China Power T&D:Outlook diverges at voltage level;Top pick,XJ Electric

Challenges ahead, opportunities exist

    In 2017, we believe the domestic grid investment will continue to shift towards distribution and UHV grid. In particular, the deregulation of incremental distribution projects, entailing new business models, will become the key force in driving the up-cycle of distribution grid investment. Equipment players with more favorable product exposure and stronger EPC/financing capabilities should be able to benefit from these trends and record an above-average growth, against a limited growth outlook for domestic grid investment as well as raw material price hikes. XJ Electric is the biggest beneficiary, hence is our top pick; we also maintain Buy on Pinggao, and stay cautious on China XD.

    Grid investment to plateau; structural shift intact

    We expect limited yoy growth for domestic grid investment given: 1) an exceptionally strong base in 2016, 2) decelerating power capacity addition (high-voltage investment likely to be hit harder than other voltage levels in this regard) and 3) potential impact from T&D price reform. However, the structural shift of grid investment towards distribution network and UHV remains intact.

    Low-mid voltage distribution network: riding on power sector reform

    We believe distribution grid construction will be the principal force supporting domestic grid investment, with its contribution expected to rise from the current c.55% to >60% by end-2020. From this year, the accelerated power sector reform that allows private capital to invest in incremental distribution grid projects is the major driver. These projects tend to adopt a PPP model, under which equipment players with strong EPC/financing capabilities (and a gridco background) ? for instance XJ Electric ? should be more competitive.

    Ultra-High Voltage: investment to remain robust in 2017

    We expect UHV investment to remain robust at the c.Rmb120bn level and project tenders to remain stable at five this year. Domestic tenders in 2018 and beyond are less visible to us, as projects could be delayed/cancelled due to power oversupply and the increasing promotion of local power utilization. The chances of a drastic decline are also low, we believe, supported by an abundant pipeline both domestically and overseas. The UHV DC equipment market should remain stable, while the AC market could see more players joining.

    Stock picks: Top Buy XJ Electric; Buy Pinggao Electric; Hold China XD

    We now prefer names with higher exposure to distribution/UHV voltage products and less sensitivity to raw material price hikes. XJ Electric is our top pick on: 1) robust/visible UHV-driven earnings growth this year, 2) favorable positioning in distribution investment, and 3) still-compelling valuation despite share outperformance. We have a Buy on Pinggao due to its high UHV/distribution product mix. We are cautious on China XD, which is more exposed to the high-voltage investment downturn & raw mat. volatility. NARI Tech’s trading has been suspended pending further announcements on asset restructuring.

    Valuation and risks

    We base our TP on DCF, with WACCs of 7.1-7.9%. Risks: variance in grid investment, market share contraction and pricing pressure due to competition, raw material cost hikes and risks in asset restructuring.