China’s high-speed transmission faces lull in profits as baseload wind sector slows (CHSTF)

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A strong tailwind fills all sails, to slightly modify an old adage. This should certainly be the case for wind energy companies in China, which stand to be the big beneficiaries of Beijing’s push towards renewables as it seeks to peak carbon emissions by 2030. and carbon neutrality by 2060.

But the argument seems to fall flat for China High Speed ​​Transmission Equipment Group Co. Ltd. (OTC:CHSTF) (0658.HK), a wind energy equipment supplier that encountered headwinds that let it falter last year, according to its annual earnings report released last week. Facing stiff competition and rising costs, the company sold some of its operations to a major asset manager, hoping that their combined resources and networks would bring new business opportunities and breathe some fresh air into its operations. turbines.

China High Speed ​​Transmission is a leading wind power transmission equipment supplier in China whose customers include well-known wind turbine manufacturers such as GE Renewable Energy and Siemens Gamesa renewable energies. On paper, at least, things look fine and dandy for the company. Its revenue rose 31.5% last year to a record 20.2 billion yuan ($3.2 billion) and its net profit rose 56.4% to 1. 32 billion yuan.

But in 2020, the company incurred a one-time expense of 548 million yuan related to increasing the capitalization of one of its units. Adding that to its reported net profit would bring the figure to 1.39 billion yuan for the year, meaning the profit figure for 2021 would mark a decline of 5.3%.

The reasons for its declining profits are hidden in its revenue structure. The strong increase in its revenue comes mainly from the progress of its new business operations. The company started its raw materials and steel supply chain trading operations in the second half of 2020, which saw revenue of 5.76 billion yuan last year, up 216.9% year-on-year and representing 28.5% of its total revenue.

Revenue from its industrial and railway transportation gear transmission equipment business increased 27.4% and 23.5%, respectively, contributing a relatively small share of 9.6% and 1.8 % of total turnover. By comparison, its core wind gear transmission equipment business slowed last year to grow just 3.3% to 12.04 billion yuan, even though it accounted for about 60% of the total turnover.

Low margin business

Commodity trading is a lucrative source of income, but it contributes relatively little to profits due to its low gross margins. It accounted for just 4.7% of the company’s operating profit last year, while wind and industrial gear transmission equipment contributed nearly 90%.

But falling prices for its wind and industrial equipment, combined with rising costs and a growing share of revenue from its less profitable trading business, caused the company’s overall gross margin to drop 5.1 points. percentage to 15.8% for the year. Rising geopolitical tensions and consecutive spikes in energy and commodity prices since the start of this year are expected to further drive up costs and squeeze the company’s gross margin.

Investors are not oblivious to the company’s problems. After its financial statements were released late on March 6, its stock price fell 9.6% the next day to HK$5.38 and fell another 5.2% the next day before finally regaining ground. It has lost nearly 40% of its value from last April, when its stock traded at a yearly high of HK$8.36.

According to data from China’s National Energy Administration, China added 47.57 GW of installed wind capacity to the grid in 2021, up 34 percent from the previous year. Much of this was for offshore wind, as wind farm builders rushed to recoup remaining government subsidies that expired at the end of 2021. As a result, installations for offshore wind capacity increased by 4.5 times last year compared to 2020 levels.

The Chinese central government will no longer subsidize new wind power projects in the future, and wind power will be priced the same as coal-generated power. As a result, the industry is turning to large wind turbines to improve economic returns. To facilitate this development, China High Speed ​​Transmission is actively developing high-power transmissions, which partly led to a 30.2 percent increase in its R&D costs last year to 670 million yuan.

Cashing in his boxes

To replenish its coffers for tougher times ahead, the company last year sold 43% of its Nanjing high-speed gear manufacturing unit to a consortium organized by resource-rich and experienced Shanghai Wensheng Asset Management. . The subsidiary mainly manufactures and sells gears, gearboxes and other components, and made a profit of 796 million yuan in 2020.

China High Speed ​​Transmission owned 93% of the unit before the sale, and it contributed more than half of the parent company’s basic net profit in 2020. The sale of the stake paid China High Speed ​​​​Transmission about 3.5 billion yuan, which it will use to build new factories. , upgrade production equipment and expand business.

In addition to increasing cash flow, the sale has the added benefit of bringing in Wensheng Asset Management as a partner. Wensheng’s website shows that it had a total of 123.2 billion yuan in assets under management at the end of 2021, and is one of the country’s leading private non-performing asset managers.

Wensheng’s investment marks a show of support for China High Speed ​​Transmission and could be followed by more resources and investment opportunities if the partnership goes well. China High Speed ​​Transmission’s Board of Directors believes that Wensheng’s strong investment experience will help win investors’ trust and bring more resources and investment opportunities to both the Nanjing subsidiary and to the company as a whole.

Leading Chinese wind equipment makers Xinjiang Goldwind (2208.HK) and Dongfang Electric (1072.HK) offer good valuation comparisons for China High Speed ​​Transmission. Both have price-to-earnings (P/E) ratios of 10.4 times and 9.7 times, respectively, based on their estimated earnings for the past year. Both are roughly double the 5x P/E ratio for high-speed transmission in China, which looks relatively attractive at this level. But the sale of the Nanjing subsidiary, the slowdown in its core wind business and rising costs are all good reasons why the company is less valued than its peers.

Disclosure: Any.

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