Tuesday, May 10, 2011

A Utility Stock with Triple-Digit Upside

If you invest for growth, I'll bet you hardly ever bother to check out the utilities sector. Why would you? Utilities are mainly for income, right?
It all depends on where you look. If you expand your search to other continents, you may uncover utility stocks offering attractive growth potential and juicy dividends.
I've found a very interesting one.
At 4.7%, its yield is just what you'd expect from a utility stock. But would you believe it has high double-digit -- if not triple-digit -- upside?
I know it sounds like a stretch, but it's true. Right now, this stock has what every investor wants in an investment -- the possibility of high returns, a better-than-average yield and very low volatility. The company, Huaneng Power International (NYSE: HNP), is China's largest independent electricity producer, operating 175 power plants in 27 provinces and Singapore.
Huaneng has been rapidly increasing output for years now. The latest example: first-quarter power generation of 75.4 billion kilowatt hours (kWh), a 29% increase compared with the first quarter of last year. First-quarter sales improved 25% to 71.1 billion kWh.
The fast growth clearly has much to do with China's economic expansion, which supported double-digit gains in electricity usage right through the global recession Analysts say usage will keep rising and outpace China's projected long-term economic growth of 9.5% a year through 2020.
Acquisitions have lately played a major role in Huaneng's growth, too. On Dec. 29, for example, the company announced the addition of a 50% interest in cargo transport firm Shanghai Time Shipping and a 30% interest in Hainan Nuclear Power.
Acquisitions are expected to be an important part of future growth.So are new power plants, existing plant expansions and diversification of fuel sources to include more oil and gas and less coal, since coal has become much pricier. There are also plans to bring clean energy sources to 25% of total capacity by 2015, up from 10% in 2010.
A major advantage for Huaneng is its focus on more developed areas of eastern China, which have consistently stronger electricity demand than other regions. The company smartly uses long-term contracts to generate more predictable revenue.
Unlike competitors, Huaneng has a close relationship with the central government. This greatly facilitates approval for acquisitions and new projects and could make it far easier to decrease the company's reliance on coal. In the past, coal prices have risen high enough to cause operating losses, like in 2008, when it had a $1.3 billion deficit -- despite revenue of $67.5 billion.
The loss highlights a big risk of intimate ties to the government, which has full discretion over rate-setting and may be slow to approve rate hikes even if commodity prices jump sharply. Because the government wouldn't raise rates when coal spiked in 2008, for example, Huaneng had to absorb the higher cost and suffered a painful $13.20 per share loss. The stock plunged 25% that year and 21% in 2009 as a result. A rate hike was finally approved in November 2009.
Also be aware that Huaneng is controlled by a state-owned corporation, which obviously gives the Chinese government a major voice in operations. Thus, there's always the risk of government interference that isn't necessarily in the best interest of shareholders.
Still, Huaneng is a top-notch investment overall, particularly now that coal prices have stabilized. I figure the stock has at least high double-digit upside in the next three or four years based on a per-share book value  of $29. If you multiply that by the historic price-to-book ratio of 1.5, you get a stock price of $43.50. However, the stock's only trading for around $22 a share right now, implying 98% upside.
And that's without the dividend  or future earnings  (analysts expect the latter to grow nearly 9% annually through 2016). If you take those into account, it's reasonable to project total returns up to 150% in the next three or four years.

Action to Take --> 
Now's a great time to buy. Sahres are dirt cheap because they haven't yet recovered from the coal-related nosedive of 2008 and 2009.
If you're looking for serious growth, consider Huaneng Power International. Despite being a utility, it's a major component of the fast-growing Chinese economy  and could deliver high returns on strong demand for electricity.
Plus, it isn't nearly as risky as the typical growth stock if you go by the beta , a measure of volatility relative to the overall market. Huaneng's beta is only 0.46, meaning it's 64% less volatile than the market.

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