Analysis of Top 4 China Power Producers (Part 2)

The author published the analysis report here is for his own reference only. It is not an indication of the author's business interests for companies being analyzed. It is definitely not an investment advice, please see the full disclaimer located at the bottom of the blog post.
 
In part 1, I look into Revenue, Net Profit and Net Profit Margin (NPM) of the top 4 China Power Producers such as Huaneng Power International, Inc. (hereafter called "Huaneng"), China Resources Power Holdings Co. Ltd. (hereafter called "CR Power"), China Power International Dev. Ltd. (hereafter called "China Power") and Datang Inter. Power Generational Co Ltd (hereafter called "Datang"). This time I will look into following items:

1. Why Huaneng's net profit of 2010 minus approximately 50% compared with 2006?
2. Why power generation industry experienced minimal profit or massive loss in 2008?

Down of Huaneng's Net Profit
In 2010, Huaneng's net profit declined 50% even operating revenue growth more than 100% compared with 2006. It is great the sales was double compared to 5 years ago, but I don't think the reduction of profit to the half of 2006 is a decent return.

By look into tabular data above, operation cost advance 168.41% and revenue advance 135.47%, operation cost grow more than 32.94% compared to revenue in 5 years period. The grow of operation cost mainly constituted by advancement of fuel cost, 200.3% in that period. Operating profit margin further narrow when ratio of operating cost to revenue achieved record level in 2010, 91.6%. Obviously, unpleasant outcome of Huaneng's operating results in 2010 was very much due to fuel and coal price hike. The fuel cost matter is not so much different compared to year 2008 when the company's management reported RMB4,551.83 millions loss. I believe the #1 challenge to the management of the company in near-term is -- fuel cost control, since it is the main dragging factor of company's performance. In my humble opinion, fuel cost control is much more critical than growing revenue to the company at this point of time.

Minimal Profit or Massive Loss in 2008
The minimal profitability for CR Power and Datang or massive loss for Huaneng and China Power in 2008 was caused by following factors:

1. Natural disaster: rainstorms and snowstorms in southern China, the severe earthquake in Wenchuan on 12 May
2. Drop of power demand due to global financial crisis
3. Continuous rise of coal price to record level historically
   
4. Significant increase in finance costs due to six interest rate hike

All things being equal, natural disaster and drop of power demand are non-controllable and unpredictable items that each company has more or less equal probability in occurrence. But I don't think so for fuel cost and finance cost. These two type of costs is very much related to efficiency of cost control of the company's manager. I believe cost control is important component to profitability especially in capital-intensive industry such as power generation. Let's see whether is this cost control factor keep CR Power and Datang remain profitability in 2008.

Looking into tabular data above, it was no doubt that fuel cost constitutes to large portion of operating cost, averagely 52% to 64% of revenue for these 4 companies. The best company in term of fuel cost efficiency is China Power, it's Compounded Annual Growth Rate (hereafter called "CAGR") of fuel cost is 28.15%, grow slightly less 0.92% than revenue, 29.06%. Next, the remaining three power companies have huge space of improvement in term of fuel cost control as all of them grow fuel cost faster relative to revenue in CAGR measure such as 5.62% for CR Power, 7.76% for Huaneng, 9.42% for Datang.

By refer to the table above, all companies grow finance cost greater than operating profit measured by CAGR, it was clear that power generation is capital-intensive industry which using financial leverages is a norm. However, it is common practices, doesn't means it is good. I believe if businesses can generate equals amount of operating profit, using lesser or no financial leverages is better, paying less finance cost means gain more in net profit. In finance cost control aspect, the previous fuel cost control winner -- China Power is the poorest performer among 4 companies, it's CAGR of finance cost is 83.52%, grow more than double of operating profit, 34.58%, different 48.93% relatively. The best company in term of finance cost efficiency is CR Power, it's CAGR of finance cost is 47% and operating profit is 34.1%, different 12.9% relatively. The 12.9% relative result is the smallest among 4 companies indicates CR Power using the least financial leverages relative to it's operating result. The second position measured by least uses of leverages is Datang, it's relative result is 29.68%, still more than double of CR Power. I believe it is combination of finance cost efficiency and fuel cost efficiency made CR Power has much wider profit margin comparing to it's peers.

That's all for the analysis of these four power producers, next blog post is devoted to analysis on CR Power including it's competitive advantages.