Titas Gas Transmission and Distribution Company Limited Fair Value Estimate (Dec 14) : BDT 111 per share Sector : Fuel and Power; Rating: OUTPERFORM

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1 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Sep-12 Sep-12 Nov-12 Dec-12 Jan-13 Jan-13 Feb-13 Apr-13 Apr-13 May-13 Jun-13 Jul-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Price, BDT Turnover, BDT Mn Analyst: Asif Khan, CFA BRAC EPL Research Update Report February 20,2014 Company Summary Current Price BDT (Feb 20, 2014) Fair Value (Feb 20, 2014) 111 Price Return 35% Dividend Yield 3% Total Return 38% Number of Shares MM 989 Market Cap USD MM 1,064 Free Float 25% Average Turnover Value USD MM (2013) 0.99 Rev & Profit (BDT MM) 2013A 2014E 2015E Sales 74,626 80,398 92,958 Op Revenue 7,491 7,927 9,093 EBITDA 8,330 8,753 9,926 Net Income 9,097 9,705 11,191 Margin 2013A 2014E 2015E Gross Margin 15.53% 15.31% 15.09% EBITDA Margin 11.16% 10.89% 10.68% Net Margin 12.19% 12.07% 12.04% Growth 2013A 2014E 2015E Revenue Growth 4.55% 7.74% 15.62% Gross Profit Growth 0.21% 6.22% 13.97% EBITDA Growth -4.44% 5.09% 13.40% Earning Growth 2.07% 6.69% 15.30% Cash Flow (BDT MM) 2013A 2014E 2015E Operating 2,202 17,206 12,203 Capex & Investments (3,589) (12,178) (6,879) Financing (3,359) (2,929) (4,082) Miscellaneous 2013A 2014E 2015E Gas Sales 73,951 79,476 91,892 Net Debt (30,450) (44,255) (51,770) Debt/Equity 3.74% 2.87% 2.19% Debt/Asset 2.13% 1.68% 1.28% Net Cash/Mkt Cap 27.61% 40.13% 46.94% Titas Gas Transmission and Distribution Company Limited Fair Value Estimate (Dec 14) : BDT 111 per share Sector : Fuel and Power; Rating: OUTPERFORM Undervalued company with catalysts in sight We strongly reiterate our buy call on Titas as we feel that it is a deeply undervalued name with catalysts in place to drive earnings and valuation. Our Dec 2014 target price of BDT 111 implies a total return of 38% from current market price. Investment Positives Highly attractive valuation based on DCF and relative comps: Stock is highly undervalued even using conservative estimates. Bibiyana field expansion to drive top line: Around 300mmcfd gas is supposed to be added in December 2014 which will increase nationwide supply by 13.6%. Gas price hike on the cards: We expect a gas prices to be revised upwards every year with a higher single digit hike happening within this fiscal year. Strong balance sheet with significant net cash: Titas has net cash/ market capitalization of 40% as of 2014E. Monopoly business model: The franchise area of Titas is fixed by the government making it free from any kind of competition. Downside Risks Regulatory risks exist as margins are set by government Lower than expected dividend payout Chances of 10% stake offloading by the government Upside Risks Per Share (BDT) 2013A 2014E 2015E EPS (Adjusted) EPS DPS Pay Out Ratio 31.1% 30.0% 40.0% NOCF/share BVPS Valuation 2013A 2014E 2015E P/E 8.29x 8.44x 7.32x P/B 1.65x 1.55x 1.36x EV/EBITDA 6.01x 4.75x 3.31x Higher than expected gas price hike Asset revaluation Catalysts Good dividend payout Timely addition of gas from Bibiyana expansion plan Profitability 2013A 2014E 2015E ROE 22.21% 19.71% 19.85% ROA 11.74% 11.38% 11.59% Chart 2: Historical PE chart of Titas 16.0x 14.0x Chart 1: Stock Performance of Titas , , , x x 8.0x 6.0x x 2.0x 0.0x 03-Jan Jan Jan Jan M Trailing P/E Mean P/E Turnover Adjusted Price Source : Company Annual Report, BRAC EPL Research, February 2014 Source : DSE, BRAC EPL Research, February 2014

2 Investment Thesis Highly attractive valuation on both absolute and relative metrics As per our DCF valuation with WACC of 17% we get to a June 2014 target price of BDT 111 per share which implies a Dec 2014 upside of 38%. We have not assigned any terminal value. Furthermore, we have modeled out till 2034 where as per our calculation the remaining 2P gas reserves of the country will be depleted. Titas Gas (BDT Mn) Figure: DCF WACC CONTINUED TILL 2034 TO DEPLETE RESERVES June Year End 2014F 2015F 2016F 2017F 2018F 2019F 2020F WACC Year Risk Free Rate 11.00% EBIT 7,927 9,093 10,358 10,863 10,902 10,942 10,977 Beta 1.00 EBIT*(1-Tax) 5,806 6,660 7,587 7,957 7,985 8,015 8,041 Market Risk Premium 6.00% (+) Depreciation/Amortization Cost of Equity 17.0% (-) Capex (920) (1,064) (1,224) (1,310) (1,348) (1,387) (1,427) Blended Cost of Debt 4.0% (-) WC change 6, Tax Rate 26.8% FCF 12,387 6,609 7,421 7,665 7,642 7,670 7,693 WACC 17.00% % cng -47% 12% 3% 0% 0% 0% Terminal Growth 0.0% PV FCF 12,387 5,649 5,421 4,786 4,078 3,498 2,999 Capital Structure Valuation 2014 Current Share Price PV of CF 56,789 Current Market Cap 81,908 Land Value 602 Net Debt (44,255) Enterprise Value 57,391 Enterprise Value 37,652 Net Debt (44,255) % Equity 100.0% Equity Value 101,647 % Debt 0.0% # of shares 989 Implied price per share (June 14) 103 Implied price per share (Dec 14) 111 Upside 35% Source: BRAC EPL Calculations Comparison with peers also show a similar picture. As per the peer analysis, Titas is trading at a significant discount on both P/E and EV/EBITDA multiples. On 2014E P/E the discount stands at 17% while on EV/EBITDA the discount stands higher at 37%. Please see next page for a comparison table. 2

3 03-Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct-13 Figure: Peer Comparison Company Comp Set EV/EBITDA P/E Company Name Country Mcap ($mn) Float % 2014E 2015E 2016E 2014E 2015E 2016E Sui Northern Gas Pipelines Ltd. Pakistan % Sui Southern Gas Co., Ltd. Pakistan % x - Gujarat Gas Company Limited India % 4.36x 4.36x 4.37x 8.80x 8.80x 8.33x GAIL (India) Limited India 7,381 28% 7.58x 7.79x 7.52x 9.96x 10.10x 9.92x Petrovietnam Gas Joint Stock Corporation Vietnam 7, % Shenzhen Energy Group Co., Ltd. China 2,379 26% 5.27x 5.27x 5.38x 10.11x 10.11x 12.55x ENN Energy Holdings Limited China 7,156 70% 10.90x 11.81x 10.11x 21.74x 24.30x 19.68x Tianjin Jinran Public Utilities Company Limited China % 10.99x 10.99x 9.25x 17.49x 17.49x 14.52x Summary Statistics Mcap ($mn) Float % 2014E 2015E 2016E 2014E 2015E 2016E High 7, % 10.99x 11.81x 10.11x 21.74x 24.30x 19.68x Low % 4.36x 4.36x 4.37x 8.80x 5.60x 8.33x Mean 3,209 52% 7.82x 8.04x 7.33x 13.62x 12.73x 13.00x Median 1,428 36% 7.58x 7.79x 7.52x 10.11x 10.11x 12.55x Comparison 2014E 2015E 2016E 2014E 2015E 2016E Titas (Market Price) Bangladesh 1,058 75% 4.75x 3.31x 2.21x 8.44x 7.32x 6.43x Premium/(discount to median) -37% -57% -71% -17% -28% -49% Titas (Target Price) Bangladesh 1,058 75% 8.33x 6.44x 4.95x 11.36x 9.86x 8.66x Premium/(discount to median) 10% -17% -34% 12% -2% -31% Source: S&P Capital IQ Titas is also trading at around 10% discount to its average 12M trailing historical P/E of 9x. We also don t think that the average P/E ratio is a good representation of the intrinsic valuation of the company considering the double digit the earnings growth that we expect in 2015 and x 14.0x 12.0x 10.0x 8.0x 6.0x 4.0x 2.0x Figure: 12M Trailing P/E 0.0x 12M Trailing P/E Mean P/E Source: DSE 3

4 F 2014F 2015F 2016F 2017F 2018F 62% 74% 67% 76% 84% 86% 88% 89% 90% F 2015F 2016F 2017F 2018F F 2014F 2015F 2016F 2017F 6.2% 4.1% 4.6% 7.7% 7.0% 18.4% 15.6% 15.1% 22.0% Revenue Growth (%) Bibiyana expansion to drive top line: Bangladesh presently has gas supply of around 2,200 mmcfd (million cubic feet per day) versus demand of around 2,700 mmcfd or more. We anticipate a major addition of around 300 mmcfd to the gas supply to come in at the end of This would be the result of expansion project that is ongoing at the Bibiyana gas (largest gas field in the country) field owned by Chevron. Source: Titas Gas/ BEPL Forecasts Assuming the market share of Titas would remain at the present levels, this would help the company grow their revenue by around 15% in 2015 and Gas price hike on the cards: Gas price ($/mmbtu) Presently weighted average gas price stand at around $2.05/mmbtu (our calculation). This is significantly lower than global peers. Even in Pakistan the marginal gas is sold at more than $5/mmbtu. Source: Titas Gas/ BEPL Forecasts The reason gas prices are so low in Bangladesh is because around 40-50% of the gas comes from state owned fields which are priced at throwaway numbers. The rest comes from International Oil Corporations (IOC) like Chevron (which manages Bibiyana) for which prices are tagged to Singapore HSFO prices. There are two clear fundamental reasons as to why prices must increase. 1. As per the trend and our expectation the share of IOCs will continue to go up and thus the weighted average cost of gas will also go up. 2. Secondly, even though on a weighted average basis the government is breakeven on gas that price is not enough to finance exploration activity which the country direly requires. Already in recent newspapers reports we are hearing that the issue of gas price will soon be brought to BERC s (Bangladesh Energy Regulatory Commission) attention. Net Cash/Equity We have however been quite conservative in our gas price hike assumptions with 7.5% hike forecasted in the next 3 years. After that our assumption is that gas price will only go up by 5% a year. Strong Balance Sheet and Cash Flow Generation: Titas has a very strong balance sheet with net cash/market capitalization of 40%. The company has low capex requirements amounting to only around 1% of sales and large free cash flows. Monopoly business model: Source: Titas Gas/ BEPL Forecasts Titas is the only player in the areas that it covers as decided by the government of Bangladesh. As a result there is no risk of competition. 4

5 F 2014F 2015F 2016F 2017F 2018F 29% 30% 31% 30% 40% 50% 50% 50% WACC Downside Risks Regulatory risk: The biggest risk for Titas would be regulatory risk. Since margins are decided by government, the government can very well decide to reduce its margin considering its profitability and cash balance. Keeping this risk in mind we have gradually reduced gross margin from 15.6% in 2013 to around 14.0% by 2020 and stay there. We have also presented a sensitivity analysis of fair value to gross margin and WACC. Sensitivity Analysis (Gross Margin vs COE) Gross Margin % 13.0% 14.0% 15.0% 16.0% 16.0% % % % % Upside % 13.0% 14.0% 15.0% 16.0% 16.0% 27% 32% 37% 43% 48% 16.5% 26% 31% 36% 41% 46% 17.0% 25% 30% 35% 39% 44% 17.5% 24% 29% 33% 38% 43% 18.0% 23% 28% 32% 37% 41% Lower than expected dividend payout: Dividend Payout Despite having a large cash balance and very strong cash flow generation Titas pays out only about 30% of its earnings as dividends. Thus Titas can turn into a value trap and continue to deliver below par return to shareholders on its excess cash holdings. Government share offloading: Source: Titas Gas/ BEPL Forecasts In the past the government had a plan to offload around 10% shares in the market. They later decided to delay that plan due to low stock price. There is a risk that if price appreciates the government might decide to go back to their original decision. As Titas is a large cap company a share offload of such a magnitude will lead to stock price overhang. Corporate governance risk: Titas got a qualified opinion at the end of 2013 from its auditor for understating some of its liability by around BDT mn and overstating its assets by around BDT 150 mn. Nevertheless the amount is quite insignificant to impact the valuation. 5

6 Upside Risk Higher than expected gas price hike: Even though we mentioned that gas prices are relatively very low we have only assumed around 7.5% gas price hike for the next 3 years. Land value going up due to asset revaluation: Titas has substantial land holdings which have been recorded at historical prices. Since then land prices have gone up quite significantly. For conservative purposes we have taken land value at historical prices which we believe are much lower than true market price. If assets get revalued then that could act as an upside risk for our valuation. Catalyst Completion of Bibiyana expansion project: Successful completion of the Bibiyana expansion project should clearly act as a price catalyst at it would be the primary driver of double digit bottom line growth in 2015 and 2015 as per our expectation. Higher dividend payout: A higher than expected dividend payout could unlock value for the company and drive the re-rating. Our model assumes gradual ramp up of dividend payout from 30% to around 60% in However, given the vast cash holding on balance sheet, low capex requirement and high free cash flow generation the company can surely afford to pay out much more in dividends. 6

7 SUMMARY FINANCIAL STATEMENTS Titas Gas (BDT mn) June ending Income Statement F 2014F 2015F 2016F 2017F Net Sales 44,700 52,903 64,557 68,551 71,375 74,626 80,398 92, , ,503 Gross Profit 7,475 8,830 11,457 13,466 11,562 11,586 12,365 14,160 16,144 17,106 S,G&A (1,362) (1,502) (1,831) (2,059) (2,245) (2,644) (2,861) (3,308) (3,808) (4,075) Depreciation (780) (813) (839) (843) (878) (839) (826) (833) (851) (879) WPPF (283) (368) (493) (617) (601) (613) (696) (800) (910) (980) EBIT 5,830 6,959 9,133 10,790 8,716 8,330 8,808 10,052 11,426 12,052 Non-Operating Income Net Interest Income ,203 1,811 3,208 4,188 4,558 5,307 6,036 6,758 PBT 5,667 7,326 9,861 12,332 12,012 12,266 13,095 15,169 17,352 18,722 Taxes (1,444) (1,875) (2,527) (3,152) (3,100) (3,169) (3,347) (3,877) (4,435) (4,785) PAT 4,223 5,451 7,334 9,180 8,912 9,097 9,748 11,292 12,917 13,937 Balance Sheet F 2014F 2015F 2016F 2017F Cash and Equivalents 2,011 5,187 6,172 7,988 6,521 5,715 7,948 9,189 10,578 11,319 Accounts Receivable 14,176 13,036 14,111 15,254 19,388 21,771 22,027 25,468 29,318 31,371 Inventories 1,437 1,832 1,819 1,815 1,726 1,887 2,237 2,591 2,987 3,202 Other Current Assets 1, ,796 5, ,011 1,164 1,245 Current Assets 19,032 20,684 22,759 25,748 32,431 35,217 33,086 38,258 44,048 47,137 Property, Plant and Equipment 11,713 11,745 11,408 11,589 11,701 11,046 11,006 11,236 11,609 12,040 Investments 6,155 10,504 16,342 22,412 30,523 34,109 46,085 53,513 60,735 67,883 Non Current Assets 17,869 22,249 27,750 34,001 42,224 45,155 57,091 64,749 72,345 79,923 Accounts Payable 9,419 10,725 12,169 14,119 15,173 14,425 16,030 18,566 21,410 22,948 Other Current Liability 4,272 5,123 6,792 6,941 12,679 9,286 9,979 11,538 13,283 14,213 Current Liability 13,691 15,848 18,961 21,060 27,852 23,710 26,009 30,104 34,693 37,161 Long Term Debt 3,148 2,983 2,585 2,443 2,302 1,713 1,513 1,313 1, Other Long Term Liabilities 6,368 7,464 7,965 8,096 8,338 9,191 9,878 11,421 13,148 14,068 Long Term Liability 9,517 10,446 10,550 10,539 10,640 10,904 11,391 12,734 14,261 14,981 Shareholders Equity 13,693 16,639 20,998 28,246 36,163 45,757 52,776 60,169 67,439 74,918 Income Statement F 2014F 2015F 2016F 2017F Cash flow from Operations 3,881 9,944 10,197 10,948 5,860 2,202 17,237 12,289 13,956 14,936 Cash flow from Investing (429) (3,805) (5,902) (6,666) (8,510) (3,589) (12,209) (6,948) (6,720) (7,537) Cash flow from Financing (4,371) (2,478) (2,539) (2,266) (2,939) (3,359) (2,929) (4,099) (5,846) (6,658) Net Cash Flow 834 3, ,815 (1,466) (806) 2,233 1,242 1,

8 IMPORTANT DISCLOSURES Analyst Certification: Each research analyst and research associate who authored this document and whose name appears herein certifies that the recommendations and opinions expressed in the research report accurately reflect their personal views about any and all of the securities or issuers discussed therein that are within the coverage universe. Disclaimer: Estimates and projections herein are our own and are based on assumptions that we believe to be reasonable. Information presented herein, while obtained from sources we believe to be reliable, is not guaranteed either as to accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation of the purchase or sale of any security. As it acts for public companies from time to time, BRAC-EPL may have a relationship with the above mentioned company(s). This report is intended for distribution in only those jurisdictions in which BRAC-EPL is registered and any distribution outside those jurisdictions is strictly prohibited. Compensation of Analysts: The compensation of research analysts is intended to reflect the value of the services they provide to the clients of BRAC-EPL. As with most other employees, the compensation of research analysts is impacted by the overall profitability of the firm, which may include revenues from corporate finance activities of the firm's Corporate Finance department. However, Research analysts' compensation is not directly related to specific corporate finance transaction. General Risk Factors: BRAC-EPL will conduct a comprehensive risk assessment for each company under coverage at the time of initiating research coverage and also revisit this assessment when subsequent update reports are published or material company events occur. Following are some general risks that can impact future operational and financial performance: (1) Industry fundamentals with respect to customer demand or product / service pricing could change expected revenues and earnings; (2) Issues relating to major competitors or market shares or new product expectations could change investor attitudes; (3) Unforeseen developments with respect to the management, financial condition or accounting policies alter the prospective valuation; or (4) Interest rates, currency or major segments of the economy could alter investor confidence and investment prospects. BRAC EPL Stock Brokerage Limited Research Ali Imam, CFA Head of Research imam@bracepl.com Khandakar Safwan Saad Deputy Head of Research safwan@bracepl.com Asif Khan, CFA Deputy Head of Research asif@bracepl.com Mehedee Hasan Research Analyst mehedee.hasan@bracepl.com Shaikh Malik Al-Razi Research Associate malik.razi@bracepl.com Farah Tasnim Huque Research Associate farah.tasnim@bracepl.com International Trade and Sales Head of International Trade Ashraf Saleheen & Sales ashraf.saleheen@bracepl.com Ahsanur Rahman Bappi Deputy Manager bappi@bracepl.com BRAC EPL Research 121/B Gulshan Avenue Gulshan-2, Dhaka Phone: Fax: research@bracepl.com 8