Guangdong No. 2 Hydropower Engineering Company (GHEC), an established leader in infrastructure construction in Guangdong Province, completed its reorganization with Guangdong Construction Engineering Group (GDCEG) in Jan 2023, forming a strong alliance. Upon completion of the reorganization, GHEC has enhanced its advantages in qualifications, talents, technology and project experience, and its comprehensive competitiveness has become even stronger. With a significant increase in new contracts and orders in hand, future earnings growth also looks more guaranteed. GHEC is an early mover in the construction of wind and photovoltaic (PV) power stations. In recent years, GHEC has shifted its focus to the renewable energy business, adopting a model of integrated investment, construction and operation and building a presence in new energy equipment manufacturing and sales to achieve higher-quality development, cost reduction and efficiency enhancement for its power generation & operation business. In 2022, the Company's renewable installed capacity under construction and approved surged. Given the higher profit level of the renewable energy business, its profitability looks likely to improve further in the future, and its long-term development is worth looking forward to. We set a target market cap of Rmb22.1bn, implying a target price of Rmb6, and initiate coverage with a "BUY" rating.
Company profile: As an established regional leader in infra construction, GHEC has been reorganized to gain new capabilities.
GHEC, established in Guangzhou in 2001 and listed in 2006, has grown into a leader in infrastructure construction in Guangdong Province. In the early stages of its development, GHEC focused on water conservancy, hydropower, transportation and other infrastructure fields. In recent years, the Company adopted the development strategy of "one specialty and multiple capabilities", focusing on the development of clean energy power generation and new energy equipment manufacturing and sales, and its related business revenue has continued to grow. On Jan 6, 2023, GHEC completed its reorganization with GDCEG via asset restructuring. After solving horizontal competition, GHEC absorbed GDCEG to form a strong alliance. This reorganization has enabled the Company to expand its scale and qualifications and improve its overall strength. Meanwhile, the earnings commitment of GDCEG will provide a basic guarantee for the Company's earnings growth.
Traditional infra: As infra continues to play a role in stabilizing growth, the strong are getting even stronger in industry competition.
Recent development: The state-level 14th Five-Year Plan (FYP) pledges to build a modern infrastructure system, focus on high-quality development, and give play to the driving role of infrastructure in stabilizing growth. In the field of traditional infrastructure, it is necessary to accelerate the construction of a transportation power and strengthen the construction of water conservancy facilities. The scale of planned projects and investments of various provinces in the transportation and water conservancy fields has increased significantly, and the construction process is likely to accelerate ahead. Industry competition: Competition in the infrastructure industry has become more intense, with an obvious trend of concentration at the top. Central state-owned construction enterprises and leading local state-owned enterprises (SOEs) have more competitive advantages. Compared with central construction SOEs, local construction SOEs are more focused on projects within the province and have more local advantages. In recent years, some local SOEs, including GHEC, have actively promoted M&As and reorganizations to expand their business scale while seeking nationwide expansion and exploring new business markets. In the context of continued investment in transportation and water conservancy infrastructure, companies with rich professional experience and strength, such as GHEC, have more competitive advantages and the strong stand to get even stronger.
New energy engineering: Favorable policies promote market expansion, and construction and power operations create new growth.
Under China's "dual carbon" goals, favorable policies have catalyzed market expansion. Infrastructure investment in water, electricity, gas and heat supply has maintained a monthly growth rate of around 20% YoY since 2022. The scale of wind and solar installed capacity in each province's energy plan for the 14th FYP period (2021-2025) has increased significantly, creating broad development space for related project construction. We expect incremental PV/wind installed capacity in China to reach 160/70 GW in 2023, respectively.
At the same time, in order to solve the problem of grid access for wind and solar power, policy support may favor the construction of technically mature pumped storage power stations, which may become new earnings growth drivers for leading water conservancy and hydropower engineering companies like GHEC.
GHEC: Fresh and legacy advantages will jointly accelerate development under dual drivers of new energy engineering + traditional infra.
Traditional infrastructure: GHEC boasts extensive qualifications. Upon completing the reorganization, it has come to have top-notch engineering, procurement, and construction (EPC) qualifications in four major engineering fields, including water conservancy and hydropower, as well as the strength to undertake high-quality projects across the country. GHEC has consistently increased investment in R&D, and as a result, the number of patents and construction methods has grown rapidly, and its technological innovation capabilities are outstanding. With the support of its edge in qualifications, technology and experience, GHEC has delivered many high-quality projects and won the most authoritative awards in the construction industry many times, creating a high-quality brand image. The Company has sufficient orders on hand, with new orders in 2022 and 1H23 reporting growth rates of 269.1% and 5.0% YoY, respectively, providing strong guarantees for future earnings.
New energy engineering: GHEC is an early mover in the construction of wind and PV power stations and has accumulated rich experience and advantages. In recent years, it has been shifting its focus to the new energy business, and its renewables installed capacity approved and under construction surged in 2022. We conservatively predict that its revenue from new energy power generation & operations will reach Rmb5.98bn in 2025. At the same time, GHEC actively participates in pumped hydro energy storage projects and vigorously develops new energy equipment manufacturing. Its full presence across the entire industry chain and the model of integrated investment, construction and operation may further promote quality improvement, cost reduction and efficiency enhancement. Operating status: GHEC has strong expense control capabilities, and its weighted return on equity (ROE) has increased year by year, reaching 9.5% in 2022. The gross profit margin (GPM) of its power generation & operation business has remained above 55% for years, with the segment contributing 19.9% of the gross profit after reorganization in 1H23. With the increase in the scale of renewables installed capacity, combined with the "investment, construction and operation" model and the full presence across the entire industry chain, the Company's new energy business may drive an overall improvement in profitability and future development looks even more promising.
Potential risks: The macro economy comes under pressure; the promotion of the dual carbon policy misses expectations; the traditional infra industry trends downward; industry competition becomes more intense; the Company's renewables installations disappoint; the prices of building materials fluctuate significantly.
Investment recommendation: GHEC completed its reorganization with GDCEG in Jan 2023, forming a strong alliance with stronger comprehensive competitiveness. With a significant increase in new contracts and orders in hand, future earnings growth also looks more guaranteed. In recent years, GHEC has shifted its focus to the renewable energy business, and its renewables installed capacity under construction and approved has surged. Given the higher profit level of the new energy business, its profitability looks likely to improve further in the future, and its long-term development is worth looking forward to. We forecast 2023E/24E/25E operating revenue of Rmb97.487bn/107.534bn/115.223bn and ANP of Rmb1.716bn/2.042bn/2.317bn, corresponding to EPS forecast of Rmb0.46/0.54/0.62, respectively. Factoring in the Company's historical PB valuation and the PE valuation of comparable peers, we believe that GHEC's reasonable market value is approximately Rmb22.1bn, implying a target price of Rmb6. We initiate coverage with a "BUY" rating.
