The report from "The Big Bank" is optimistic about CKI HOLDINGS' stable free cash flow, which is expected to bring better returns to shareholders

Huayan published a report indicating that the Hong Kong utility sector has recently outperformed the market index, with a quarterly return of 6% to 8% (relative to the Hang Seng Index's decline of 3%), demonstrating its strong ability to withstand market volatility. At the same time, market expectations for the Federal Reserve to possibly cut interest rates again in December have increased. For the entire year, the sector's beta coefficient relative to the Hang Seng Index is 0.1, maintaining resilience. From a fundamental perspective, existing businesses continue to generate stable cash flow as expected. However, Huayan must acknowledge that certain company-specific catalysts are yet to materialize, such as the merger and acquisition actions of CKI Holdings (01038.HK), the asset sale and/or restructuring of Energy Australia under CLP Holdings (00002.HK), and the improvement of free cash flow for Hong Kong and China Gas (00003.HK).

Nevertheless, Huayan believes that due to the clear asset growth in Hong Kong, which has become a major driver of allowable profits, the quality of earnings and cash flow growth in the sector is expected to improve as 2026 approaches. Additionally, lower fuel costs will help alleviate working capital pressure, thereby improving cash flow management. Furthermore, recent price adjustments in the UK utility sector are encouraging, with allowed rates of return and total returns exceeding draft requirements. Considering the necessary upgrades to power infrastructure to meet anticipated developments in artificial intelligence and the growing long-term demand for green transformation, Huayan believes that the supportive regulatory environment will continue.

Huayan currently favors CKI Holdings the most, followed by CLP Holdings and HKELECTRIC. CKI Holdings is chosen as the top pick in the Hong Kong utility sector due to its robust free cash flow, which is expected to deliver better shareholder returns, and it is anticipated to have stronger merger and acquisition value potential in 2026. CLP Holdings is also favored due to its ample free cash flow that can continuously enhance shareholder returns; while HKELECTRIC (02638.HK), being fully focused on the Hong Kong electricity market, has strong defensiveness, but considering its tight free cash flow, the likelihood of a recent dividend increase is deemed low.

Given the tight free cash flow of Power Assets Holdings (00006.HK) and Hong Kong and China Gas, which may lead to limited growth in shareholder returns, Huayan maintains a "Hold" rating on them. Based on applying higher valuation multiples, the target price for CLP Holdings has been raised from HKD 78 to HKD 80.

For Huayan's ratings and target prices on Hong Kong utility stocks, please refer to the accompanying table