Elixir Securities Limited – Elixir Insight

Karachi, December 08, 2017 (PPI-OT): Kot Addu Power Company Limited – The End Draws Near

KAPCO has corrected by 20.3% YTD and 15.0% in the last two weeks as the HUBC deal got suspended and PPA expiry becomes the base case for the market.

We have removed the HUBC deal from our valuation model which reduces our PT by ~PKR10/share.

While we maintain our base case of PPA expiry in FY21, we have delayed the terminal dividend payment by an additional two years as it is unlikely that KAPCO’s PKR100bn of receivables will be cleared in one timely payment.

We revise our stance to a HOLD call with a Dec-18 PT of PKR50/share, resulting in 14.4% total potential upside from last close (including 17.9% leading dividend yield).

Stock Has Corrected by 20.3% Since 1st November as Reality Sets In: Kot Addu Power Company (KAPCO) has dropped 20.3% YTD. The decline has been even more abrupt in the past 2 weeks, with the stock falling by 15.0%. In principal, we see three reasons for the decline; Suspension of deal to acquire Hub Power Company (HUBC), sudden closure of RFO based power plants and realization that the PPA (Power Purchase Agreement) may not renew in FY21, a point we have made time and again as PPA extension does not make economic sense.

Suspension of the 17.37% Acquisition of the Hub Power Company: KAPCO announced the proposed acquisition on 27th October 2017 which would have extended the company’s life to FY50. On 10th November, due to reservations by WAPDA; KAPCO’s majority shareholder, the deal has been suspended. As pointed out in our previous report, the deal does not make economic sense to us (for an investor) as exposure to HUBC’s assets can be gained directly rather than through a holding company. Resultantly we have removed the acquisition from our valuation model, which reduces KAPCO’s valuation by ~PKR10/share.

Sudden Closure of RFO Power Plants: We believe RFO based generation will continue to decline in the country as new capacity additions come online. This however does not pose a threat to reported earnings as KAPCO is fuel inefficient and therefore benefits if utilization levels fall. The impact on cash flows is more uncertain as plant closure could lead to delays in receiving capacity payments.

Power Purchase Agreement Expires in June 2021: We maintain our base case of PPA expiry in FY21 as excess capacity additions in the system negate the need to extend KAPCO’s life. The plant would have completed 3o years of operations by 2021; further operation could lead to deterioration in thermal efficiency if the plant is run beyond its operating life.

Building in Delayed Payments in FY21: We had assumed a terminal dividend of PKR55/share dividend from KAPCO. By netting of receivables with current liabilities, KAPCO would potentially receive PKR42/share in cash. Disposing off spare parts and PPE would result in PKR9/share in additional cash flow. We believe the former cash flow is highly unlikely to be received on time as this would entail a PKR100bn payment to KAPCO from NTDC. The latter cash flow of PKR9/share is also uncertain as it assumes the plant is disposed off at book value which may not be the case. Therefore we have assumed that the balance sheet is wound up till FY23 with clear up of all dues in 12 quarters starting Sep-20. This reduces the present value of the terminal cash flow from PKR34/share (assumed earlier) to PKR25/share.

Rolling over our valuation to Dec-18: We have revised our earnings estimates, by removing the KAPCO/HUBC deal which raises dividends to their previous levels, lowering utilization levels on RFO and distributing the final terminal dividend over three years (FY21-23). Lastly we have rolled over our valuation to Dec-18 with a PT of PKR50/share, resulting in 14.4% total potential upside. Therefore we revise our stance to a HOLD call.

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Elixir Securities Limited – Elixir Insight

Karachi, December 08, 2017 (PPI-OT): Kot Addu Power Company Limited – The End Draws Near

KAPCO has corrected by 20.3% YTD and 15.0% in the last two weeks as the HUBC deal got suspended and PPA expiry becomes the base case for the market.

We have removed the HUBC deal from our valuation model which reduces our PT by ~PKR10/share.

While we maintain our base case of PPA expiry in FY21, we have delayed the terminal dividend payment by an additional two years as it is unlikely that KAPCO’s PKR100bn of receivables will be cleared in one timely payment.

We revise our stance to a HOLD call with a Dec-18 PT of PKR50/share, resulting in 14.4% total potential upside from last close (including 17.9% leading dividend yield).

Stock Has Corrected by 20.3% Since 1st November as Reality Sets In: Kot Addu Power Company (KAPCO) has dropped 20.3% YTD. The decline has been even more abrupt in the past 2 weeks, with the stock falling by 15.0%. In principal, we see three reasons for the decline; Suspension of deal to acquire Hub Power Company (HUBC), sudden closure of RFO based power plants and realization that the PPA (Power Purchase Agreement) may not renew in FY21, a point we have made time and again as PPA extension does not make economic sense.

Suspension of the 17.37% Acquisition of the Hub Power Company: KAPCO announced the proposed acquisition on 27th October 2017 which would have extended the company’s life to FY50. On 10th November, due to reservations by WAPDA; KAPCO’s majority shareholder, the deal has been suspended. As pointed out in our previous report, the deal does not make economic sense to us (for an investor) as exposure to HUBC’s assets can be gained directly rather than through a holding company. Resultantly we have removed the acquisition from our valuation model, which reduces KAPCO’s valuation by ~PKR10/share.

Sudden Closure of RFO Power Plants: We believe RFO based generation will continue to decline in the country as new capacity additions come online. This however does not pose a threat to reported earnings as KAPCO is fuel inefficient and therefore benefits if utilization levels fall. The impact on cash flows is more uncertain as plant closure could lead to delays in receiving capacity payments.

Power Purchase Agreement Expires in June 2021: We maintain our base case of PPA expiry in FY21 as excess capacity additions in the system negate the need to extend KAPCO’s life. The plant would have completed 3o years of operations by 2021; further operation could lead to deterioration in thermal efficiency if the plant is run beyond its operating life.

Building in Delayed Payments in FY21: We had assumed a terminal dividend of PKR55/share dividend from KAPCO. By netting of receivables with current liabilities, KAPCO would potentially receive PKR42/share in cash. Disposing off spare parts and PPE would result in PKR9/share in additional cash flow. We believe the former cash flow is highly unlikely to be received on time as this would entail a PKR100bn payment to KAPCO from NTDC. The latter cash flow of PKR9/share is also uncertain as it assumes the plant is disposed off at book value which may not be the case. Therefore we have assumed that the balance sheet is wound up till FY23 with clear up of all dues in 12 quarters starting Sep-20. This reduces the present value of the terminal cash flow from PKR34/share (assumed earlier) to PKR25/share.

Rolling over our valuation to Dec-18: We have revised our earnings estimates, by removing the KAPCO/HUBC deal which raises dividends to their previous levels, lowering utilization levels on RFO and distributing the final terminal dividend over three years (FY21-23). Lastly we have rolled over our valuation to Dec-18 with a PT of PKR50/share, resulting in 14.4% total potential upside. Therefore we revise our stance to a HOLD call.

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