(March 31, 2010)
Gone With The Wind: Capital for China’s Turbine Makers
“A great wind is blowing, and that gives you either imagination or a headache.” Catherine the Great surely was referring to capital raising for China’s wind turbine makers. As Dow Jones Investment Banker reports, for them, a headache is more likely.
Last year was a good time for China when it became the largest wind market by annual installed capacity at 13 gigawatts, according to the Global Wind Energy Council.
Unfortunately that growth heralds overcapacity for Chinese turbine makers, suggesting a shake-out for some smaller names after 2009’s aggressive build out. That should, of course, play to survivors’ advantage in the long-term.
Meanwhile, for the clutch of wind-farm operators reportedly toying with a Hong Kong listing the business outlook is probably better, though the recent IPO market hasn’t been forgiving.
Favorable macro-tailwinds and preferential policy over the last five years have helped China’s wind industry. For example, farm operators are aided by on-grid tariffs for wind being higher than fossil fuels’, while local component-makers gain from rules ensuring at least 70% of turbine components by purchase value are made domestically.
And in the seven years to 2008 electricity generation grew at a compound annual growth rate of 12.8%, eclipsing China’s real GDP CAGR of 10.5% over the period.
And the bad news?
First: friendly market-share rules don’t translate into supporting margins when new entrants flood in.
Turbine makers, for example, have increased from six before 2005 to around 70 today. Meanwhile Xinjiang Goldwind Science & Technology Co. Ltd., one of the country’s top three turbine manufacturers by sales, saw its Ebit margins decline to 16.7% last year against 21.5% in 2006.
Smaller, unlisted firms likely experienced a similar trend, aggravated by lower margins given their higher operating leverage.
With farms shifting toward larger turbine sizes manufacturers are being pushed into capex for new production and R&D in an already highly competitive market.
Additionally, big farm operators gravitate to suppliers with a performance history, which favors larger, established outfits. China Longyuan Power Group Corp. - China’s largest wind-farm operator by capacity - sourced three-quarters of its turbine capacity from Gamesa and Goldwind at the end of June last year. This implies the domestic component sector is primed for realignment, especially among the second tier makers. That isn’t a great backdrop for listings or capital raising but survivors’ margins should benefit from less competition.
Wind farm operators -China Huaneng Group and China Datang Corp,’s renewable power unit - may have better prospects given superior earnings visibility over turbine assemblers.
Longyuan floated in Hong Kong in December. It has outperformed the MSCI China index by 5.9% since debuting - yes, with a somewhat erratic trajectory -making it one of the Hong Kong’s more successful IPOs since December.
A composite index of renewable energy power providers China Windpower Group Ltd. and China Power New Energy Development Co. has outperformed the MSCI China by about 30% over the past six months.
However, in contrast with most of Asia, both mainland and Hong Kong equity markets have logged negative returns since January and foreign fund flows into Chinese equity markets have been poor lately, underscoring the tougher environment for IPOs there.
Moreover, internal rates of return for 50 megawatt farms are around 10%, industry observers say, which sounds respectable, until you read Credit Suisse’s estimate that a 40%-equity financed 50MW Chinese wind farm probably generates a return on equity of some 4-6%.
That could be juiced with leverage but, with Chinese monetary and lending policy tightening, that mightn’t be so easy or appealing for equity investors.
So Chinese wind farm operators may still have their work cut out convincing investors that now is the time to bet on wind.
– Jamie Miyazaki