Power Sector: Ipps: Hedged To Near Perfection
Power Sector: Ipps: Hedged To Near Perfection
Power Sector: Ipps: Hedged To Near Perfection
PowerSector
IPPs:Hedgedtonearperfection
The Power sector of Pakistan has been in the limelight for the past couple of years due to its inability to supply power and settle dues of energy chain. This has triggered lot of adjustments in the countrys energy mix and proved costly to some and indirectly beneficial for others. Consequently, we believe Power sector woes have opened investment opportunities at the local bourse. For example, FFC and FFBL in the fertilizer sector which have performed in the last couple of months due to urea price hike amid gas rationalization by the GoP. Similarly, we see a window of opportunity in the power sector mainly in Hub Power Company (HUBC) and Kot Addu Power Company (KAPCO). Their Power Purchase Agreement (PPA) with the GoP make their business model resilient to changes in consumer power tariffs, PKR/USD parity and the US CPI. Furthermore, the generation bonuses and guaranteed tariff structure also act as an added advantage for investment in the sector. Moreover, the recent 150bps cut in DR and the market expectations of further easing in the policy rate going forward also bodes well for the high dividend yielding stocks of the power sector.
Power s ec tor v s . KSE 130% 115% 100% 85% 70% Jan-10 Apr-10 KSE Oct-10 Jul-10 Jan-11 Apr-11 Pow er Oct-11
1.5 5.9 17.4% 5.6% 25.0% 1.5 6.0 15.7% 6.8% 24.7%
HUBC: Key statistics FY10A FY11A FY12E FY13F PBV (x) PE (x) Div.Yield (%) ROA (%) ROE (%) 1.2 6.7 15.6% 5.2% 18.7% 1.4 7.8 15.1% 4.0% 18.3% 1.5 6.2 16.1% 4.6% 23.6%
Source: JS Research
KAPCO: Key statistics FY10A FY11A FY12E FY13F PBV (x) PE (x) Div.Yield (%) ROA (%) ROE (%) 1.8 8.0 10.8% 7.4% 22.3% 1.5 5.6 15.5% 7.5% 28.1% 1.5 6.4 14.5% 5.8% 23.7%
Source: JS Research
Completed on Nov 15, 2011 Distributed on Nov 16, 2011 All prices are as of Nov 15, 2011
Naveed Tehsin Senior Analyst [email protected] 92 (21) 111-574-111 (ext. 3100) JS Research is available on Bloomberg, Thomson Reuters and CapitalIQ Please refer to the important Disclaimer on the last page
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Contents
Power supply shortfall Subsidies: Augmenting circular debt concerns IPPs are somewhat the safest investment Hub Power Company Riding on Power shortage Generation bonus from higher load factor Expansionary moves Favourable penal rates Valuation Key assumptions and risks to our thesis Financial highlights Kot Addu Power Company Resilient earnings Circular debt concerns Plant maintenance Valuation Key assumptions and risks to our thesis Financial highlights 04 05 06 07 07 08 08 09 09 10 11 11 12 12 12 14
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Thermal (WAPDA)
Furnace oil based IPPs are not the long term solution
Though thermal power plants are cheaper and take less installation time compared to hydel power plants, they (especially furnace oil based plants) have higher operating costs. Operating costs for gas fired thermal power plants are low (power generation cost through gas is approx. one third the cost of furnace oil based plant), but due to unavailability of indigenous natural gas very few gas based power plants are in the pipeline.
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Furthermore, GoPs gas allocation policy prioritizes requirements of domestic, commercial, fertilizer and industrial sectors. As a result, power sector consumed 29% of total gas production in FY10 versus 44% in FY05. Consequently, the GoP has relied on power production through furnace oil which has resulted in mounting pressure on the government in the form of higher subsidies.
Alternatives
According to a World Bank report, energy source for worldwide electricity production in percentage terms is led by coal at 40% followed by gas, nuclear, hydel and oil at 19%, 16%, 16% and 7% respectively. In Pakistan, however, energy requirement are met through oil which constitutes 38%, followed by gas and hydel at 29% each. Coal and nuclear, on the other hand contributes only 0.1% and 3.3% respectively, leaving vast potential for growth. Although Pakistan has been blessed with ample water resources but it stores only 13% of the annual flow of its rivers. The storage is fast depleting due to sedimentation. The hydropower potential in Pakistan is over 55,000MW. At present, the projects that are under study include Diamer Basha (4,500MW), Bunji (7,100MW) and Kohala (1,100MW) amongst many others. With 185bn tons of coal reserves, the fourth largest in the world, utilization of this resource is non-existent. According to some estimates, if half of these resources are exploited properly, it would be sufficient for generating 100,000MW of electricity for 30 years.
Elec tr ic ity gener ation by s our c e Nuclear & Imported, 3.3% Hydel, 29.4%
Gas, 29.4%
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alternative i.e. furnace oil. Despite hefty increase of power tariff in recent years, a significant gap still exists between the generation cost and the power tariff charged from consumers. Therefore, the GoP provides a subsidy to bridge this gap which has been the root cause of the circular debt issue. This has caused liquidity concerns for the whole energy chain leading to fuel supply issues. In a recent development, the GoP has reportedly converted outstanding financing and accrued markup worth ~ Rs 313bn of public sector power companies (PHL, NTDC and WAPDA) into PIBs. The measure will primarily benefit banks, however, companies in the energy chain will also gain as additional credit will be available for the sector. Moreover, a fresh funding request of US$2bn for power sector from Asian Development Bank and World Bank shows GoPs commitment for the resolution of the issue. However, we still believe that reforms in form of cutting down the power sector subsidies are required to solve the circular debt issue permanently.
(Rupees)
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Jul-11 Oct-11
(%)
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BUY
Rs48
KATS Code: HUBC Bloomberg Code: HUBC PA Reuters Code: HPWR.KA Market Price: Rs37.34
Market Cap: Rs43.2bn US$498.7mn 1-yr Avg. Daily Volume: 1.5mn shares Rs58.9mn US$0.7mn 1-yr High/Low: Rs42.57/35.54 Estimated free float: 810mn shares (70%)
Source: JS Research
HUBC v s KSE- 100 index 160% 140% 120% 100% 80% 60% 40% 20% 0%
HUBC with cash flows based on 30 year PPA, has a relatively predictable cash flow stream. According to the tariff structure of HUBC, the PCE component which is predefined in CPP ensures guaranteed earnings uptick till the validity of HUBCs agreement, leading to increased returns to equity investors even in real terms excluding changes in PKR/USD exchange rate and US CPI.
HUBC Jul-11
6.4 25.4 5.9 1.5 17.4%
Key statistics FY10A FY11A FY12E FY13F EPS (Rs) BV (Rs) PE (x) PBV (x) Div.Yield (%) 4.8 25.8 6.7 1.2 15.6% 4.7 25.5 7.8 1.4 15.1% 6.0 25.5 6.2 1.5 16.1%
Source: JS Research
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increased accordingly. Consequently, the company has taken advantage of this generation bonus which is likely to continue going forward.
Expansionary moves
Narowal Plant
After delays, HUBC finally announced its Narowal Plant Commercial Operation Date (COD) in April 2011 (initially targeted for March 2010). Its an oil fired power plant with capacity of 225MW. The term of power purchase agreement would be 25 years and the fuel supply agreement has been signed with PSO. As per the power policy, Narowal project will get 15% USD based IRR. The revenue from Narowal plant continues to be recognized on the basis of reference tariff as the NEPRA is yet to announce the post COD tariff for the plant. Therefore, the differential amount of revenue due to an agreed tariff adjustment will be recognized moving forward.
Effec ts of c ir c ular debt 100 80 (Rs bn) 60 40 20 FY05 FY06 FY07 FY08 FY09 FY10 FY11 0 Running Finance borrow ing Trade Payable Cash Trade Debt
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Valuation
HUBC offers an upside potential of 29% to our target price of Rs48. HUBC at its current price offers a dividend yield of 16.1% for FY12E, compared to JS Universe average dividend yield of 8.4%. Its dividend yield is also considerably higher compared to the regional average of 5.4%. Moreover, it trades at a FY12E PE of 6.2x which is at a discount of 57% compared to its regional peers. We currently maintain a Buy stance on the scrip.
Regional PE c ompar is on
HUBC KAPCO Gujarat Ind Pwr Electricity Gen Co Dat ang Intl YTL Power PTC India Ltd Ratchaburi Elec Tat a Pwr India GD Pwr Dev Co China Rsrcs Pwr Huaneng Pwr Intl Glow Energy Ltd Huadian Pwr Intl Reliance Pwr India 0 10 20 30 40
Hub Power 0.5% 1.0% US CPI 1.5% 2.0% 2.5% 3.0% 3.5%
Source: JS Research
The fair value of HUBC is highly sensitive to interest rate movements as well. In the current economic scenario, where the market expectation is for further easing in monetary stance by the SBP, may act as a catalyst for the stock.
Source: JS Research
Key Risks
The key risk for HUBC in particular and power sector in general is the mounting circular debt. Although the GoP is trying to bridge this gap by increasing power tariffs, however, we still believe drastic measures by ways of eliminating subsidies are required. Nonetheless, given FY13 is the election year, the GoP may not raise power tariff by the required amount as a part of its populous measure, consequently worsening the circular debt issue.
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BUY
Rs50
KATS Code: KAPCO Bloomberg Code: KAPCO PA Reuters Code: KAPCO.KA Market Price: Rs41.38 Market Cap: Rs36.4bn US$420.4mn 1-yr Avg. Daily Volume: 0.4mn shares Rs17.8mn US$0.2mn 1-yr High/Low: Rs47.45/39.26
Source: JS Research
The PPA for KAPCO also provides a hedge over major exogenous variables such as PKR/USD exchange rate, US CPI and fuel price changes. Although, the company is facing cash flow constraints in the near term but its predetermined tariff structure ensures profitability moving forward.
KAPCO v s KSE- 100 index 140% 120% 100% 80% 60% 40% 20% 0%
KSE-100
KAPCO
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
6.5 27.7 6.4 1.5
Key statistics FY10A FY11A FY12E FY13F EPS (Rs) BV (Rs) PE (x) PBV (x) Div.Yield (%) 5.8 25.6 8.0 1.8 10.8% 7.4 27.2 5.6 1.5 15.5% 6.9 28.1 6.0 1.5 15.7%
Penal rates
The impact of circular debt is more severe for KAPCO compared to HUBC because it has a higher interest payment on delayed payments to PSO compared to interest receivable on payments from WAPDA. KAPCO manages its cash flow problems arising from delayed payments from WAPDA, by delaying payments to
November 2011
14.5%
Source: JS Research
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(Rs bn)
PSO and through short term borrowings. Under the PPA, delayed payments from WAPDA are penalized at DR+4%, while KAPCO pays PSO at a penal rate of 6M TBill+6%. As short term borrowing was cheaper, the company was able to earn a small spread on taking short term financing and charging higher penal rate from WAPDA. However, now due to its increased leverage position it is finding it difficult to get short term borrowing and has to take resort in higher penal payment.
Effec ts of c ir c ular debt 80 70 60 50 40 30 20 10 0 Running Finance borrow ing Trade Payable Cash Trade Debt
FY05
FY06
FY07
FY08
FY09
FY10
Power gener ation & load fac tor Load Factor-LHS Pow er Gen.(GWh)
Plant maintenance
KAPCO has entered into US$14mn contract with GE for upgrading four gas turbines. When the total project is completed i.e. by the end of 2011, overall plant net combined-cycle efficiency is expected to increase by 0.44%, while the output of each gas turbine will increase by 3MW for a plant total of 12MW. The completion of the project will improve the bottom-line of the company going forward.
FY05
FY06
FY07
FY08
FY09
FY10
Valuation
Although the relative attractiveness of the scrip is overshadowed by HUBC and it carries greater exposure to the circular debt issue, we believe most negatives are priced in at its current price. KAPCO at its current price offers a dividend yield of 14.5% for FY12E, compared to JS Universe average dividend yield of 8.4%. Its dividend yield is also higher compared to the regional average of 5.4%. Moreover, it trades at a FY12E PE of 6.4x which is at a discount of 55% compared to its regional peers. At the current price, we have a Buy stance on the scrip.
Regional PE c ompar is on
HUBC KAPCO Gujarat Ind Pwr Electricity Gen Co Dat ang Intl YTL Power PTC India Ltd Ratchaburi Elec Tat a Pwr India GD Pwr Dev Co China Rsrcs Pwr Huaneng Pwr Intl Glow Energy Ltd Huadian Pwr Intl Reliance Pwr India 0 10 20 30 40
Source: JS Research
November 2011
FY11
0%
FY11
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The fair value of KAPCO is highly sensitive to interest rate movements. In the current economic scenario, where the market expectation is for further easing in monetary stance by SBP, may act as a catalyst for the stock. Following is the sensitivity analysis of KAPCOs fair value to changes in risk free rate.
Source: JS Research
Key Risks
As per PPA, KAPCO is liable to pay higher interest on delayed payments to PSO compared to its interest receipts on delayed payments from WAPDA. Although the company manages this gap with short term borrowing, however, now due to its increased leverage position it is finding it difficult to get short term borrowing and things may worsen if the circular debt issue gets out of control.
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November 2011
Research Team
Naveed Tehsin Syed Atif Zafar Bilal Qamar Muzzammil Aslam Furqan Ayub Raheel Ashraf Adeel Jafri Muhammad Furqan Power & Gas Distribution Strategy, E&P, OMCs, Refinery, Autos & Chemicals Banks, Fertilizer, Insurance & Textile Economy & Politics Cements & Telecom Technical Analyst Database Manager Librarian (92-21) 111574111 (ext. 3118) (92-21) 111574111 (ext. 3099) (92-21) 111574111 (ext. 3035) (92-21) 111574111 (ext. 3103) (92-21) 111574111 (ext. 3098) (92-21) 111574111 (ext. 3098) (92-21) 111574111 (ext. 3105) [email protected] [email protected] [email protected] [email protected] [email protected] [email protected] [email protected] (92-21) 111574111 (ext. 3100) [email protected]
Equity Sales
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