Power Equipment Industry: Still Seeing Robust Growth

Power equipment mainly falls into four categories: power station equipment, primary transmission and transformation equipment, secondary equipment, and power environmental protection equipment. Investment in power sources primarily generates demand for power station equipment and power environmental protection products, while demand for primary and secondary transmission and transformation equipment stems from power grid investment and fixed-asset investment. Steel serves as the key raw material for the power equipment industry. National power investment policies, developments in the steel sector and fluctuations in steel prices exert a profound influence on the power equipment industry. To achieve profits above the industry average, power equipment manufacturers must not only possess leading technologies but also control manufacturing costs and improve profit margins by adopting hedging tools and accurately forecasting raw material price swings.

Driven by national power investment policies, power station equipment manufacturers hold massive order backlogs, with production schedules booked out to 2006 and 2007. Growth momentum will gradually slow after 2007. By contrast, manufacturers of primary transmission and transformation equipment, secondary equipment and power environmental protection equipment benefit from power construction cycles and national industrial policies for enhanced environmental protection, enjoying longer growth cycles than power station equipment producers. Therefore, the power equipment industry can maintain a relatively high growth rate over the next 2 to 3 years.

Power supply across China remained tight in 2005, and the nation further accelerated fixed-asset investment in power infrastructure. The revenue of the power generation equipment sub-sector is expected to sustain rapid growth of roughly 50%, while revenue from primary and secondary power equipment sub-sectors will grow at approximately 25%. In terms of investment orientation, power fixed-asset investment was mainly channelled into fast-track thermal power plant projects to ease the nationwide power shortage as soon as possible. Notably, China plans to build 40 nuclear power plants in the coming 15 years. The preliminary blueprint for China’s nuclear power development targets an installed nuclear power capacity of around 36 GW by 2020, accounting for 4% of the country’s total installed power capacity. Hence, manufacturers of nuclear power-related equipment merit attention.

1. Power Generation Equipment

Power generation equipment mainly consists of utility boilers and steam turbines for thermal power generation, as well as hydro generators for hydropower. Over the past two decades, China’s power generation equipment sector, a cyclical industry, has experienced drastic ups and downs under the administrative approval system for power station projects inherited from the planned economy. Large power generation equipment manufacturing is capital-intensive and technology-intensive with high industry barriers. Consequently, the competitive landscape of China’s large power generation equipment market is largely stable, dominated by three groups: Dongfang Electric Corporation (including Dongfang Electrical Machinery Factory and Dongfang Boiler Factory), Shanghai Electric Group (including Shanghai Boiler Works and Shanghai Turbine Works), and Harbin Electric Corporation. Although global power generator giants such as Alstom and Siemens have established joint ventures or wholly-owned subsidiaries in China, their current market share remains limited.

Steel plates constitute the primary raw material for power generation equipment manufacturing, accounting for 40%–60% of total production costs. Rising plate prices undermine the development of the power generation equipment sector. Order delivery schedules for power generation equipment manufacturers are concentrated in 2005 and 2006, with very few orders for delivery after 2007. Affected by macroeconomic regulation in 2005, manufacturers received fewer new orders for delivery post-2006. As the construction boom of power station projects winds down in 2006, a new industry downturn is expected to emerge. Macroeconomic regulatory measures introduced in November 2004 to curb blind investment in power station projects have gradually taken effect. With a series of non-compliant orders suspended and the scale of ongoing power station projects stabilised, the power generation equipment sector faces considerable uncertainties after 2005. Despite surging earnings of listed firms amid the overheated power generation equipment sector, we maintain a neutral rating. Listed companies in this sub-sector include Huaguang Co., Ltd., Dongfang Boiler, Shanghai Electric Power Co., Ltd., and Dongfang Electrical Machinery.

2. Primary Power Equipment

The primary power equipment industry enjoys sound overall growth momentum. It is mainly divided into sub-sectors such as transformers and switchgear. The transformer industry is currently expanding rapidly. However, silicon steel sheets, a key raw material widely used in transformer production, are in short supply. No new production capacity was scheduled to come online in 2005, so silicon steel sheet prices remained on an upward trend, putting heavy pressure on transformer gross profit margins and dragging down earnings of listed transformer firms. Investors are therefore advised to avoid this sub-sector. The competitive landscape of China’s transformer market remains generally stable. For ultra-high voltage large-capacity transformers, only three manufacturers can produce 500kV transformers: TBEA Shenyang Transformer Works, Xi’an Transformer Factory and Tianwei Baobian. Among more than 100 domestic transformer manufacturers, only 12 can produce 220kV transformers. The market for transformers below 220kV features numerous manufacturers and fierce competition. Listed transformer companies include TBEA, Tianwei Baobian, Zhixin Electric and Galaxy Technology. Siyuan Electric mainly produces arc suppression coils; its product market and raw materials are highly similar to those of transformers, so its performance is compared alongside transformer listed firms.

Primary power switchgear comprises disconnectors, circuit breakers, earthing switches, current transformers and other products. Following improvements in global manufacturing technologies after the 1980s, gas-insulated switchgear (GIS), which integrates disconnectors, circuit breakers, earthing switches and current transformers, was successfully developed. Featuring high voltage, large capacity and compact footprint, GIS products are widely adopted in modern high-voltage switchgear. The high-voltage switchgear sub-sector delivers relatively good performance and has formed a moderately monopolistic market structure. Nevertheless, its production costs are extremely sensitive to price volatility of non-ferrous metals. Only a small number of domestic manufacturers have mastered the production technology for new-type GIS products, leaving few investable listed companies. In contrast, low and medium-voltage switchgear has low technical barriers, a large number of producers and severe overcapacity, leading to cut-throat competition and long-term operational difficulties for manufacturers; no listed companies operate in this segment.

Raw materials account for 88% of the production cost of high-voltage switchgear, among which copper, aluminium and insulating parts make up 80% of raw material costs. Production costs are thus highly vulnerable to non-ferrous metal price fluctuations. At the start of the year, power equipment purchasers adopted a fixed-price contract model, shifting the risk of annual raw material price volatility to equipment suppliers. Listed manufacturers of high-voltage switchgear include Pinggao Electric, Tianyu Electric, Changzheng Electric and Great Wall Electric. Among them, only Pinggao Electric is capable of manufacturing high-voltage GIS products; the rest mainly produce conventional products with relatively low investment value.

3. Secondary Power Equipment

Secondary power equipment refers to automated systems and devices used to monitor and protect primary power equipment. It is partially dependent on primary equipment, and its market demand lags behind that of primary equipment to some extent. Its products fall into three major categories: main equipment protection automation systems, power grid dispatching automation systems, and substation automation systems.

Over more than 30 years of development, China’s secondary power equipment industry has undergone fierce market competition and natural selection. A cohort of core enterprises with production scale and competitive advantages has emerged, and industry entry barriers have risen markedly. The market competition of the secondary power equipment sector is characterised as monopolistic competition.

The competitive landscape of its three major product segments is as follows: First, power grid dispatching automation. China’s power grid dispatching system consists of national, regional, provincial, prefectural and county-level dispatch centres. Dispatching automation systems for provincial-level and above centres as well as large prefectural dispatch centres are almost entirely imported. For high-end national, regional and provincial dispatching systems, the domestic market is a duopoly of NARI Technology and Beijing Kedong Power Control System Co., Ltd. Second, substation automation. This market is mainly shared by NARI Technology, Nanjing SAC Power Grid Automation, Beijing Sifang Automation, Xuji Group and other enterprises. NARI Technology holds a 50–60% domestic market share in substation automation products, concentrated in high-end solutions, with gross profit margins of approximately 50%. Third, main equipment protection automation. For this product category, Nanjing SAC Power Grid Automation historically boasted strong competitiveness and once captured over 60% of China’s market share in the 1990s. After 2000, however, the market share of players such as NARI Technology gradually increased.

High entry barriers persist in this market. Apart from several well-established international firms, only a handful of domestic enterprises including NARI Technology, Beijing Sifang Automation, Nanjing SAC Power Grid Automation, Xuji Electric and Holley Technology compete in this space, supporting relatively high gross profit margins for their products. Ranked by industry standing, NARI Technology is the undisputed sector leader. Gross profit margins of secondary power equipment products are seeing a mild uptick. NARI Technology and Nanjing SAC Power Grid Automation are sound investment targets with core competitiveness and fast-growing earnings.