Hub Power Company Limited

Hub Power Company Limited A safe heaven in shaky market BUY Target Price Jun 14: PKR 72 Current Price: PKR 63 Bloomberg Reuters HUBC.PA HPWR.KA MCAP (USD mn) 691 12M ADT ( USD mn.) 1.0 Shares Outstanding 1,157 Valuations 2013A 2014F 2015F EPS 8.1 8.7 9.9 DPS 8.0 8.5 9.5 FY14F Dividend Yield (%) 13% Capital Gain (%) 13% Total Gain (%) 26% Wednesday September 25, 2013 Hubco reported a net profit after tax of PKR9.4bn (EPS: PKR8.11) for FY13, marking an impressive growth of 15% YoY against FY12 s net earnings of PKR8.2bn (EPS: PKR7.08) We foresee FY14 profit after tax to be around PKR10bn (EPS: PKR8.69), depicting a growth of 7% YoY. The reason for subdued growth in bottomline lies in company s tariff structure, where FY14 Project Company Equity (PCE) component is supposed to shrink by 5% Over FY15 to FY19, earnings are expected to grow at a CAGR of 7% despite increasing finance cost. Moreover, we have assumed a payout ratio of 95% in longer term that makes dividend per share grow at a CAGR of 6% during FY15 FY19 Our ballpark estimates suggest income of PKR0.9/share in the form of dividends from Laraib. Incorporating these dividend will increase our target price by at least PKR7/share (10% of current target price) Our Dividend Discount Model (DDM) based June 14 target price for HUBC works out to PKR72/share Our target price offers an upside potential of 13% from current levels in addition to 13% dividend yield. A total return of 26% calls a BUY for Hubco HUBC vs. KSE100 Relative Chart KSE100 Index 170 155 140 125 HUBC Company background Hub Power Company Limited (HUBC) was incorporated as a limited liability company in August 1991, to represent a 1292 MW power project led by Xenel Industries of Saudi Arabia. The company signed a Power Purchase Agreement (PPA) with Wapda for thirty years (expiring 2027 as it achieved commercial operations in March, 1997). Apart from private investors and a number of multilateral sources, government of France, Italy, Japan, United Kingdom and United States provided debt finance for the project. 110 95 80 Sep 12 Oct 12 Nov 12 Dec 12 Jan 13 Mar 13 Feb 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 HUBC Profile: The Hub Power Company Ltd. was incorporated in Pakistan on August 1,1991. The principal activities of the company are to develop, own, operate and maintain power stations. The Company owns an oil fired power station of 1200MW (net) in Balochistan (Hub Plant) and a 214MW (net) oil fired power station in Punjab (Narowal Plant).The company also has a 75% controlling interest in Laraib Energy Limited, a subsidiary company which owns an under construction hydel power project of 84MW. Taseer Abbas taseer.abbas@bmacapital.com +92 111 262 111 Ext: 2056 During 2012, old sponsors of Hubco divested their investment and local investors (Dawood group) assumed control of growing company. Currently, Mr. Hussain Dawood serves as the Chairman board of directors at Hubco. A review of FY13 financial result Hubco reported a net profit after tax of PKR9.4bn (EPS: PKR8.11) for FY13, marking an impressive growth of 15% YoY against FY12 s net earnings of PKR8.2bn (EPS: PKR7.08). The topline shrank by 5% YoY to PKR166 bn in FY13 primarily due to a) lower load factor for Narowal plant (44% in FY13 vs. 70% in FY12) and b) relatively stable oil prices as furnace oil price changed by a mere 1% YoY during the year. However, 5% depreciation (on closing basis) in PKR/USD parity enabled the company to achieve 4% YoY growth in gross profits. Other significant factor towards bottom line growth was 8% YoY lower finance cost of PKR6.6bn. Recall that Government of Pakistan issued Term Finance Certificates (TFCs) of PKR82bn in Sep 12 to bring down circular debt. These non cash transactions lowered HUBC s interest bearing payables towards fuel supplier (PSO) and thus, finance cost was kept in check. or sell the securities mentioned. 1

FY12 FY13 Financial Highlights PKRmn FY12A FY13A YoY Sales 174,712 165,862 5% Cost of Sales 159,091 149,544 6% Gross Profit 15,621 16,318 4% Other Operating Income 35 34 3% Profit from Operations 15,272 15,937 4% Finance Cost 7,083 6,548 8% Profit before taxation 8,190 9,389 15% Profit after taxation 8,190 9,388 15% Earnings per share (PKR) 7.08 8.11 15% Dividend per share (PKR) 6.00 8.00 33% Our assumptions going forward Being conservative We have reviewed our financial model for HUBC incorporating sectors improved dynamics after recent power sector reforms and government s steps to curtail circular debt. However, we have been conservative in our assumptions as we have assumed slight accumulation of receivables as well as accelerated payments towards PSO. As per the latest available accounts of the company, amount owed to trade payables exceeds trade debts. Therefore, we have assumed payments towards PSO in FY14 reducing cash available for equity investors. From FY15 onwards, we foresee delay in receipts will be passed on to PSO as has been the history. Other than cash cycle assumptions, we have revisited our PKR/USD assumptions as well. For FY14, we have incorporated depreciation of 9% (FYTD depreciation 6% on average), 6% for FY15 and 5% in the long term. Our sensitivity analysis suggests that every 1% increase in depreciation increases HUBC s earning by 1%. What do we foresee in years to come? Incorporating the aforementioned assumptions, we foresee FY14 profit after tax to be around PKR10bn (EPS: PKR8.69), depicting a growth of 7% YoY. The reason for a subdued growth of bottom line lies in company s tariff structure, where FY14 Project Company Equity (PCE) component is supposed to shrink by 5%. Nevertheless, net profitability is forecasted to improve, thanks to PKR depreciation during the year. It is worth mentioning here that impacts of changes in foreign exchange rates become visible after a lag, therefore, FY15 is expected to witness strong growth of 15% YoY. As far as finance cost and penal income is concerned, effects of lower finance cost will be muted by absence of penal interest income from Wapda/NTDC as gov t. has cleared most of the outstanding dues. Therefore, penal interest income has lost its importance at least for the short term. The payout ratio in FY14 is expected to be 100% despite payments towards PSO, as company reported cash balance of PKR15/share with strong credit lines still available to company. or sell the securities mentioned. 2

Hubco: Projected Income Statement PKR mn FY14E FY15F FY16F FY17F FY18F FY19F Sales 172,307 173,488 172,980 170,555 168,824 166,900 Cost of Sales 158,325 157,991 156,055 153,658 151,201 148,681 Gross Profit 13,983 15,496 16,925 16,896 17,622 18,219 Other Operating Income 158 123 120 122 124 130 Profit from Operations 13,738 15,217 16,644 16,613 17,344 17,946 Finance Cost 3,687 3,705 3,701 3,751 3,850 3,933 Profit before taxation 10,051 11,512 12,943 12,862 13,494 14,013 Profit after taxation 10,051 11,512 12,943 12,862 13,494 14,013 Earnings per share (PKR) 8.69 9.95 11.19 11.12 11.66 12.11 Dividend per share (PKR) 8.50 9.50 10.00 10.50 11.00 11.50 Dividends need not to be missed! Over the longer horizon, HUBC appears to be a good investment as insulation against PKR fall provides a natural advantage. Over FY15 to FY19, earnings are expected to grow at a CAGR of 7% despite increasing finance cost. Moreover, we have assumed a payout ratio of 95% in longer term that makes dividend per share at a CAGR of 6% during FY15 FY19. As depicted in the graph, dividend yields over next six years continue to grow and the difference between HUBC s dividend yield and government s PIB yields is expected to widen further. Earnings and Dividend Forecast DPS EPS Yield (RHS) 15 19% 18% 13 11 9 8.5 8.7 9.5 9.9 10.0 11.2 11.1 10.5 11.0 11.7 12.1 11.5 17% 16% 15% 14% 13% 12% 11% 7 FY14 FY15 FY16 FY17 FY18 FY19 10% Update about growth projects Narowal: Hubco completed its expansion project (225MW thermal power plant located in Narowal) in 2011 and since then plant has been operating side by side with Hubco s old plant. During FY13, Hubco s management announced separation of Narowal plant into a separate company. We believe the motive behind this separation is efficient management of expanded part, which is located far away from main plant. This will also enable the or sell the securities mentioned. 3

authorities to manage working capital separately and the financial burden due to liquidity constraint won t affect disclosures for old plant. We expect the separation to be complete in near future. Laraib s hydel project: Hubco s second growth project was being developed by its 75% subsidiary, Laraib Energy Limited. The 84MW hydel power project achieved its commercial operations in March 2013 and its tariff at commercial operations date is under revision. Currently, we have not incorporated any financial benefits from this project as we await revision of tariff. However, our ballpark estimates suggest income of PKR0.9/share in the form of dividends from Laraib. Incorporating these dividend will increase our target price by at least PKR7/share. Coal conversion: Going forward, coal conversion of Hubco s old plant will be the main challenge for management. The government intends to convert furnace oil based power plants in two years and Hubco is also one of these plants. The management s commitment for the conversion can be witnessed by proposed increase of company s Authorized Share Capital from PKR 12bn to PKR25 bn. The increase will allow company to raise fresh rounds of equity financing by offering right issues, in order to sponsor equity portion of coal conversion. Other than right issue, management can also opt for combination of stock dividend (in order to hold cash) and offer for sale of Narowal s small portion (retaining control). However, the probability of right issue is higher than stock dividend/offer for sale, we believe. Valuation Our Dividend Discount Model (DDM) based June 14 target price for HUBC works out to PKR72/share. In our valuation, we have assumed a risk free rate of 12.5% (10 year PIB yield), risk premium of 6% and five year daily adjusted beta of 0.85. Moreover, we have assumed 95% payout ratio for the entire valuation horizon. The details are provided in table below, while company s key financials are forecasted at the end of report. Valuation Valuation FY14 FY15 FY16 FY17 FY18 FY19.. Dividend per share 8.50 9.50 10.00 10.50 11.00 11.50 Cost of Equity 17.6% 17.6% 17.6% 17.6% 17.6% 17.6% NPV of Dividends 8.50 8.08 7.23 6.45 5.75 5.11 30.74 Target Price(PKR/Share) 72 Price (as on 24 Sep, 2013) 64 Upside Potential 13.1% Cost of Equity 17.6% Risk free rate 12.5% Premium 6.0% Beta 0.85 Recommendation Our target price offers an upside potential of 13% from current levels (target price excludes Laraib which will be a plus). This is in addition to 13% dividend yield for FY14 while the yield is forecasted to grow further. The total return for HUBC works out to 26% compared with 10 year PIB yield of 12.5 %, a strong reason to recommend BUY for HUBC! or sell the securities mentioned. 4

Financial Highlights of of the the company comapny Income Statement FY13A FY14E FY15F FY16F FY17F FY18F FY19F Sales 165,862 172,307 173,488 172,980 170,555 168,824 166,900 Gross profit 16,318 13,983 15,496 16,925 16,896 17,622 18,219 Other income 34 158 123 120 122 124 130 Finance cost 6,548 3,687 3,705 3,701 3,751 3,850 3,933 Profit before tax 9,389 10,051 11,512 12,943 12,862 13,494 14,013 Net profit 9,389 10,051 11,512 12,943 12,862 13,494 14,013 Earnings per share (PKR) 8.11 8.69 9.95 11.19 11.12 11.66 12.11 Dividend per share (PKR) 8.00 8.50 9.50 10.00 10.50 11.00 11.50 Balance sheet FY13A FY14E FY15F FY16F FY17F FY18F FY19F Total shareholder's equity 32,633 32,559 33,656 35,318 36,319 37,373 38,368 Non Current Liabilities Long term loans 23,551 17,568 14,414 11,800 9,625 7,449 5,274 Total non current liabilities 23,551 17,579 14,422 11,806 9,633 7,457 5,282 Current Liabilities Trade payables 34,815 33,595 33,692 33,529 33,487 33,426 33,200 Total current liabilities 43,129 45,953 49,139 51,366 53,688 56,324 58,688 Total equity and liabilities 99,313 96,091 97,218 98,489 99,640 101,154 102,338 Assets Noncurrent assets 49,834 47,377 44,973 42,530 40,106 37,622 35,168 Current assets 49,480 48,714 52,244 55,959 59,533 63,532 67,169 Total Assets 99,313 96,091 97,218 98,489 99,640 101,154 102,338 Cashflow statement FY13A FY14E FY15F FY16F FY17F FY18F FY19F Cash flow from operations 26,821 3,611 12,378 14,778 15,391 15,759 16,171 Cash flow from investing activities (633) (233) (298) (269) (298) (247) (288) Cash flow from financing activities (9,616) (15,308) (13,570) (14,439) (14,473) (14,615) (15,194) Net change in cash 16,572 (11,930) (1,490) 70 620 897 689 Ending Cash 17,069 5,139 3,649 3,719 4,339 5,235 5,925 Key ratios FY13A FY14E FY15F FY16F FY17F FY18F FY19F ROE 30% 31% 35% 38% 36% 37% 37% ROA 6% 10% 12% 13% 13% 13% 14% Debt to Equity 0.79 0.64 0.52 0.41 0.32 0.26 0.19 Debt to Total Assets 0.26 0.22 0.18 0.15 0.12 0.10 0.07 P/B 2.25 2.26 2.18 2.08 2.02 1.97 1.92 P/E 7.83 7.31 6.38 5.68 5.71 5.45 5.24 Dividend yield 13% 13% 15% 16% 17% 17% 18% Source: Company Reports, BMA Research or sell the securities mentioned. 5