HK Utilities:Sector fully valued; prefer CLP

Deutsche Bank Markets Research Asia China Utilities Utilities Industry HK Utilities Date 13 February 2017 Coverage Change Sector fully valued; prefer CLP Prefer CLP in the fully-valued sector ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016. Thomas Zhu, CFA Research Analyst (+852 ) 2203 6235 thomas.zhu@db.com Michael Tong, CFA Research Analyst (+852 ) 2203 6167 michael.tong@db.com Key Changes Company Target Price Rating 1038.HK 68.00 to 60.40(HKD) - 0002.HK 73.00 to 74.00(HKD) - 0006.HK 72.50 to 71.60(HKD) - Source: Deutsche Bank Top picks CLP Holdings (0002.HK),HKD77.65 Hold Source: Deutsche Bank Companies Featured CKI (1038.HK),HKD63.25 Hold 2015A 2016E 2017E P/E (x) 14.88 15.95 18.66 EV/EBITDA (x) 18.2 14.1 15.9 Price/book (x) 1.8 1.6 1.5 CLP Holdings (0002.HK),HKD77.65 Hold 2015A 2016E 2017E P/E (x) 14.57 16.29 16.11 EV/EBITDA (x) 9.3 10.5 10.1 Price/book (x) 1.7 1.9 1.8 Power Assets (0006.HK),HKD76.50 Hold 2015A 2016E 2017E P/E (x) 18.94 21.64 23.71 EV/EBITDA (x) 17.7 21.3 31.2 Price/book (x) 1.2 1.3 1.4 Source: Deutsche Bank The HK utilities sector has risen ~5ppt YTD and performed in line with the HSI Index. In our view, it is fully valued, with ~4% dividend yield and ~17x 2017E PE. The key things to watch out for in 2017 are potential US rate hikes, the regulatory decision for the Hong Kong power Scheme of Control (SoC) business, a profitability recovery in the Australian business, UK inflation and potential foreign currency depreciation. Among the Hold-rated stocks, we prefer CLP to PAH and CKI on the potential upside surprise from its Australia business and dividend sustainability. This report marks coverage transfer from Michael Tong to Thomas Zhu. Overhang from potentially higher US interest rates Our economics team expects the US 10-year yield to rise above 3.5% on global QE pullback, Fed tightening and rising inflation expectations. We see potential Fed rate hikes as an overhang on share prices for HK utilities at their current dividend yield of ~4%. Historically, HK utilities have traded at a 1.5ppt premium over the US 10-year interest rate on average. Strong momentum in Australian power market; CLP’s dividend sustainability Australian power demand has been high for 2016 and early 2017, driven by an increase in demand from new LNG projects in Queensland and warm weather. The upcoming closure of Hazelwood power station should tighten Victoria’s wholesale electricity market by ~20% and can further drive up pricing and margins. We see upside risk to CLP’s Australia business profitability and estimate that every 10% earnings surprise from its Australia business brings a 1.3% earnings surprise for CLP. CLP has the most sustainable dividend and greatest flexibility to increase the dividend (if needed), with its dividend payout ratio at ~60%, much lower than that of ~75% for CKI and ~85% for PAH. CKI/PAH priced in potential M&A; UK inflation positive especially for CKI We believe that CKI/PAH shares have priced in potential M&As – we have factored in US$25bn EV deal in our target prices, the deal size that we believe is achievable given their balance sheets and the HK$5/share special dividend from PAH payable in end Feb. Potential rise in UK inflation is positive especially for CKI: 1ppt higher-than-expected UK inflation in 2017/18 should increase CKI earnings by 0.6% in 2017/18. Strategically, CKI is better positioned than PAH with a broader M&A mandate in infrastructure. Earnings and target price changes Major earnings changes: we lower CLP’s 2018E earnings by 8% on weak AUD and lower profitability from China, and reduce CKI’s 2018E earnings by 6% on lower GBP. While we have not factored in the proposed DUET deal, on ownership uncertainty, we believe that PAH/CKI earnings should be boosted by 4% in 2018 under our base-case scenario. We cut our TP by 11% for CKI on lower GBP assumptions and marginally change our TP for CLP/PAH. We expect minimal value creation from the DUET deal on the high M&A premium. Valuation and risks We use a SoTP valuation for the sector. Key risks: regulatory development, M&A progress, and foreign currency movement. Distributed on: 12/02/2017 21:00:00 GMT 13 February 2017 Utilities HK Utilities Page 2 Deutsche Bank AG/Hong Kong Sector