2016 results miss expectation

In 2016, revenue was Rmb6.987bn, up 12.31% YoY; net profit attributable to shareholders was Rmb473mn, up 10%YoY, or Rmb0.35 per share, lower than expected. The company plans to pay a dividend of Rmb1.5 for every 10 shares.

In 1Q17, revenue was Rmb1.139bn, down 14.27% YoY; net profit was Rmb42mn, down 45.55% YoY.

Gross margin fell 1.5ppt in 2016 and 4.8ppt in 1Q17, due to revenue structure adjustments, higher costs and lowerprices. Gross margin in 2016 fell 1.5ppt to 16.9%, because 1） energy-saving business with a lower gross margin grewrapidly; 2） gross margin of energy-saving business fell due to increased subcontracting projects; 3） gross margin ofamorphous transformer business fell 4.3ppt due to higher raw material costs and lower product prices.

New orders in 2016 reached Rmb8.157bn, which will support steady earnings growth in 2017.

Trends to watch

The first-mover advantage in the carbon market could help boost valuation. 72 countries, including Chinaand the US, are pushing for the entry into force of the Paris climate agreement, which includes a major task to controlcarbon emissions. China’s State Council targets an 18% decline in China’s carbon dioxide emissions per unit of GDP from2015 to 2020. A nationwide carbon trading market will likely be launched in 2017 and may reach >Rmb100bn. Thecompany has a first-mover advantage in the carbon market. It is the only company within the system of State Gridspecializing in carbon asset business. It has established cooperation with nine domestic carbon exchanges and signedletters of intent on carbon asset management cooperation with a number of provincial power companies and localgovernments. The company had Rmb187mn of carbon assets at end-2016. It will benefit significantly from the launch ofthe nationwide carbon trading market and its valuation will receive a boost.

Power distribution network investment will accelerate. According to the NEA, power distribution networkinvestment over 2016~2020 will be no less than Rmb1.7trn. Investment will be high in 2017~2020. In addition, theproportion of high-efficiency power distribution transformers will increase from <8.5% in 2015 to 14% in 2017. AsChina’s largest amorphous transformer manufacturer, the company is likely to benefit significantly.

Fast-growing energy-saving business will fuel growth. Its revenue in 2016 grew 147% YoY to Rmb1.38bn, asthe projects in the Rmb6bn energy-saving framework agreement signed with a State Grid subsidiary in Zhejiang in 2014were being implemented. State Grid’s energy-saving reconstruction needs provide the company with enough marketspace. High growth is visible.

Earnings forecast

Lower 2017/18e net profit by 16/17% to Rmb549mn/Rmb647mn, or Rmb0.40/Rmb0.48 per share.

Valuation and recommendation

The stock is trading at 22x/18x 2017/18e P/E. Considering valuation rollover and sector valuation change, we maintainBUY, but lower TP by 23.9% to Rmb10.66 （27x 2017e P/E）， implying 22% upside. Risks: Sharp fluctuations in rawmaterial prices/exchange rates.