ALTERNATIVE ENERGY | Neutral China Wind Power 4 April 2011 Taking the wind out of its sales We initiate coverage on China’s wind power sector with a Neutral Analysts rating – decelerating growth, grid bottlenecks, carbon income Clarisse Pan (852) 2533 2400 uncertainty, and rising interest rates being major concerns. Yet it’s [email protected] not all doom and gloom: the development of overseas markets and Alan Lau (852) 2533 2479 offshore wind are potential growth drivers from 2012. As the sector [email protected] has underperformed the Hang Seng China Enterprises Index (HSCEI) by 28% since 3Q10, we believe most market concerns have been priced in and we see long-term investment opportunities for industry leaders with historical trough valuations. We prefer wind equipment producers Xinjiang Goldwind Science & Technology (2208 HK, Outperform) and China High Speed Transmission Equipment (658 HK, Outperform) over wind farm operators China Longyuan Power (916 HK, Neutral) and China Datang Corporation Renewable Power (1798 HK, Underperform). Please read the analyst certification and other important disclosures on last page China Wind Power 4 April 2011 Table of Contents Taking the wind out of its sales .................................................................................................................3 Executive summary ..................................................................................................................................4 China sees decelerating growth in wind power capacity ...........................................................................9 Grid-related problems remain a serious challenge..................................................................................17 CDM (carbon trading) income uncertainty ..............................................................................................22 Overseas expansion a growth driver from 2012......................................................................................27 Offshore wind power – attractive theme by 2012 ....................................................................................34 Competition landscape – wind farm operators in China ..........................................................................40 Competition landscape – WTG manufacturers in China .........................................................................45 China High Speed Transmission Equipment (658 HK)............................................................................53 Xinjiang Goldwind Science & Technology (2208 HK) ..............................................................................70 China Ming Yang Wind Power (MY US)..................................................................................................89 China Longyuan Power (916 HK) .........................................................................................................107 China Datang Corporation Renewable Power (1798 HK) .....................................................................124 Appendices ..........................................................................................................................................138 2 China Wind Power 4 April 2011 China Wind Power Sector Rating: Neutral Taking the wind out of its sales (initiation) We initiate coverage on China’s wind power sector with a Neutral rating. Decelerating growth, grid bottlenecks, carbon income Stock price vs HSCEI uncertainty, and rising interest rates are major concerns for the 130% industry. Yet it’s not all doom and gloom. The development of overseas markets and offshore wind are potential growth drivers 120% from 2012. As the sector has underperformed the Hang Seng 110% China Enterprises Index (HSCEI) by 28% since 3Q10, we believe 100% most market concerns have been priced in and we see long-term investment opportunities for industry leaders with historical trough 90% valuations. We prefer wind equipment producers Xinjiang 80% Goldwind Science & Technology (Goldwind, 2208 HK, 70% Outperform) and China High Speed Transmission Equipment (CHST, 658 HK, Outperform) over wind farm operators 60% Jul 10 Aug 10 Sep 10 Oct 10 Nov 10 Dec 10 Jan 11 Feb 11 Mar 11 China Longyuan Power (Longyuan, 916 HK, Neutral) and China CHST Goldwind Mingyang Longyuan Datang HSCEI Datang Renewable Power (Datang, 1798 HK, Underperform). Source: Bloomberg Growth deceleration due to serious grid bottlenecks. Although China is likely to remain the largest wind market Valuations summary globally, we project CAGR of annual wind installation in CHST Goldwind Mingyang Longyuan Datang China at 1% in 2010-2015F, down sharply from 120% in (658 HK) (2208 HK) (MY US) (916 HK) (1798 HK) 2006-2009, due mainly to grid bottlenecks, an issue we Rating* O O N N U expect to persist for another three-to-five years. Share price HK$12.54 HK$14.56 US$10.52 HK$8.47 HK$2.38 Other industry overhangs include carbon income Target price HK$15.60 HK$16.60 US$11.00 HK$9.10 HK$2.00 uncertainty post expiration of the Kyoto Protocol, potential Upside/downside (%) 24 14 5 0 (16) interest hikes in China, overcapacity of wind turbine PER (x) generator (WTG) manufacturing, and pressure on pricing 2011F 10.1 13.2 8.4 19.7 14.2 and margins. 2012F 9.4 12.9 7.1 15.3 10.9 Next wave of growth from overseas expansion and EV/EBITDA(x) offshore wind from 2012F onwards. We estimate 2011F 6.9 15.2 6.6 5.7 3.3 overseas shipments will be c.13% of total shipments of the 2012F 6.3 14.0 5.7 4.5 2.4 leading Chinese wind equipment producers by 2012F. We ROE (%) also expect China’s cumulative offshore wind capacity to 2011F 16.9 17.1 22.6 8.9 8.6 reach 5GW by 2015F, implying a 90% CAGR in 2012F 16.2 15.4 21.0 10.1 10.0 2010-2015F. EPS YoY change (%) Our contrarian stock view: prefer selective wind 2011F (5) 10 48 35 122 equipment producers over wind operators. Some 2012F 7 3 18 28 30 consider Chinese wind operators superior to wind * O = Outperfom; N = Neutral; U = Underperform equipment manufacturers owing to their higher earnings Source: CCBIS estimates CAGR. We disagree believing that wind operators’ current Data as of 1 April 2011 valuations are either fair (Longyuan) or too demanding (Datang) given low company ROEs (9-10%), stretched balance sheet positions and high earnings dilution risk from refinancing activities. We like CHST and Goldwind for their Clarisse Pan industry leading positions and believe current valuations, at (852) 2533 2400 [email protected] historical trough levels, provide good entry points for the long-term. We have a Neutral rating on China Ming Yang Alan Lau Wind Power (Mingyang, MY US) due to the high risk (852) 2533 2479 involved in its new product launch. [email protected] 3 China Wind Power 4 April 2011 Executive summary China faces decelerating growth in wind power capacity In 2010, China overtook the US to become the country with the largest cumulative wind power capacity globally. Wind installation had an impressive 120% CAGR in 2006-2009. But 2010 represented a major stumbling block for wind installation, when annual installation growth slowed significantly to 37% YoY due mainly to a grid connection bottlenecks in the shape of a lack of physical grid connections and power curtailment. As we do not expect the grid connection problems to be resolved any time soon, we project annual wind installation growth could slow to a paltry 3% YoY for both 2011F and 2012F. Over the five-year period from 2010 to 2015F, we forecast that annual wind installation in China will grow at a CAGR of 1% with cumulative wind installation at a CAGR of 26%. Although our forecasts have factored in drastic growth deceleration for wind power in China going forward, our estimate for wind power capacity, both onshore and offshore, of 245GW by end-2020F is much higher than the government’s target of 150GW, which we believe to be far too conservative. In our view, there is a mismatch in China’s targets for renewable energy capacity and renewable energy consumption. To achieve its goal of having 15% energy consumption from renewable energy sources by 2020F, China needs to take a much more aggressive renewable capacity installation target, in our opinion. Moreover, we believe wind power could be the beneficiary if the Chinese government decides to adopt a more cautious stance on nuclear power development post the nuclear crisis in Fukujima, Japan, earlier this year. Grid-related problems remain a serious challenge We found two types of grid-related problems within the Chinese wind power industry: (1) installed wind capacity lacking physical grid connections; and (2) wind power curtailment. These problems will reduce the profitability of wind farm operators as they either let wind capacity idle, lower effective capacity utilization hours of wind farms or cap capacity growth potential of wind farm operators. Based on our estimates, 30% of installed wind capacity will not be connected to the grid by end-2011. Moreover, according to data from China Electricity Council (CEC), approximately 11% of wind power generated in China was not procured by grid operators in 1H10. While the central government has been grappling with such issues since 2009 and is expected to adopt measures to improve grid connection and wind power generation conditions, we only expect grid-related problems to be resolved gradually over the next three-to-five years. 4 China Wind Power 4 April 2011 CDM income uncertainty remains an overhang up to 2012F In addition to wind power tariffs, wind farm operators in China