CLP: volatility hedge and more

StockHouse LogoThe perception of CLP Holdings [2] as a defensive utility play largely sees it attract interest only when the market is volatile. During the market correction earlier this month, the stock outperformed as investors sought a safe haven from rising oil prices and tensions in the Middle East. But while analysts see little excitement in this year’s profit outlook, they are more bullish for FY2001 when non-electricity operations become an earnings driver.

The operations of CLP are divided into three broad categories:

  1. the supply of electricity in Hong Kong, which is governed by a Scheme of Control Agreement with the Hong Kong Government 
  2. electricity-related ventures outside of Hong Kong, and; 
  3. non-electricity investments.

The Company generates electricity at three power stations in Hong Kong: Castle Peak, Black Point and Penny's Bay. All three stations are owned by the Castle Peak Power Company, a 60:40 joint venture between Exxon Energy and CLP, respectively.

With 70% of local electricity supplied by CLP and the remainder supplied by Hongkong Electric [6], the two companies enjoy duopoly status. In the six months to June 30, local unit sales of electricity rose 5.3% YoY, while total unit sales, which include sales to the mainland, increased 5.9% YoY.

In order to liberalize the electricity market, the SAR Government has undertaken a number of modifications to the Scheme of Control Agreement under which CLP operates. But these have stopped short of any steps that would introduce new electricity operators before 2008. Furthermore, significant barriers to entry protect CLP’s franchise, as the power supply business requires enormous fixed investment costs.

Meanwhile, local demand for electricity is forecast to continue to grow steadily on the back of the establishment of new towns along the Airport Express line and on Lantau Island.

Aggressive overseas expansion

stockhouse pic: CLPBut as profit from local electricity supply is governed by an annual 15% maximum return on fixed assets as set out in the terms of the Scheme of Control, CLP has moved aggressively into overseas markets.

To this end, it has made a number of recent moves. CLP acquired a 14.9% stake in EGCO, a Thai electricity company, in July 1998 and has since further increased its stake in EGCO to 20.2% at the beginning of this year. The Company also acquired a 15% interest in YTL Power International of Malaysia in September 1999. More recently, CLP announced its intention to increase its holding in Taiwan’s Ho-Ping power project from 30% to 40% at a cost of $54 million.

Mainland China has also been a destination for expansion. The Company currently holds a 29.4% stake in the Shandong Zhonghua power project. The $2.2 billion venture consists of four coal-fired power stations and will have a total installed capacity of 3,000MW when completed in 2004. In addition, the Company holds a 41.5% interest in the HK$940 million ($120.56 million) Guangdong Huaiji hydroelectric power project that will comprise nine hydroelectric power stations with a combined power generating capacity of 99MW.

CLP has also turned to business diversification to increase non-Scheme of Control earnings. The Company has joined with Exxon Mobil [XOM] of the US to form a consortium to bid for the Shenzhen liquefied nature gas project, which will be China's first such terminal. The consortium is one of four short-listed for the final round of bidding. But even with a successful bid, earnings contributions are unlikely before 2004.

Also falling outside of the Scheme of Control are CLP’s property development projects. The Company has placed a greater emphasis on this division in recent years.

Profits from the sale of the Laguna Verde joint venture residential development in Hung Hom have been booked as exceptional items and special dividends have been passed on to shareholders in each of the past two years. CLP’s partner in the development is local property heavyweight Cheung Kong [1].

As the property market has shown recent signs of recovery, Cheung Kong has recently launched the sale of Laguna Grande, the fourth phase of Laguna Verde. Initial market response has been positive and further exceptional profits for CLP and special dividends for shareholders are forecast.

Majority shareholders, the Kadoorie family spent HK$12.8 billion to buy back a 15% stake in CLP from CITIC Pacific [267] in August 1999. Following the buyback, the Kadoorie Family's interest in CLP was increased to 27.6%, while that of CITIC Pacific was reduced to 6.3%. Since then, CITIC Pacific has sold a further 2% of its holding in the open market, thus reducing its shareholding 4.3%. The latest disposal took place in early September at a slight discount to the market price of CLP.

CLP’s share price did not react negatively to the CITIC Pacific stake sale and a further sell-down of CITIC’s stake is unlikely to lead to massive selling. The market understands that CITIC Pacific’s intention to offload its holdings in CLP is not a reflection of the Company or its prospects but rather a decision by CITIC management to shift its focus towards a more new economy-based direction.

Likely to remain attractive

CLP is likely to continue to attract investor interest given the volatility in local and global stockmarkets under pressure from interest rate uncertainties and high oil prices. More aggressive investors, historically frustrated by the Company’s lack of growth prospects in its core operations, may begin to view the stock in a different light.

Prudential-Bache Securities has a "Strong Buy" rating on CLP with a 12-month price target of HK$42.70. The broker forecasts CLP's FY2000 and FY2001 net profit at HK$5.8 billion (-9.5% YoY) and HK$8.1 billion (+39.3% YoY), respectively, with earnings growth driven by its geographical and business diversification.

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