KESTREL CAPITAL. Kenya Power and Lighting Company Recommendation: BUY. February Member of the Nairobi Securities Exchange

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1 Member of the Nairobi Securities Exchange February 2014 Kenya Power and Lighting Company Recommendation: BUY Based on our fair value of KES 23.35, presenting a 61.6% upside to the current trading price, we recommend a BUY on Kenya Power and Lighting Company Limited (KPLC). Our optimistic sentiments are founded on strong revenue and bottom line growth in FY14F and FY15F (+45.3% y/y PBT to KES 9.3bn in FY14F, 2-yr PBT CAGR: 31.3% to KES 11.1bn in FY15F) impelled by increased power unit sales (3-yr CAGR: 4.0%) from increasing annual energy consumption especially amongst Small Commercial and large Commercial & Industrial customers, on the back of capacity expansion and economic growth. Ongoing network upgrade and automation is also bound to significantly improve power transmission efficiency, translating to bottom line growth going forward. Aside from its core business, Kenya Power s consideration of venturing into the data transmission space in the medium term promises income generating potential. Positives Revenue growth driven by increased unit sales on the back of economic growth and favorable tariff review Progressive introduction of cheaper energy to the grid to control power purchase costs going forward Network upgrade and automation to improve power transmission Funding at concessionary rates to boost connections and network upgrade in the medium term Data transmission to support medium term income growth and cost management Attractive on a relative basis-current price a good entry point Risks System losses-a downside risk to revenue growth and cost containment: Period lags in capacity expansion projects to render power generators heavily reliant on hydro-power; a risk to power supply stability: Medium & Long Term Projects Eastern Africa Hydro Interconnector Lake Turkana Interconnector Tororo-Lessos power Interconnector The Metropolitan Ring 1H14 Results-A word of Caution Half year (1H14) earning will not be a reflection of FY14 earnings Investment Summary FY13 FY14F FY15F FY16F EPS %change DPS %change P/E (x) P/B (x) Div yield (%) ROE (%) Source: Company, Kestrel Capital estimates Bloomberg Ticker : Reuters Ticker: Share Statistics KPLL KN KPLA NR Fair Value (KES) Price (KES) Issued shares (m) 1,951.5 Market cap (KES bn) 28.2 Market cap (USD m) Year end June Free Float % 41.8 Av daily trading vol (USD) 86,907 Price Trend Source: NSE NSE 20 Share Index Research Analyst Linet Muriungi linetm@kestrelcapital.com Kenya Power 22-Feb May Aug Nov Feb

2 EUT (KES) KES m Kenya Power and Lighting Company Limited Positives Revenue & Gross Profit growth to FY16F 90,000 80,000 70,000 Electricity sales 60,000 50,000 40,000 30,000 Gross Profit 20,000 10,000 - FY2011 FY2012 FY2013 FY2014F FY2015F FY2016F Revenue growth driven by increased unit sales on the back of economic growth and favorable tariff review: In late 2013, the Energy Regulatory Commission (ERC) released the revised End User Tariffs (EUT), which (when weighted against energy consumed per customer category) increased 32.4% y/y, and was effective from 1st December 2013, hence will be applicable for 7 months in FY14F, despite an overall decrease in total power costs due to a decline in fuel costs. The End User Tariffs are then going to increase a further 28.0% y/y in FY15, before easing 4.4% in FY16, due to cheaper geothermal and wind energy introduction to the grid. Unit sales are expected to be impelled by growing annual energy consumption amongst the Commercial & Industrial customer segments (power consumption ranging between 415V and 132kV) which currently account for 55.9% of annual energy consumption. Source; Company, Kestrel Research KPLC Customer Growth 1, , , , , , , , , , KPLC Customers ('000) Power consumption/capita (MW) Kenya Power seeks to grow unit sales in the medium term by setting up reliable power distribution points around major power generation areas, thus giving incentive to manufacturing firms to set up around these areas to receive improved power quality and reduce idle time caused by power outages. A new Commercial & Industrial (132kV) customer, Base Titanium, has recently been introduced to the grid. Base Titanium estimates it will produce 330,000 tonnes of ilmenite, 80,000 tonnes of rutile (equivalent to 14.0% of the world s rutile output) and 30,000 tonnes of zircon each year over a 13-year mine-life. We estimate a 21.5% y/y decline in fuel cost to KES 2.9bn and expect 21.3% y/y growth in electricity sales to KES 58.1bn in FY14F, driven by a 17.2% y/y increase in the weighted average unit price of electricity, and a 3.5% y/y growth in units sold to 6,454 GWh in FY14F. 1, Year on year End User Tariff change to FY16 Source; Company, Kestrel Research / / / /16 DC (Domestic, 240V) SC (Small Commercial, 240V) CI1 (Commercial, 415V) CI2 (Commercial, 11kV) CI3 (Commercial, 33kV) CI4 (Commercial, 66kV) CI5 (Commercial, 132kV) IT (Interruptible-Domestic water heating) Weighted average EUT Financial year (July-June) Source: ERC, Kestrel Research Progressive introduction of cheaper alternative energy to the grid to control power purchase costs going forward: As cheaper alternative energy sources continue to be introduced to the grid, we expect Kenya Power s unit purchase cost to be contained over the next 3 years, and

3 Financial Year (July-June) Capacity weighting Kenya Power and Lighting Company Limited Capacity weighting based on power sources 100.0% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Source; Kestrel Research FY13 FY14 FY15 FY16 Financial Year (July-June) Capacity weighting based on Power generators FY16 FY15 FY14 FY13 0% 20% 40% 60% 80% 100% Capacity weighting Source; Kestrel Research KenGen Iberafrica Tsavo Bio fuel Wind Geothermal Thermal Hydro Mumias CO Generation Or Power 4 (Geothermal) Lake Turkana Wind Power Aggreko EPP Others decline thereafter, translating to improved gross margins in the short term (+171bps y/y to 49.5% in FY14F). Cognizant that new Power Purchase Agreements have recently been reviewed upwards following the End User Tariff revision, albeit at a lower rate than the EUTs, we believe the net effect will result to sustained gross profit growth (3 year CAGR of 13.0% to FY16F), due to the progressive introduction of geothermal and wind energy to supplement hydroelectricity generation that is very susceptible to power supply volatility due to unpredictable hydrologic cycles. Kenya Power has historically had to rely on diesel reliant thermal energy as a source of emergency power during periods of drought or sub-optimal water levels at hydro dams, paying a premium of up to 433.3% to hydro sourced unit power cost. Despite the increase in alternative energy capacity, we believe hydroelectricity will continue to take first priority during periods of heavy rainfall. Additional power capacity totaling 520.4MW is expected to be contracted over the next 4 years (Aelous (60.0MW), Lake Turkana (300.0MW), Ngong 1 Phase II (6.8MW), Ngong 2 (13.6MW) and Agil (140.0MW)). More so, KenGen s Olkaria I and IV projects are expected to be commissioned in FY15F, with a total capacity of 280.0MW. Year on year reduction in fuel cost will however be dependent on obtaining a generation mix where the contribution of thermal generation-relative to total generation-is minimal, favourable movement in fuel price in the international market and commissioning of committed port and pipeline projects within the planned timelines. Kenya Pipeline Company (KPC) has commissioned a feasibility study to replace the current Mombasa-Nairobi product oil pipeline with a 14- inch spur-line to Kisumu City (Western Kenya) to complement the existing 6 inch multi-product oil pipeline. Another multi-product oil pipeline is planned to be constructed from Nakuru town in Western Kenya to Isiolo town to serve Central Kenya demand. Modernization of the current toping oil refinery currently operating at approximately 40.0% of its design capacity (4.0m tonnes) is expected to be completed by The above projects, coupled with Kenya Ports Authority s scheduled re-location of the Kipevu Jetty, are bound to reduce congestion and fuel transportation costs further inland. We expect a decline in thermal power capacity weight, from 31.7% in FY13 to 26.7% respectively in FY16F, as geothermal and wind power reliance increases from 16.1% and 0.3% in FY13 to 28.8% and 14.0% in FY16F respectively. KenGen will however remain the chief power generator going forward, albeit accounting for a lower contribution to total power production, with its market share shedding 447bps over the next 3 years to account for 66.3% of total capacity in FY16F. Power source Avg. purchase cost (USD) Hydro 0.03 Thermal 0.18 Geothermal 0.07 Wind 0.16 Source; Kestrel estimates

4 Network upgrade and automation to improve power transmission in the medium term: Kenya Power plans to increase its investment in upgrading and expanding its grid. This will include sectionalizing and allocating specific distribution lines to large Commercial & Industrial consumers, repair and reinforcement of existing system lines as well as substation and feeder improvement. Currently, the Nairobi North segment system reinforcement is almost complete and Kenya Power plans on focusing on the Southern section of Nairobi in FY15, following the completion of the former. Additionally, plans to implement an Automatic Meter Infrastructure (AMI) to ensure correct meter readings are relayed back to the power transmitter as well as facilitate remote disconnections and reconnections. A Distribution Automation system is expected to be rolled out to cover Nairobi and Mombasa regions. This will facilitate prompt fault location, isolation and restoration of supply in the event of a power outage. Our forecasts therefore project a forward 3-year CAGR of 15.4% in EBITDA/units sold (in GWh) to KES 1, in FY16F (KES 1, in FY13) and +203bps y/y in EBITDA margin to 23.8% in FY14F). Funding at concessionary rates to boost connections and network upgrade in the medium term: For the purpose of financing capital expenditure going forward, Kenya Power will use a debt: equity mix of 75: 25. The power distributor is expected to receive US dollar loans equivalent to KES 32.0bn in 2H14 from 3 banks at an average rate of 6.6%, with the payment period ranging between 7 and 11 years. Part of the KES 32.0bn will be used to clear Kenya Power s outstanding overdraft facility that has high interest rates (effective rate of 16.4% in FY13). The overdraft facility was sourced in FY13 from 4 banks (KCB Bank, NIC Bank, Co-op Bank and Commercial Bank of Africa) at base rate minus 2.0%, 4.0%, 5.0% and 4.0% respectively in FY13. We anticipate that Kenya Power will secure a Partial Risk Sharing Facility (RSF) with the International Finance Corporation (IFC) in the foreseeable future (possibly in January 2015) to enable Kenya Power source additional debt funding with longer tenure, possibly year term loans that match the commissioning period of its projects in order to match cash flow streams going forward. The Government of Kenya (B+ foreign currency credit rating) has a 50.1% stake in Kenya Power and this has historically aided Kenya Power in securing debt financing at concessionary rates. As Kenya Power is yet to obtain a credit rating, an RSF with AAA rated IFC will be a plus for the power distributor due to even longer tenures, while providing the power distributor with the possibility of less reliance on the GoK for loan guarantees. It is our conjecture that Kenya Power will possibly issue a USD 300.0m long term Eurobond in with Partial Credit Guarantee from the World Bank in FY16F. Data transmission to support medium term income growth and cost management: Kenya Power has the potential to get into the data transmission space via a blend of fibre optics and power line communication. Currently, Kenya Power has a bandwidth lease license and a total of 1,200 Km of fibre optic cable, leasing about 20.8% of its available fibre optic capacity to Safaricom, Jamii Telcom, Airtel, KenGen and Wananchi Online while it uses 25.0% of its capacity internally, thus rendering the balance 54.2% available for lease. Kenya Power will only realize the full potential of the fibre business when the broadband services can be offered up to the customers premises. Kenya Power is currently in the initial stages of carrying out a feasibility study

5 on key stations and distribution lines to assess the possibility of transmitting data to end users for home control and home networking purposes via Fibre To The Home (FTTH) or Broadband over power line (BPL) technology which will ultimately influence Kenya Power s application for last mile data transmission status license. We estimate a pilot program implementation cost of KES 10.0bn. Should Kenya Power s findings conclude that the venture is feasible, Kenya Power will target 250,000 customers in the long term following the rollout, in the cities of Nairobi and Mombasa. With the advantage of FTTH or BPL technology, Kenya Power believes that any amount charged to its customers upon reaching the last mile status will directly feed its bottom line. This will be sufficient to provide home users and small businesses with internet services at significantly lower costs than other ISPs. As for cost containment, the FTTH and Broadband over will facilitate provision of meter reading solutions for electricity and water, as well as load control and demand response purposes, thus eliminating end user theft and minimizing the time lapse between disconnection and reconnection periods and automating the process. Attractive on a relative basis-current price a good entry point: Kenya Power trades at forward EV/EBITDA, P/E and P/B multiples of 6.9x, 4.5x and 0.5x respectively. We note that currently, Kenya Power trades at P/E and P/B multiples of 6.5x and 0.6x, against our mean utility sector comparables (Africa and Middle East) of 12.3x and 1.5x, thus providing a 43.1% and 60.0% discount on an P/E and P/B basis. Kenya Power has historically traded at a P/E multiple of 7.3x, presenting a 65.9% discount. On a PEG basis, the counter trades at a multiple of 0.1x. We therefore strongly believe that the current price serves as a good entry point for Kenya Power.

6 Factors of System losses 27.8% 27.8% Courtesy of transmission lines 44.4% Source; Kestrel estimates Courtesy of distribution system Customers at the meter reading level Risks System losses-a downside risk to revenue growth and cost containment: System losses continue to be an issue of concern for Kenya Power, at 18.6% in FY13 (Sub Saharan Africa s system loss average 26%-27%). Kenya Power s system losses are a factor of two main aspects, commercial losses and technical losses. Technical losses stem from energy conversion to heat during transmission, points of weakness disrupting power transmission and loss attributable to sub stations operating at sub optimal levels, due to few customer connections within the servicing radius of the sub station (despite a certain quantum having to be converted to heat during its operation). Commercial losses on the other hand are as a result of meter reading errors and theft at the end user level, especially among domestic and small commercial users. Notably, 1.0% system loss is equivalent to a cost of KES 900.0m, which is a factor of both purchase and opportunity cost for the company. A standard for cost absorption is pre-set for Kenya Power by the Energy Regulatory Committee (below), whereby if the power transmitter s system losses exceed these levels, the cost is borne by Kenya Power. 2012/ / / /2016 Target system loss pre-set by ERC (%) Source: Kenya Power Should Kenya Power s system losses remain at current levels up to FY16, it risks absorbing huge costs, approximately KES 2.4bn. However, we believe the intensified network upgrading measures, customer bundling in low power demand areas and system automation will reduce system losses in the medium term. Additionally, we expect Kenya Power to put up new sub stations upon ensuring potential geographical loci have enough power demand to warrant sub stations to be constructed and operated at optimal capacity, in order to avoid power wastage. We also expect the 450 Km, 400kV transmission line running from Nairobi to Mombasa to also contribute to reduced system losses when completed, as power is currently transmitted through 132kV and 220kV transmission lines over the same distance. In light of the estimated system loss of 18.3% in FY14F, we project a 20.6% y/y increase in distribution and commercial services costs to KES 6.6bn, and 19.3% y/y rise in energy transmission costs to KES 1.8bn. We however expect a further 112bps y/y decline in system losses to 17.2% in FY15F. Period lags in capacity expansion projects to render power generators heavily reliant on hydro-power; a risk to power supply stability: Due to the current heavy reliance on hydro power (whose contribution to total energy produced reduced to 30.0% in as a result of severe droughts experienced), this has historically led to reliance on diesel-based emergency power supply, hiking power purchase costs significantly. While several projects are expected to be commissioned over the next 3 years totaling 800.4MW to level out power supply going forward, the downside risk of period lags during capacity expansion projects (thus rendering Kenya Power more vulnerable to power purchase costs hikes during seasons of low/delayed rainfall) continues to be an issue of concern. Although Kenya Power expects the projects (below) to be commissioned at the specified periods, these are only tentative dates.

7 Risks contd Upcoming projects Project Name Type MW Date of Commissioning (%) Agil Geothermal Aelous Wind Lake Turkana Wind Olkaria I & IV Geothermal Ngong 1 Phase II Wind Ngong 2 Wind Total Source; Kenya Power

8 Medium Term & Long Term Projects The regional economic integration among East African states has driven East African countries (Burundi, Ethiopia, the Democratic Republic of Congo, Kenya, Rwanda and Uganda) to embark on a plan to unify their national electric power grids to facilitate trade in hydropower electricity and minimize reliance on thermal power to plug the deficit power supply, thus reigniting interest in the East Africa Power Pool (EAPP). Due to Kenya s central location, it will be a key player in the interconnection of the EAPP. The regional grid integration plan is being implemented under the Nile Basin Initiative (NBI), which aims to cut the over-reliance on oil-powered electricity generation caused by occasional drought in the East African region and help to reduce regional power deficits. The planned international power transmission project was kicked off in 2012 with a tentative completion date of Below are some projects: Eastern Africa Hydro Interconnector: Ethiopia has huge hydro generation potential at approximately 45,000 MW. The power line will start from the planned Wolayta/Sodo substation in Ethiopia and end at the planned converter 400kV HVAC Suswa substation in Kenya, over approximately 1,045km using a +500kV HVDC (High Voltage, Direct Current) bipolar line. The power line is expected to pass through Marsabit, Samburu, Isiolo, Laikipia, Nyandarua and Nakuru counties. Kenya Transmission Company (KETRACO) is charged with the mandate of expanding the national electricity transmission network for power lines of 132kV and above and is therefore responsible for the project. Upon completion, the power line will facilitate the export of up to 2,000MW annually from Ethiopia to other countries with power supply deficit within the EAPP, through Kenya. The transmission line is expected to be completed in Lake Turkana Interconnector: The Lake Turkana interconnector will start from the Loiyangalani substation and terminate at the Suswa substation, stretching over approximately 428km. The construction of the 2 substations is underway, with the connection point at Loiyangalani substation at 220/400kV level. The transmission line will have a double metering system and a SCADA interface for controlling and monitoring the 300MW wind farm. The transmission line is expected to be completed in 2H16. Tororo-Lessos power Interconnector: A 127km, 220kV double circuit from Lessos sub station (Kitale) to Tororo sub station in Uganda will be constructed, mostly parallel to the existing 132kV Tororo-Lessos as a component of the interconnection of the grids of Nile Equatorial Lakes Countries project. KETRACO has already secured funding from the African Development Bank to finance the construction of the portion within Kenya. The tender invitation was closed in 2012 and is currently in the preliminary stages of construction. The transmission line will then connect Kenya Power to another proposed line from Tororo in Uganda, that will in turn stretch to Rwanda. The Metropolitan Ring: In 2012, KETRACO and Kenya Power embarked on sectionalizing the Nairobi region by constructing a 100km, 400kV double circuit line with 220/66kV sub stations at Athi River, Ngong, Koma Rock and a 200kV sub station at Isinya. This is for the purpose of transferring capacity to meet Nairobi s rising demand and enhance power security by providing alternative electricity paths. In FY13, the Nairobi Region accounted for 52.9% of system demand (max) at 716MW, and 56.2% of Kenya Power sales (3,507 GWh) and is therefore a critical

9 Medium & Long Term Projects contd region to Kenya Power s revenue stream. Aside from sectionalizing the Nairobi power lines, measures to revamp the existing power and feeder lines and automate lines with SCADA system are underway so as to minimize power outages and enable monitoring of transmission, distribution and feeder lines. Proposed Kenya Network LEGEND Source; Kenya Power, KETRACO

10 Eastern Africa Interconnections Proposed Kenya Network LEGEND Source; Kenya Power, KETRACO Source; KETRACO

11 1H14 Results-A word of caution Dec-14 Dec-13 y/y ch Revenue-Basic 26,236 23, Forex Surcharge 4,107 4, Total non-fuel revenue 30,343 27, Fuel recovery 14,898 16, Total electricity revenue 45,241 44, Power purchases-non fuel 16,311 14, Power purchases-fuel 15,245 16, Total power purchases 31,556 31, Gross margin 13,685 13, Gross trans & dist costs 12,210 10, Miscellaneous revenue (2,057) (1,470) 39.9 Net trans & dist costs 10,153 8, Operating Profit 3,532 4, Finance cost (1,041) (846) 23.0 PBT 2,491 3, (KES m) Dec-14 Dec-13 y/y ch Non current assets PPE 142, , Pre paid land leases Other assets Inventories 13,511 12, Trade and Other receivables 17,098 14, Tax recoverable Govt securities Short term deposits Bank and Cash Balances 778 1,583 - Total Assets 175, , Capital & Reserves Ordinary share capital 4,879 4, Share premium 22,021 22, Other Reserves 20,273 19, Total Equity 47,173 46, Deferred income 16,145 14, Non Current liabilities Deferred Taxation 11,537 9, Borrowings 42,547 21, Preference shares Trade & Other payables 17,782 17, ,909 48, Current Liabilities Trade & Other payables 21,014 18, Borrowings 7,980 6, Overdraft 8,616 8, Other current liabilities 2,427 1, Total Current liabilities 40,037 35, Total equity & liabilities 175, , Based on our half year estimates, we would like to issue a word of caution with regards to Kenya Power s 1H14 results. We encapsulate a 30.3% y/y decline in PBT to KES 2.5bn, on the back of high finance costs. We forecast electricity sales to grow modestly, (+9.5% y/y) due to the old End User Tariffs being applicable for the 5 months to 30th November, as the new tariffs came

12 1H14 Results-A word of caution contd into effect on 1st December Transport & distribution costs are expected to be up 19.0% y/y to KES 12.2bn, resulting to 20.1% y/y decline in the operating profit. We note that the KES 8.6bn overdraft facility recorded in Kenya Power s books in 1H13 (KES 6.7bn in June 2013) was taken up on December 2012, thus reflecting accrued finance costs from the facility of only 1 month. We therefore estimate 23.0% y/y increase in finance costs, as overdraft finance costs accrue over the full 6 months in 1H14 translating to 30.3% y/y decline in Profit Before Tax. However, Kenya Power s 1H14 results will by no means be a reflection of its FY14 results mainly due to: The End User Tariff review that results to 32.4% y/y increase in the weighted average EUT will be effective in 7 out of 12 months of FY14. The estimated KES 8.6bn overdraft facility to be retired in 2H14, as Kenya Power s cash position improves due to improved cash from operations and financing activities (KES 32.0bn loan to be received).

13 Valuation of KPLC We have used two appropriate valuation methods (DDM and RVA - P/B and P/E ) to derive a fair value for the ordinary shares of KPLC. The premise of our discount rate (cost of equity) assumption of 19.0%, is founded on a Risk free rate of 13.0%, Market Risk premium (6.0%) and a Beta coefficient of 1. A long-term sustainable growth rate of 6.0% was assumed (long term inflation (3.5%) and GDP (2.5%)). Discounted Dividend Method (DDM) Based on a 3 year historical average payout ratio of 20%, our DDM model assumes this payout ratio will remain so going forward. We discount dividends over a 3 year period (until FY16) and thereafter derive a value based on the perpetuity method. Our estimated dividends were discounted using the cost of equity. DDM Valuation Cumulative PV of Dividends 3,323,747 PV of Terminal value 43,087,498 Total Intrinsic value 46,411,245 Shares in issue 1,951,467 Per Share Value Relative Value Analysis (RVA) We have used two relative valuation techniques (P/B and P/E) to derive our valuation. For each technique, a historical weighted multiple for the last 3 years was combined with the utility industry average (using weights of 50.0%) to derive at a relative value. Relative Weighting ratio Historic 0.5 Industry 0.5 P/B Historic P/B 0.68 Utility industry average 0.85 Derived Weighted average P/B 0.76 Forward book value Per share Value P/E Historic average P/E 6.71 Utility industry average 9.20 Derived Weighted average P/E 7.96 Forward EPS - adjusted 3.24 Per share Value Per Share Value-DDM Per share Value-P/B Per share Value-P/E Average Value 23.36

14 FY13 Results analysis Income Statement (KES '000) FY12 FY13 1H13 2H13 y/y% ch h/h% ch Electricity Sales 45,008,000 47,916,000 23,260,415 24,655, Foreign Exchange adjustment 8,759,000 9,222,000 4,453,871 4,768, Fuel cost adjustment 41,896,000 31,771,000 16,541,324 15,229,676 (24.2) (7.9) Total Revenue 95,663,000 88,909,000 44,255,610 44,653,390 (7.1) 0.9 Power Purchase Costs Non fuel 21,080,000 24,761,000 12,183,726 12,577, Fuel Costs 42,789,000 32,297,000 16,686,476 15,610,524 (24.5) (6.4) Foreign exchange costs 6,094,000 5,120,000 2,170,898 2,949,102 (16.0) 35.8 Total Power Purchase Costs 69,963,000 62,178,000 31,041,100 31,136,900 (11.1) 0.3 Gross Profit 25,700,000 26,731,000 13,214,510 13,516, Other income 1,788,000 3,192,000 1,470,323 1,721, Transmission & Distribution costs (19,680,000) (21,130,000) (10,262,193) (10,867,807) Operating Profit 7,808,000 8,793,000 4,422,640 4,370, (1.2) Interest income 489, ,000 62,015 48,985 (77.3) (21.0) Interest expense (1,216,000) (2,495,000) 1,064,722 (3,559,722) (434.3) Foreign exchange gains/(losses) 1,425,000 15, ,367 (141,367) (98.9) (190.4) Net finance costs 698,000 (2,369,000) 1,002,707 (3,371,707) (439.4) (436.3) Profit Before Tax 8,506,000 6,424,000 3,576,300 2,847,700 (24.5) (20.4) Income Tax (3,889,000) (2,072,000) (478,826) (1,593,174) (46.7) Profit After Tax 4,617,000 4,352,000 3,097,474 1,254,526 (5.7) (59.5) FY12 FY13 1H13 2H13 y/y bps ch h/h bps ch Share Price E.P.S (KES) N.A.V (KES) ROE (%) P/E (x) P/B (x) Effective Tax Rate (%) Gross Profit Margin (%) Operating Profit Margin (%) (21) Pre-tax Profit Margin (%) (167) (170) Kenya Power & Lighting Company (Kenya Power) released its FY13 results for the 12 months ending June 2013, recording a 5.7% y/y decline in EPS to KES The company s electricity sales were up 6.4% y/y (+6.0% h/h) to KES 47.9bn driven by a 14.3% y/y increase in customer base to see a total of 2.9m customers connected to the power grid. Kenya Power s board of Directors did not declare a final dividend in FY13 but this not an indication of a change in dividend policy going forward. We highlight the key earnings drivers below: Total revenue was down 7.1% y/y to KES 88.9bn, as a result of a 24.2% y/y decline in fuel cost adjustment to KES 31.8bn. Kenya Power s electricity sales grew by 3.2% y/y to

15 FY13 Results analysis 6,184 million units in FY13, from 5,991 million in FY12. The company s gross profit margin also improved by 320bps y/y to 30.1%, owing to reduced fuel and foreign exchange costs. In the financial year ending June 2013, the reliance of oil-dependent thermal energy declined due to improved hydrology, which translated to 24.6% y/y increase in hydro power generation to 4,298GWh, and a decline in fuel cost s weight in the power purchase mix, from 61.1% in FY12 to 51.9% in FY13. Other income recorded by a significant 78.5% y/y growth to KES 3.2bn, driven by fiber optic lease charges, miscellaneous sales as well as connection and reconnection charges. Operating profit grew 12.6% y/y to KES 8.8bn, lifting the company s operating profit margin by 173bps y/y to 9.9%. This was as a result of relatively slower growth in total income relative to operating expenses, as transmission and distribution costs recorded 7.4% y/ y increase to KES 21.1bn, primarily due to an increase in depreciation charges. The company s finance costs also recorded a significant increase from KES 1.2bn to KES 2.5bn, due to higher financing costs arising from short and medium term loans to finance working capital needs as well as network expansion and system developments. During the year, the company recorded a 53.8% y/y increase in capex ventures to KES 40.0bn, with connectivity projects valued at KES 1.8bn completed. 28.8% of the funds (KES 518.0m) was from a loan facility provided by French financial institution, AFD. Finance and forex income however recorded 77.3% and 98.9% y/y decline to KES 111.0m and 15.0m respectively in FY13 due to the easing in interest rates and strengthening of the Kenyan Shilling against major world currencies. All the aforementioned factors resulted to a 5.7% y/y decline in Profit After Tax to KES 4.4bn. Going forward, we expect Kenya Power to note growth from various strategic endeavors: Creating demand for the 5,000+ MW capacity addition expected in the future by working with the Government to identify and attract investors to develop large scale businesses and take advantage of opportunities at the county level as well as bringing the grid closer to the people to increase accessibility to power Reinforce and Upgrade the system by expanding the national grid in line with increased generation and customer demand, improve the quality of supply and reducing system losses. We highlight that for every decrease in system losses by 1.0%, Kenya Power will save approximately KES 900.0m. Kenya Power however needs significant capital to finance its projects, with capital expenditure estimated at about KES 156.0bn (USD 1.8bn) between The financing requirement is expected to be met through improved revenue collection, leasing out fiber optic capacity to diversify revenue streams and from long term funding such as corporate bond issuance, concessional funding and possibly a rights issue.

16 Africa and Middle East Utility industry comparables Country Name P/E P/B P/S EV/EBIT ROE Ivory Coast COMPAGNIE IVOIRIENNE D Jordan IRBID DISTRICT ELECTRIC Kenya KENYA POWER & LIGHTING Morocco LYDEC Oman UNITED POWER CO MAN NATIONAL ENGINEER Saudi Arabia SAUDI ELECTRICITY CO Zambia COPPERBELT ENERGY CO Average Median Source: Bloomberg

17 Financial Summary Income Statement (KES m) FY12 FY13 FY14F FY15F FY16F 1 yr 3 yr ch (%) CAGR (%) Electricity Revenue 45,008 47,916 58,123 77,762 78, Electricity purchase costs 21,080 24,761 29,167 46,294 45, Gross Profit 23,035 22,630 28,544 31,284 32, Operating costs 19,680 21,131 24,558 25,970 28, Operating profit 5,144 4,691 7,816 9,910 10, Net finance income/(cost) 3,363 1,733 1,519 1, Profit before tax 8,507 6,424 9,334 11,070 10, Taxation (3,890) (2,072) (3,015) (3,575) (3,537) Profit after tax 4,617 4,352 6,319 7,494 7, Attributable Income 4,617 4,352 6,319 7,494 7, Weighted shares (m) 1,951 1,951 1,951 1,951 1,951 EPS (KES) DPS (KES) Balance Sheet (KES m) Fixed assets 105, , , , , Other non-current assets Current assets (excl. cash) 28,159 36,578 36,701 50,753 60, Cash & cash equivalents 2,464 4,637 6,843 11,943 22, Total assets 134, , , , , Shareholders equity 43,512 47,406 52,410 58,344 64, Non current liabilities 46,875 74,018 92, , , Current liabilities 31,383 39,646 32,576 35,531 32, Total equity and liabilities 121, , , , , Cash flow Statement (KES m) Cash flow from operations 14,405 19,392 20,546 23,065 23, Cash flow from investing (26,676) (40,431) (26,115) (26,138) (26,275) Cash flow from financing 4,580 20,690 17,262 11,660 16, Cash at the beginning 9, (2,097) 6,866 11,966 Net increase for the year (8,922) (2,898) 8,964 5,100 9,484 Cash and cash equivalents end 800 (2,097) 6,866 11,966 21,450 Source: Company, Kestrel Capital estimates

18 Key Ratios and Multiples Ratios and multiples FY2012 FY2013 FY2014F FY2015F FY2016F Profitability Turnover Growth (%) EBITDA Margin (%) EBIT Margin (%) Profit Margin (%) Operating Efficiency EV/EBITDA EBITDA/GWh (KES) 1, , , , ,962.1 Fixed asset turnover (x) Return On average industrial assets (%) Return On average Assets (%) Return on average Equity (%) Leverage & Capitalization Total Debt to equity (%) Total Debt to total assets (%) Total Debt: EBITDA (%) Return on equity Asset turn (x) ROA (%) Equity multiplier (x) ROE (%) Liquidity Inventory turnover (x) Receivables turnover (x) Payables turnover (x) Current Ratio (x) Other ROCE (%) Borrowings 24,521 29,452 54,646 71,908 84,883 Capital employed (KES m) 105, , , , ,004 Book value per share (KES) Source: Company, Kestrel Capital estimates

19 Recommendation guide STRONG BUY: BUY: ACCUMULATE: HOLD: LIGHTEN: SELL: Highly undervalued/ strong fundamentals Good value/ strong fundamentals Buy on price dips Correctly valued with little pricing upside or downside Overvalued by the market/ Reduce exposure/declining fundamentals/ industry concerns Weak fundamentals and challenging operating environment/highly overpriced Disclaimer Note: Readers should be aware that Kestrel Capital (EA) Ltd does and seeks to do business with companies covered in its research reports. Consequently, a conflict of interest may arise that could affect the objectivity of this report. This document should only be considered a single factor used by investors in making their investment decisions. The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. The opinions and information portrayed in this report may change without prior notice to investors. This publication may not be distributed to the public media or quoted or used by the public media without prior and express written consent of Kestrel Capital (EA) Ltd. Directors, staff of Kestrel Capital (EA) Ltd and their family members, may from time to time hold shares in the company it recommends to either buy or sell and as such the investor should determine for themselves the applicability of this recommendation. This document does not constitute an offer, or the solicitation of an offer, for the sale or purchase of any security. Whilst every care has been taken in preparing this document, no representation, warranty or undertaking (express or implied) is given and no responsibility or liability is accepted by Kestrel Capital or any employee of Kestrel Capital as to the accuracy of the information contained and opinions expressed herein.