Huadian Power International's 2014 earnings predicted to be broadly flat

No thanks to higher power generation cost.

Huadian Power International's 36GW of installed capacity makes it one of the larger listed power producers in China, and since Huadian is likely to continue growing its capacity in the next three years, it has been observed that this would restrict any material balance sheet de-leveraging.

According to a research note from Barclays, balance sheet de-leveraging for the company is unlikely despite strong FCF. It noted that Huadian has more than RMB110bn in net debt, implying gearing of close to c500%.

Further, although the company guides for continuing capacity additions in the next three years, Barclays estimate its FCF generation will still improve.

However, despite the better FCF, Barclays not expect its net debt to decline materially from the current levels as interest costs are likely to remain high.

Indeed, the report noted that it expects the cumulative FCF of RMB17bn (before interest) between 2014 and 2016 to fall short of a total interest cost of RMB21bn.

Here's more from Barclays:

Positives of leverage reflected in quadrupling of share price: Huadian's share price has rallied over 400% in the past two years as the sharp decline in coal prices helped the company to lift its earnings 600% by 2013 from a loss in 2011.

The large increases in earnings and share price reflect the company's highly leveraged investment case, in our view.

However, we expect 2014 earnings to be broadly flat y/y as the tariff cut for coal IPPs is likely to offset the impact from lower coal prices and higher power generation.

Attractive valuations but far from being a structural story: Its P/E at 7.2x for 2015E is optically attractive.

However, this is not too far off from the China IPP sector average, implying that its valuation discount would need to rise before Huadian could become a preferred stock in the sector given its high gearing.

We believe this high gearing and low visibility on any potential debt reduction are likely to keep the stock from becoming either a structural growth story or steady cash flow or yield play in the longer term.