20151214-三星证券-LS_to_stand_out_in_sluggish_sector_in_2016_35页_1mb

Sector Update Summary: Utilities (NEUTRAL)

Core Content

The Utilities sector in South Korea is reviewed and downgraded from OVERWEIGHT to NEUTRAL for 2016 due to weak fundamentals, including sluggish energy demand, limited growth prospects, potential tariff cuts, and unattractive valuations. Despite this, LS Corporation is highlighted as the top pick for 2016.

Main Points

1. Sector Performance in 2015

• The utilities sector (including electricity, gas, and electric-power equipment providers) returned 4.7% year-to-date (as of November 30, 2015), slightly outperforming the Kospi index.
• Kepco and Korea District Heating (KDH) were standout performers, gaining 14.6% and 7.8%, respectively, due to lower fuel costs and frozen tariffs.
• Other firms like Kogas and city gas companies underperformed due to declining oil prices and reduced LNG demand.

2. 2016 Outlook

• Oil prices will continue to be a key determinant of sector performance.
• If oil prices remain flat at around USD50/bbl, the sector may not see significant gains, but if prices drop to USD30-40/bbl, Kepco and KDH could benefit further from lower fuel costs.
• However, tariff cuts are expected in 2016, which will likely reduce earnings and investor sentiment.

3. Investment Focus

• Investors should prioritize companies that:
  • Can offset domestic weakness with overseas growth, particularly outside the Middle East.
  • Benefit from domestic policy changes, such as increased investment in Kepco.
  • Offer attractive valuations and stable dividend yields.

4. LS Corporation as Top Pick

• LS Corporation is identified as the top pick for 2016 due to:
  • Expected 58% increase in operating profit to KRW41 billion.
  • Strong domestic orders and technological capabilities to drive international sales.
  • Potential one-off gains from selling and listing subsidiaries.
  • Improved financials and dividend yield of over 3%.

Key Information

5. Sector Fundamentals

• Energy demand has been slowing due to economic stagnation, structural changes in China, and improved energy efficiency.
• LNG and renewable energy are reducing the role of oil in power generation.
• Korea's energy intensity has dropped by 22% since 2002-2013, indicating more efficient energy use.

6. Dividend and Valuation Concerns

• The average dividend yield for Korean listed companies in 2014 was 1.75%, lower than global peers.
• The government plans to increase dividend payout ratios for state-owned firms to 40% by 2020, but this is unlikely to significantly improve valuations due to strict regulations and low dividends.

7. Policy Changes and Future Opportunities

• Kepco is expected to benefit from domestic policy shifts, including investment in underground and high-voltage direct current (HDVC) lines.
• The 2030 New Energy Plan aims to:
  • Expand distributed power generation.
  • Promote residential solar and ESS (Energy Storage Systems).
  • Develop green energy towns, zero energy buildings, and microgrids.
  • Increase EV (Electric Vehicle) charging stations and smart factories.
  • Upgrade transmission systems to DC technology for efficiency and flexibility.

8. Global Trends in Renewable Energy

• Renewable energy investments are growing, especially in the US and China, which account for 40% of global greenhouse gas emissions.
• Solar and wind are the main drivers of renewable energy growth, with solar increasing from 3% to 27% of global capacity and wind from 29% to 56-57%.
• Technology innovation, mass production, and competition are leading to cost reductions in renewable energy.

9. Challenges and Risks

• Global new/renewable energy growth is expected to slow after 2017 as the industry matures.
• Smaller firms may struggle due to intensifying competition and technological gaps.
• Korean companies face challenges in solar and wind markets, lagging behind Chinese and European firms in economies of scale and technology.

Conclusion

While the Utilities sector faces challenges in 2016 due to weak fundamentals and potential tariff cuts, LS Corporation is positioned to outperform through domestic orders, international expansion, and dividend yield. Investors are advised to focus on firms with strong overseas potential, benefiting from policy changes, and attractive valuations.