Imara Sub Saharan Africa Energy Sector Report A different kind of power struggle... February 2012

Transcription

1 Imara Sub Saharan Africa Energy Sector Report A different kind of power struggle... February 2012 Analyst Batanai Matsika batanai.matsika@imara.co

2 CONTENTS PAGE Overview of Global Energy Sector 2 Energy Sector in Africa 2 Comparative Analysis for Energy Stocks 3 Nigerian Oil and Gas Sector 4 Oando Nature of Operations. 8 Operational Review... 8 Outlook, Valuation and Recommendation 9 Total Nigeria Nature of Operations Operational Review Outlook, Valuation and Recommendation 13 Kenya Energy Sector 15 Kenol Kobil Nature of Operations. 18 Operational Review Outlook, Valuation and Recommendation 19 KenGen Nature of Operations. 22 Operational Review Outlook, Valuation and Recommendation 23 Kenya Power Nature of Operations. 26 Operational Review Outlook, Valuation and Recommendation 27 Zambia Energy Sector Copperbelt Energy Corporation Nature of Operations. 32 Operational Review Outlook, Valuation and Recommendation 33 Puma Energy Zambia Nature of Operations. 36 Operational Review Outlook, Valuation and Recommendation. 37 Imara Contact Details 39 Appendix to Abbreviations: Barrel Bpd c CDM CO² EAC GDP GWh IAS ISP IOC KES kwh LNG LHS MNOCs MW OECD OML OPEC PMS : is a unit of volume for fluids such as oil : Barrels per day : circa : Clean Development Mechanism : Carbon dioxide : East African Community : Gross Domestic Product : Gigawatt Hour (unit of energy = 1000 megawatt hr) : Imara Africa Securities : Internet Service Provider : International Oil Company : Kenya Shilling : Kilowatt Hour (unit of energy = 1000 watt hrs) : Liquefied Natural Gas : Left Hand Side : Multinational Oil Company : Megawatt (a unit of energy = watts) : Organisation for Economic Cooperation & Development : Oil Mining Licence : Organisation of the Petroleum Exporting Countries : Premium Motor Spirit RHS SADC SSA USD yoy ZESCO : Right Hand Side : Southern Africa Development Community : Sub Saharan Africa : United States of America dollar : year on year : Zambia Electricity Supply Company 4

3 OVERVIEW OF ENERGY SECTOR The surge in global energy consumption has, to a large extent, been the major driver of energy costs. On the supply side, the world is simply not finding energy sources fast enough to replace what is being consumed. There has also been an unprecedented population explosion in the world, with the population growing at a rate of c1.0% per year and projected to reach 8.2bn by the year 2030 from 6.8bn currently. In addition, nonoecd countries will account for about 90% of population growth and 90% of energy demand growth over the period from 2010 to 2035, according to estimates. It is also worth noting that more motor vehicles will be sold over the next 25 years than have been sold throughout the entire history of the automobile industry. In China and India for example, the demand for electricity, cars, and consumer goods is having a profound impact on the world s energy balance. A massive supply gap. Globally, the number of people without access to electricity remains high at about 1.3bn (c20% of the world s population). Events such as those at the Fukushima Daiichi nuclear power plant and the turmoil in parts of the Middle East and North Africa (MENA) have cast doubts on the reliability of energy supply. Also, the world is currently consuming about 8.0m bpd of oil and by 2030 global energy demand is projected to reach approximately 115.0m bpd, signalling the world s first ever demandbased energy shock. Electricity consumption has been increasing, driven by the growing economies. Global electricity consumption has averaged 15,763bn kwh against production at 17,030bn kwh. Electricity demand has been growing at a CAGR of 7.1% over the last 8 years while production has registered a CAGR of 6.97% as countries grow their capacity. According to the International Energy Agency (IEA), there is a need to invest about USD 38.0tn in energy supply over the period to 2035 with almost twothirds of the total investment in countries outside of the OECD. Oil and gas collectively account for almost USD 20.0tn, as both require upstream investments while the power sector claims most of the remainder, with over 40% of this being for transmission and distribution networks. Growth in Primary Energy Demand Source: International Energy Agency (IEA) Moving towards alternative energy sources. Generally, fossil fuels still account for c80% of the world s total primary energy supply. In fact, global primary energy demand rebounded by a remarkable 5.0% in 2010, pushing CO² emissions to a new high. Scientific consensus is that global warming exists and that it is being caused by human activity. Governments and individuals are therefore recognizing the need for action. There is an urgent need to reduce the amount of carbon in the atmosphere in order to lessen the greenhouse effect. It is estimated that electricity generation and transportation contribute 38.1% of greenhouse emissions worldwide. The age of fossil fuels is far from over. It is quite clear that traditional energy sources such as oil, coal, and natural gas still meet the majority of global energy demand. Emerging economies such as China, which is undergoing its own industrial revolution, are busy building, on average, one new coalfired electrical plant each week. China already produces as much global warming emissions as the USA and is not alone, as India and other developing nations are racing to catch up to the industrialised world. Despite the increase however, it is estimated that the share of fossil fuels in global primary energy consumption was about 81% in 2010 but will decline to 75% in Natural gas is the only fossil fuel that is expected to increase its share in the global mix over the period to Rising energy prices, the finite nature of fossil fuels, energy security concerns and global warming have driven the global community to consider other alternative energy sources such as solar, wind and geothermal power. In fact, the United Nations has declared 2012 to be the International Year of Sustainable Energy for All. An overview of the Energy Sector in Africa Electricity access in Africa remains low despite the high access rate of 90% in the North which is attributed to the availability of hydrocarbons. Only 27% of the population in SubSaharan Africa (SSA) is connected to electricity. Demand has been growing steadily at a CAGR of 4.9% and is expected to accelerate to 7.0% through However, installed capacity has been growing at a lower rate, raising fears that if not accelerated, then parts of the continent will not be able to meet their projected demand. One key area of concern in SSA has been power generation and distribution. The region is in a deficit and planned capacity additions are unlikely to expunge the current shortages, yet population growth and rapid urbanisation will add further demand to an already overstretched grid. SSA has the capacity to generate 68GW which, however, shrinks to a mere 28GW if South Africa is excluded. To put it into perspective, excluding South Africa, the whole region matches the installed capacity of some nations that are still developing such as Argentina. Furthermore, a huge chunk of Africa s power plants are out of production owing to a myriad of factors, among them obsolescence and lack of repair. While GDP growth averaged 5.0% in recent years, generation capacity has grown at an annual rate of less than 3.0% since It is therefore not surprising that only below 27.0% of SSA s population has access to electricity. The gap can only be plugged if significant investment goes into generation and distribution. There is also a need to adjust electricity tariffs so as to reflect the true cost of power generation in most SSA countries. Private sector participation in SSA power generation projects for example has largely been curtailed by uneconomic tariffs common across the region. Some level of deregulation of tariffs will thus attract capital and allow aggressive capacity additions. 2

4 SSA Energy Sector Comparative Analysis Oil/Gas Comparatives Country Market Cap (USDm) PER PER (T+1) PBV EV/EBITDA EV/Sales Div Yield NP Margin OP Margin Africa Total Nigeria Plc Nigeria % 3.4% 3.8% Oando Plc Nigeria % 3.0% 7.2% KenolKobil Kenya % 1.7% 3.6% Puma Energy Zambia Zambia % 2.1% 4.4% Total Cote d'ivoire SA Ivory Coast % 2.0% 4.2% Total Kenya Kenya % 0.8% 2.0% Shell Mauritius Mauritius % 2.8% 3.5% MRS Oil Nigeria Plc Nigeria % 3.0% 3.2% Mobil Oil Nigeria plc Nigeria % 6.8% 9.9% Conoil Plc Nigeria % 2.6% 4.0% Oman Oil Marketing Co Oman % 3.1% 3.5% Emerging Markets Qgep Participacoes S.A. Brazil 2, % 4.9% 11.5% Petrominerales Colombia 1, % 3.5% 38.2% Oil Refineries Israel 1, % 0.2% 0.7% Africa (Av.) % 2.8% 4.5% Emerging Markets (Av.) 1, % 2.9% 16.8% Power Sector Comparatives Country Market Cap (USD) PER PER (T+1) PBV EV/EBITDA EV/Sales Div Yield NP Margin OP Margin Africa Kenya Power & Lighting Kenya % 5.9% 10.0% KenGen Kenya % 14.5% 39.3% Copperbelt Energy Corporation Zambia % 6.1% 9.4% Compagnie Ivoirienne d'electricité Ivory Coast % 2.2% 3.5% Maghreb Oxygene Morocco % 7.3% 14.5% Air Liquide Tunisie SA Tunisia % 19.2% 22.8% Emerging Markets Energisa S.A. Brazil 1, % 8.5% 15.9% Light SA Brazil 3, % 3.8% 13.1% Maxima Air Separation Center Israel % 5.9% 13.6% Muscat Gases Company Oman % 20.2% 20.8% SMN Power Holding SAOG Oman % 2.7% 23.1% Africa (Av.) % 9.2% 16.6% Emerging Markets (Av.) % 8.2% 17.3% Source: IAS/Bloomberg Methodology Our research covers seven SSA petroleum marketers and power companies including Oando plc, Total Nigeria plc, KenolKobil, Kenya Generating Electricity Company (KenGen), Kenya Power, Copperbelt Energy Corporation (CEC) and Puma Energy Zambia. We also focus on the industry fundamentals in the covered geographies including Nigeria, Kenya and Zambia, focusing on key trends and fundamentals. In valuing the companies, we broadly applied comparative valuation approaches given the similar nature of business models, even across various geographies. However, due to limitations in the aforementioned valuation method, we also applied Discounted Cash Flow (DCF) valuations techniques. Recommendation and Conclusion As the energy supply and demand picture continues to change in the world and indeed in SSA, we see a strategic logic in gaining exposure to companies engaged in activities such as the exploration, production or distribution of oil, natural gas, coal, nuclear power, utilities, and alternative energy. However, within SSA, factors such as government controls, regulations, tariff structures and price controls tend to affect the financial viability of such companies. Nevertheless, we see growth prospects in companies such as Oando plc in Nigeria, KenolKobil and Kenya Power, from an investment perspective. We are Neutral on CEC, given its impending capital raise. We recommend investors HOLD Puma Energy in Zambia as it is yet to finalise a mandatory offer on the LuSE. We assign a SELL recommendation on Total Nigeria plc given its demanding ratings. We think the upside for KenGen will come in the long term given its move towards greener energy sources. We thus assign a LT BUY recommendation. 4 3

5 NIGERIAN OIL & GAS SECTOR Nigeria is Africa s largest oil producer with daily output (including condensates) of 2.6mpbd (up from 1.7mbpd in 2009, following the relative postamnesty calm in the Niger Delta). Oil has historically accounted for more than 50% of the federal government s revenue. In 2010, it accounted for 75% (2009: 66%) of collected revenue when the average price of Bonny Light rose to USD 81/barrel from USD 64/barrel in As a requirement to join OPEC, in the 1970 s, Nigeria nationalised its oil industry. This led to the creation of what is now known as NNPC (Nigerian National Petroleum Corporation), formerly known as Nigerian National Oil Company (NNOC). Geology The oil industry is concentrated in Nigeria's Delta region for the simple reason that this is where the bulk of oil and gas deposits are located. The Niger Delta's sedimentary basin, made of deposits transported by the river for millions of years, is one of the world's most extensive oil traps. It occupies an area of over 75,000km². The continental section of the Delta and its extension into conventional offshore tracts contains 85% of the country's current oil and gas reserves; the remaining 15% are buried deep offshore, at depths of 500m under water. Oil Reserves by Country Nigeria, 32.0% Sudan, 3.0% Tunisia, 0.3% Other Africa, 4.0% Algeria, 19.0% Angola, 6.0% Chad, 0.4% DRC, 1.0% Egypt, 8.0% The Upstream Industry The upstream oil industry is an important sector in the country s economy as it involves exploration and extraction activities. It currently produces c1.825mpd of crude oil and provides over 90% of its total exports. Oil is produced from five of Nigeria s seven sedimentary basins in the Niger Delta, Anambra, Benue Trough, Chad, and Benin. The Niger Delta, onshore and shallow offshore basins are well explored and the basins contain about 80% of producing wells drilled in Nigeria. Midstream Industry Given the need to find alternative, cheaper and cleaner fuel for industrial and economic activities, the mid stream industry which mainly involves the exploitation of natural gas is emerging as a positive development in the country s energy sector. Nigeria has the world s 8th largest proven natural gas reserves at 5.215tn m³. Nigeria is also a very important supplier of LNG to European buyers exporting over 20.55bn m³. The country has associated and nonassociated gas reserves estimated at about 187tn cubic feet (tcf) or 2.8% of the world s total reserves. Industry experts have said that Nigeria s proven gas reserves could potentially be as high as 600tcf if deliberate steps are taken to explore for gas as against the coincidental discovery during oil exploration. The country is currently producing over 32.82bn m³ and consuming over 12.28bn m³. Major African Natural Gas Producers (tcf) Others 14 4% Algeria % Source: IAS/ Company Reports Libya, 24.0% Others, 16.0% Equatorial Guinea, 1.0% Nigeria % Oil Production by Country Nigeria, 21.0% Libya, 17.0% Sudan, 5.0% Others, 16.0% Source: IAS/ Company Reports Tunisia, 1.0% Equatorial Guinea, 3.0% Other Africa, 1.0% Algeria, 19.0% Chad, 1.0% DRC, 3.0% Egypt, 8.0% Angola, 18.0% Industry Overview The oil and gas industry is a pillar of the Nigerian economy and a major factor in its world standing. A member of OPEC, Nigeria is responsible for 8.24% of the organisation s overall production. The oil and gas sector in Nigeria is broadly divided into three categories: the up stream, mid stream and down stream industry. Source: IAS/ Company Reports Angola 9.6 3% Downstream Industry The downstream industry in Nigeria is also a key sector in the country s economy. Nigeria as a nation consumes over 286,000bpd and has four oil refineries, eight oil companies and numerous independent petroleum products marketers. Insufficient capacity utilisation of the refineries has however resulted in shortages of refined product and the need to increase imports to meet domestic demand. The main players in the Down Stream Sector... The two categories of market participants include the major marketers and the independent marketers. Majors are companies which over the years have established their footprints through significant investments across the country. These include players such as Oando, Conoil, Forte Oil, Mobil Nigeria and Total Nigeria. Majors have a combined network of about 2,700 stations. On the other hand, independent marketers consist of about 3,800 oil marketing companies. 4

6 In terms of market share, Oando and Total Nigeria have generally ranked in the top two positions in terms of distribution. However, the sector remains highly competitive and the commoditised nature of the industry means that margins in the petroleum marketing sector are inherently low as participants struggle to differentiate themselves. In the past years, net margins in the Nigerian petroleum marketing sector have averaged 3.0%. Petroleum marketing companies have therefore begun to look for additional growth drivers beyond PMS and this has led to a focus by the majors on lubricants. For example, Mobil and Total have been able to leverage on their global brand, reputation and OEM (original equipment manufacturer) status to build capacity in lubricants. Supply constraints still looming... A striking paradox is that despite the fact that Nigeria is the 6th largest producer of oil in the world, the country s downstream sector is mainly supplied through imports. In fact, imports have historically accounted for around 80% of Nigeria s consumption. The key issue is that Nigeria s four refineries have consistently operated well below their potential due to lack of investment. Nigeria s refineries, with a combined installed capacity of 445,000bpd, have operated at an average capacity of 18% in the past five years. With respect to PMS specifically, the refineries were only able to satisfy 3.8% of Nigeria s demand. There is therefore an urgent need to revamp the nation s refineries. Av. Capacity Utilisation of Nigeria's Refineries 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Source; IAS/Company Reports Demand on the increase Consumption per capita of petroleum products is on the increase in Nigeria largely due to the rapid economic growth and urbanisation. More households and industries have turned to generating their own power as opposed to relying on the grid. Over the periods, the volume of petroleum products consumed in Nigeria grew by an average of 4.6% versus a population growth rate of 3.1% over the same period and average GDP growth of 6.3%. The Nigeria power sector has also been experiencing notable constraints of power supply given that transmission and distribution networks have been poorly maintained and inefficiently operated making it difficult to move power from generation sites to consumption points. Electricity generation in Nigeria in 2008 was estimated at about 7,000 MW, consisting of 73% of thermal power and 27% of hydropower. The Power Holding Company of Nigeria (PHCN) accounted for 85.3% of total generation while Independent Power Projects accounted for 14.7%. Pricing structure remains regulated... The PPPRA (Petroleum Products Pricing and Regulatory Agency) is the government agency responsible for the pricing of regulated petroleum products in Nigeria. The price of PMS, for example is based on a pricing template which is updated regularly to reflect, among other things, the price of crude oil in the international market, predetermined margins and the naira/usd exchange rate. Regulatory Framework The petroleum marketing sector in Nigeria has progressively moved from a completely regulated market to a partiallyregulated one in which the government provides subsidies on only a few refined petroleum products. The subsidies represent the difference between the market cost of the products and the fixed pump price which is set by the government. The government has successfully eliminated subsidies on AGO while HHK (kerosene) prices are partially subsidised. The Petroleum Subsidy Fund (PSF) The Petroleum Subsidy Fund (PSF) is the government s main tool in regulating the price of PMS in Nigeria. The PSF is funded through tax revenues and accruals realised from periods when the landed cost of PMS is actually lower than the regulated price. The PPPRA is responsible for monitoring subsidy payments to the marketers by verifying that volumes of petroleum products imported by the marketers match the subsidy claim documents submitted to the agency. Prior to April 2010, the government owed marketers huge sums in subsidies stretching to over six months in some cases. This largely resulted in the marketers incurring huge financing costs. This led to a product supply shortage in the nation. In April 2010, President Goodluck Jonathan then introduced the sovereign debt note (SDN) programme to ensure prompt payment of subsidies within 45 days from the verification of marketers claims. This has ensured the uninterrupted supply of PMS. The debate on the ballooning subsidies burden... Over the last few years, the burden which the government has borne in the form of subsidies has grown significantly. Globally, subsidies have been condemned for encouraging the wasteful consumption of fossil fuels and have jumped to over USD 400.0bn. In Nigeria, subsidies have grown from around NGN 260.0bn (USD 1.7bn) in 2006 to about NG 600.0bn (USD 3.9bn) in 2008, which equates to around 2.5% of GDP. Indications are that the government spent approximately NGN 385.0bn on subsidies in the first 5 months of The magnitude of the subsidies has prompted the government to increasingly move towards fullblown deregulation. The Global Subsidies Initiative (GSI) estimates that subsidies provided to producers of fossil fuels, mostly given in OECD countries, are about USD 100.0bn per year. Furthermore, fossilfuel subsidies tend to benefit highincome households more than the poor households, due to the former s higher consumption levels. For example, the Indonesia reported that the top 40% of highincome families absorb 70% of energy subsidies, while the bottom 40% of lowincome families only receives 15% of the benefit. 5

7 Economic Value of Energy Subsidies in NonOECD Countries Source: IEA More recently, the Nigerian government has been pushing for the removal of PMS subsidies as part of efforts to cut Nigeria's exorbitant cost of government. This has been a flagship policy of President Goodluck Jonathan and his economic management team. The estimated cost of the fuel levy has been estimated at USD 8.0bn a year. In the month of January 2012, garages in the main centres of Nigeria had pushed up petrol prices from NGN 65/l to around NGN 141/l, as the government moved to remove the subsidy. However, the Nigeria Labour Congress (NLC) and the Trade Union Congress (TUC) declared a showdown with the federal government through mass protests and strikes, calling for the price of PMS to be reversed to NGN 65/l. However, a compromise between government and the unions saw a 50% reduction in the fuel levy, taking the price of petrol to NGN 97/l from NGN 65/l. It s also a game of politics... The issue of deregulation of the Nigerian petroleum sector has been quite controversial. While the general populace has called for the government not to remove subsidies, deregulation is seen as desirable in freeing government of its concurrent control, and involvement in the businesses of refining, importation, and distribution of refined petroleum products in the Nigerian market. Furthermore, it relieves the government from subsidising PMS prices. It is also worth noting that previous administrations in Nigeria have in fact used subsidies on PMS as a political gimmick. In January 2009, for example, the government under the late President Yar Adua ceded to labour s demands that the price of PMS be reduced to reflect the fall in oil prices, moving the price from NGN 70 to NGN 65 per litre. Since then oil prices climbed over 150% but there was no revision at all to the fixed price of PMS. New Reforms through the Petroleum Industry Bill... The Nigerian government has broader plans to reform the oil and gas sector in Nigeria through the Petroleum Industry Bill (PIB). This is a wide range of legislation that seeks to reform the oil and gas sector and the regulatory bodies in Nigeria. The Bill will comprise of a Nigerian Content Policy, NNPC Marginal Field Bid Rounds and Downstream price regulation. It has been delayed for more than two years because of its complexity and various vested interests. While the government appears to be gearing up to put up a stronger fight to push through its reforms, the possibility exists that further delays could creep in. Also related to PIB, is the Local Content Act, derived from the Nigerian Content Policy, which is now in force following its assent by President Goodluck Jonathan. The law seeks to increase indigenous participation in the oil and gas industry by prescribing minimum thresholds for the use of local services and materials and to promote employment. The bill also seeks to allow greater participation of indigenous companies in the sector and has significant ramifications for the upstream sector. The policy focuses on the promotion of value addition in Nigeria through the utilisation of local raw materials, products, and services in order to stimulate growth of indigenous capacity. Outlook on global oil prices In 2009 and 2010, commodity prices increased higher than expected, which reflected a combination of strong demand growth and a number of supply shocks. Oil prices rebounded in 2009, reaching the USD 80 barrier by the end of the year. The price of Brent crude hit USD 95 a barrel for the first time in 27 months in January In 2011, oil prices rose significantly due to the unrest in the Middle East. Due to the Japanese earthquake, there is likely to be higher demand for oil for power generation and reconstruction which will offset downward nonoecd adjustments. Oil (Light Crude) Prices Oil Price USD/barrel Jan07 Apr07 Jul07 Oct07 Jan08 Apr08 Jul08 Oct08 Jan09 Apr09 Jul09 Oct09 Jan10 Apr10 Jul10 Oct10 Jan11 Apr11 Jul11 Oct11 Jan12 Source: Index Mundi Despite fears that oil demand will be low given a fragile global economy, demand is likely to increase marginally in The global economy is expected to demand 90.3m bpd in 2012, up 1.0m barrels from While the increase is marginal, supplyside problems are expected to help keep a floor under prices. NonOPEC production was already weak in 2011, and will continue to be so in 2012, totaling 53.9m bpd. OPEC production will increase 0.8m bpd to 31.0m bpd, despite public bickering between Saudi Arabia and other members. The return of Libyan production, which in 2010 hit 1,559m bpd, is another factor that will conspire to keep oil prices under control in Higher oil prices in 2012 imply increased export value and GDP growth for oil producing nations like Nigeria. 6

8 EQUITY RESEARCH NIGERIA FEBRUARY 2012 OIL & GAS Oando plc Diversifying into upstream and midstream activities Oando s E&P division is currently undergoing a Reverse TakeOver (RTO) on the Toronto Stock Exchange (TSX) in a transaction that will carve out the E&P division as a standalone business. We opine that the RTO and listing transaction will create a platform that will facilitate the E&P Division s access to equity capital required for the acquisition of proven and producing assets, as well as the further development of its current assets (production of 5,000bpd). Management has indicated the intention to further sweat the two producing assets (OML 56 and OML 125). Management therefore expects the projects to add net production of 2,500 bpd to current levels during We think the diversification strategy is a positive. Oando is diversifying away from the lowmargin (PAT margins of c3.0%) downstream petroleum marketing business into upstream and midstream activities. The marketing business constitutes c47% to revenue and 24% to PAT whereas exploration contributes 32% to PAT. We feel growing the business in the upstream and midstream areas will not only ensure survival but offers steady growth prospects for the group. Valuation upside. Based on our forecasts, we estimate that Oando s FY 2011 sales will be 25% ahead of FY 2010, and estimate earnings growth of 9.1%. At the current price of NGN 17.5 per share, the counter is trading on a PER (T+1) of multiple of 3.0x which is significantly below Mobil (10.1x) and Total (15.9x). Our price target of NGN 37.0 per share, that is based on a blend of valuation methodologies points to 111.7% upside potential. We therefore recommend investors BUY. BLOOMBERG: OANDO:NL BUY Current price (NGN) Current price (USD) 0.1 Target price NGN) 37.0 Target price (USD) 0.2 Upside/Downside (%) 111.7% Liquidity Market Cap (NGNm) 39,552.2 Market Cap (USDm) Shares (m) 2,262.7 Free float 13% Ave. daily vol (000) 2,800 Share price performance 6 Months (%) % Relative change (%)* 35% 12 Months (%) % Relative change (%)* 48% *Relative to MSCI Frontier Market Index Financials (USDm) FY 31 Dec F 2012F Turnover 2,547,965 3,183,926 4,114,184 EBITDA 230, , ,117 Profit before tax 142, , ,458 Profit after tax 75,873 82, ,047 EPS (USD) NAV/share (USD) DPS (USD) Valuation Ratios F 2012F PER (x) PBV (x) EV/EBITDA (x) EV/OP (x) EV/Sales (x) EBITDA margin 9.1% 8.0% 7.5% Earnings Yield 39.6% 33.7% 44.0% Dividend Yield 18.5% 15.8% 20.7% Gearing 156.7% 161.1% 130.1% RoaA 3.5% 3.6% 4.3% RoaE 15.5% 12.4% 14.6% Oando VS S&P Africa FM Index (Rebased) Jan11 09Feb11 02Mar11 23Mar11 13Apr11 04May11 25May11 15Jun11 06Jul11 27Jul11 17Aug11 07Sep11 28Sep11 19Oct11 09Nov11 30Nov11 21Dec11 11Jan12 01Feb12 PriceRebased S&PRebased STRENGTHS Strong management team Knowledge of local and regional market dynamics Access to trading lines in excess of USD 1.0bn Access to internatonal capital through international listings ie JSE and TSX. Divesification to midstream and upstream businesses ensures better margins than peers. OPPORTUNITIES Increased demand for Lubricants and petroleum products in Nigeria. Increased consumption of LNG in Nigeria presents opportunities for the company. New acquisitions would enable the company to achieve its long term production target of 100,000 bpd. WEAKNESSES Fuels are homogeneous products and very competitive since product differentiation is difficult in a market with a large number of petroleum marketers. THREATS Deregulation uncertainty in Nigeria. Increased competition from existing and new entrants in the industry due to deregulation. 7

9 Nature of Operations Oando plc is one of Africa s largest integrated energy solutions providers. It has a primary listing on the NSE and a secondary listing on the JSE. The Oando Group comprises of Oando Marketing (a retailer of petroleum products which sells and distributes one in every five litres of petroleum in Nigeria via over 500 retail outlets, and has operations across West Africa (Ghana, Togo, and the Republic of Benin), Oando Supply & Trading (Africa s largest independent and privatelyowned oil trading company involved in the large scale export and import of a broad range of refined petroleum products), Oando Gas and Power (pioneer in fields of private sector pipeline network construction and the distribution of natural gas to industrial and commercial consumers), Oando Exploration and Production (E&P) (with 13 oil and gas assets) and Oando Terminaling (manages the development of a greenfield petroleum refinery with a 240,000bpd production capacity and a 210,000MT capacity product reception terminal in the Lekki Free Trade Zone located in Lagos state). Q Results Overview Oando Plc released its unaudited results for the nine months period ended 30 September, Turnover grew by 41% to NGN 392.3bn (USD 2.4bn) compared to NGN 277.5bn (USD 1.7bn) in According to management, the growth in revenues was due to increased contributions from the higher margin upstream and midstream segments. In the same vein, gross profit was up 14% to NGN 49.6bn (NGN 43.6bn: 2010), implying a GP margin of 12.7%. However, EBITDA grew at a lower rate of 7.0% to NGN 30.9bn (EBITDA margin of 7.9%) largely due to a 17.0% surge in operating expenses. PBT grew by 39% to NGN 19.4bn, compared to NGN 13.9bn (PBT margin of 4.9%) and PAT was up 34% to NGN 10.2bn (USD 63.2m). Operational Review Solid growth from upstream businesses. The upstream units accounted for 51% of group PBT, up from 30% a year ago and average production was around 5,000bpd from two producing assets (OML 125 and OML 56). OEPL executed agreements for the Reverse Takeover of Exile Resources Inc., a Canadian listed oil company, for the creation of Oando Energy Resources Inc (OER). OER s listing will create an international platform to fund the substantial investment required for exploration and production growth. Oando s management is looking to bring the upstream production to 10,000bpd by 2015 from around 5,000 bpd currently and, with the acquisition of additional assets, to 100,000bpd in the next five years. Midstream business showing gradual growth. Oando Gas and Power (OGP) completed the construction and testing of the 128km East Horizon Gas Pipeline (EHGC) in the South East of the country that is expected to start generating revenue from Q There was also an increase in gas customers on the Lagos gas pipeline grid. Management has revealed that it has signed an MoU for the development of the Western gas pipeline, which is a 400km transmission pipeline passing through different cities in the western region. Oando expects the right of way, acquisition, front end engineering and design to be concluded in 2012, pipeline laying to start in 2013 and segmental commissioning of the pipeline to occur in 2014 and 2015 The third pipeline franchise in Rivers State has commenced. Oando Gas and Power Plc signed an agreement with the Rivers State government to assume the operation and expansion of the state s existing gas infrastructure in the greater Port Harcourt Shareholder Structure % Shareholding Individuals 25.50% Private Companies 24.30% Nominees/Trust Companies 21.80% Pension Funds 16.06% Mutual Funds 4.95% Oando Organisational Structure Source: IAS/ Company Reports Income Statement (NGNm) Q Q % Δ Turnover 277, , % Gross Profit 43,588 49, % Operating Expenses (23,130) (27,073) 17.0% Other operating Income 8,509 8, % EBITDA 28,967 30, % Profit before tax 13,948 19, % Income tax (6,384) (9,200) 44.1% Profit after tax 7,564 10, % EPS (kobo) % Balance Sheet (KES 000) Q Q % Δ Total Assets 184, ,299 21% NAV 77,720 99,730 28% Current Assets 47,297 60,117 27% Current Liabilities 15,142 16,143 7% Current ratio Cash flow (KES 000) Q Q % Δ Operating activities 3,143 (8,464) 369% Investing activities (12,379) (22,272) 80% Financing activities (5,236) 38, % Net inc/dec in cash (14,472) 7,416 Oando 2010 Revenue Split Marketing 47% Source: IAS/ Company Reports Explorations 0% Supply & Trading 44% Gas & Power 5% Energy Services 4% 8

10 industrial areas. The development is expected to catalyse rapid industrial development. Under the agreement, Oando will rehabilitate and operate the existing natural gas infrastructure at TransAmadi and expand the network to Choba Airport; New UST area of Greater Port Harcourt City; Abuloma, Heliconia Park; Reclamation Road and other adjoining areas. The existing gas pipeline has a throughput of about 40.0m m³ per year, which currently serves industries in TransAmadi including Nigerian Bottling Company (NBC), First Aluminium Company and Stallion Foods. Oando 2010 PAT Split Marketing 24% Supply & Trading 25% In terms of the Energy business, Oando expects an additional rig to be in operation in Q and a 4th rig in June 2012, which could improve the division s current contribution levels to PAT of c1.0%. Pole position in the downstream business. Oando has managed to maintain pole position in the supply and distribution of petroleum products across the country. Furthermore, additional cash flow generation is anticipated in Q from high seasonal demand. We anticipate that deregulation of the downstream units is likely to occur in H We opine that prices will gradually move up but marketers costs will also rise just as the selling price of PMS sees a marked increase and as such, profits will not necessary move up substantially in the longer term. Potential for M&A activity and upstream asset acquisitions in E&P. Oando has previously stated that as part of its ambitions to grow its production to 100,000bpd, it was seeking to acquire four small producing assets (10.0m barrels 2P reserves) and a large producing asset (150.0m barrels 2P reserves) by While there has been no announcement with regards to M&A, we suspect that Oando is on the look out for new acquisitions. Debt levels to come down gradually. Oando reduced its leverage (debttocapital ratio) from 75% in 2009 to 61% in 2010 because of the NGN 19.5bn raised from the rights issue and a NGN 14.0bn reduction in its debt balance to NGN 147.0bn. The company restructured its debt profile such that c50% of the balance is now long term debt as opposed to previously when the proportion was c15%. However, Oando s leverage is now back to levels seen prior to Explorations 32% Source: IAS/ Company Reports OandoFinancial Analysis 4,500,000 4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000, ,000 Gas & Power 18% Energy Services 1% F 2012F Sales (USD 000)LHS EBITDA (USD 000)LHS Net Profit (USD 000)LHS EBITDA marginrhs NP marginrhs 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Outlook In future, the group expects to generate additional cash flow from the deployment of its 3rd rig with an IOC, the flow of gas from the new pipeline systems in the Southeast and SouthSouth regions of Nigeria and the downstream division which traditionally benefits from high seasonal demand. Oando s long term plan is to reach net production of 10,000bpd by 2015, while its 5year target is 100,000 bpd. Valuation and Recommendation Looking attractive relative to peers. While Oando s operating structure does not make for effective peer comparison with other petroleum markets, we believe the stock is undervalued. Based on our forecasts, we estimate that Oando s FY 2011 sales will be 25% ahead of FY 2010, and estimate earnings growth of 9.1%. At the current price of NGN 17.5 per share, the counter is trading on a PER (T+1) of multiple of 3.0x which is significantly below Mobil (10.1x) and Total (15.9x). Our price target of NGN 37.0 per share, that is based on a blend of valuation methodologies points to 111.7% upside potential. We therefore recommend investors BUY. Oando: Return Measures Vs Dividend Yield 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% F 2012F Dividend YieldRHS Ro aalhs Ro aelhs Source: IAS/ Company Reports 50.0% 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 9

11 OANDO 5 YEAR CGR COMPARISON 31 DEC (USD 000) F 2012F 5yr CAGR Balance Sheet Noncurrent assets 243, , ,779 1,001,389 1,259,050 1,444,458 1,412,885 1,510,529 43% Current assets 386, , ,708 1,213, , ,084 1,008,632 1,152,687 14% Total Assets 629, ,047 1,403,487 2,214,966 2,164,300 2,200,542 2,421,517 2,663,216 28% Capital and reserves 172, , , , , , , ,808 30% Noncurrent liabilities 37,459 34, , , , , , ,988 76% Total current liabilities 420, , ,728 1,467,715 1,545, ,494 1,021,692 1,225,420 17% Total Equity and Liabilities 629, ,047 1,403,487 2,214,966 2,164,300 2,200,542 2,421,517 2,663,216 28% Income Statement Turnover 1,381,200 1,647,840 1,501,794 2,686,544 2,283,557 2,547,965 3,183,926 4,114,184 13% Cost of Sales (1,249,369) (1,516,427) (1,328,514) (2,360,439) (2,041,943) (2,183,401) (2,738,177) (3,538,198) 12% Gross Profit 131, , , , , , , ,986 23% Operating Profit 30,477 48,620 64, , , , , ,448 43% EBITDA 38,959 56,463 75, , , , , ,117 43% Net Finance costs (7,579) (12,759) (3,437) (47,132) (57,779) (42,150) (48,543) (78,990) 41% Profit before Tax 22,898 35,861 60,692 90,925 93, , , ,458 44% Income tax expense (6,405) (13,839) (10,888) (16,346) (19,048) (66,437) (73,368) (88,411) 60% Profit after Tax 16,493 22,022 49,804 74,579 73,954 75,873 82, ,047 36% Attributable Income 14,541 19,267 43,944 74,544 74,943 75,903 82, ,072 39% Ratios EPS (USD) DPS (USD) NAV/Share Dividend Cover (x) Dividend Yield 13.9% 29.0% 31.3% 44.1% 18.7% 18.5% 15.8% 20.7% Growth Ratios Sales growth 19.3% 8.9% 78.9% 15.0% 11.6% 25.0% 29.2% EBITDA growth 44.9% 34.6% 148.5% 1.4% 23.8% 10.9% 20.8% OP growth 59.5% 31.9% 115.3% 9.2% 22.3% 10.9% 34.6% PBT growth 56.6% 69.2% 49.8% 2.3% 53.0% 9.7% 25.8% Earnings growth 33.5% 126.2% 49.7% 0.8% 2.6% 9.1% 30.6% Margins Gross margin 9.5% 8.0% 11.5% 12.1% 10.6% 14.3% 14.0% 14.0% EBITDA margin 2.8% 3.4% 5.1% 7.0% 8.2% 9.1% 8.0% 7.5% OP margin 2.2% 3.0% 4.3% 5.1% 6.6% 7.2% 6.4% 6.7% PBT margin 1.7% 2.2% 4.0% 3.4% 4.1% 5.6% 4.9% 4.8% PAT margin 1.2% 1.3% 3.3% 2.8% 3.2% 3.0% 2.6% 2.6% Effective tax rate 28.0% 38.6% 17.9% 18.0% 20.5% 46.7% 47.0% 45.0% 10

12 EQUITY RESEARCH NIGERIA FEBRUARY 2012 OIL & GAS Total Nigeria plc Digging deeper for more reserves Just like its peer Oando plc, Total Nigeria plc has been more aggressive in the midstream and upstream businesses. Of the ten deep offshore discoveries in Nigeria, Total Upstream is the operator in three and partner in another three. Total's production methods for raising oil and gas from great depths and under great pressures and temperatures represent a major achievement that makes today's exploits possible. Revenues likely to surge due to deregulation. We opine that Jonathan s administration is preparing to tackle deregulation issues head on. The government would definitely prefer to fully deregulate the sector, passing on the burden of subsidies directly onto consumers. We think that a compromise is likely to be reached in the form of price increases over the next two years while some level of subsidies will remain. As a result of the price increases, we expect sales for petroleum marketers such as Total Nigeria plc to surge significantly in 2012 but margins are likely to remain thin. (PAT margin of c3.5%). Ratings look demanding. While we forecast revenue growth of 7.6% in 2011, we estimate a 30% decline in after tax earnings (effect of extraordinary item in FY 2010). Total shares are trading on a demanding PER (T+1) multiple of 15.9x, which is above our SSA oil and gas sector average of 10.1x. Furthermore, ratings are not as attractive as Mobil s (10.0x) or Oando s (3.0x). At current levels, we see downside risk in holding the stock. As such, we initiate with a Sell rating. BLOOMBERG: TOTAL:NL SELL Current price (NGN) Current price (USD) 1.1 Target price NGN) Target price (USD) 1.1 Upside/Downside (%) 2.5% Liquidity Market Cap (NGNm) 61,283.7 Market Cap (USDm) Shares (m) Free float 30% Ave. daily vol (000) 68 Share price performance 6 Months (%) % Relative change (%)* 7% 12 Months (%) % Relative change (%)* 0% *Relative to MSCI Frontier Market Index Financials (NGNm) FY 31 Dec F 2012F Turnover 160, , ,852 EBITDA 7,807 7,588 8,516 Profit before tax 5,783 5,669 5,947 Attributable earnings 5,437 3,859 3,967 EPS (NGN) NAV/share (NGN) DPS (NGN) Valuation Ratios F 2012F PER (x) PBV (x) EV/EBITDA (x) EV/OP (x) EV/Sales (x) EBITDA margin 4.9% 4.4% 3.5% Earnings Yield 8.9% 6.3% 6.5% Dividend Yield 4.4% 3.1% 3.9% Gearing 60.4% 93.6% 84.5% RoaA 10.4% 6.7% 6.2% RoaE 68.3% 41.0% 38.1% Total VS S&P Africa FM Index (Rebased) Jan11 04Feb11 04Mar11 04Apr11 04May11 04Jun11 04Jul11 04Aug11 04Sep11 04Oct11 04Nov11 PriceRebased S&PRebased 04Dec11 04Jan12 STRENGTHS Highly experienced management team. Knowledge of local and regional market dynamics. Economies of scale advantages. Strategic support from parent company, Total SA. Moving into downstram activity where margins are more lucrative than downstream acivities. Use of advanced processing methods. OPPORTUNITIES Increased demand for lubricants and petroleum products in Nigeria. Increased consumption of LNG in Nigeria presents opportunities for the company. Massive upside potential in Total Nigeria's long terms projects such as the Akpo Project Oil and Gas Project, Odudu (OML 100) and Ofon (OML 102) WEAKNESSES Fuels are homogeneous products and very competitive since product differentiation is difficult in a market with a large number of petroleum marketers. THREATS Deregulation uncertainty. Slow down in global economic growth Increased competition from existing and new entrants in the industry due to deregulation. 11

13 Nature of Operations Total Nigeria s activities are carried out by three main subsidiaries; Total E&P Nigeria Limited (TEPNG), Total Upstream Nigeria Limited (TUPNI) for Oil and Gas, and Total LNG for Gas. Total Nigeria plc became public in 1978 and its principal activity involved the marketing of petroleum products and Liquefied Petroleum Gas (LPG). However, the company has diversified into the marketing of nonfuel products. The company has expanded its business through a network of over 500 retail outlets, corporate customers and organisations that are served through six regions (Lagos, Mid Western, Eastern, Far North, NorthCentral and Western). Total Nigeria also has bulk storage facilities at Apapa, Ibafon, Kano, Kaduna and Bukuru Depots, three lubricants blending plants at Koko in Delta State, at Kaduna in Kaduna State and Apapa in Lagos State and 10 Liquefied Petroleum Gas (LPG) bottling plants and a coastal storage in Apapa. Furthermore, it is one of the two larger suppliers of JET A1 fuel to the aviation industry in Nigeria at Lagos Airports (Domestic and International), Kano, Abuja and Port Harcourt Airports. Total s overall production in Nigeria, where it has been active for 50 years was about 300,000bpd in Overview of Q Results Total Nigeria recorded a turnover of NGN 129.9bn (USD 807.0m) in Q3 2011, up from NGN 121.9bn (USD 757.0m) in Q This represented turnover growth of 6.5%. In our view, the slow growth in turnover reflects the tepid rate of investment in the sector occasioned by uncertainty surrounding the deregulation of the downstream sector, as well as other industryspecific issues such as the delayed passage of the Petroleum Industry Bill (PIB). We are also of the view that competitive pressures were largely responsible for the uninspiring results. Management attributed the decline in Q profitability to increased competition in diesel (AGO) and aviation fuel (ATK). Both are more profitable than PMS (petrol) which performed in line with the company s expectations. PMS accounts for over 80% of total s revenue. Shareholder Structure % Shareholding Total Societe Anonyme 45.24% Elf Aquintane SA 16.48% Enifor Limited 8.12% Nigerian Citizens & Associations 30.16% Crude Oil Production In Nigeria (Major Companies) Texaco, 1.0% NAOC, 7.0% ELF, 8.0% Others, 16.0% Chevron, 16.0% Source: IAS/ Company Reports SPDC, 24.0% Mobil, 28.0% Income Statement (NGNm) Q Q % Δ Turnover 121, , % Profit before tax 4,422 4, % Tax (1,691) (1,529) 9.6% Profit after tax 2,731 2, % PBT margin 3.6% 3.2% PAT margin 2.2% 2.0% Negative growth on the bottom line. PBT at NGN 4.1bn declined 7.4% from NGN 4.4bn in 2010, implying a PBT margin of 3.2%. After taking into account a tax charge of NGN 1.5bn, the company ended the period with a profit after tax of NGN 2.5bn (USD 15.9m), compared with NGN 2.7bn in the corresponding period of 2010 (PAT margin of 2.0%). An interim dividend of NGN 679.0m, which translates into NGN 2.0 per share for Q3 2011, was declared. Operational Review Intense competition is the main threat. While Total Nigeria remains a dominant player in the sector, having maintained an average market share of 16% of petroleum products distributed over the last 6 years, the group reported its lowest quarterly sales figure in ten successive quarters in Furthermore, 2010 volumes contracted by 37% to 1.5bn litres. This is an indication that Total and its peers (other major marketers) have experienced increased competition largely due to new entrants. A new discovery for Total Nigeria plc. In a recent development, Total Nigeria announced that it has hit a new oil discovery at its offshore Etisong North 1 well. The well was drilled to a total depth of 2,387m in 80.0m of water. According to the company, one of the three reservoirs encountered tested at 8,500bpd of 40 degree API oil. 12

14 The find is indeed part of a twopronged strategy the company is mounting in Nigeria. On one hand, the strategy is to strengthen exploration near production hubs in the conventional offshore to maintain production levels (0.3m bpd). On the other hand, the group intends to amplify deep offshore exploration on riskier prospects of large size around the Akpo and Usan field to grow its reserves. The following are the key upstream and midstream projects that can unlock value for Total Nigeria plc in the long term: The Amenam Kpono Oil and Gas Export Project (AKOGEP) The AmenanKpono field sits astride two offshore blocks, OML 99 and OML 70, about 30km off the coast in the eastern part of the Niger Delta. Discovered in 1990, AmenanKpono is one of the largest conventional offshore developments ever undertaken in West Africa. The field is already producing a substantial amount of light crude and will soon be delivering natural gas to the Bonny liquefaction plant. The first phase has already been completed. AmenamKpono began producing oil in July 2003 and reached plateau production off 125,000bpd a year later. Full development of AmenamKpono will effectively double Total Nigeria s operated production in Nigeria. The Akpo Project Oil and Gas Project (OPL 246) The Akpo Project is a deep offshore installation based on a standalone facility. Some 44 subsea wells (22 producers, 20 water injectors and two gas injectors) are arranged around various subsea infrastructure wells in water depths ranging from 1,300 to 1,500m and connected to production facilities on a newbuilt FPSO (Floating Production, Storage and Offloading vessel) via insulated production flow lines and steel catenary risers of the most advanced model. The FPSO, which is designed for 240 people aboard, has a capacity of 175,000 for stabilised condensate, 530 for produced gas and a capacity of 2.0m barrels crude storage. Exported to the Amenam/Kpono gas hub via a 150 km subsea pipeline, the gas from Akpo allows for the monetisation of significant quantities of gas at Bonny. Total NigeriaFinancial Analysis 300, , , , ,000 50, F 2012F Sales (NGNm)LHS EBITDA (NGNm)LHS Net Profit (NGNm)LHS EBITDA marginrhs NP marginrhs Total Nigeria: EBITDA Vs Capex 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, F 2012F 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% ODUDU (OML 100) and OFON (OML102) The gas produced on the Odudu and Ofon fields is expected to boost the volume of gas exported to NLNG via Amenam/Kpono. Every day, 3.0million m³ of additional associated gas will be transported from Ofon to Amenam/Kpono. Of the two fields, which came on stream in 1993 and 1998, Ofon will make the most significant contribution to the Nigerian liquefaction sector. Additional developments planned for the field will increase production of oil and gas simultaneously. Outlook We expect FY 2011 to be a slow year for Total Nigeria given competitive pressures and a lackluster performance in H While we forecast revenue growth of 7.6% in 2011, we estimate a 30% decline in after tax earnings (effect of extraordinary item in FY 2010). Revenue growth is likely to be stronger in 2012 (40% growth) on the back of stronger prices. EBITDA (NGNm)LHS Capex (NGNm)LHS EBITDA/CapexRHS Source: IAS/ Company Reports Total Nigeria: Return Measures Vs Dividend Yield 80.0% 8.0% 70.0% 7.0% 60.0% 6.0% 50.0% 5.0% 40.0% 4.0% 30.0% 3.0% Valuation and Recommendation Total shares are trading on a demanding PER (T+1) multiple of 15.9x, which is above our SSA average of 10.1x. Furthermore, ratings are not as attractive as Mobil s (10.0x) or Oando s (3.0x). At current levels, we see downside risk in holding the stock. As such, we initiate with a Sell rating. 20.0% 10.0% 0.0% F 2012F Dividend YieldRHS Ro aalhs RoaELHS Source: IAS/ Company Reports % 1.0% 0.0%

15 TOTAL NIGERIA 5 YEAR CGR COMPARISON 31 DEC (NGNm) F 2012F 5yr CAGR Balance Sheet Noncurrent assets 9,015 10,441 11,488 12,985 14,830 16,785 17,469 19, % Current assets 19,936 15,855 24,009 28,786 34,871 37,817 43,685 48, % Total Assets 28,951 26,296 35,497 41,771 49,701 54,601 61,154 67, % Capital and reserves 4,132 5,766 6,339 7,269 6,983 8,929 9,885 10, % Noncurrent liabilities 22,162 17,880 26,312 31,635 39,344 43,467 48,819 53, % Total current liabilities 2,226 2,024 2,303 2,849 4,473 5,651 5,134 5, % Total Equity and Liabilities 28,951 26,296 35,497 41,771 49,701 54,601 61,154 67, % Income Statement Turnover 126, , , , , , , , % Cost of Sales (111,166) (111,784) (120,410) (158,265) (156,571) (139,577) (151,157) (215,006) 4.7% Gross Profit 15,556 14,790 16,930 19,147 22,000 21,027 21,594 26, % Operating Profit 4,889 3,414 4,906 6,777 6,680 6,248 5,912 7, % EBITDA 5,694 4,247 5,935 7,872 7,960 7,807 7,588 8, % Profit before exceptional item 4,820 3,249 4,829 6,508 6,163 5,783 5,669 5, % Exceptional item 415 Profit before taxation 5,235 3,249 4,829 6,508 6,163 5,783 5,669 5, % Taxation (1,620) (732) (1,573) (2,115) (2,195) (1,812) (1,810) (1,980) 2.3% PAT 3,615 2,517 3,255 4,393 3,968 3,972 3,859 3, % Extraordinary item 1,465 PAT & extraord item 3,615 2,517 3,255 4,393 3,968 5,437 3,859 3, % Ratios EPS (NGN) DPS (NGN) NAV/Share (NGN) Dividend Cover (x) Dividend Yield 5.3% 4.1% 5.3% 7.2% 6.5% 4.4% 3.1% 3.9% Growth Ratios Sales growth 0.1% 8.5% 29.2% 0.7% 10.1% 7.6% 40.0% EBITDA growth 25.4% 39.7% 32.6% 1.1% 1.9% 2.8% 12.2% OP growth 30.2% 43.7% 38.1% 1.4% 6.5% 5.4% 20.7% PBT growth 30.4% 29.4% 34.9% 9.7% 37.0% 29.0% 2.8% PAT growth 30.4% 29.4% 34.9% 9.7% 37.0% 29.0% 2.8% Margins Gross margin 12.3% 11.7% 12.3% 10.8% 12.3% 13.1% 12.5% 11.1% EBITDA margin 4.5% 3.4% 4.3% 4.4% 4.5% 4.9% 4.4% 3.5% OP margin 3.6% 2.6% 3.4% 3.6% 3.7% 3.8% 3.6% 2.6% PBT margin 4.1% 2.6% 3.5% 3.7% 3.5% 3.6% 3.3% 2.5% PAT margin 2.9% 2.0% 2.4% 2.5% 2.2% 3.4% 2.2% 1.6% Effective tax rate 30.9% 22.5% 32.6% 32.5% 35.6% 31.3% 31.9% 33.3% 14

16 KENYA ENERGY SECTOR Kenya s commercial energy is largely supplied by electricity, coal, fuel wood and oilderived products that are imported. The country has no proven reserves of hydrocarbons. However, petroleum products are the main source, accounting for about 80% of the country s commercial energy requirements. The National Oil Corporation of Kenya Limited (NOCK), which is 100% owned by the government, was initially incorporated in 1981 to coordinate oil exploration activities and later mandated to supply the country's crude oil requirements. In recent years, NOCK has been actively promoting Kenyan exploration acreage which has led to the signing of numerous Production Sharing Contracts (PSCs) covering exploration blocks. PETROLEUM SECTOR OVERVIEW There are various petroleum companies in the country involved in the distribution of petroleum products. There are about seven main companies and a growing number of independent oil distribution companies that have sprung up since the liberalisation of the sector. The Kenyan petroleum sector was partiallyderegulated in late 1994 with the deregulation of retail prices of petroleum products and of the importation of crude oil and refined products. Oil exploration activities A number of oil exploration companies were involved in the exploration for oil in Northern Kenya in the 1980 s and 1990 s, but they have all since pulled out. Kenya has four major sedimentary basins (Lamu, Anza, Mandera and Tertiary Rift) with a total surface area of 400,000km². The potential of discovering oil and gas is high given the fact that data acquisition and interpretation techniques being used are now more advanced that those used in the 1990 s. There are 38 blocks, of which only 19 are licensed. Out of the remaining 19 blocks, 10 have received Production Sharing Contracts (PSC) expression of interest, with negotiations underway for some others. The main industry players are Kenya Petroleum Refinery Limited (KPRL), Kenya Pipeline Company (KPC), the National Oil Corporation of Kenya Limited (NOCK) and the Energy Regulation Commission (ERC). Kenya Petroleum Refinery Limited (KPRL) The refinery was initially set up by Shell/BP in 1960 to serve the East African region. In 1971, the government acquired a 50% stake in the refinery. The refinery has a processing capacity of 4.0m tonnes but currently only processes approximately 1.6m tonnes. The company operates as a toll operator, refining crude on behalf of marketers, but has plans to convert into a merchant refinery. KPRL however suffers from major infrastructural constraints, but has recently signed loan agreements with various financial institutions so as to access funding for the expansion and improvement of its facilities. Kenya Pipeline Company (KPC) It is a state corporation under the Ministry of Energy with a mandate to provide storage and transportation of oil products. KPC operates the pipeline system that transports refined petroleum products from Mombasa to Nairobi and parts of western Kenya. The pipeline, which is operating at full capacity, will have its throughput doubled to 880m³ per hour as a result of ongoing capacity enhancements. Improved capacity is expected to reduce intermittent shortages of petroleum products experienced in Kenya and other export markets which use Kenya as a gateway. National Oil Corporation of Kenya Limited (NOCK) It was incorporated in 1981 under the Companies Act (Cap 486). The company's main objective then was to coordinate oil exploration (upstream) activities. The Kenyan government has spent in the region of USD 1.6m on oil exploration and is increasing its attempts to attract investors to the oil exploration industry. NOCK is also involved in downstream activity given that it operates its own fuels stations and helps keep prices down. Energy Regulation Commission (ERC) It was established under the Energy Act (2006) with a view towards better regulatory oversight of the energy industry. Its mandate includes determining the monthly maximum pump prices, advising the Ministry of Energy about developments in the energy sector, developing policy specific to the energy sector and ensuring that fair competition and good conduct are in place within the energy sector. In December 2010, the government through ERC issued the Energy (Petroleum Pricing) Regulations These regulations were implemented with a view of instituting price controls in the retail oil market. The ERC then issued pricing guidelines based on the Free on Board (FOB) costs of crude oil delivered to the refinery, transportation costs from Mombasa to the nearest wholesale depot and a wholesale margin of 6.0%. Market Developments in the Energy Sector The Kenyan petroleum industry has been growing steadily since independence. In the early years the petroleum industry was in the hands of the multinational oil firms such as Total Kenya, Shell/BP, Chevron, Agip, Esso and Kenyan firm Kenol Kobil. These firms had set up their own physical infrastructure including depots, loading facilities and retail outlets. However, after the petroleum industry deregulation in October 1994, a number of smaller players entered the industry. The increased number of market players resulted in unattractive economic conditions for the multinationals as the smaller players would compete on lower margins. It then led to a period of consolidation and exiting amongst the multinationals. Agip and Esso sold their assets to Shell/BP and Mobil respectively. Later on, Mobil sold its assets to Oil Libya followed by Chevron which sold its assets to Total Kenya. More recently, Shell agreed to sell its African assets to a consortium composed of Swiss trading firm Vitol and Private Equity (PE) firm Helios. The deal ensured that the Helios/Vitol consortium obtained Shell s depots and also the Kipevu Oil Terminal formerly owned by Triton. Other exits by MNCs include Libya Oil s purchase of Mobil s retail petrol stations as the latter closed shop in 14 countries across the continent. 15

17 THE DOMESTIC POWER SECTOR The main players in Kenya s power sector are Kenya Electricity Generating Company (KenGen), the powergenerating company, Kenya Power, the distribution company, KETRACO, the transmission company and a number of Independent Power Producers (IPPs). IPPs are private investors who generate power for commercial purposes. Currently, four IPPs are operational, namely Iberafrica Power, Westmont Power, Orpower 4 and Tsavo Power Company. All players in the sector are overseen by the industry regulator, the Energy Regulation Commission (ERC). KenGen is therefore the main power generator while IPPs supply bulk power to the grid. Kenya Power, formerly Kenya Power Lighting Company Limited (KPLC), supplies the power to consumers (retail and industrial). The government in 2009 incorporated KETRACO which builds and maintains new transmission lines. Electricity demand growing at a faster pace than production In Kenya, electricity demand has been on an upward trend growing at a CAGR of 4.9% in line with the growing connectivity over the last five years. Production has however been growing at a lower CAGR of 4.3% over the same period. Notably, it is estimated that electricity access in the country has risen from 15% in 2006 to 29% by March 2011, largely as a result of notable growth in investment in alternatives such as geothermal energy whose electricity potential is estimated at 4,000MW. Overall, Kenya has an installed electricity capacity of c1,600mw while effective capacity stood at 1,306 MW as at March Transmission and distribution lines, circuit length (11kv to 220kv) cover 43,523km. Hydropower constitutes 43% of the total electricity generated in Kenya. The interconnected grid has a total effective capacity of 1,360MW, comprising 748MW of hydro, 393 MW of thermal, 189MW of geothermal, 5.0MW of wind and 26MW from cogeneration. It is worth noting that the frequent changes in the rain patterns in East Africa have largely rendered hydropower unreliable. On the other hand, geothermal power currently accounts for 20% of power generated but its contribution to the grid is set to rise as the government intensifies exploration activities in this area. Alternative Energy Sources Kenya is a good case study of a country that is moving swiftly towards renewable energy so as to enhance stability in power supply. This move towards green energy is expected to minimize pressure on tariffs in the long term. Despite the fact that hydropower generation remains vulnerable to drought and variations in rainfall, additional hydro facilities are being developed in order to reduce the country's dependence on costly oilfired capacity. Over the longerterm, the favoured form of renewable energy is geothermal, where potential is believed to be considerable. Meanwhile, coalbased generating schemes should provide mediumterm electricity supply. In the five years from 2012 to 2017, Kenya's overall power generation is expected to increase by an annual average of 8.4% to reach 10.7TWh. Driving this growth will be a 6.4% annual average increase in hydropower and a 10.2% annual average rise in the supply of renewablebased electricity SSA Countries Electricity Tariffs (USc/ Kwh) 0 Botswana Mauritius Source: IAS Estimates Mozambique Angola Malawi South Africa Kenya Industrial (kwh) Commercial (kwh) Domestic (kwh) Significant planned investments Kenya plans to significantly increase the amount of energy generated by geothermal facilities. The country is already Africa's largest producer of geothermal power thanks to its strategic position of shifting tectonic plates. Over the next two to three years, the government plans to invest USD 1.4bn in the construction of several new geothermal power plants with a total installed generation capacity of 280MW. By 2030, Kenya hopes to be generating 5.0GW of power from geothermal power. Local investment firms TransCentury and Centum have announced multibillion shilling investments in the power sector with the focus on clean geothermal energy while foreign PE firms such as Egypt's Cidatel, UK's CDC and Globeleq are keen to bet on Kenya's electricity market. Private equity investors are showing increased interest in Kenya's power sector as slower investments by the government in building new power plants make the sector the next frontier for private capital. The interest is informed by the increased demand for electricity in Kenya and the relatively high price structure which is foreign currency denominated and one of the best structured bulk tariffs. Kenya, through the stateowned Geothermal Development Co recently received a USD 149.0m loan from the African Development Bank (AfDB) to develop 400MW of power generation. The loan was approved under two separate arrangements, with USD 124.0m coming from the African Development Fund and USD 25.0m from the Climate Investment Fund, which is implemented by the African Development Bank. The Menengai fields have a potential of up to 1,600MW. The loan will help develop generation capacity of up to 400 MW in the first phase. This will represent 20% of the planned geothermal power generation by The larger project, projected to cost USD 867.0m, will be cofinanced by the Government in conjunction with a group of lenders. Lesotho Namibia Swaziland Tanzania Uganda Zimbabwe Zambia 16

18 EQUITY RESEARCH KENYA FEBRUARY 2012 KenolKobil Limited Taking advantage of SSA exits by MNOCs KenolKobil is pursuing a two fold strategy hinged on geographical expansion outside Kenya and a focus on certain niche business lines (African Trading desk, Non Fuels, LPG and Fuel Oil). We think there is a strategic logic in pursuing such a strategy given the persistent constraints of the downstream business in particular and government interference in the industry. There has also been under investment and inefficiencies associated with petroleum storage and transportation infrastructure in Kenya. We like KenolKobil s regional expansion initiatives. In line with its Move South Expansion Strategy, the company registered a Company, Kobil Mocambique Limited in July 2010 and subsequently set up an office in Harare, Zimbabwe, to oversee its overland trading business using the ports of Mozambique. The fuel marketer has also ventured into the DRC, announcing the acquisition of a 4,000m³ terminal. This came after the firm signed an agreement with World Oil Congo SPRL for the terminal located in Lubumbashi, setting the group up to begin its downstream operations in the country. The acquisition is strategic as it plays a complementary role to KenolKobil s existing subsidiaries in Zambia, Mozambique and Tanzania. Compelling valuation. We expect KenolKobil to remain a dominant player given an estimated local market share of 24.0%, supported by its large distribution network and strategic asset base. On a relative basis, the counter is trading at an EV/EBITDA multiple of 6.1x (Total Nigeria 8.3x and Shell Mauritius 10.6x). We think that valuations are compelling given the expected RoAE expansion and sustained high dividend yield. BUY OIL & GAS BLOOMBERG: KNOC: KN BUY Current price (KES) Current price (USD) 0.1 Target price (KES) 15.0 Target price (USD) 0.2 Upside/Downside (%) 46% Liquidity Market Cap (KESm) 15,086 Market Cap (USDm) Shares (m) 1,472 Free float 30% Ave. daily vol (000) 720 Share price performance 6 Months (%) % Relative change (%)* 4% 12 Months (%) 9.8 5% Relative change (%)* 25% *Relative to MSCI Frontier Market Index Financials (USDm) FY 31 Dec F 2012F Turnover 101, , ,954 EBITDA 4,363 9,401 12,031 Profit before tax 2,698 6,442 8,839 Profit after tax 1,777 4,252 5,834 EPS (KES) NAV/share (KES) DPS (KES) Valuation Ratios F 2012F PER (x) PBV (x) EV/EBITDA (x) EV/OP (x) EV/Sales (x) EBITDA margin 4.3% 5.9% 6.3% Earnings Yield 11.8% 28.2% 38.7% Dividend Yield 5.1% 12.1% 16.6% Gearing 108.4% 144.1% 150.9% RoaA 5.6% 10.8% 12.3% RoaE 14.7% 31.5% 39.8% Kenol Kobil VS S&P Africa FM Index (Rebased) Jan11 03Feb11 03Mar11 03Apr11 03May11 03Jun11 03Jul11 03Aug11 03Sep11 03Oct11 03Nov11 PriceRebased S&PRebased 03Dec11 03Jan12 STRENGTHS Geographical diversificationpenetration in SSA markets through purchasing assets from exiting MNCs Product diversification involved in higher margin businesses such as lubricants and properties. Wide retail network across various markets in SSA. A dominant player in the local market that also benefits through economies of scale. OPPORTUNITIES Exit of MNCs can create entry opportunities into new African countries. Higher growth from new subsidiaries, aquisitions and markets. WEAKNESSES Fuels are homogeneous products and very competitive since product differentiation is difficult. Exposure to countryspecific risks due to regional expansion initiaives across the continent. Low margins in commercial reseller markets. THREATS Foreign exchange risks. Government interference and regulations. Competitive threats in the market due to a proliferation of new players in the petroleum marketing industry. Sovereign/Country risk factors can affect company operations negatively. Legal risk factors. 17

19 Nature of Business KenolKobil Group is an indigenous oil marketing conglomerate with an expansive investment portfolio spanning the entire Eastern, Central and Southern parts of Africa. The group consists of subsidiaries in eight African countries outside Kenya (Head Office) including; Uganda, Tanzania, Rwanda, Zambia, Ethiopia, Burundi, Zimbabwe and Mozambique. The group has developed its business in downstream sourcing and marketing of petroleum. It trades in both crude and refined petroleum products which include motor fuels, industrial oils, LPG, aviation fuels, lubricants and various other specialist oils. It is the only oil marketing company in East, Central and Southern Africa regions with an African Trading Desk. The main business segments therefore are Fuels Business (Retail Sales & Commercial Marketing), Aviation Business (Jet Fuel), Lubricants Business, K Gas, Supply and Trading and the Non fuel Business. Total inland sales volume in 2010 amounted to c2.5m tonnes. Overview of H Financial Results Aggressive sales and profitability growth. KenolKobil posted a solid set of financials in H as net sales were 38% ahead of H at KES 83.3bn (cusd 973.0m). The strong results were largely driven by a period of steep increases in international oil prices, effective inventories management, development of niche business lines and regional growth with renewed focus on customer care. Price controls also resulted in stability in gross margins for oil marketers due to significant elimination of price undercutting in the sector. Gross profit grew by 58% and the GP margin thickened from 7.1% in H to 8.1% as the cost of sales grew by 36.5% (lower than sales growth of 38%). Operating profit grew by 89.6% on the year to KES 4.5bn (OP margin of 5.4%). This was largely due to the fact that the group realised capital gains of KES 79.0m in the period from disposal of noncore assets. Forex losses, a key downside risk. Finance costs grew by 85.5% on the year mainly due to the devaluation of all local currencies against the USD. In fact, forex losses accounted for 65% of total financing costs. Currency risk for KenolKobil arises as a result of the large mismatch between USD denominated contract liabilities, and receivables denominated in domestic currencies (KES, ZMK and UGX). Furthermore, bank interest costs also went up as a result of borrowings that were related to an increase in trading activity. The borrowing figure, net of cash balances, amounted to ckes 10.0bn. The company also announced the continuance of its KES 1.5bn commercial paper programme to finance working capital requirements. Overall, PBT for the period was KES 3.2bn (USD 37.6m) and PAT was KES 2.2bn (USD 25.2m), representing an increase of 86% and 83% respectively. Generally, the key risk to KenolKobil s near term performance is the risk of currency depreciation. While the company is 50% hedged on its USD liabilities, there is a high likelihood of significant forex losses as a result of the depreciation of the KES and other domestic currencies visàvis the USD. Shareholder Structure % Shareholding Wells Pretroleum Holdings 24.91% Petroholdings Limited 17.34% Highfield Limited 12.46% Chery Holding Limited 8.71% Energy Resources Capital 5.99% Income Statement (KES 000) H H % Δ Sales 60,349,692 83,313, % Cost of Sales (56,085,214) (76,571,167) 36.5% Gross Profit 4,264,478 6,742, % Operating Profit 2,377,946 4,509, % Finance costs (721,869) (1,338,861) 85.5% Finance income 76,035 47, % Profit before tax 1,732,112 3,218, % Income tax (552,619) (1,061,149) 92.0% Profit after tax 1,179,493 2,157, % Balance Sheet (KES 000) H H % Δ Total Assets 32,216,630 46,110,796 43% NAV 12,705,512 14,317,878 13% Current Assets 26,062,068 39,786,666 53% Current Liabilities 18,879,407 31,174,345 65% Current ratio Cash flow (KES 000) H H % Δ Operating activities (6,361,988) 2,908, % Investing activities (351,031) (321,055) 9% Financing activities 6,802,176 5,733,521 16% Net inc/dec in cash 89,157 8,321,229 Kenol Kobil Geographical 2010 Revenue Split Kenyaother 43% EAC subsidiaries 14% Operational Review Better margin expansion prospects due to diversification. KenolKobil embarked on an assets rationalisation exercise in 2010 with the aim of enhancing productivity of its various assets. Furthermore, a number of projects have been completed across the group so as to diversify operations. Kenya Inland 33% Source: IAS/ Company Reports Other subsidiaries 10% 18

20 These include fast food, offices, shopping and motor service businesses. We opine that diversification from low margin businesses of petroleum marketing will in the long term boost margins (PAT margin of c2.0%). The trading desk, which mainly operates on the African east coast has also provided opportunities for KenolKobil to participate in nonspeculative bulk cargo sales originating from the Arab Gulf market. We expect that the company will benefit on margins generated from this niche market with relatively low operating risk since the fuel volumes are precontracted. The trading desk currently accounts for c11% of PBT. Outlook Growth through acquisitions in SSA. With an enhanced capex programme, KenolKobil intends to grow its presence further in new markets by participating actively in the buyout of downstream oil assets in SSA. Management estimates that subsidiaries will account for about 45.0% of the company s operating profits in FY 2011, which we think is plausible given the company s growing presence in SSA downstream markets. KenolKobil s rapid growth has been supported by accumulation of strategic midstream and downstream oil assets through continued participation in acquisitions and buyouts. The company has outlined a capex programme of USD 17.0m (financed through medium term loans) to participate in the acquisition of downstream assets in SSA as MNOCs exit downstream markets in Africa. Assets already acquired during 2011 include a terminal in Tanzania, depots in Burundi and Uganda, and the acquisition of assets from Phoenix Petroleum Limited in Uganda. To maintain leadership position in key market. We note that KenolKobil currently has the leading market share for Kenya inland sales at c24% (from January to June 2011), supported by its wide distribution network of 156 fuel stations and strategic assets such as depots and blending plants. Export volumes are also on the rise as a result of increased demand from growing regional economies. Another competitive strength is that the group has been strategically acquiring storage facilities. Exposure to high growth markets. KenolKobil is experiencing growth in all its markets as a result of strong regional economic growth. We expect that expansions into markets with high growth potential will be a key driver for future profitability. More specifically, we are positive about the company s move to Southern African markets (such as Zambia and Mozambique), which have historically yielded higher margins than East African markets. Valuation and Recommendation We like the fact that that KenolKobil is the largest independent downstream oil marketer in East Africa and has been aggressive in terms of diversifying its income streams. Based on our estimates, as guided by H results, FY 2011 earnings are likely to double (139.3%), implying an undemanding PER (T+1) of 3.5x (versus SSA average of 10.0x and emerging market average of 13.9x). The counter is trading at an EV/EBITDA multiple of 6.1x (Total Nigeria 8.3x and Shell Mauritius 10.6x). We think that valuations are compelling given the expected RoAE expansion and sustained high dividend yield. Our target price, which is a combination of a DCF and comparative valuation approach, points to a target price of KES 15.0 per share. BUY. KenolKobilFinancial Analysis 200, % 180, % 160, , % 120, % 100,000 80, % 60, % 40, % 20, % F 2012F Sales (KESm)LHS EBITDA (KESm)LHS Net Profit (KESm)LHS EBITDA marginrhs NP marginrhs Kenol Kobil Total Sales Volume (m³) 3,000,000 2,500,000 2,000,000 1,500,000 1,000, , F Kenol Kobil Retail Sales Volume (m³) 800, , , , , , , , F Kenol Kobil Commercial Sales Volume (m³) 450, , , , , , , ,000 50, F 19

21 KENOL KOBIL 5 YEAR CGR COMPARISON 31 DEC (KESm) F 2012F 5yr CAGR Balance Sheet Noncurrent assets 2,429 2,992 3,286 6,597 6,118 6,155 6,324 8,428 20% Current assets 5,955 10,359 9,983 21,111 25,171 26,062 40,363 39,942 34% Total Assets 8,383 13,351 13,269 27,709 31,289 32,217 46,688 48,370 31% Capital and reserves 4,019 4,673 4,984 10,916 11,455 12,706 14,318 14,966 26% Noncurrent liabilities % Total current liabilities 4,093 8,278 7,701 16,302 19,293 18,879 31,714 32,743 36% Total Equity and Liabilities 8,383 13,351 13,269 27,709 31,289 32,217 46,688 48,370 31% Income Statement Sales 37,537 74,097 85, ,518 96, , , ,954 22% Cost of sales (34,724) (70,381) (80,107) (126,910) (90,655) (94,053) (145,632) (174,758) 22% Gross profit 2,812 3,716 5,339 7,609 6,038 7,708 12,664 15,196 22% Operating profit 1,596 1,651 2,412 3,442 2,387 3,667 8,650 11,224 18% EBITDA 1,895 1,959 2,729 4,186 3,062 4,363 9,401 12,031 18% Finance costs (235) (302) (409) (1,562) (454) (971) (2,209) (2,386) 33% Profit before tax 1,361 1,350 2,003 1,879 1,933 2,698 6,442 8,839 15% Tax (458) (400) (717) (724) (639) (921) (2,190) (3,005) 15% Profit for the year ,286 1,155 1,295 1,777 4,252 5,834 14% Minority interest Attributable income ,286 1,155 1,295 1,777 4,252 5,834 14% Ratios EPS (KES) DPS (KES) NAV/Share (KES) Dividend Cover (x) Dividend Yield 2% 2% 0% 3% 3% 5% 12% 17% Growth Ratios Sales growth 97.4% 15.3% 57.4% 28.1% 5.2% 55.6% 20.0% EBITDA growth 3.4% 39.3% 53.4% 26.9% 42.5% 115.5% 28.0% OP growth 3.4% 46.1% 42.7% 30.6% 53.6% 135.9% 29.8% PBT growth 0.8% 48.4% 6.2% 2.9% 39.5% 138.8% 37.2% PAT growth 5.2% 35.4% 10.2% 12.1% 37.2% 139.3% 37.2% Margins Gross margin 7.5% 5.0% 6.2% 5.7% 6.2% 7.6% 8.0% 8.0% EBITDA margin 5.0% 2.6% 3.2% 3.1% 3.2% 4.3% 5.9% 6.3% OP margin 4.3% 2.2% 2.8% 2.6% 2.5% 3.6% 5.5% 5.9% PBT margin 3.6% 1.8% 2.3% 1.4% 2.0% 2.7% 4.1% 4.7% PAT margin 2.4% 1.3% 1.5% 0.9% 1.3% 1.7% 2.7% 3.1% Effective tax rate 33.6% 29.6% 35.8% 38.6% 33.0% 34.1% 34.0% 34.0% 20

22 EQUITY RESEARCH KENYA FEBRUARY 2012 POWER Kenya Electricity Generating Company Limited Moving towards greener energy sources We maintain our view that KenGen is a classic case study of a company in SSA that has been aggressive in terms of moving to greener energy sources. KenGen is in fact among the top 10 geothermal producers in the world. Furthermore, it is the leader in wind power generation in East Africa with an installed capacity of 5.1MW. Kenya as a nation has a target to develop 5,000 MW of geothermal power by year We therefore expect Kengen s medium to long term performance to be enhanced by the diversification to sustainable and renewable energy, notably geothermal. Hydropower (65% of installed capacity) has generally been inconsistent due to climatic changes and drought thereby leading to earnings volatility. A pioneer in the Clean Development Mechanism (CDM) project development process. Kengen is set to increase its revenue streams through carbon credits. CDM, as defined under Article 12 of the Kyoto Protocol of the United Nations Framework Convention on Climate Change (UNFCCC) is a mechanism which provides the framework for stabilisation of green house gases concentrations in the atmosphere at nondangerous levels. We estimate Kengen s CDM revenues to be between USD 20.0m USD 30.0m/ annum in the next 23 years. IPPs pose serious competitive threats. A key risk for KenGen, in our view, is the increased activity of the private investors (IPPs) that are likely to squeeze KenGen s market share to less than 40% in the next three years. In FY 2012, we expect a 15% growth in turnover and 59% growth in PAT (low base effect). In the long term, we expect performance to be enhanced by the diversification to sustainable renewable energy such as solar and geothermal. Our target price of KES 9.0 points to 21.6% upside. LT BUY BLOOMBERG: KEGC:KN LT BUY Current price (KES) 7.40 Current price (USD) 0.1 Target price (KES) 9.0 Target price (USD) 0.1 Upside/Downside (%) 21.6% Liquidity Market Cap (KESm) 16,267.9 Market Cap (USDm) Shares (m) 2,198.4 Free float 30% Ave. daily vol (000) 323 Share price performance 6 Months (%) % Relative change (%)* 29% 12 Months (%) % Relative change (%)* 35% *Relative to MSCI Frontier Market Index Financials (USDm) FY 30 Jun F 2013F Turnover 14,389 16,547 19,443 EBITDA 10,198 11,988 13,497 Profit before tax 3,651 5,074 6,192 Profit after tax 2,080 3,298 4,025 EPS (KES) NAV/share (KES) DPS (KES) Valuation Ratios F 2012F PER (x) PBV (x) EV/EBITDA (x) EV/OP (x) EV/Sales (x) EBITDA margin 70.9% 72.4% 69.4% Earnings Yield 12.7% 20.3% 24.7% Dividend Yield 6.8% 10.7% 13.1% Gearing 98.9% 97.7% 98.1% RoaA 1.4% 2.1% 2.4% RoaE 3.0% 4.5% 5.2% KenGen VS S&P Africa FM Index (Rebased) Jan11 03Feb11 03Mar11 03Apr11 03May11 03Jun11 03Jul11 03Aug11 03Sep11 03Oct11 03Nov11 03Dec11 PriceRebased S&PRebased 03Jan12 STRENGTHS Moving towards renewable energy sources such as Geothermal and Wind Energy. Diversified revenue streams through carbon credits and new energy sources. Ability to raise funds on local and international capital markets through bond issues. Enjoys support from the government. OPPORTUNITIES Growing electricity consumption in East Africa. Continued support by developmental finance institutions such as the AfDB and the World Bank in terms of promoting green energy sources such as geothermal, wind and solar. WEAKNESSES Volatility in earnings due to hydrodependency. Limited funding for expansion projects. Government involvement can slow decision making processes and may reduce competitiveness. THREATS High global fuel prices can lead to high tariffs and therefore limit demand. The costs of funds on borrowings can translate into high tariffs. Competitive threats from IPPs in the local market. 21

23 Nature of Business KenGen is the largest electricity power generation company in Kenya, producing c80% of electricity consumed in the country. In January 1997, the management of Kenya Power Company (KPC) was formally separated from Kenya Power and Lighting Company (KPLC) as a result of the new reforms that were undertaken in the energy sector. This effectively resulted in a separation of functions, with KPC responsible for power generation and KPLC for transmission and distribution. In October 1998, KPC was relaunched under a new name and corporate identity, the Kenya Electricity Generating Company Ltd (KenGen). KenGen has 767MW capacity for hydro, diesel 120MW, geothermal 150MW and wind 5.1MW. The group is the first company to earn global carbon credit funds in Africa and was also the first to float the largest infrastructure bond in East and Central Africa. It is also among the top 10 geothermal producers in the world, and is currently the leader in wind power generation in East Africa (5.1MW). Overview of FY 2011 Financial Results Hydro power bringing home the bacon. Kengen reported a 31% growth in revenues to KES 14.4bn (USD 168.1m) (FY 2010: KES 10.9bn). The growth was mainly driven by an increase in hydrogeneration revenue which grew by KES 1.7bn. Total income for the year increased 32.2% to KES 15.2bn (USD 177.8m). A surge in operating and finance costs. We note that operating expenses increased 17% to KES 10.0bn largely due to operational and maintenance costs associated with the commissioning of Kipevu III, Olkaria II Unit 3, Kiambere, and Tana power plants. Also, finance costs skyrocketed 170% to KES 1.9bn (USD 23.3m) mainly due to interest expenses on the Public Infrastructure Bond funds that was utilised on projects such as the Kiambere Optimisation, Tana Redevelopment and Kipevu III projects. PAT was down 27% on the year. While PBT rose 47% to KES 3.7bn, the expiry of the fiveyear IPO tax rebate resulted in the change of the corporate tax rate from 25% to 30%. Consequently, the taxation expense was KES 1.6bn from a credit of KES 802.0m in the prior year. As a result, PAT dropped from KES 2.1bn (USD 24.3m). A deterioration in liquidity. On the balance sheet, total assets grew 7.0% to KES 160.9bn (USD 1.9bn) largely due to a 20% growth in noncurrent assets as a result of Kipevu III, Tana, Olkaria II Unit 3, additions to workinprogress of Sang oro, Kindaruma and Eburru. While current assets decreased 41% due to utilisation of the Public Infrastructure Bond funds in implementation of projects, current liabilities increased by 62% to KES 11.3bn due to the first principal repayment of Public Infrastructure Bonds funds amount. As a result, the current ratio deteriorated from 4.7x to 1.7x. Shareholder Structure % Shareholding Permanent SecretaryGOK 70.00% National Social Security Fund 1.32% Standard Chartered Nominees A/C % Standard Chartered Nominees A/C 9098AC 0.37% CFC Stanbic Nominees 0.28% Units Sold (MW) Hydro 3, , , , ,412.0 Diesel Geothermal ,029.0 Gas turbine Isolated Diesels Wind Turbine Total 4,598 4,818 4,338 3,595 4,933 Income Statement (KES 000) FY 2010 FY 2011 % Δ Revenue 10,998,429 14,389, % Interest income 398, , % Other income 113, , % Total Income 11,510,443 15,222, % Other gains and losses 274, , % Operating costs (8,558,448) (10,013,507) 17.0% Operating Profit 3,226,444 5,648, % Finance costs (741,491) (1,996,951) 169.3% Profit before tax 2,484,953 3,651, % Income tax 801,534 (1,571,186) 296.0% Profit after tax 3,286,487 2,080, % EPS (KES) % Balance Sheet (KES 000) FY 2010 FY 2011 % Δ Total Assets 150,566, ,993,290 7% NAV 70,530,868 69,418,587 2% Current Assets 32,849,414 19,539,034 41% Current Liabilities 6,969,815 11,256,593 62% Current ratio Cash flow (KES 000) FY 2010 FY 2011 % Δ Operating activities 2,125,123 4,512,526 Investing activities (16,356,012) (22,397,726) Financing activities 31,340,345 (330,648) Net inc/dec in cash 17,109,456 (18,215,848) Kengen 2011 Revenue Split Capacity Charges 85% Increased capex due to investment expansion projects. Cash generated from the operations increased to KES 4.5bn mainly due to an increase in revenue from the newly commissioned plants of Tana and Kipevu III. However, cash and cash equivalents decreased to KES 3.1bn mainly due to investment of Public Infrastructure Bond funds in designated projects. Consequently, capex for the year rose from KES 13.6bn (USD 160.0m) to KES 19.2bn (USD 220.0m) due to investment in new projects. Source: IAS/ Company Reports EPP 1% Energy 8% Forex adjustment payments 6% 22

24 Operational Review CDM scheme to boost income streams. KenGen has announced that it expects to generate around USD 20.0m annually from the conversion of 2.0m tonnes (rate of USD 10/tonne) of carbon dioxide (C0²) emission reduction under the Clean Development Mechanism (CDM). According to management, 10% of carbon revenues will be channelled towards community projects while the rest of the funds will be invested into KenGen s expansion plans. Kengen Geographical 2011 Revenue Split West Kenya Region 21% Global concessionary funds are chasing green energy projects. It is worth noting that development banks such as the AfDB are creating facilities to enable businesses and countries across the continent to take advantage of the emerging CDM market. Africa accounts for only 3.0% of global CDM projects. KenGen has managed to access KES 85.5bn (USD 1.0bn) in concessionary funding for the construction of the 240.0MW Olkaria based geothermal plant with a commissioning date of The total cost of the plant is expected to be in the region of KES 120.0bn (USD 1.4bn). Nairobi Region 60% Source: IAS/ Company Reports Kengen Installed Capacity (1, MW) Diesel 16% Coast 19% Geothermal 13% Increased private sector involvement to intensify competitive threats. We opine that KenGen may lose a significant share of its market to IPPs in the medium to long term. Increased electricity demand coupled with insufficient government investment in energy has given more incentives for IPPs to increase their investment in the sector. KenGen s market share dropped to 66% in February 2011 from 75% in Some of the IPPs operating in Kenya include the likes of Iberafrica, Rabai Power, Aggreko and Tsavo, which mainly produce thermal electricity. We also note that sugar and cement manufacturers are moving towards self sustainability with the excess power expected to be supplied to the national grid. Hydro Power 65% Source: IAS/ Company Reports KenGenFinancial Analysis 25,000 20,000 Wind Turbine 0% Gas turbine 5% Isolated Diesels 1% 80% 70% 60% Outlook Focus earmarked on increasing capacity. KenGen plans to add 500MW by the end of 2012 so as to stabilise the power situation in the country. In 2011, the group commissioned the Kipevu III plant (120MW), Sondu Miriu (60MW), Olkaria II 3rd Unit (35MW), Kiambere Optimization (24MW), Ngong Wind (5.1MW), Kipevu III (120MW) and Redevelopment of Tana Power Station (20MW). Management has set a target that in the period between 2012 and 2018, KenGen will inject an additional 2,000MW into the national grid. The composition of clean energy set to increase in the long term. Kengen plans to generate c70% of electricity from clean sources of energy. The company has completed a feasibility study for the 60MW Karura Hydro Power project on Tana River cascade in preparation for the construction phase. Feasibility studies for wind projects in Isiolo and Bubisa have been concluded and the group has also engaged feasibility consultants for the development of a 600MW coal project that will use clean coal technology. Moreover, the group is assessing a feasibility report on the construction of a 50MW wastetoenergy plant within the Nairobi Metropolitan. On the solar front, the group is tendering for a consultant to undertake a grid connected solar power plant. Valuation and Recommendation. Based on a hybrid of a DCF and comparative valuation method, we derived a target price of KES 9.0 points, implying 21.6% upside. LT BUY 15,000 10,000 5, F 2013F Sales (KESm)LHS EBITDA (KESm)LHS Net Profit (KESm)LHS EBITDA marginrhs NP marginrhs Total Installed Capacity 1,200 1,150 1,100 1,050 1, % 40% 30% 20% 10% 0% 23

25 KENGEN 5 YEAR CGR COMPARISON 30 JUNE (KESm) F 2013F 5yr CAGR Balance Sheet Noncurrent assets 53,111 92,143 96, , , , , , % Current assets 11,675 9,824 10,655 12,870 32,849 19,539 22,367 24, % Total Assets 59,716 94,733 99, , , , , , % Capital and reserves 36,499 63,638 68,403 66,980 70,531 69,419 73,671 76, % NonCurrent liabilities 23,217 31,094 31,005 40,097 73,066 80,318 84,259 88, % Total Current liabilities 5,071 7,234 7,586 5,868 6,970 11,257 11,232 11, % Total Equity and Liabilities 59,716 94,733 99, , , , , , % Income Statement Sales 14,300 14,552 11,548 12,652 10,998 14,389 16,547 19, % Operating costs (11,565) (11,410) (8,012) (8,247) (8,558) (10,014) (10,756) (12,541) Gross Profit 2,735 3,142 3,537 4,405 2,440 4,376 5,792 6, % Interest income Foreign exchange gain Other income 1, Operating Profit 3,776 3,853 3,877 4,880 3,226 5,648 7,119 8, % EBITDA 5,777 7,299 7,281 8,727 7,056 10,198 11,988 13, % Net finance income/(costs) (56) 866 (798) (756) (741) (1,997) (2,046) (2,096) Profit before taxation 3,721 4,719 3,079 4,123 2,485 3,651 5,074 6,192 Taxation 2,818 (2,485) 802 (1,571) (1,776) (2,167) Net Profit for the year 3,769 2,446 5,897 1,638 3,286 2,080 3,298 4, % Ratios EPS (KES) DPS (KES) NAV/Share (KES) Dividend Cover (x) Dividend Yield 7.4% 10.8% 12.2% 6.8% 6.8% 6.8% 10.7% 13.1% Growth Ratios Sales growth 29.9% 1.8% 20.6% 9.6% 13.1% 30.8% 15.0% 17.5% EBITDA growth 0.0% 26.4% 0.2% 19.9% 19.1% 44.5% 17.5% 12.6% OP growth 31.1% 2.0% 0.6% 25.9% 33.9% 75.1% 26.0% 16.4% PBT growth 42.1% 26.8% 34.8% 33.9% 39.7% 46.9% 39.0% 22.0% PAT growth 8.2% 35.1% 141.1% 72.2% 100.7% 36.7% 58.5% 22.0% Margins Gross margin 19.1% 21.6% 30.6% 34.8% 22.2% 30.4% 35.0% 35.5% EBITDA margin 40.4% 50.2% 63.1% 69.0% 64.2% 70.9% 72.4% 69.4% OP margin 26.4% 26.5% 33.6% 38.6% 29.3% 39.3% 43.0% 42.6% PBT margin 26.0% 32.4% 26.7% 32.6% 22.6% 25.4% 30.7% 31.8% PAT margin 26.4% 16.8% 51.1% 12.9% 29.9% 14.5% 19.9% 20.7% Effective tax rate 1.3% 48.2% 91.5% 60.3% 32.3% 43.0% 35.0% 35.0% 24

26 EQUITY RESEARCH KENYA FEBRUARY 2012 POWER Kenya Power Pursuing aggressive recovery strategies Kenya Power has introduced various measures to boost its revenue, increase efficiency and also minimise cost pressures on the bottomline. Management expects to achieve revenue collection as a percentage of billing of 98% through various means such as the introduction of prepaid meters. We therefore expect Kenya Power to maintain topline growth of 15% at least in the next 2 years in line with the expected surge in power demand. We note that Kenya s power reserve capacity as a country has dipped to record levels of about 6.0% of the effective demand, which is way below the reserve limit of 15%. This therefore implies consistent demand for power in the country. Growth to be driven by demand factors. The national access rate to electricity in Kenya is estimated at 29% and is targeted to reach 40% by Kenya Power has been aggressive in terms of expanding its distribution network. The company plans to add about 1.0m new customers to the grid in the next 5 years. Pursuing similar strategy as Zambia s CEC. Just like CEC in Zambia, Kenya Power has been installing fibre optic cables on its electricity network and leasing surplus capacity to telecom operators so as to diversify revenue streams. Currently about 1,200km of fibre network has been completed and the excess capacity leased to Safaricom, Jamii Telecoms, Wananchi and Kenya Data Networks. Attractive on a mark to market basis. At a current trading price of KES 15.7, we estimate a PER (T+1) of 4.2x. We view this as undemanding given an SSA average of 14.1x. A hybrid of a DCF and comparative valuation method yields a target price of KES 20, implying 27.4% upside. BUY BLOOMBERG: KPLL:KN BUY Current price (KES) 15.7 Current price (USD) 0.2 Target price (KES) 20.0 Target price (USD) 0.2 Upside/Downside (%) 27.4% Liquidity Market Cap (KESm) 27,233.8 Market Cap (USDm) Shares (m) 1,734.6 Free float 37% Ave. daily vol (000) 850 Share price performance 6 Months (%) % Relative change (%)* 11% 12 Months (%) % Relative change (%)* 11% *Relative to MSCI Frontier Market Index Financials (KESm) FY 30 June F 2013F Turnover 69,729 79,840 92,614 EBITDA 13,736 14,632 20,227 Profit before tax 6,255 9,641 14,891 Profit after tax 4,220 6,459 9,977 EPS (KES) NAV/share (KES) DPS (KES) Valuation Ratios F 2012F PER (x) PBV (x) EV/EBITDA (x) EV/OP (x) EV/Sales (x) EBITDA margin 19.3% 18.0% 21.4% Earnings Yield 15.5% 23.7% 36.6% Dividend Yield 2.9% 4.7% 7.3% Gearing 61.7% 47.7% 43.5% RoaA 4.1% 5.3% 7.9% RoaE 12.3% 14.6% 19.2% Kenya Power VS S&P Africa FM Index (Rebased) Jan11 3Feb11 3Mar11 3Apr11 3May11 3Jun11 3Jul11 3Aug11 3Sep11 3Oct11 3Nov11 3Dec11 3Jan12 STRENGTHS Moving towards renewable energy sources such as Geothermal, wind and solar. A solid clientele base of c1.4m customers. Wide transmission network across the country. Aggressive recovery strategies through prepaid meters and use of Safaricom's Mpesa service Diversification leasing surplus capacity to telcos OPPORTUNITIES The modernisation of its services will be significant in lowering operating costs. Presence in the counties to boost access. Rural electrification programmes penetration in rural areas remains low at less than 10%. WEAKNESSES High power losses due to network inefficiencies. Inadequate capacity to limit gains from surging demand. Inadequate funding will limit capacity expansion. THREATS The company incurs about KES 0.6bn/annum in transformer vandalism. Illegal electricity connections and theft. PriceRebased S&PRebased 25

27 Nature of Business Kenya Power transmits, distributes and retails electricity to customers throughout Kenya. It has an installed capacity of 1,576MW, an effective capacity of 1,306MW and an interconnected network of transmission and distribution lines covering about 41,486km. Kenya Power s total number of customers is estimated at c1.4m and total sales are in the region of 5,600 GWh. Estimates are that Independent Power Producers (IPPs) in Kenya supply approximately 30% of the total power supplied to the grid. With the expected increase in power demand, Kenya Power is looking to grow its capacity to 1,750MW between 2012 and Overview of FY 2011 Financial Results FY 2011 results were in line with expectations. Electricity sales grew by 9.0% from 5,345m units in the previous year to 5,816m units, due to enhanced demand as the number of customers increased. As a result, electricity revenue (nonfuel revenue) increased by 8.6% to KES 42.5bn (USD 496.4m), while foreign exchange recoveries rose to KES 1.3bn due to depreciation of the KES against major hard currencies. However, the fuel cost recovered from customers declined by 22% to KES 25.9bn from KES 33.19bn in FY Management indicated that the decrease in fuel cost recoveries was attributable to reduction in generation of electricity from thermal plants by 24% from 3,139 GWh in 2010 to 2,374 GWh. Overall, total revenue declined 4.6% to KES 69.7bn (USD 814.7m). Improved margins despite an increase in transmission and distribution costs. We note that management at Kenya Power has been progressively focusing on increasing efficiency. The company s GP margin improved by 716 basis points from 26.3% in FY 2010 to 33.5%. In addition, the OP margin improved by basis points from 8.1% in FY 2010 to 10.2%. Overall, the company s operating profit increased by 19.1% to KES 7.1bn (USD 82.7bn). However, it is worth noting that transmission and distribution expenditure increased to KES 17.7bn (FY 2010: KES 14.9bn) as a result of higher maintenance costs associated with the company s expanded electricity network and facilities. Bottom line growth. PBT increased by 11% to KES 6.3bn (USD 73.1m), implying a PBT margin of 8.8%. After taking into account a tax charge of KES 2.0bn (up 6.2% yoy), the company recorded a PAT figure of KES 4.2bn (USD 49.3m), representing yoy growth of 13.6%. Shareholder Structure % Shareholding Permanent SecretaryGOK 50.08% Standard Chartered Nominees 12.82% CFC Stanbic Nominees 4.57% Board of Trustees, NSSF 4.11% Coop Bank Custody 2.15% Income Statement (KESm) FY 2010 FY 2011 % Δ NonFuel Revenue 39,107 42, % Forex losses recovered 869 1, % 39,976 43, % Fuel Cost Recovered 33,100 25, % Total Revenue 73,076 69, % Power purchase costs (53,847) (46,364) 13.9% Gross Margin 19,229 23, % Operating Profit 5,949 7, % Finance income % Finance costs (493) (999) 102.6% Profit before tax 5,633 6, % Income tax (1,917) (2,035) 6.2% Profit after tax 3,716 4, % EPS % DPS Balance Sheet (KESm) FY 2010 FY 2011 % Δ Total Assets 85, ,879 41% NAV 28,741 39,743 38% Current Assets 20,584 35,151 71% Current Liabilities 18,847 30,371 61% Current ratio Cash flow (KESm) FY 2010 FY 2011 % Δ Operating activities 15,746 14,167 Investing activities (17,479) (20,683) Financing activities (463) 15,473 Net inc/dec in cash (2,196) 8,957 Continual investment in PPE driving balance sheet growth. Looking at the balance sheet, the total assets figure increased by 41% to KES 119.9bn (USD 1.4bn) as PPE grew by 29% to KES 83.4bn (FY 2010: KES 64.4bn), owing to the continuing capital investment in projects aimed at improving the quality of power supply and increasing connection of new customers. Kenya Power 2011 Revenue Split Forex losses recovered 2% Fuel cost recovered 36% Operational Review Successful completion of the rights issue. Kenya Power undertook a comprehensive capital base restructuring programme that involved the issuance of new shares, which resulted in the creation of 1,735m shares from the initial 79.0m. We note that the rights offer proceeds of KES 9.1bn (USD 110.0m) will go towards the financing of capital projects. Moreover, the transaction implied that the ordinary shareholding of Government of Kenya (GoK) Nonfuel revenue 60% Source: IAS/ Company Reports Other revenue 2% 26

28 increased to 50.1% from 40.4%. The increased GoK shareholding is deemed important given that only about 29% of Kenyans have access to electricity. It is hoped that the GoK will continue to play a crucial role in the company by mobilising concessionary funding for electricity system expansion and electrification. It is worth highlighting that more than 70% of all of Kenya Power s current loans are onlent by the GoK on concessionary terms. Increasing transmission and distribution capacity. Kenya Power has already set up 62 branches in line with the new county structure in Kenya. The group is also building additional substations to enhance distribution. In 2010 alone, it built about 40 new substations. A master plan has been initiated to spearhead the roadmap for implementing its power distribution projects that are aimed at accelerating quality electricity access to over 50% of the country s population by Diversification efforts to positively impact bottomline growth. Kenya Power seeks to maximise return on investment through leveraging of assets. The company has been installing fibre optic cables on the electricity network, and leasing surplus capacity to telecom operators. Currently, about 1,200km of fibre network covering the Coastal, Western and Mt. Kenya transmission systems has been completed, and the excess capacity leased to Safaricom, Jamii Telecoms, Wananchi and Kenya Data Networks. The leasing out of the extra capacity is therefore expected to support its revenue base. It is estimated that Kenya Power is set to earn in the region of KES 200.0m from the leasing of fibre optic cables in Company strategy aimed at improving recoveries. We note that Kenya Power recently signed an agreement with telecom operator Safaricom to enable electricity customers to settle power bills through the MPESA service. Kenya Power is looking to achieve c98% revenue collection as a percentage of the total billing. Furthermore, the introduction of prepaid meters will be a major enhancement to revenue collection. The company has already connected over 25,000 customers and plans to roll out the service to 250,000 customers in The introduction of an easy pay service has also supported revenue collection. The service allows customers to pay bills through commercial banks, post offices and through money transfer services. Outlook Lower electricity access and strong demand to catalyze growth. Electricity demand in Kenya is expected to grow at a CAGR of 7.0% in the next five years. Penetration in rural areas remains low at less than 10%. We expect rural electrification to be a key driver and therefore opine that Kenya Power is well positioned to take full advantage of the expected high electricity demand given its wide network across the country. Valuation and Recommendation Our model assumes a 15% growth in revenues in FY 2012 and a 53% growth in PAT on the back of margin expansion and additional income streams (telecom revenues). At a current trading price of KES 15.7, we estimate a PER (T+1) of 4.2x. We view this as undemanding given an SSA average of 14.1x. Our target price of KES 20 implies 27.4% upside. BUY Kenya PowerFinancial Analysis 100,000 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10, F 2013F Sales (KESm)LHS EBITDA (KESm)LHS Net Profit (KESm)LHS EBITDA marginrhs NP marginrhs Kenya Power: EBITDA Vs Capex 30,000 25,000 20,000 15,000 10,000 5, F 2013F EBITDA (KESm)LHS Capex (KESm)LHS EBITDA/CapexRHS Source: IAS/ Company Reports Kenya Power: Return Measures Vs Dividend Yield 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% F 2013F Dividend YieldRHS RoaALHS RoaELHS Source: IAS/ Company Reports 25% 20% 15% 10% 5% 0% % 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 27

29 KENYA POWER & LIGHTING 5 YEAR CGR COMPARISON 30 JUNE (KESm) F 2013F 5yr CAGR Balance Sheet Noncurrent assets 22,787 28,283 39,057 50,307 64,442 84,728 94,036 99, % Current assets 15,942 19,039 19,755 21,257 19,610 35,151 29,077 29, % Total assets 38,729 47,322 58,812 71,564 84, , , , % Total equity 20,560 22,249 23,882 26,848 28,741 39,743 48,455 55, % Non current liabilities 6,044 7,226 17,412 26,161 37,438 49,765 49,585 49, % Current liabilities 12,125 17,846 17,518 18,555 17,874 30,370 25,073 23, % Total liabilities 18,169 25,072 34,930 44,716 55,312 80,136 74,658 72, % Total equity and liabilities 38,729 47,322 58,812 71,564 84, , , , % Income Statement Total revenue 33,967 37,944 40,801 65,209 73,167 69,729 79,840 92, % Gross margin 10,490 11,832 12,172 18,091 19,320 23,364 27,145 33, % Total operating expenses 32,750 36,666 38,245 60,688 68,824 64,059 70,872 78, % Operating Profit 2,206 2,544 3,522 5,675 5,949 7,082 10,592 15, % EBITDA 3,589 4,058 5,272 7,829 8,710 13,736 14,632 20, % Finance income/(costs) (784) (892) (317) (828) (952) (1,095) Profit before taxation 2,498 2,649 2,738 4,782 5,633 6,255 9,641 14, % Taxation (854) (930) (973) (1,557) (1,917) (2,035) (3,181) (4,914) Profit for the year 1,644 1,718 1,765 3,225 3,716 4,220 6,459 9, % Ratios EPS (KES) DPS (KES) NAV/Share (KES) Dividend Cover (x) Dividend Yield 0.4% 0.9% 1.2% 2.3% 2.3% 2.9% 4.7% 7.3% Growth Ratios Sales growth 20.5% 12.2% 6.5% 58.9% 12.7% 4.9% 14.5% 16.0% EBITDA growth 9.5% 13.1% 29.9% 48.5% 11.3% 57.7% 6.5% 38.2% Op Profit growth 19.8% 15.4% 38.4% 61.1% 4.8% 19.0% 49.6% 50.9% PBT growth 26.2% 6.0% 3.4% 74.6% 17.8% 11.0% 54.1% 54.5% PAT growth 29.4% 4.5% 2.7% 82.7% 15.2% 13.5% 53.1% 54.5% Margins Gross margin 30.0% 30.2% 29.1% 27.3% 25.8% 32.8% 33.3% 34.9% EBITDA margin 10.3% 10.3% 12.6% 11.8% 11.6% 19.3% 18.0% 21.4% OP margin 6.3% 6.5% 8.4% 8.6% 8.0% 10.0% 13.0% 16.9% PBT margin 7.1% 6.8% 6.6% 7.2% 7.5% 8.8% 11.8% 15.8% PAT margin 4.7% 4.4% 4.2% 4.9% 5.0% 5.9% 7.9% 10.6% Effective tax rate 34.2% 35.1% 35.5% 32.6% 34.0% 32.5% 33.0% 33.0% 28

30 ZAMBIA ENERGY SECTOR A key issue within the Southern African Development Community (SADC) region is that GDP growth, which has been in excess of 5.0% in most member countries, has resulted in the unprecedented growth in electricity consumption and demand. Energy demand is also being driven by the increased demand for base metals on international markets that have led to high metals prices and therefore a need to boost production in resourcedriven countries such as Zambia and Mozambique. In Zambia, for example, more new mining companies have been established while others are expanding capacity. Furthermore, we note that most SADC countries such as Zimbabwe and Zambia have called for rural electrification programmes against a background of inadequate investment in generation and transmission infrastructure over the last years. POWER SECTOR OVERVIEW Zambia as a nation currently has available capacity of 1,170MW versus national demand of 1,450MW. The deficit is however a peakperiod phenomenon given the fact that there is sufficient capacity during offpeak periods. Therefore, load management is required in order to maintain a balance of supply and demand during peak periods. The electricity supply industry in Zambia mainly comprises of a vertically integrated state utility, ZESCO, and an energy service company called Copperbelt Energy Corporation (CEC) that purchases power from ZESCO and through its power distribution network, supplies it to the mines. In addition, one independent power producer, Lunsemfwa Hydro Power Company supplies also participates in the industry. Lunsemfwa Hydro Power Company is a privately owned IPP created after the privatisation of the Zambian Mining conglomerate, ZCCM. It has an installed capacity of about 40MW and currently sells all its power to ZESCO under a power purchase agreement (PPA). At present, ZESCO is the largest electricity company in Zambia, running and operating power stations, transmission lines, and distribution networks around the country. ZESCO is 100% owned by the Government of Zambia. In 2003, revision of the Electricity Act Cap 433 allowed the participation of private companies which have subsequently begun selling electricity to ZESCO. ZESCO Grid across Zambia Source: Ministry of Energy Regulatory Framework Electricity in Zambia is under the jurisdiction of the Ministry of Energy and Water Development (MEWD) and operates based on the policies established by MEWD. The Electricity Regulation Board (ERB) under the Ministry supervises the power companies in accordance with the Electricity Act and the Energy Regulation Act. Rural electrification was implemented by the Department of Energy (DOE) of MEWD mainly through expansion of transmission lines, which were constructed by ZESCO under a subcontract funded by the Rural Electrification Fund established in However, rural electrification projects did not progress smoothly because of DOE s limited capabilities. As a result, MEWD formed a new organisation, the Rural Electrification Authority (REA), in order to promote rural electrification as well as establish the Rural Electrification Act in Tariff Framework in Zambia The ERB is currently in the process of reviewing its tariff setting framework for electricity with the aim of developing a tariff regime that promotes economic efficiency and financial viability. This will result in a transition from the basic revenue requirement approach to a more versatile incentive based regulatory regime under a multiyear pricing framework. The new framework is also envisaged to set tariffs at different price points, i.e. generation, transmission, distribution and supply. This will further help simulate the positive effects of competition and better target incentives. It has been widely argued that electricity tariffs in Zambia are at uneconomic levels. Presently, a World Bank supported cost of service study is being undertaken to help establish the real cost of supplying electricity to different consumer categories. This will help strengthen the tariff design process and move the industry towards cost reflective or economic tariffs. Southern African Power Pool: SAPP The Southern African Power Pool (SAPP) was established in 1995 to create an international power market in SADC by the seven original member countries. As of 2006, 12 of the 14 SADC countries had joined SAPP. Nine of the twelve countries are already linked by interconnection lines (the exceptions are Angola, Tanzania and Malawi) and are managing an international power market. Zambia has two international interconnection lines to DRC and Zimbabwe with 220 kv and double circuits 330 kv lines, respectively. Through these lines, Zambia participates in the import and export of power among SAPP countries and wheeling between neighbouring countries. Challenges in Energy Sector Projects The SAPP is set to roll out massive energy generation and transmission projects over a fiveyear phased project plan that will see member states commissioning 16,962MW of energy worth USD 83.0bn by However, these planned projects face a plethora of implementation constraints ranging from uneconomic tariffs to poor levels of electricity access. Levels of access to electricity in the SADC region are still poor, with over 8 countries (including Zambia) being classified as in the 'much to be done' or 'further effort required' brackets of access analysis. 29

31 ZAMBIA PETROLEUM SECTOR Like many land locked nations, Zambia has no known oil or gas reserves and therefore no upstream oil industry. Its downstream oil industry however is an important sector in the national economy. The country has an oil refinery at Ndola, one of very few refineries in Africa located inland. It also imports refined petroleum products from other countries, especially South Africa. Oilderived products supply approximately 37% of the country's commercial energy needs, the balance being provided by hydroelectricity and coal. Distribution of fuels and lubricants is carried out by a number of international and local companies. The distribution infrastructure consists of pipeline, road and rail systems, all of which are in need of upgrading. The Indeni Refinery, which is situated at Ndola, came on stream in In early 1999, the refinery was gutted by fire which brought operations to a standstill. Rehabilitation of the refinery was completed by the last quarter of The refinery has been constantly upgraded as this is seen as more economical for the nation as opposed to solely relying on exports given the landlocked country s lack of necessary pipeline infrastructure. The 24,000bpd Indeni Refinery was previously 50% jointly owned each by Total El Fina EIF and the Zambian government. However, in 2009, the government then raised its stake in Indeni to 100%. Zambia: Petroleum Consumption by Sector Commerce & Industry, 10% Source: IAS/ Industry Reports Households, 6% Transport, 53% Government & Service, 4% Mining, 27% The chart above indicates that the bulk of consumption of fuel on the Zambian market is in the transport sector which accounts for 53%, followed by mining with 27%. Commerce and industry takes 10%, households account for 6% and goods and services at 4%. Generally, the consumption pattern is key for the purpose of setting appropriate policy to ensure that the productive sectors of the economy such as mining, agriculture and manufacturing remain at the focal point of sustaining economic growth. In terms of regulations, the industry is regulated by the Ministry of Energy. The petroleum industry is a key driver to the Zambian economy and therefore high petroleum prices always have a negative impact on economic activity. Besides the threat of high prices of petroleum products in Zambia, there are a plethora of constraints obtaining in the petroleum industry that ought to be managed. Logistics and Transportation Currently, all the petroleum products in Zambia are imported into the country either as finished products or as feedstock which is then processed into finished products by Indeni Refinery in Ndola. The feedstock is usually transported by ship to DaresSalaam where it is then pumped onto the Tazama tank farm storage facilities. Tazama transports this feedstock to Indeni refinery via a 1,700km pipeline where it is processed into various finished products and then stored at the Ndola Fuel Terminal storage facility ready to be transported to various parts of the country by Oil Marketing Companies (OMCs). The pricing of petroleum products is derived from various costs along this supply chain. On the other hand, imported finished petroleum products are transported into the country mainly by road and rail. Main developments in the petroleum sector The distribution of refined products is carried out by a number of Oil Marketing Companies (OMCs). Most of them own several storage depots and service stations and supply in bulk to commercial customers. The OMCs buy petroleum products at wholesale prices from the importer of the feed stock. The wholesale price is regulated by the Energy Regulation Board (ERB). In 1968, the Government of Zambia embarked on major economic reforms that resulted in the nationalisation of a number of private enterprises. In the petroleum distribution business, there were six international OMCs registered in Zambia at the time and these were BP, Caltex, Esso, Mobil, Shell and Total. BP and Shell, although separate companies, operated jointly in Zambia as ShellBP. In 1970, Agip, a subsidiary of ENI, also entered the Zambian petroleum distribution industry. In the same year, the government negotiated with ShellBP for the government takeover of the majority (51%) shareholding in ShellBP in line with the government s economic reforms. Later, the government and Agip agreed on a 50:50 shareholding in Agip Zambia. Following state acquisition of 51% and 50% shareholding in ShellBP and Agip respectively, the government directed that all government and SOE s oil and fuel purchases be conducted through the two OMCs. This directive had a significant impact on the structure of the market share in the petroleum distribution by conferring market dominance to the two players. The effects of this directive are still evident today. Shell was the first company to exit the Zambian market when the company pulled out of ShellBP. The remaining company was renamed BP Zambia Limited and later BP Zambia Plc. As a result of the liberalisation of the petroleum retail business in 2001, a number of new OMCs have been entering the Zambian market. The new companies are diverse in size. The first OMCs to enter were Engen, Jovenna and Ody s. In the early 2000s, the Agip group decided to exit a number of African downstream markets including Zambia. The assets of Agip Zambia were acquired by the Total Group. In 2004, Jovenna exited the industry and its assets were acquired by Kobil. In 2006, Mobil exited fourteen African markets including Zambia. The Total Group then acquired Mobil assets in Zambia. More recently, BP Africa sold its 75% stake in BP Zambia plc to Puma Energy International. 30

32 EQUITY RESEARCH ZAMBIA FEBRUARY 2012 POWER Copperbelt Energy Corporation A promising pipeline of energy projects Copperbelt Energy Corporation (CEC) supplies power to the mines based on the Copperbelt, owns and operates a network comprising 900km of transmission lines, 38 high voltage substations, a system control centre and 80MW of gas turbine generators. CEC accounts for c50% of the total power consumed in Zambia. CEC has also extended its mandate northwards beyond Zambia to DRC, where it has been providing transmission services to mining operations in DRC since The company is also jostling for a share in the Power Holding Company of Nigeria (PHCN) in West Africa. A pipeline of energy projects. The company intends to commence the construction of the 40MW Kabompo Gorge HydroPower Station (KHP) in 2012, which will increase its generation capacity to 120MW by Indications are that CEC is likely to conduct a capital raising exercise to finance some of its expansion projects. However, we await information on the quantum sought and funding mix A positive outlook. We opine that CEC s future growth strategy is hinged on seeking new concessions to develop generation and transmission projects. The migration towards cost reflective tariffs in the region, in our view, will ensure that the investments will provide sufficiently attractive returns. Capital raise on the horizon. Our valuation does not take into account the Kabompo Hydro Power project or the effects of the company s planned capital raising exercise. Based on a current trading price of ZMK 666, there is potential upside of 5.1%. We would recommend investors HOLD pending the finalisation of the capital raising exercise. CEC VS S&P Africa FM Index (Rebased) BLOOMBERG: CEC:ZL HOLD Current price (ZMK) Current price (USD) 0.13 Target price (ZMK) Target price (USD) 0.14 Upside/Downside (%) 5.1% Liquidity Market Cap (ZMKm) 666,000.0 Market Cap (USDm) Shares (m) 1,000.0 Free float 28% Ave. daily vol (000) 149 Share price performance 6 Months (%) 700 5% Relative change (%)* 1% 12 Months (%) 670 1% Relative change (%)* 20% *Relative to MSCI Frontier Market Index Financials (USD 000) FY 31 Dec F 2012F Turnover 167, , ,625 EBITDA 30,293 34,837 40,062 Profit before tax 15,223 17,658 19,205 Attributable earnings 10,227 11,831 12,867 EPS (USc) NAV/share (USc) DPS (USc) Valuation Ratios F 2012F PER (x) PBV (x) EV/EBITDA (x) EV/OP (x) EV/Sales (x) EBITDA margin 18.1% 17.4% 17.4% Earnings Yield 9.6% 9.0% 9.8% Dividend Yield 7.6% 7.1% 7.7% Gearing 19.9% 28.9% 42.6% RoaA 3.7% 4.2% 4.3% RoaE 6.4% 7.4% 8.2% STRENGTHS WEAKNESSES Monopoly in electricity transmission on the Copperbelt Sensitivity to mining activity. Strong mining clientele base which ensures consistency Tariffs in Zambia are still regarded as "uneconomic". in revenue streams. Gearing levels likely to increase as a result of Capital raising exercise to provide the company an capital raising initiatives. opportunity to exploit new electricity generating opportunities in and outside Zambia Jan11 04Feb11 04Mar11 04Apr11 04May11 04Jun11 PriceRebased 04Jul11 04Aug11 04Sep11 04Oct11 04Nov11 S&PRebased 04Dec11 04Jan12 OPPORTUNITIES Medium term power shortages. Growth in mining activity ensures consistent demand. Telecoms presents upside opportunities in the long term and ensures diversification. Upside in long terms energy projects such as Kabompo. New acquisition opportunities in Africa eg PHCN in West Africa (Nigeria). THREATS Lower gross margins than peers. Strained dividend obligations low reinvestment. New entrants in the power sector present competitive threats e.g Chinese investors. 31

33 Nature of Business Copperbelt Energy Corporation Plc (CEC) is a Zambian electricity utility whose core business is the supply of power to the mining industry and transmission for national utilities, ZESCO Limited of Zambia and SNEL of the DRC. It is a 52% owned subsidiary of Zambian Energy Corporation Limited, and the ultimate holding company is Batoka Energy (Holdings) Limited, which has a 60% interest in Zambian Energy Corporation Limited. Furthermore, CEC is a licensed carrier of telecommunications traffic using broadband optic fibre. It owns and operates 520km of fibre on the Copperbelt on powerlines, and a further 250km underground throughout the country. In March 2011, CEC announced that it would invest USD 15.0m in a JV with Liquid Telecom Holding Limited to form CEC Liquid Telecommunications Limited, with the aim of increasing its fibre optic reach, as well as the provision of wholesale bandwidth to local ISPs. Overview of H Financial Results Volume growth on the back of increased demand. Group turnover increased by 29.6% to USD 107.9m on the back of an increase in load sales volume, that were up 5.0% to 482MW (H1 2010: 461MW), largely due to increased demand from mining companies. Furthermore, there was also a tariff increase, which also led to an increase in the cost of sales. Sales of electrical energy to CEC customers in H totalled 1,861 GWh, being an increase from 1,771 GWh sales in The total energy import into the network was 2,704 GWh, of which 2,697 GWh were company purchases while GWh were wheeled from ZESCO. Tighter margins in H EBIT decreased by 1.5% to USD 11.1m (H1 2010: USD 11.3m) as the EBIT margin declined to 10.3% from 13.6% in the previous year. Likewise, PBT was 5.0% lower at USD 10.4m, implying a PBT margin of 9.7%, versus 13.2% in H As a result, growth on the bottom line was a marginal 1.3%. EPS increased by 2.0% to US 0.72c per share, compared to US 0.71c in the previous period. Operational Review Telco business developing strongly. The telecommunications network rollout is progressing, with an international fibre link from Chirundu to Lusaka having been commissioned. It is worth highlighting that in 2002, CEC installed optic fibre on its power lines to enhance the quality of its communications infrastructure. With the vast spare capacity on the network, CEC sought to lease out excess capacity to other licensed entities in the ICT sector. This then led to the formation of CEC Liquid Telecom, a joint venture between CEC and Liquid Telecom. Liquid Telecom is currently building the largest regional fibre network across Central Africa which will provide backhaul between most urban areas and last mile connectivity in the main cities. It will be directly connected to the submarine cables of Seacom, SAT3, WACS and Eassy. New electricity generation opportunities. CEC has completed feasibility studies for the construction of the 40MW Kapombo Gorge Hydro (KGH) power project, which will cost USD 170.0m. CEC has indicated that it will seek to raise at least USD 25.0m for KGH, which will be invested as CECs 50% equity stake into a JV that will focus on investing in power generation going forward. Shareholder Structure % Shareholding Zambian Energy Corporation 52.0% ZCCMIH 20.0% Individual shareholders 15.8% African Life Financial Services Limited 7.2% CEC Employees Share Ownership Plan 5.0% Income Statement (USD 000) H H % Δ Revenue 83, , % Other comprehensive Income 3, % EBIT 11,309 11, % Net finance costs (308) (684) Profit before tax 11,001 10, % Income tax expense (3,861) (3,893) 0.8% Attributable profit 7,140 7, % EPS (USc) Balance Sheet (USD 000) H H % Δ Total Assets 276, ,683 5% NAV 159, ,233 2% Current Assets 36,817 55,053 50% Current Liabilities 44,214 47,883 8% Current ratio Cash flow (USD 000) H H % Δ Operating activities 36,296 4,756 87% Investing activities (12,627) (5,248) 58% Financing activities (17,166) 2, % Net inc/dec in cash 6,503 1,513 The latest Liquid Telecom terrestrial fibre map Source: 32

34 The balance will be a USD 25.0m equity contribution from a joint investee and USD 120m will be raised as debt. The project will be undertaken by the CEC Kabompo Hydropower Limited, a subsidiary of CEC. The proposed output of the power station is 40MW of capacity and 166GWh of energy per annum. Increased demand from mining sector. With copper prices recovering, the case for increased mining activity in CEC s primary operational space has grown. In 2010 alone, CEC signed new Power Supply Agreements (PSAs) with Konnoco Zambia Limited (African Rainbow/Vale), The Muliashi Project (CNMC Luanshya Copper Mine), and The Synclinorium (Mopani Copper Mines). CEC projects that demand will reach over 600MW by 2016 based on increased demand from its current and pending customers. Tariffs review to also provide some momentum. Following from the last extensive review of tariffs in 2008, and a request by ZESCO for a renegotiation of the tariffs at which CEC purchases power under the BSA with ZESCO, CEC commissioned a Cost of Service study in The idea was to bring tariffs to costreflective levels, in view of the power transmission and generation infrastructure under use. In August 2011, the ERB approved a 30% increase in BSA tariffs between ZESCO and CEC, and has urged both companies to develop a multiyear framework for bringing mine tariffs to costreflective levels by Second DRC Zambia interconnector Project. The construction of a new double circuit 220kV interconnector between Zambia and the DRC will commence as a joint project between CEC and the DRC s electricity utility, SNEL. The cost of the Zambian portion of the project is estimated at USD 16.5m. The project forms part of the Southern African Power Market Plan being supported by The World Bank, and will facilitate increased power trading within the SAPP. This line, according to CEC, will facilitate the transfer of 550MW firm power from DRC to Zambia. Outlook Growth in and outside Zambia. Nigeria is currently planning a multibillion dollar privatisation of its power sector so as to improve efficiency and cut persistent electricity outages. CEC was invited to submit bids for power distribution companies in Nigeria. Nigeria has infact split the Power Holding Company of Nigeria (PHCN) into 11 different units valued at about USD 100.0m each and the consortia that CEC is in has been shortlisted to buy at least two of them. It is therefore possible that CEC could take on more debt if it opts to buy the power units. Within Zambia, CEC was granted the rights to conduct feasibility studies for the development of hydro power generation on the Luapula River. Valuation and Recommendations Capital raise on the horizon. We have used a DCF and relative valuation model to value CEC and arrived at a valuation of ZMK 700 per share. The valuation however does not take into account the Kabompo Hydro Power project or the effects of the company s planned capital raising exercise. Based on a current trading price of ZMK 666, there is potential upside of 5.1%. We would recommend investors HOLD pending the finalisation of the capital raising exercise. CECFinancial Analysis 250, , , ,000 50, F 2012F Sales (USD 000)LHS EBITDA (USD 000)LHS Net Profit (USD 000)LHS EBITDA marginrhs NP marginrhs CEC s Major Customers CEC: Return Measures Vs Dividend Yield 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% F 2012F Dividend YieldRHS RoaALHS RoaELHS Source: IAS/ Company Reports 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 33