Foundation Research Equities

PAKISTAN
20 February 2014
KAPCO PA
Stock price as of 19 Feb Dec-13 target Upside/downside Valuation - DDM based Rs Rs % Rs

Kot Addu Power Co. Ltd

Outperform
57.1 64.5 13.0 64.5

Sharp price reaction to weak 1H EPS is unjustified; Upgrade to O/P

Event
We upgrade Kot Addu Power Company Ltd (Kapco), Pakistans largest listed IPP, to Outperform from Neutral with revised TP of PKR64.5/sh (up 9%) suggesting 13% upside. An unjustified sharp correction in stock price (price down 9% in two sessions) on weak 2Q earnings has opened up valuation, in our view. Resultantly, Kapco offers an attractive PKR/US$ IRR of 13/11%. We see strong recovery in earnings/dividend in 2H on improved thermal efficiency and lower repair cost. KAPCO posted 2Q EPS of PKR1.27 (down 38% QQ) and paid cash dividend of PKR2.75. Both earnings and dividend undershot consensus estimate as repair cost on energy block-I came significantly ahead of estimate. 1H EPS clocked in PKR3.3 and was down 21% YoY.

Power Generation & Distribution Sector Market cap Rs bn 30-day avg turnover US$m Market cap US$m Number shares on issue m

50 0.2 513 880

2016E 126,204 18,022 2.6 9,832 9,832 11.2 10.3 11.2 10.3 5.1 5.1 8.4 14.7 12.5 31.9 4.3 70.5 1.6

Investment fundamentals
Year end 30 Jun Total revenue EBIT EBIT Growth Recurring profit Reported profit EPS rep EPS rep growth EPS rec EPS rec growth PE rep PE rec Total DPS Total div yield ROA ROE EV/EBITDA Net debt/equity Price/book m m % m m Rs % Rs % x x Rs % % % x % x 2013 97,705 18,904 2.6 7,353 7,353 8.4 21.1 8.4 21.1 6.8 6.8 7.5 13.1 11.8 28.7 3.6 28.2 2.0 2014E 2015E 119,713 122,123 14,481 17,568 (23.4) 21.3 6,700 8,914 6,700 8,914 7.6 (8.9) 7.6 (8.9) 7.5 7.5 6.3 11.0 8.7 26.2 5.4 87.7 2.0 10.1 33.0 10.1 33.0 5.6 5.6 8.0 14.0 11.6 31.6 4.4 77.5 1.8

Impact
21% YoY drop in 1H earnings: Kapco unveiled its 2Q results on18th Feb and delivered negative surprises in both earnings and dividend. Earnings in 2Q of PKR1.27 is down 38% QoQ primarily driven by (1) steep jump in overhaul and repair cost, and (2) lower thermal efficiency. Kapcos one of the three energy blocks underwent a major overhaul in 2Q14 in compliance with its maintenance cycle. The overhaul was earlier scheduled for last year however stretched into FY14 due to overhaul plans on other plants. One-off O&M cost on KAPCOs energy block I (326MW) is primarily behind weak set of results. The block has resumed operations in Dec14. Along with overhaul cost, drop in thermal efficiency of the complex has also dragged down bottom-line in 2Q. This is attributable to (1) sub optimal production due to overhaul, (2) fuel quality, and (3) not so smooth plant running. We estimate QoQ drop in thermal efficiency of 70-100bps. Load factor decreased to 48% in 2Q: In-line with past practice, electricity generation has slipped in 2Q, dragging down load factor to 48%. LSFO reliance remains high in absence of gas allocation. Big improvement in net interest cost: The impact of big pay-down of energy debt in 4Q is also visible in 2Q with net interest spread (differential b/w interest income and interest expense) coming down to merely PKR36mn in 2Q14 from a high of PKR1.5bn in 4Q13. We believe this has led by (1) improved receivables position relative to FY13, and (2) Kapco gradually moving away from expensive supplier credit priced at T-bill+6% to bank loans (Kibor+1-1.5%) to fund the remaining overdue receivables. Reasons for strong turnaround in 2H earnings: There are at least three reasons to believe in strong rebound in 2H earnings:
1- Improved efficiency of the whole complex following completion of repair and overhaul of an important energy unit. We expect 50-100bps uptick in overall thermal efficiency of the complex. 2-Absence of repair and overhaul cost which dragged 2Q earnings. Kapcos

KAPCO PA rel KSE100 performance

2 1.5 1 0.5 0
Feb-14 Jan-14 Dec-13 Nov-13 Sep-13 Aug-13 Jul-13 Jun-13 May-13 Apr-13 Mar-13 Feb-13 Jan-13 Dec-12 Nov-12 Oct-12 Sep-12 Aug-12

KSE (all figures in PKR unless noted)

KAPCO

Source: Bloomberg, Foundation Research, Feb 2014

Analyst
Mohammad Fawad Khan, CFA 92 21 5612290-94 Ext 338 fawad.khan@fs.com.pk

Disclaimer: This report has been prepared by FSL. The information and opinions contained herein have been compiled or arrived at based upon information obtained from sources believed to be reliable and in good faith. Such information has not been independently verified and no guaranty, representation or warranty, express or implied is made as to its accuracy, completeness or correctness. All such information and opinions are subject to change without notice. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete and this document is not, and should not be construed as, an offer, or solicitation of an offer, to buy or sell any securities or other financial instruments. FSL may, to the extent permissible by applicable law or regulation, use the above material, conclusions, research or analysis before such material is disseminated to its customers. Not all customers will receive the material at the same time. FSL, their respective directors, officers, representatives, employees, related persons may have a long or short position in any of the securities or other financial instruments mentioned or issuers described herein at any time and may make a purchase and/or sale, or offer to make a purchase and/or sale of any such securities or other financial instruments from time to time in the open market or otherwise, either as principal or agent. FSL may make markets in securities or other financial instruments described in this publication, in securities of issuers described herein or in securities underlying or related to such securities. FSL may have recently underwritten the securities of an issuer mentioned herein. This document may not be reproduced, distributed or published for any purposes.

Kot Addu Power Co Ltd.

February 20, 2014

outage schedule suggests the other two blocks are unlikely to face outage due to overhaul until at least next year. 3-Impact of revision in indexation factor. The escapable component in the tariff 1H earnings incorporated an average exchange rate of PKR98 prevailing during the 2H13. The tariff component in 2H14 will be based on average exchange rate in 1H14 which is up 7% over 2H13.

Earnings and TP revision

We have cut our FY14 earnings estimates by 15% to reflect 1H14 actual earnings. Our FY15-21 estimates have been
revised up by 4-5% due to adjustment in exchange rate.

Revision in target price reflects changes in earnings estimate and roll-forward of TP to Dec14.

Price catalyst
3Q earnings substantiating our thesis on strong re-bound in earnings. Progress on conversion of auxiliary boiler to coal (610MW)

Action and recommendation

13% upside to our revised target price of PKR64.5: An unjustified sharp correction in stock price on weak 2Q EPS
has opened up valuation with stock trading at PKR/US$ IRR of 13/11%. Kapco offers FY14/15 DY of 11/14% which we find attractive relative to peers D/Y. We see strong recovery in earnings/dividend in 2H on improved thermal efficiency and lower repair cost. We believe expectation of rebound in earnings will likely drive stock price outperformance as we move close to 3Q results.
Kapco: 1HFY14 earnings review PKRmn Net Sales CoGS Gross Profit Administration Costs Other Income EBIT Financial Charges Earnings Before Tax Taxation Earning After Tax EPS DPS Load factor Receiveable days Days Inventory Payables days 57% 141 23 66 1QFY14 29,801 27,147 2,654 92 650 3,212 806 2,407 614 1,792 2.04 2QFY14 27,199 25,171 2,029 81 924 2,871 960 1,912 793 1,119 1.27 2.75 48% 145 23 60 QoQ -9% -7% -24% -12% 42% -11% 19% -21% 29% -38% -38% 1HFY13 48,666 42,410 6,256 275 3,053 9,034 3,555 5,479 1,786 3,693 4.2 3.00 53% 170 12 92 1HFY14 57,001 52,318 4,683 173 1,574 6,084 1,765 4,318 1,407 2,911 3.3 2.75 52% 143 23 63 YoY 17% 23% -25% -37% -48% -33% -50% -21% -21% -21% -21%

Source: KSE, Foundation Research, Feb'14

Foundation Securities (Pvt) Limited

Kot Addu Power Co Ltd.

Fig 1: A big improvement in Kapcos WC profile
2,000 5.0 4.5 1,500 4.0 3.5 1,000 3.0 2.5 500 2.0 1.5 0 1.0 0.5 (500) 0.0 20% 60% 80% 100% 120%

February 20, 2014

Fig 2: has translated into stronger support to EPS

40%

1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

3Q13

1Q14

0%

1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

3Q13

Net Interest Spread (LHS, PKRmn) EPS (RHS,PKR)

Source: Company accounts, Foundation Research, Feb14

% funded by creditors

% funded by banks

Foundation Securities (Pvt) Limited

1Q14

Kot Addu Power Co Ltd.

About The Company

February 20, 2014

The Kot Addu Power Company Limited (KAPCO) is Pakistans largest Independent Power Project (IPP) and its principal activities are to own, operate and maintain multi fuel fired power station with gross capacity of 1,600MW at a site in Kot Addu, District Muzaffargarh in the Punjab province. The company supplies power exclusively to WAPDA under a 25 year Power Purchase Agreement (PPA) extending up to 2021. The company has an exclusive agreement for supply of furnace oil with Pakistan State Oil (PSO). The shares of the company are listed on the Karachi, Lahore & Islamabad Stock Exchanges.

Foundation Securities (Pvt) Limited