Statistics from analysts at China Investment Online show that analyst attention toward the power equipment industry has risen sharply. This week, the industry climbed to the 12th spot in analyst coverage, up 5 places from the prior week. The continuous strengthening of energy conservation and environmental protection policies is the primary driver behind this surge in analyst interest. On May 4, the State Council issued the Notice of the State Council on Further Intensifying Efforts to Ensure the Achievement of Energy Conservation and Emission Reduction Targets for the 11th Five-Year Plan. It required all regions and departments to fully recognize the importance and urgency of energy conservation and emission reduction, strengthen their sense of mission and responsibility, fight a tough battle, and guarantee the fulfillment of the 11th Five-Year Plan energy-saving and emission-reduction goals. On May 5, the State Council convened a national teleconference on energy conservation and emission reduction to mobilize and arrange relevant work. Industrial power consumption accounts for approximately 70% of China’s total electricity use, among which motor power consumption makes up 60%-70% of industrial electricity. In contrast, industrial power consumption accounts for only about 45% in developed nations. China’s energy efficiency remains low; motor system efficiency is roughly 20%-30% lower than that of developed countries, leaving enormous room for energy saving.

In terms of market performance, the power equipment sector index has outperformed the CSI 300 Index by 29 percentage points over the past six months, and by nearly 8 percentage points in the past month. This reflects growing market confidence in rising investment within the downstream power industry. Data indicates that the power equipment sector achieved a year-on-year revenue growth of 39.23% in Q1 2010, demonstrating a stronger post-financial-crisis recovery than the overall A-share market. While the broader market has entered a downward correction amid internal and external pressures, some high-valued power equipment stocks lacking earnings support have pulled back. Nevertheless, stocks with solid earnings expectations have maintained high consolidation.

From the perspective of earnings growth, the power equipment industry saw a marked earnings recovery since 2009, accompanied by widening divergence across firms. Among sub-sectors, new energy equipment posted the fastest growth in operating revenue and net profit, while power generation equipment recorded the slowest growth. Revenue growth of primary equipment lagged behind secondary equipment. Companies with core competitive advantages still delivered robust growth, such as TBEA, Tianwei Baobian, NARI Technology and Rongxin Power Electronic. Century Securities believes earnings divergence in the power equipment industry will persist, mainly for three reasons: (1) the convergence trend of primary and secondary equipment enables enterprises undergoing business restructuring to achieve varying revenue growth rates; (2) amid rising raw material prices and falling selling prices, differences in enterprises’ bargaining power across the industrial chain lead to varied gross profit margins; (3) differing prosperity levels of power equipment sub-sectors result in divergent profitability. According to statistics from China Investment Online analysts, the projected consolidated earnings growth rate of the power equipment industry for 2010 reaches 35.99%.

In terms of market valuation, the P/E ratio of the A-share power equipment sector stands at 35.99 times, versus 20.50 times for the overall A-share market, representing a valuation premium of 75%, lower than the level in the same period of 2009. Cross-sector valuation comparison shows that the large power grid equipment sector sits roughly at the market median, while energy-saving and smart-grid-related stocks command slightly higher valuations, reflecting positive market expectations for industry operating conditions. From a longitudinal view of smart-grid equipment valuations over the past eight years, current sector valuations are near the average level. With smart grids elevated to a national strategy, the industry’s future earnings outlook is relatively certain, underpinning sector valuations. Given the certainty of domestic fixed-asset investment in the power sector, especially the rapid rollout of construction projects by the two major grid operators, market demand for related power equipment, particularly power transmission & transformation equipment and power control equipment, will further expand. Therefore, the current valuation premium of the power equipment industry is reasonable.

Investment Opportunities in the Power Equipment Industry

Great Wall Securities holds that future investment opportunities in the power equipment industry will mainly come from electrical energy conservation and supporting businesses for smart grids where enterprises possess core technologies. Key stocks include Rongxin Power Electronic, Hiconics Drive Technology, Kyushu Electric, Inovance Technology, Siyuan Electric, Xuji Electric, NARI Technology, and Clou Electronics. In addition, China’s ongoing and newly built nuclear power plants have gradually entered commissioning starting in 2010. Nuclear power equipment manufacturers are entering a period of rapid earnings recognition and profit growth, and related stocks merit attention, mainly including Dongfang Electric, CNNC Sci-tech and Shanghai Electric.

Meanwhile, it should be noted that since near-term growth in China’s power grid capital expenditure is unlikely to exceed expectations, and uncertainties remain regarding the construction pace of UHV power grids, investors should adopt a relatively cautious stance on large power grid-related stocks. Examples include enterprises whose core businesses are transformers, circuit breakers and GIS equipment. Among these stocks, only TBEA with strong competitiveness deserves key attention. For grid framework construction, DC power transmission enjoys strong prosperity and certainty, and supporting industries will continue to benefit. The top recommended stock is Xuji Electric.