Stable Returns Driving Chinese Investment
BMI View: SG CC 's latest investment in two of Australia's most important power utilities is undoubtedly aimed at reaping stable , long-term returns from a market that is reliant on energy -intensive industry and has a stable operating environment. With China looking to pick up strategic assets in the energy sector to offset low-yielding domestic operations, this is trend that we expect to continue to accelerate over the coming months.
State Grid Corporation of China (SGCC) has signed an agreement with Singapore Power Limited under which it will purchase stakes in the latter's Australian assets. Under the deal , signed on May 17 , SGCC will take a 60% stake in energy infrastructure firm SPI (Australia) Assets Pty Ltd (SPIAA) for an undisclosed amount , and also a 19.9% share of electricity supplier SP Ausnet for US$810mn, according to Bloomberg.
This latest move will see SGCC acquire stakes in some of Australia's biggest energy utility companies - a development we believe aligns with the company's strategic plans to expand overseas , and also with our relatively bearish view on the Chinese domestic power market. In recent months SGCC has been swooping on overseas assets in an effort to compensate for its lo w-yielding domestic operations . Consequently, it is hoped its acquisitions in Australia will drive revenues, as well extend China's economic might throughout the region.
To put SGCC's situation in context, w hile China is unmatched in terms of the sheer size of its power sector, tightly regulated on-grid and retail power prices have eroded profitability for power producers, even causing a number of generators to cut production in 2011. Furthermore, with our Country Risk team forecasting that economic growth in China will slow to a below-consensus 7.5% in 2013, based partly on a realisation that state investment-led domestic policies are ultimately unsustainable, we hold a relatively bearish view on electricity consumption. We further note that a substantial emphasis on energy conservation and possible structural reform supports our belief that years of double-digit consumption growth might be coming to a close.
To this end, in an effort to diversify its overseas asset portfolio and dilute its reliance on its domestic market, SGCC President Liu Zhenya is aiming to purchase up to US$50bn in international assets by 2020. With this target in mind, in November 2012, SGCC moved to buy 41.1% of Electranet, the operator of the biggest transmission network in South Australia. SGCC has also been gaining exposure to the Philippines, Brazil and Portugal in recent months and is reportedly interested in acquiring Powerco Ltd, the second-biggest electricity and gas distributor in New Zealand. Demonstrating that SGCC intends to pursue this strategy further, we note that it launched its first international bond sale in the week beginning May 13, offering US$2bn of dollar-denominated securities to fund overseas acquisitions and boost profits limited by the cap on prices in the Chinese electricity market.
While Australia is a mature market, we believe the main draws are its stable regulatory environment and projected steady growth in electricity demand thanks to the growth of its numerous energy-intensive industries. While China will undoubtedly be keen to deepen its influence over Australia's abundant mining and natural resources sectors, under this latest deal, the company will also gain access to power and gas assets worth US$14.6bn, which supply 2.8mn customers in one of the world's largest economies. Such assets offer the company the prospect of strong, stable returns, aligning with a view that we have been highlighting across the global infrastructure sector in recent years: namely - with bond yields low and global equity markets volatile, infrastructure (which is classified as an inflation-linked asset class) is an attractive prospect for firms with money to invest.
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However, this deal does not only bring benefits for China. Australia's vast size currently creates challenges in terms of energy transmission and distribution (T&D). As Australia moves to overcome these challenges, SGCC certainly brings considerable experience in long-distance T&D. While it is obvious T&D infrastructure in China requires significant investment, the fact that SGCC draws electricity from an estimated 22,000 power stations and has a domestic customer base of 1.1bn people should not be underestimated in terms of the expertise it can offer, even in a developed market like Australia.
Supporting this view, we note that, after upgrading SGCC's investment grade to Aa3 on May 8 2013, Moody's justified the decision based partly on the grid operator's world-leading role in the development of UHV grids and smart grid technology, and the success it has had in facilitating the transmission of power from resource-rich western China to the economic hubs of eastern China. The ratings agency noted that there are few companies in the world with such experience of large-scale power transmission and distribution - a strength that could certainly be brought to bear in Australia.
Gauging The Mood
It is, however, notable that China might also be using this latest move to gauge Australian sentiment towards Chinese investment in the country. In recent years there have been rumblings of discontent about China's growing role in Australia - its biggest destination in terms of outward direct investment (ODI). As a consequence of these worries, both of SGCC's transactions will be subject to the approval of Australia's Foreign Investment Review Board (FIRD), which examines investment from all foreign state-owned enterprises. We note that in this case, the assets may have held further appeal for SGCC because the stakes it purchased were already foreign owned, meaning the FIRB is likely to grant approval, with the assets being transferred from one sovereign state fund (Singapore's Temasek Holdings) to an arm of another.