Earnings downside not fully priced-in
Shares of Power Assets’ (PAH) have rebounded 15% and outperformed the H.S.I. by 17% in the past three months, mainly due to the market's increased preference for seeking more defensive exposure, reduced concern on interest rate hikes, and greater expectation on acquisition upside. However, we believe the market is oblivious to the recurring earnings decline from a reduced stake in the HK business, absence of the deferred tax credit from the UK business, and regulatory return resets for the overseas business; reiterating Sell.
2014E earnings to decline by 23% after excluding one-off disposal gain
After excluding the HK$52-53bn one-off gain from the partial disposal of the HK business, we expect PAH’s earnings to decline by 23% in 2014, which would be mainly driven by a 50.1% reduced stake in its core HK business and no more deferred tax credit from its UK business arising from the UK corporate tax cut. We also see risks from renewed concerns on interest rate hikes, lower returns from the regulatory resets from its UK and Australia businesses starting 2015-16, as well as a lower HK Scheme of Control permitted return after 2018.
Market seems optimistic on acquisition upside; special dividends unlikely
PAH received total cash of close to HK$60bn after the spin-off of its Hong Kong business and is now in a net cash position. Theoretically, PAH can cover the earnings shortfall if it can deploy the entire amount on new projects at 8% investment return but this would be challenging to achieve, in our view. We do not expect PAH to declare a special dividend in 2014.
Sum-of-the-parts valuation of HK$60.2 (from HK$57.0); risks
We nudged up our target price by 6%, mainly reflecting the spin-off of PAH’s HK business at a higher valuation than our assumption. Key upside risks include acquisitions, better-than-expected outcome from regulatory review and return, and a renewed spell of macro volatility .