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UHV manufacturers to benefit from China’s clean air drive

As China’s nine month-long stock market rout drags on, certain counter-cyclical growth stocks have stood out from the crowd, with analysts recommending them on the basis of cheap valuations relative to their growth prospects.

Among the standouts are power grid equipment makers, whose shares have been under pressure in recent months. Many have regained investment attractiveness, especially those making high-end gear used to build so-called “ultra-high voltage (UHV)” power lines, which are expected to be in demand through the end of the decade, analysts said.

UHV lines would play a big role in helping tackle the nation’s air pollution problem, according to Liu Zhenya, the chairman of state-owned State Grid that has monopoly distribution in all but five southern regions in China, who said they would send excess renewable energy from northern and western regions to consumption centres in central and coastal regions so that some old coal-fired plants in the latter can be retired.

“UHV power lines are at a peak approval and construction tendering stage, with a number of lines expected to be approved in this year’s second-half,” said Sinolink Securities analyst Zhang Shuai in a report. “State Grid Corporation is also pushing for global grid inter-connection with UHV lines … this will spur development of UHV and smart grid technology.”

State Grid has an eight-year plan to spend some 600 billion yuan (HK$717.43 billion) to build 37 UHV lines by 2020. By the end of last year, only eight were in operation.

After delays related to technical and safety issues , approvals for new lines were accelerated in 2014 amid growing air pollution problems in major cities, so that a total of 16 lines are expected to be under construction this year and next year, according to a Daiwa Capital Markets report.

The average investment cost of each line is estimated by Daiwa at 20 to 25 billion yuan.

The overall power grid equipment production industry is fragmented and competitive. Only a few have the expertise to make UHV products and the key players are subsidiaries of State Grid.

They include Pingdingshan-based Henan Pinggao Electric which focuses on making switchgears, Nanjing-based Nari Technology which produces grid operation automation equipment, and Xuchang, Henan province-based XJ Electric which makes grid protection and surveillance systems.

Shanghai-listed Henan Pinggao shares have fallen 47.8 per cent from their level in early June last year, while those of Shenzhen-listed XJ have plunged 61.8 per cent and Shanghai-listed Nari have tumbled 55.2 per cent.

By contrast, the Shanghai Composite Index has retreated 45.3 per cent in the same period, while the Shenzhen Composite Index has slumped 42.7 per cent.

XJ Electric, which is 41 per cent-owned by State Grid, is a leader in direct current UHV. The company has a dominant market share in the converter valve and converter transformer segment, according to Daiwa.

The company’s shares are trading at 11.2 times this year’s earnings and 8.2 times for 2017, according to estimates by Sinolink.

As one of only three qualified suppliers in China, Pinggao has about a 40 per cent share of the “gas-insulated switchgear” market for alternating current UHV transmission lines.

This business segment accounted for 28 per cent of its total sales last year, according to Zheshang Securities analyst Zheng Dandan.

Switchgears, which combines electrical disconnect switches and circuit breakers, control and protect electrical equipment.

“It has the most advanced technology for switchgear, [and] as a subsidiary of [State Grid], it can take part in setting standards and government-initiated research projects,” said Daiwa head of utilities and renewables research Dennis Ip in the report.

Pinggao early this month posted a 19.3 per cent growth of net profit to 826.8 million yuan for last year.

It is targeting for pre-tax profit to rise from last year’s 943.5 million yuan to between 1.08 billion and 1.29 billion yuan this year, without including the acquisitions of businesses announced last year but not yet completed. If they are included, the targeted pre-tax profit is between 1.21 billion and 1.56 billion yuan.

With rising profits, Zheshang’s Zheng estimated its price-to-earnings ratio could fall to 16.2 times this year, 13.7 times next year and 12.1 times in 2018, if the profit guarantees provided in the acquisitions are realised.

Henan Pinggao in October agreed to sell shares to 10 investors to raise 4.89 billion yuan, to fund the purchase and expansion of its parent’s mainland China switchgear plants and a new plant in India.

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