AKD Securities Limited – KEL: Electrifying returns yet to be priced in!

Karachi, April 30, 2015 (PPI-OT): Pakistan’s largest vertically integrated electric utility continues on a growth trajectory, despite. Growth is predominantly underpinned by: 1) persistent reduction in T and D losses (currently at 23.8%, ~2% cut p.a. down from 36% in FY09), 2 substantial governance turnaround, 3) improved fleet efficiency and 4) enhanced transmission infrastructure. With several projects in the pipeline, growth and value creation are set to continue simultaneously in the medium and long term (5yr forward EBITDA CAGR of 18.5%).

The debt re-profiling post issuance of PkR22bn Sukuk, has aligned KEL’s capital structure with planned long term investment prospects, while capitalizing on the current low interest environment (reducing weighted average interest rate by ~2%). Moreover, the remaining PkR395bn in deferred tax assets, of which PkR290bn are deductible by FY17, further the case for sharp EPS growth. With a 5yr forward NPAT CAGR of 40.8%, AKD Securities Limited believes KEL offers an undemanding valuation set (FY16F/17F P/E of 6.1x/4.5x ) underpinning AKD Securities Limited’s bullish stance. Based on AKD Securities Limited’s Dec’15 TP of PkR13.5/share, the stock offers an upside of 82% – BUY!

Strong track record: The persistent decrease in T and D (36% in FY09 to 23.8% on 1HFY15) accompanied by increase in fleet efficiency (30.4% in FY09 to 37.0% in FY14) make up for the core of the turnaround affected by Abraaj controlled management. The impact of qualitative changes is well reflected in the company’s financial performance where it achieved a positive EBITDA by FY11 and PBT was in the green zone by FY12. This continuous growth in the bottom line enabled KEL to post NPAT of PkR12.9bn (EPS: PkR0.47) in FY14. With this trend likely to continue AKD Securities Limited estimates the company’s EBITDA to expand by a 5yr CAGR of 18.5%.

Projects in the pipeline: Following formal approval of the K-energy’s generation license and tariff, two units of BQPS-I (420MW) are to undergo coal conversion by FY17. Furthermore, KEL has signed an MoU for an EPC contract with China Datang Corporation for a 700MW Greenfield coal power plant. Also devised is a US$300mn transmission package spread over 3yrs for rehabilitating and enhancing transmission lines, underground cables, grid and substations. These planned projects aim to enhance operations by: 1) increasing low cost generation (coal generation at PkR4.1/KwH vs. PkR14.3/KwH for RFO), 2) curbing remaining T and D losses with infrastructure improvements (1% reduction in T and D adds ~PkR0.1/share) and 3) executing new ventures to modernize the utility.

Capital Restructuring: Debt restructuring allows KEL to capitalize on prevailing monetary easing by reducing financial charges (~16%YoY reduction in FY16F), improving cash flows and reducing the weighted average cost of debt. Aligning the debt structure to the firm’s long term project commitments, while leaving room for additional borrowing, the PkR22bn Sukuk issue (with green shoe option of PkR2bn) connects short term liquidity with long term capital efficiency. Remaining sizeable accrued tax benefits of PkR395bn, with PkR290bn deductible by FY17, bringing 5yr forward NPAT CAGR to 40.8%.

Investment Perspective: RFO prices easing off by 41%FY15TD, allows for a reduction, not only in the cost of generation but also the cost of purchased electricity. Additionally, due to the built in allowance for 15% T and D in the multi-year tariff (MYT), the quantum of additional losses (past 15%) born by the company is curtailed. Coupled with improvements in the debt structure unlocking cash flows, increased CAPEX delivering value, KEL is positioned for price performance. Value signified by FY16F/FY17F P/Bv of 1.6x/1.2x and organic cash flow generation signaled by a 5yr CFO CAGR of 41.8%, affirm AKD Securities Limited’s bullish stance on the scrip. The scrip at present trades at FY16F/FY17F P/E of 6.1x/4.5x and provides an upside of 82% against AKD Securities Limited’s Dec’15 TP of PkR13.5/share,