A Classic China Power Play

02/05/2008 12:00 am EST

Focus: GLOBAL

Jim Trippon

Editor-in-Chief, China Stock Digest

James Trippon, editor-in-chief of China Stock Digest, says a Chinese power company should profit from strong demand and an acute power shortage in the country now.

A number of solid Chinese companies are falling to bargain-basement prices. [Investors] have profited hugely from taking advantage of previous price plunges like the drop in the Shanghai market a year ago. The outlook for China is much different from that of the United States!

I expect the market for Chinese stocks to turn very quickly, and the time is right to buy shares of an old favorite, Huaneng Power International (NYSE: HNP).

This electricity-producing giant is now attractively valued with a P/E ratio of less than 13x and a relative dividend yield of approximately 2%. Despite an aggressive expansion strategy, the company has given up 40% of its value since its stock peaked in October.

We believe Huaneng Power is oversold considering current conditions in China. Facing an unusually harsh and snowy winter, China has issued an urgent call to the coal industry and to electricity providers to help avert a nationwide power crisis.

The electricity shortage in China is so severe that Aluminum Corporation of China (NYSE: ACH) has been forced to shut down production at two of its plants. Aluminum smelting uses up extremely large quantities of electricity, and it’s a sign of the scale of China’s shortage of power that Beijing has been forced to order the shutdown of two important factories.

Although electricity prices were frozen several months ago in an effort to ease inflation, Huaneng Power is still profitably ramping up its production capacity to meet China’s insatiable demand. In its most recent report, Huaneng said it had increased power generation by 13.21% during 2007, a massive jolt of electricity for China’s energy grid.

The current energy shortage indicates that demand is continuing to rise, and accordingly, Huaneng Power is actively expanding its thermal power capacity. The company also added to shareholder equity by purchasing the Jinling Power Plant, and it is bidding to purchase the massive Tuas Power Station in Singapore.

The level of demand for new electricity sources in China is becoming critical with 13 provinces facing a shortfall of seventy gigawatts (billion watts) of electricity generating capacity according to one estimate. It would require more than 25 new large-scale plants to satisfy this demand. Facing such a severe shortfall, it seems unlikely that Beijing will be able to continue the freeze on electricity prices while allowing coal prices to float.

State Grid Corporation of China, a still-unlisted electricity network operator, reported a 75% increase in profits during 2007. Given current conditions, we’re looking to Huaneng to deliver substantial profit increases in 2008. We suggest a “Buy up to” price of $35 per share. (It closed Monday slightly above $36—Editor.)

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