Chinese state-owned power groups might potentially relist their renewable-energy arms on domestic markets after privatizing in Hong Kong, where the companies trade at low valuations. S&P Global Ratings believes the delistings could be part of a broader effort to widen the equity bases and lower the debt dependency of their parents, all of which are large independent power producers (IPPs). If successful, relistings would be credit positive for the heavily leveraged sector.

On July 6, 2020, Beijing Jingneng Clean Energy Co. Ltd. became the latest such company to announce plans to privatize, with an offer from the controlling shareholder, the state-owned enterprise (SOE) Beijing Energy Holding Co. Ltd. Long traded below book value and on thin volumes, two such firms have already gone private since last August, and three others have offers on the table. (see table 2). Only two remain: China Longyuan Power Group Corp. Ltd. and China Datang Corp. Renewable Power Co. Ltd.

The privatization trend will add to the parents' debt in the short run, but should be a route to a better mix of debt and equity funding. The renewable segments of the SOE IPP groups have hefty capital expenditure needs, and debt-funding such initiatives leaves them open to cash-flow volatility. Moreover, higher-quality equity will help the sector deal with changes ahead, including the coming end to broad subsidization of renewable energy in China. S&P Global Ratings rates four of the seven major Chinese SOE IPPs that have Hong Kong-listed renewable arms (see table 1).

Table 1

Why Delist?

Business fundamentals for renewable energy firms have changed a lot in recent years. Delisting and relisting allow the SOE parents to restructure their subsidiary holdings and inject the units that will perform better in an evolving landscape.

Table 2

China's renewables firms have persistent negative free operating cash flow (FOCF), in part because they depend on state subsidies which are always late to arrive. We calculate that in the past five years, the seven SOE renewables listcos have seen operating cash flow (after deducting financing costs) decline by an average 5% annually despite 10% annual net income growth. This is mostly because delayed subsidy receipts have kept accruing on the balance sheet, eating up working capital and resulting in a spike of account receivable days. At the same time, capacity addition outlays exceed internal cash flow generation.

The low valuations stymie equity fundraising in Hong Kong to expand China's renewables capacity (see chart 1). Since 2015, equity funds raised (not including hybrid issuance or injections by the controlling shareholders) by the seven listed SOE renewable arms have totaled HK$2.2 billion (about US$280 million), or a meager 1% of the capex spent by the listcos during the period. The listcos accounted for just over one-third of their parents' consolidated renewables capacity by 2019, declining from 47% in 2015: this, in our view, shows that low multiples might have discouraged asset injections as a means of fundraising in Hong Kong.

Table 3

Chart 1

However, to buy out Hong Kong-based shareholders, the parent companies will likely have to once again tap debt markets.

Privatizations Will Increase Debt Burdens By 1%-3%

Major SOE power groups have deep resources, and wide access to China's state-owned banks and onshore capital markets. In our view, they can easily borrow to fund the privatizations of their Hong Kong listed arms.

We estimated the aggregate cost of privatizations for the subsidiaries of our four rated SOE IPP groups (see tables 1-2). By our estimates, the full cost will range from HK$30 billion-HK$32 billion, or roughly 10% of their annual capex on average (two of deals are already complete). That may add 1%-3% to the debt burdens of the parents. The strain on debt servicing will be marginal given their competitive funding costs, and easing monetary settings in China. We expect interest coverage ratios to be maintained comfortably above a safe threshold of 2x for our the rated companies.

The bill for privatization comes at a tough time, given power demand has weakened, due to the impact of COVID-19. However, lower coal prices amid economic fallout in China will ease operating costs for the IPPs (which still rely substantially on coal-generated output), allowing the companies to absorb a 10% decline in revenue without a significant impact to cash flows. In the first half of this year curtailment rates of wind and solar was lower than last year, well under the government's target of 5%. Expanded nuclear output is another source of cash flow. China General Nuclear Power Corp.'s nuclear units generated 13% more power year-on-year (1.2% more, if excluding new units).

A Tricky Mandate: Expand Capacity While Lowering Leverage

SOE power groups need to strengthen their equity to meet complicated, and somewhat conflicting policy mandates. First and foremost, they have to increase renewables capacity to meet energy-mix goals to cut pollution. Our four rated SOE IPPs spent a total RMB246 billion capex in 2019, 24% higher than the year before. Spending levels didn't retrench in the face of subsidy delays. The majority of the capex has been dedicated to wind and solar capacity, which has expanded more than 15% annually over the past five years and will likely continue to see significant growth, even though subsidies for the sector are scheduled to be fully removed by the end of this year (except for offshore wind, which will get subsidies until end-2021).

Debt is a typical means to funding inflexible capex, given internal cash flows can't grow as fast, unaided by subsidy delay.

Chart 2

Deleveraging is another mandate the sector has to embrace. The State-owned Assets Supervision and Administration Commission (SASAC)--directly controlled by the State Council--has ordered centrally owned power SOEs to lower total liabilities-to-total-assets ratio (TL/TA) to 70% by 2020 from 2017's 80%+ level.

SOE power groups have mostly met targets by issuing perpetual securities, which they treat as equity on their books. These hybrid-capital instruments are in our view a suboptimal deleveraging tool. S&P Global Ratings treats perpetual securities as debt for many obvious reasons, including that the instruments need to be refinanced every three or five years to avoid penalizing coupon step-ups (typically 300 basis points or more). Excluding the effect of hybrid-capital issuance, TL/TA for the central SOEs would be only moderately lower, instead of nearing 70%.

Chart 3

China's policymakers have indicated that issuing more hybrid capital is not the solution to de-risking an expanding balance sheet. In its accounting-treatment guidance from January 2019, the Ministry of Finance said further deliberation is required to determine whether such repayment obligations should rank equally with other debt. At this stage, debt treatment is not mandatory, and issuers have continued to treat them as equity; this even as often they enjoy tax-deductibility on the interest rate payments.

The Path To A Bigger Equity Base

In our view, the Hong Kong delistings of renewable subsidiaries indicate that China's power groups are focused on shoring up their long-term equity bases. "A-shares" (issued in bourses in mainland China) have a long history of trading at higher valuations than "H-shares" (issued in Hong Kong), even for the same (dual-listed) company. Moreover, by delisting from Hong Kong, these IPP SOE groups can--and in our view likely will--restructure their renewables assets to better fit the changing landscape.

We note that in China, non-hydro renewables trade at much higher multiples for price-to-earnings and book value (see table 4).

Table 4

Chart 4

We also see scope for the IPPs to follow the path of other major SOEs, and raise equity-linked funds through exchangeable bonds. In this case, the nonlisted parent issues bond exchangeable for their listed subsidiaries. We don't treat exchangeable bonds as equity, but the cost of funding is cheap and the funds raised by this means can be substantial, at up to RMB20 billion for one single issue (see table 5). The cost of this funding is cheap, with coupons of just 0.5%-1.5%.

Table 5

More Predictable Cash Flows Would Also Help Capital Structure

China's renewables face unique burdens and a rapidly evolving landscape. While profitability may never return to past peaks, we believe the cash flow patterns may prove more predictable in the subsidy-free regime. We also believe companies are learning to adapt to more market-competitive pricing regimes. Tariffs competitively won will be fixed for the project life. Save for a small share of market volumes which tend to be sold at discounts, the pricing risk is manageable, in our view. Volumes also receive prioritized dispatch with prevailing curtailments kept under 5%, even during economic downturn.

More predictable cash flows are helpful for capital raising, in our view. Successful widening of the equity base would be a credit positive, in our view.

We note that China's privately owned, Hong Kong-listed renewable firms have not made moves to delist, despite similar low valuations. These companies have less flexibility, because they lack large SOE parents and pay higher financing costs. Some of these POEs have sold assets to their SOE peers, a process we expect to continue.

Table 6

Related Research

• China Huadian Corp. Ltd., July 29, 2020
• Earnings Accretion Underpins China General Nuclear's Creditworthiness, March 27, 2020
• State Power Investment Corp. Ltd. Rating Affirmed At 'A-' On Strong Contribution From Clean Energy; Outlook Stable, Oct. 30, 2019
• China Huaneng Group Assigned 'A-' Rating With Stable Outlook, Sept. 27, 2019
• The Limits To Perpetuals: China's SOEs Need A New Deleveraging Tool, April 15, 2019