Power sector, major event review: added value tax reform, a long term positive for thermal power segment – Yang Zhishan and Wu Fei – Underperform (Reiterate)

Event: it has been decided on the executive meeting of the State Council that since Jan. 1st, 2009, added value tax reform will be implemented in all sectors across the country. Main content of the reform is as follows:  enterprises will be allowed the added value tax imbedded in the newly purchased equipment to be withheld or deducted. Meanwhile, the policies of exempting enterprises from added value tax on their imported equipment and allowing tax rebate to foreign funded enterprises on domestically made equipment they purchase will be cancelled and added value tax rate on small sized taxpayers will be lowered to 3%. Added value tax rate on ore products will be resumed to 17%. We view that the abovementioned changes to added value tax policies will be long term positives for thermal power segment and have little influence on hydropower segment.

This adjustment will lower the original value of new project booked as fixed assets via reducing the added value tax burden on enterprises and on the P&L statement, this policy will decrease the depreciation expenses of new projects.  Take things in 2006 as an example, expenses for purchasing thermal power equipment accounted for 47% of the total investment while mechanical & electrical and metal framework equipment expenses for hydropower equipment took up around 23%. Based on 17% added value tax rate, the deduction unveiled on this executive meeting will help lower the original value of fixed assets under new thermal power and hydropower projects by about 7.9% (47%×17%) and 3.8% (23%×17%). Take Huaneng Power International (600011) and CHINA YANGTZE POWER (600900) as example, their depreciation expenses accounted for 14.1% and 19.9% of their revenues. This policy will increase the gross margin from new thermal and hydropower projects by around 1.1 and 0.8 ppt (7.9%×14.1% and 3.8%×19.9%) and influence the pre-tax profit margin by 7.6% and 1.2%. As this reform is targeted at only newly operated projects. At present, most listed power companies will have less than 10% growth rate of newly operated projects. Therefore, it will have little influence on the overall performance of the sector.  

Hike of added value tax on ores: little influence as a whole. As the two power tariff hikes and downward coal price trend being formed , most thermal power enterprises will see their gross margin recover into positive territory in 2009. Against this background, higher added value tax rate will only result in more added value tax paid by coal miners and less added value tax paid by thermal power generators while have no impact on thermal power plants’ coal costs in real term largely.  

In all, this added value tax reform will alleviate the burden on thermal power companies via reducing the depreciation expenses of newly operated projects. It will have relatively little effect in short term but is really positive policy supporting the thermal power segment in the long run. Investors are advised to watch out for leading thermal power companies and those with more thermal power generator sets to be put into operation going forward such as Huaneng Power International (600011) and GD POWER DEVELOPMENT (600795).