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KENYA_POWER_VALUATION_REPORT_REVISED

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KENYA_POWER_VALUATION_REPORT_REVISED

  1. 1. KENYA POWER powering people for better lives Intiation of coverage and valuationreport. I initiate coverage of Kenya Power midway on its plans to increase electricity inclusion from the current 30% to 70% by 2017.This effort will be boosted by the expected increase of additional power from 1700MW in 2013 to 6700MW in 2017.The aim of the powerincrease is to change the energy mix in power away from relying on weather prone hydro plants andexpensive emergency power to renewable and reliable sources of energy (geothermal) and cheap fossil powered plants(coal and gas).To date, geothermal powerinstalled power capacity has increased by 406MW against a set target of 506MW by September 2015.Legal complications delayed the Lamu coal plant, but they are now in the clear. Multiple power generation projects have runintolegal headwinds but the general expectation is that theywill clear through active community participation with the power investors. Kenya power and the Rural ElectrificationAuthority(REA) have renewed vigor toincrease electricity inclusion with some 435,558 customers connected to the grid between the financial years 2013- 2014.Though the agencies hope to connect an additional one million between 2014-2015, my belief is that they will connect about 700,000 additional customers and hitting the one million mark as from financial year 2015.If they race to connect 70% by 2017, the company risks to accumulate excessive debt that will choke the company. Spacing it by anextra two years allows for proper and sustainable growth in tandem with the increase in installed cheaper capacity who are already behind schedule. Kenya power is a buy with a fair value of 24.9 against a trading price 16.45 with a 51% upside. Over the last three years Kenya power has been experiencing a trading price discovery towards its cashflow generated from operations per share. 2012 2013 2014 2015E Cash flow generated from operations per share 7.38 9.46 11.89 15.10 Trading price at 30th June 15.10 14.50 13.30 16.45 The main reason is that the FCFE and FCFF (Free Cash Flow to Equity and Free Cash Flow to Firm) has been negative for several years given the heavy fixed capital investments and debt payments.
  2. 2. Below is a snapshot of a few historical metrics. Note: My definition (and the right definition for that matter) of EV is. Enterprise value=Market value of equity at 30th June+ market value of preferred stock at 30th June+ book value of debt as at 30th June-Cash and cash equivalents as at 30th June. Kenya Power intends toincrease electricityinclusion from the current 30% to over 70% by 2017, a very ambitious move.I opine that the most sustainable growth rate would be to achieve this target by 2019 Year Ending (June) 09A 10A 11A 12A 13A 14A Ksh billion Revenue 65.2 73.2 73.2 95.7 88.9 105.4 EBITDA 7.8 8.8 10.9 12.4 14.6 21.8 Operating Profit 5.7 5.9 7.1 7.8 8.9 15.0 Pre-Tax Profit 4.8 5.6 6.3 8.5 6.6 10.2 EPS (Ksh) 40.76 46.97 2.43 2.37 1.77 3.31 DPS (Ksh) 8.00 8.00 0.45 0.50 0.00 0.50 Revenue Growth % 59.82% 12.20% -0.02% 30.77% -7.06% 18.54% EBITDA Growth % 48.5% 11.8% 24.8% 13.2% 17.8% 49.5% Earnings Growth % 82.74% 15.23% 13.54% 6.40% 4.96% 58.01% Operating Margin % 8.7% 8.1% 9.7% 8.2% 10.1% 14.2% Net profit margin 4.9% 5.1% 5.8% 4.7% 5.3% 7.1% Dividend Payout % 19.6 17.0 18.5 21.1 0.0 15.1 Return on Equity % 12.7% 13.4% 12.3% 11.2% 7.6% 12.7% Return on Assets % 4.91% 4.75% 4.09% 3.49% 2.94% 3.68% Gearing Ratio % 28.58% 29.88% 27.20% 38.53% 53.00% 53.95% Capex Coverage 95.67% 92.44% 66.12% 49.69% 37.31% 72.56% EBIT Coverage 6.44 9.37 18.43 6.82 6.46 6.41 P/CF 0.75 0.98 2.55 2.24 1.78 1.34 Price/Sales 0.18 0.22 0.51 0.31 0.32 0.25 EV/ EBITDA 4.88 5.02 4.77 4.56 5.59 4.11 P&L items as percentage of total assets Revenue 91% 86% 60% 70% 48% 48% EBITDA 11% 10% 9% 9% 8% 10% Depreciation 3.0% 3.3% 3.2% 3.3% 3.0% 3.0% Finance Costs 1.25% 0.37% 0.68% -0.51% 1.29% 2.18% Pre-Tax Profit 6.68% 6.62% 5.16% 6.25% 3.57% 4.63% Net Income 4.51% 4.37% 3.48% 3.30% 2.56% 3.38% Source: Paul Maina
  3. 3. without compromising the financial health of the company. The company intends to invest an extra USD 1.3Bn to support the distribution of the extra capacity to the grid of which 70% will constitute debt. 70% electricity inclusionwould see the company have 6,812,989 customers. 2014 2019F Kenya's Population 45,010,056 49,963,279 Number of house holds 8,767,954 9,732,841 Number of domestic customers 2,481,450 6,812,989 Electricityinclusion 28.30% 70% People per household 5.13 5.13 KeyAssumptions. a) Kenya’s population growth rate continues at the current 2.11%. b) Population per household remains constant. A key metric to forecast both FCFF and FCFE is the fixed capital investments (FCinv).To forecast capital expenditures, I noticed a strong correlation between the amount of money invested in time T and the growth of customer numbers in time T+1.Typically this is how Kenya Power works.After numerous applications for connectivityin a given area, Kenya power extends the distribution to that area. The numbers have to be sufficient to justify the extension. That is why there are cases of people who paid for connectivity and remain pending for months. The plan to connect all schools hasled to heavy investments and significant increase in customer numbers. Building and extending the network takes a long time such that its effects are felt one year period later.
  4. 4. The FCinv at financial year T versus increase in customer numbers at T+1 is as follows. Year 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E FCinv/Customer inc t+1 60 78 91 98 99 94 86 76 65 56 Fcinv (Mn) 26,511 26,949 30,742 33,550 35,453 36,713 37,706 In 2014, they spent Ksh 26,650Mn.My forecast stands at 26,949Mn, a margin of error of less than 1.2%.The expenditure per additional increase in customeris decreasing due toeconomies of scale, transformer maximization and leverage of newer electricity distribution strategies. Convexity analysis of FCinv and targetincrease in customer numbers is used to create the FCinv model. 2015E 2016E 2017E 2018E 2019E CFO 23,431,150 28,389,021 34,395,945 38,685,948 42,941,402 Borrowings 12,928,233 15,312,199 18,135,768 21,480,004 25,440,916 Debt Repayments (8,303,795) (9,835,015) (11,648,592) (13,796,592) (16,340,684) Fixed Capital Inv (30,741,823) (33,550,183) (35,452,856) (36,712,784) (37,706,122) interest expense 2,462,640 2,916,751 3,454,600 4,091,628 4,846,124 - - - - - FCFE (2,686,236) 316,022 5,430,264 9,656,575 14,335,513 - - - - - (4,551,222) (4,995,622) (3,119,436) 1,361,308 4,837,303 8,627,567 Valuation as at 30 Sept 2015 (5,090,394) (2,948,429) 1,193,503 3,933,899 6,508,201 Discount Factor 1.0190 0.9452 0.8767 0.8132 0.7543 Terminal Value - - - - 96,565,298 FCFF 100,162,078
  5. 5. COST OF EQUITY NSE 20 Market Return WACC 7.81% Equity Level 30.00% 30 June 2002 1,077.96 Risk free rate (FXD1/2012/20YR) 12.92% 30 June 2015 4,906.07 Historical equity risk premium 2.86% Annual Return 12.36% Beta 0.79 Bond YTM2004 9.50% CAPM E(R) 15.17% CURRENT CAPITAL MIX cost of equity 4.55% EQUITY 54,205,569 0.5050 COST OF DEBT DEBT 53,141,442 0.4950 Debt level 70.00% Cost of Debt 6.64% TOTAL 107,347,011 After tax cost of Debt 3.25% FCFF Value 100,162,078.18 Less Debt 53,141,442.00 Equity Value 47,020,636.18 Equity Value per share 24.10 Current Price 15.8 Upside 52.50% FCFF forecast assumptions: a) CFO will increase by 21% per annum over the next five years. b) Debt will grow by USD 0.91Bn to support evacuation and distribution of additional electricity. c) Electricityinclusionin the country will increase from 28% to 70% by 2019. d) Annual debt repayments average 10% p.a e) 1% terminal growth rate.
  6. 6. Alternatively, Should investors continue to price the stock at CFO generated from operations per share then the five year forecast would be 2012 2013 2014 2015E 2016E 2017E 2018E 2019E CFO_gen 14,405 8,454 23,208 29,474 37,432 47,539 60,375 76,676 Operation costs 19,680 20,984 22,683 26,629 30,369 34,548 39,193 44,325 Bank overdraft est 4,628 6,580 4,229 Bank overdraft interest exp 1,110 1,669 Borrowings 27,762 51,079 70,110 83,037 116,485 137,965 157,106 163,406 interest expense 1,144 1,383 2,338 2,856 3,495 4,276 5,232 6,401 Cash flow generated per share 7.38 9.46 11.89 15.10 19.18 24.36 30.94 39.29 Trading price at 30th June 15.1 14.5 13.3 18.35 2019 30th June expected trading price range: Kshs 42.86-ksh 46 Conclusion The next few years will be veryinteresting for Kenya Power. It has a lot of value lockedin it. From an entrepreneurial stand point, KenyaPower meets the threshold of a good and potentially great company; Home grown management, big hairy audacious goals, the power of alignment, a clear vision, increasingly strong customerfocus among others. RECOMMENDATION: BUY Paul Maina: Head of research, Relic Capital.

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