China. Market Outlook and Clean Energy Opportunities. Representing Schroders: David MacKenzie Head of Asia ex Japan Equities Product Management

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1 China Market Outlook and Clean Energy Opportunities Representing Schroders: David MacKenzie Head of Asia ex Japan Equities Product Management June 2011 Additional information: For Professional Investors only. Not Suitable for Retail Clients

2 China Contents China Market Review & Outlook Clean energy in China Nuclear Solar Wind China opportunities 1

3 2 All that glitters

4 China market outlook

5 China GDP growth has been by supported robust FAI and stable consumption Market outlook GDP growth by expenditure 20 Growth rate (% y/y 3mma) Consumption Fixed investment Net exports 4 Source: CEIC, Haver, Bloomberg, UBS, May 2011

6 China Some sectors have been the target of policy goals Market Outlook Rural subsidy scheme and social housing programmes are policy tools to achieve the objective of rebalancing the economy, achieve social harmony and bring equitable wealth distribution Promoting consumption through rural subsidy scheme Total sales volume of rural subsidy Units mn 190% 140% 90% Quantum Leap in social housing supply Number of units started units mn % Minimum wages have been rising across the country a move supported by the government to gradually realign the economy in favour of consumption over the long term % -10% -60% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec E 2012E YoY % Social Housing Commodity Housing Residential: Social Housing (RHS) 5 Source: CEIC, CREIS, Morgan Stanley Research, April 2011 Source: MoHURD, CEIC, Morgan Stanley Research, April 2011

7 China Is the golden age of consumption coming? Market outlook Share of wage income and consumption will rise in China reversing a decade-long declining trend Wages to increase % of GDP Wage as % of National Income US China E 2011E 2012E 2013E 2014E 2015E Wage Other Income Private Consumption Source: CEIC, Credit Suisse estimates, January 2011 Source: Historical Statistics of the United States, CEIC, Credit Suisse, January

8 China s growth longer term must slow Market outlook Morgan Stanley s research suggests for developing economies growth slows sharply when they reach a GDP per capita of US$7,000 on a constant PPP basis History: Growth deceleration post inflection point Average GDP growth post inflection point (%) 12 Growth deceleration post inflection point GDP growth (%, 3-yr MA) T-30 T-25 T-20 T-15 T-10 T-5 T Oil Crisis T+5 T+10 Asia Financial Crisis T+15 T+20 T+25 T+30 Average GDP growth prior to inflection point (%) China (T=2007) Korea (T=1988) Japan (T=1969) 7 Source: Angus Maddison, 2006, The World Economy: A Millennial Perspective, OECD, Morgan Stanley Research, November 2010 Source: CEIC, Morgan Stanley Research, November 2010

9 China Is the golden age of consumption coming? Market outlook Rising share of consumption post inflection point Consumption (% of GDP) Investment (% of GDP) T-30 T-25 T-20 T-15 T-10 T-5 T T+5 T+10 T+15 T+20 T+25 T+30 T+35 T+40 T-30 T-25 T-20 T-15 T-10 T-5 T T+5 T+10 T+15 T+20 T+25 T+30 T+35 T+40 China (T=2007) Korea (T=1988) Japan (T=1969) China (T=2007) Korea (T=1988) Japan (T=1969) 8 Source: CEIC, Morgan Stanley Research, November 2010 Source: CEIC, Morgan Stanley Research, November 2010

10 China The service sector should grow rapidly over the coming years Market outlook Rising share of service sector post inflection point Industrial Sector (% of GDP) Service Sector (% of GDP) T-30 T-25 T-20 T-15 T-10 T-5 T T+5 T+10 T+15 T+20 T+25 T+30 T+35 T+40 T-30 T-25 T-20 T-15 T-10 T-5 T T+5 T+10 T+15 T+20 T+25 T+30 T+35 T+40 China (T=2007) Korea (T=1988) Japan (T=1969) China (T=2007) Korea (T=1988) Japan (T=1969) 9 Source: CEIC, Morgan Stanley Research, November 2010 Source: CEIC, Morgan Stanley Research, November 2010

11 China Consumer credit is still in early stage of development Market outlook Consumer credit-gdp ratio (%) (1H10 or latest available) CN CN (2015E) ID TH MY JP US UK Source: CEIC (for Asia), Datastream (for Ex-Asia), Credit Suisse estimates, January

12 China Healthcare still a long way to go Market outlook National Healthcare Expenditure (NHE) as a % of GDP in selected countries 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% US Germany France UK Japan Brazil South Korea Russia India China Source: WHO, Credit Suisse, January

13 China s CPI should peak mid 2011 given easier comparisons y/o/y Equity market recently starting to anticipate better headline data in H2 China monthly CPI forecast Market Outlook 8% 6% 4% 2% 0% -2% -4% Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 yoy Base effect CPI yoy % Forecast Source: Deutxche Bank, March

14 China Fighting inflation remains the top priority Market Outlook China CPI y-y % Current m. growth% CPI food CPI:non-food Source: NBS, BNP Paribas, May

15 Chinese M2 money supply now larger than the US This is real QE, Chinese M2 is now greater than USA with an economy that is ⅓ the size. Inflation and speculative bubbles will remain an issue until credit is priced correctly. Money supply USD, bn 12,000 Market outlook 10,000 8,000 6,000 4,000 2,000 0 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 China M2 US M2, SA 14 Source: Bloomberg, January 2011

16 China Property no sign of policy relaxation yet Market Outlook Property sales volume slumped, but not prices Property price index in Tier 1 cities Ytd % m-m%, 3mma property investment Floor space sold ytd Beijing Shanghai Shenzhen Source: NBS, BNP Paribas, May 2011 Source: NBS, BNP Paribas, May

17 Affordability of housing has become key political issue tug of war to continue Market Outlook Rising Chinese property prices a symptom of loose policy stance Mortgage payment/annual income: Four major cities Mortgage payment/annual income: National 100% 60% 90% 80% 50% 70% 60% 40% 50% 30% 40% 30% National Average: 43% 20% 20% 10% 10% 0% % e Shanghai Guangzhou Shenzhen Beijing % of Mortgage / Household Income 16 Source: Morgan Stanley Research, Jul 2010 Source: Morgan Stanley Research, Jul 2010

18 China Continues to tighten at a steady pace Market Outlook Both CPI and PPI have surprised on the upside leading to tightening response and a hawkish policy tone. Expect policy tightening till inflation starts to moderate later in the year. Chinese economy is facing twin challenges of rising labour cost and appreciating currency and we think policy environment, despite hawkish tone, will be supportive of stable economic growth to offset these challenges. Policy tightening to continue till inflation moderates later in the year % % Pace of loan growth moderated in 2011 RMB bn 1,600 1,400 1,200 1, , , Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr 1-Yr Lending Rate RRR (rhs) New loan creation Source: CEIC, Morgan Stanley, May 2011 Source: CEIC, Morgan Stanley, May

19 China Valuations are getting more attractive Market outlook MSCI China 10X Forward PER MSCI China Trailing P/B Versus ROE MSCI China Trailing Dividend Yield Avg ROE Avg P/B Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Mar-01 Mar-03 Mar-05 Mar-07 Mar-09 Mar-11 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 MSCI China - 12M PER Source: IBES Aggregates, Credit Suisse, 23 May 11 MSCI China - Trailing ROE (%) MSCI China - Trailing dividend yield (%) MSCI China - Trailing P/B (x), RHS Source: MSCI, Credit Suisse, 23 May 11 Source: MSCI, Credit Suisse, 23 May 11 18

20 China s power opportunity

21 China clean energy China is in a unique place to adopt alternative energy supply & demand Wind growing quickly of the cleanest and least environmentally destructive energy alternatives WTE is small and very profitable NIMBY challenges growth The logic of biomass is being challenged as a logical alternative Grid technology and capacity a challenge to alternatives For growth and funding, China remains the place to be 20

22 China Power shortage mainly due to failure of coal price pass-through and low hydro-power generation Profitable Non- profitable Northwest China Grid: Shaanxi: 1,650 Xinjiang: 1,030 Ningxia: 970 Qinghai: (60) Gansu: (520) Total: 3,070 IN N ER M ON GOLIA H EILONGJIAN G JILIN Northeast China Grid: Inner Mongolia: 4,270 Liaoning: (250) Jilin: (340) Heilongjiang: (720) Total: 2,960 XIN J IA N G TIBET QINGHAI SICHUAN N IN GXIA GA N SU SHAANXI CHONGQING GUIZHOU `` H EB EI SHANXI SHANDONG HENAN HUBEI HUNAN BEIJING TIANJIN JIANGXI ANHUI JIANGSU FUJIAN LIAONING ZHEJIANG North China Grid: Beijing: 980 Hebei: 950 Tianjin: 10 Shandong:(2,790) Shanxi: (3,210) Total: (4,060) SHANGHAI East China Grid: Jiangsu: 8,300 Zhejiang: 6,710 Shanghai: 1,800 Fujian: 460 Anhui: (30) Total: 17,240 South China Grid: Guangdong: 13,580 Guangxi: 1,580 Guizhou: 780 Hainan: (30) Yunnan: (260) Total: 15,650 YUNNAN GUANGXI GUANGDONG HAINAN Central TAIWAN China Grid: Chongqing: 150 Sichuan:(430) Hubei: (930) Jiangxi: (1,150) Hunan: (1,190) Henan: (3,300) Total : (6,850) 21 Notes: The profit and loss situation of thermal power generation plants, by province from January to November No data on Tibet. Source: China Electricity Council, Gao Hua Securities Research.

23 China However, there is capacity shortage in Eastern China Major provinces facing power capacity shortage Capacity deficit (GW) 16 Deficit ratio (%) % % 7% 6% 9% 8% Jiangsu Henan Zhejiang Guangdong Anhui Jiangxi Shandong 2% 0.00 Capacity shortage Deficit ratio (RHS) Source: China Electricity Council, Hexun.com, China Daily, Gao Hua Securities Research. 22

24 China power prices On the residential side, power prices are subsidised but tariffs are rising to combat power shortages Comparison of industrial power prices US$/kWh Comparison of residential power prices US$/kWh Italy Grenada Jamaica Nicaragua Ireland El Salvador Austria Hungary Brazil Japan United Kingdom Czech Republic Singapore Turkey China Ecuador Denmark Romania Germany Spain Argentina United States Australia Netherlands Canada Belgium Denmark Netherlands Italy Jamaica Ireland Germany Grenada UK Austria Brazil Hungary Japan Nicaragua Spain El Salvador Czech Singapore Belgium Turkey Romania United States Argentina Australia China Canada Indonesia Thailand 23 Source: CEIC, EIA, Standard Chartered Research

25 China power consumption Primary energy consumption in m tonnes of oil equivalent (toe) Power consumption may double in the next 10 years mn TOE 2,500 2,000 1,500 USA China 1, US China Russian Federation India Japan 24 Source: BP Statistics, Standard Chartered Research

26 Powering up China A growing mix of clean energy 2010 and 2020 power generation capacity and volumes by fuel type China s current power capacity is 962 GW and is expected to grow to 1,976 GW by % CAGR Capacity as of 2010 Thermal 707GW Hydro 213GW Wind 31GW Nuclear 11GW Solar Insignificant amount Others Insignificant amount This compares to German s installed capacity of 134 GW and Denmark s of 13 GW 2010 % of generation capacity (%) % of power generation (%) 73.4% 80.8% 22.2% 16.2% 3.2% 1.2% 1.1% 1.8% Insignificant amount Insignificant amount Insignificant amount Insignificant amount E generation capacity CAGR (%) 5% 8% 20% 21% N/M N/M Capacity target of ,200GW 440GW 200GW 75GW 56GW 5GW 2020E % of generation capacity (%) 60.7% 22.3% 10.1% 3.8% 2.8% 0.3% % of power generation (%) 70.2% 16.9% 4.9% 7.0% 0.9% 0.1% Note: Others refer to biomass, geothermal, and waste-to-energy, etc Source: NDRC, Gao Hua Securities Research, EIA 25

27 China power stimulus Funding secure Clean energy stimuli by sector, 2009 Clean energy stimuli by country, 2009 Energy stimuli could be at risk across the world given current economic difficulties Unspecified 9% All renewables 24% US$bn China has the means to continue to spend on clean energy R&D 16% Efficiency 21% Grid 18% 0 U.S. China South Korea EU27 Japan Spain Germany Australia UK France Brazil Canada 26 Note: Data for 2009 Source: Global Climate Change Consultancy, Standard Chartered Research

28 Nuclear power Nuclear power s shaky potential Nuclear power is only 2% of power production. This is in contrast to 23% in Germany and 20% in the US Capacity target for 2020 is for > 75 GW representing 7.0% of power generation Currently all new projects have been suspended leaving 32GW of capacity in construction China s nuclear power penetration rate is still low Nuclear power capacity (GW, vertical bars) and penetration rates of the largest ten countries by cumulative installed nuclear power capacity, 2009 Nuclear power capacity (GW) Nuclear power penetration U.S. France Japan Russia Germany South Korea Ukraine Canada U.K. China 0 27 Note: Nuclear power penetration = nuclear power generation / total power generation Source: Energy Information Administration (EIA), Gao Hua Securities Research

29 Wind power Total installed wind power Wind power capacity expected to grow 20% per annum to 200 GW by 2020 Relatively cheap to install Not great fung shui The grid remains the large challenge Offshore may provide better solutions <100MW MW MW MW >5000MW Xinjiang Yunnan Inner Mongolia Ningxia Gansu Shanxi Hebei Shandong Guangdong Liaoning Jiangsu Zhejiang Fujian Heilongjiang Jilin Offshore wind farm demand could be more than 30000MW Capacity as of end-2010 (MW) 28 Source: Standard Chartered Bank, China Wind Energy Association

30 Wind power Growth stalling Equipment manufactures best days of growth are behind them Best way to play this segment is through wind farms Slowing wind power capacity growth in China Cumulative installed wind capacity in China, Installed wind power capacity (MW) YoY change (%) 140, , ,000 80,000 60,000 40,000 20, % 120% 100% 80% 60% 40% 20% 0% Annual installation may have peaked in 2010 Annual installation of wind capacity in China, Installed wind power capacity (MW) YoY change (%) 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2, % 140% 120% 100% 80% 60% 40% 20% 0% -20% E 2012E 2013E 2014E 2015E E 2012E 2013E 2014E 2015E Cumulative installed wind capacity (MW) yoy change (%) (RHS) Newly installed wind capacity (MW) yoy change (%) (RHS) Source: China Electricity Council, China Wind Energy Association, Gao Hua Securities Research estimates 29

31 Solar power Total installed solar power Solar power capacity expected to grow to 56 GW by 2020 Expensive Jilin 5.0 Grid challenges generation capacity not close to consumption Inner Mongolia 8.3 Solar power resources in China <1050 kwh/m kwh/m kwh/m2 Qinghai 16.0 Yunnan 20.0 Ningxia 60.3 Gansu 50.5 Shanxi 15.0 Hubei 3.8 Shandong 37.1 Anhui 2.0 Jiangxi 4.1 Guangdong 23.5 Jiangsu 25.5 Zhejiang 13.9 Fujian 13.0 Shanghai >1750 kwh/m2 Note: Installed/under-construction solar PV power capacity (MW) as of June 2010 Source: SERC, Standard Chartered Bank Hainan 20.0 Capacity as of June 2010 (MW)

32 China clean energy Conclusions China can compete on price technology barriers are few but funding may allow them to take the lead wind and solar are commodity businesses Replacement of nuclear energy as a key driver of base demand would favour hydro and natural gas going forward with spill over into alternatives Offshore wind farms while relatively more expensive have superior geographic positioning 31

33 China s clean energy portfolio Investing in the future Price performance Clean energy names have underperformed excluding solar Solar is not a great place to be now either Change in pp Stocks in renewable energy and environmental sectors have underperformed YTD Jan-10 Feb-10 Mar-10 Apr-10 Hang Seng Index MSCI Asia ex-japan Solar Sector May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Stocks under our coverage REEF stocks in Asia (excluding Solar) 32 Note: REEF stocks in Asia excludes solar energy Source: Bloomberg, Standard Chartered Research

34 China clean energy Opportunities Growth in wind is stagnant better to play wind farms Solar prices dropping daily so are the stocks watch this space Natural gas looks attractive as might solar if panel prices drop far enough WTE while very small offers excellent returns though not without policy risk 33

35 Appendix

36 Asian valuations Schroders analysts are finding investment opportunities at reasonable values Market Outlook Stock prices versus fair value % of stocks above Schroders fair value 27-Nov Oct Oct Mar-09 9-May-11 China Hong Kong India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Source: Schroders 35

37 China are the cheap stocks a value trap given policy risks? Valuations polarised within the market domestic growth is highly rated already Market outlook Price MSCI P/E (X) EPS growth P/B (X) Dividend yield Index 24/5/2011 Weighting 2011E 2012E 2011E 2012E 2011E 2012E 2011E 2012E MSCI China HSMLFI x 9.6x 16.6% 17.5% 1.9x 1.7x 3% 3% H-share HSCEI 12, x 8.9x 21% 16% 1.8x 1.5x 3% 4% Sector (MSCI China): Consumer discretionary 5% 14.4x 12.2x 12% 19% 2.6x 2.3x 2% 2% Consumer staples 5% 17.7x 14.8x 6% 19% 3.1x 3.0x 2% 2% Energy 18% 10.0x 9.5x 23% 6% 1.9x 1.7x 4% 4% Financials 38% 10.0x 8.4x 16% 20% 1.8x 1.5x 3% 4% Health Care 1% 23.9x 19.0x 32% 26% 4.2x 3.6x 1% 2% Industrial 8% 11.1x 9.5x 0% 17% 1.4x 1.3x 3% 3% Information technology 6% 19.5x 10.6x 48% 85% 4.1x 3.5x 1% 1% Materials 6% 11.9x 10.2x 44% 17% 1.8x 1.6x 2% 2% Telecom 11% 11.6x 10.8x 9% 7% 1.7x 1.5x 4% 4% Utilities 2% 14.2x 12.2x 12% 17% 1.5x 1.4x 2% 3% Source: Bloomberg, JP Morgan estimates, 24 May

38 China Rmb is it really hugely undervalued? China s real effective exchange rate Market Outlook Current account balance as % of GDP is dropping Index, 2005 = % of GDP Recent trend 10 year average China: Real effective exchange rate F Source: BIS, BofA Merrill Lynch Global Research, May 2011 Source: BIS, BofA Merrill Lynch Global Research, May

39 Is China s coal consumption is nearing its secular peak? Market outlook Commodity intensity in China approaching peak in coming years Coal consumption per capita in major countries Coal Consumption / Capita (tonnes) China India 2014Ea India China 2014Ea United States Korea Japan Taiwan China India China 2014E India 2014E Real 2009 U.S. $ GDP / Capita (000s) Source: US Energy Information Administration, Morgan Stanley Research, December 2010

40 Power generation costs Market outlook Generation cost of various energy sources US /kwh Nuclear Coal Geothermal Wind Hydro Solar Thermal Solar PV Source: IEA

41 Nuclear share by country Market outlook Nuclear share by country-2009 (%) China Pakistan India Brazil Netherlands Mexico South Africa Argentina UK Canada Russia Romania Spain USA Japan Germany Finland Czech Republic Bulgaria Korea Hungary Armenia Switzerland Slovenia Sweden Ukraine Belgium Slovakia Lithuania France Source: Bank of America Merrill Lynch

42 Global investment in clean energy Market outlook Global: Annual investment in clean energy US$bn Hit by the world s financial crisis E 41 Source: The Climate Change Institute estimates, Standard Chartered Research

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