banking/Finance Saurabh MEHTA (91) 22 6622 1009 [email protected] Head of Custom Products Group Thomas HO (852) 2773 8716 [email protected] Capital Goods; Utilities

Custom Products Group SINGAPORE Ramakrishna MARUVADA (65) 6499 6543 [email protected] PHILIPPINES Bianca SOLEMA (63) 2 737 3023 [email protected] Head of Singapore Research; Telecommunications (China/ASEAN/India) Utilities and Energy Royston TAN (65) 6321 3086 [email protected]

Oil and Gas; Capital Goods David LUM (65) 6329 2102 [email protected] Property and REITs Shane GOH (65) 64996546 [email protected] Small/Mid Cap (Singapore) Jame OSMAN (65) 6321 3092 [email protected] Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore)

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Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items.  In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction.  In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.  For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.  There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.  There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us.  Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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