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FINN200 – INTERMEDIATE FINANCE

PROJECT

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AMAN BASHIR (21020369)
IQRA MUAZZAM (21110171)
WAJEEHA NOOR (21110143)
MUHAMMAD HASSAN AFZAL (21020461)
MUHAMMAD AUNS FAROOQ (21110243)
MUHAMMAD KHIZER ATTA TUNG (22110154)
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INTRODUCTION
K-electric is a joint-stock public limited company registered under Companies Ordinance 1984,
listed on Pakistan Stock Exchange. It supplies electricity to all the industrial, commercial,
agricultural, and residential areas that come under its network. The organization has over 2.5
million customer accounts in Karachi, Dhabeji and Gharo in Sindh, and Hub, Uthal, Vindar and
Bela in Balochistan

KE is the only vertically-integrated power utility in Pakistan, which means it manages all three
key stages – generation, transmission, and distribution- of producing and delivering energy to the
consumers.

ECONOMIC ANALYSIS

Before we move on to this section, it is pertinent to know that K-Electric is a local Pakistan based
company, so the only relevant economic analysis for our project will be that of Pakistan.

Pakistan is a developing country, it has and is expected to be more affected by the COVID-19
situation than the developed nations of the world.

Pakistan's pre-corona economy was facing a mild recession as a result of the stabilization
measures put forward through the fiscal and monetary policies. Then, on 22 nd March 2020, the
whole country went into lockdown, which resulted in a lot of socio-economic problems.

On the social front, livelihood opportunities have been compressed; daily wage earners and small
businesses have taken a huge hit. Charitable organizations and the government have tried to
make the situation more manageable with its relief packages, but the number of people affected
is uncontrollable.

On the economic front, the sudden closure of large industries, businesses, ports, and airports
have jammed the economic wheel. The consumption of petroleum products has gone down
substantially, resulting in a partial closure of refineries; This has affected millions of people who
are now jobless since industrial projects and businesses were a source of income for them.
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Electricity companies, such as K-electric, are facing issues of defaulting customers in the form of
businesses and industries, which have lost revenues to the point that paying the electricity bills is
out of the question. Similarly, on a residential level people have no source of income to pay bills.
As a result, the government is providing subsidies to these companies to pass on to residential
and industrial users.

Due to the current state of the economy, many key pressure points have taken a hit, such as the
GDP growth, inflation rate, unemployment rate, and current account deficit. According to the
World Economic Outlook Report by IMF, the GDP growth of Pakistan has decreased from 3.3 in
2019 to 2.4 in 2020, and the unemployment level has risen from 6.1 in 2019 to 6.2 in 2020.
Similarly, the inflation rate has risen from 7.3 in 2019 to 13 in 2020.

The current economic situation is not expected to get better soon. According to the Planning
Commission of Pakistan, the size of the nation's GDP is Rupees 44 Trillion. A 10 percent loss on
this is expected in the period between April and June 2020. The inflation rate accelerated to 13
percent is an alarming factor for the future as even more price hikes are expected, which can lead
to downsizing.

In conclusion, the current and the expected future trends suggest a problematic situation which
is expected to worsen which can have adverse impacts on investor confidence and negatively
affect the share price of K Electric.

INDUSTRIAL ANALYSIS

Electricity in Pakistan is generated, transmitted, distributed, and retail supplied by two vertically
integrated public sector utilities:

1. Water and power development Authority (WAPDA) for all of Pakistan (except Karachi)

2. Karachi electric (K-Electric) for the city of Karachi and its surrounding areas.

There are around 42 independent power producers (IPPs) that contribute significantly to
electricity generation in Pakistan.
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WAPDA is the only main competitor in this industry; it is a government-owned public utility
maintaining power and water in Pakistan. WAPDA includes Tarbela and Mangla dams among its
resources. Its headquarters are in Lahore.

IPP’s are operating in the private sector. They were brought into the industry to handle the
power shortage which Pakistan is facing. In 1994, the Government of Pakistan announced an
investor-friendly policy to develop IPPs based on oil, coal, and gas, which helped establish 16
IPPS. Later in 1995, a hydropower policy was announced, which resulted in the development of
the country's first Hydro IPP. In 2015, Pakistan adopted a new power policy by which another 13
IPPs were established, mostly by Chinese companies. As of 2018, currently, more than 40 IPPs
are operating in Pakistan.

Electricity generation in Pakistan has shrunk by up to 50% in recent years due to an over-
reliance on fossil fuels. China, Central Asia, and Iran have been offering to export electricity to
Pakistan at subsidized rates, but Pakistan has not yet responded to the offers for unknown
reasons. The country has begun diversifying its energy-producing capacity by investing in wind
and solar energy parks to help offset the energy shortage while larger projects such as the
Diamer bhasha dam and new nuclear plants are under construction.

FIRM ANALYSIS

Expansion plan, policy change, and capital expenditures:

Since October 2019, K-Electric (KE) has invested in and completed many ongoing projects, like
TP-1000, but has also accounted for the issues that the country's economic situation is
highlighting. Pakistan's circular debt has risen to a tremendously large amount, and KE's
significant receivables like the Government of Pakistan have accumulated to massive figures.

On 12th December 2019, K-Electric (KE) signed the issuance of Pakistan's largest-ever retail-
listed Sukuk worth PKR 25 billion (including PKR 5 billion greenshoe option). A Sukuk is an
Islamic financial certificate similar to a bond, which complies with Islam's laws. Since Pakistan is
on an economic downturn and circular debt in the country is rising by the day, this Sukuk might
be a way for KE to maintain its liquidity position, although it would mean rising finance costs and
a different capital structure.
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As of 12th March 2020, KE has energized a new grid station at Port Qasim, the 10 th 220kV grid
station in the KE fleet. This subproject is a part of KE's 460 million USD initiative, referred to as
TP-1000. The aim of TP-1000 is to add 1000 MVA to KE's transmission capacity, out of which 940
MVA is achieved by the energizing of the Port Qasim grid station, which is located at the heart of
the key industrial zone in Karachi. The management claims that they are attempting to achieve
commercial and industrial prosperity for Karachi with their projects.

Lastly, the coronavirus outbreak has stopped many industries in Pakistan and around the world.
As a firm in the power and utility sector, KE is facing logistical and fiscal bottlenecks due to
COVID-19, which is now impacting project timelines, which in turn may impact costs. However,
to cater to the rising unemployment rates and the government's regulations to account for
COVID, the company is allowing deferred payment for consumers less than 300 units per month
(21st April 2020). Although this helps the citizens get through these difficult times, for KE's
financials, this puts their cash flows at risk considering their already deteriorating liquidity
position. Continuous strain on cash flows poses a threat to KE's operations and the ability to
supply power to the city seamlessly.

Assumptions:
PRO FORMA INCOME STATEMENT

The data available to us for KE was from 2012 – 2018; we expanded that to 2023 using
appropriate methods keeping in mind the nature of the accounts and followed a proper
procedure.

Let us examine the projections starting from the Sales and Cost of Sales(COS); we accounted for
the factors that possibly affect the sales and cost of sales using a linear regression model. The
independent variables considered for the sales were: GDP, interest rate, inflation rate, and
population of Karachi. We also ran a regression analysis for COS taking the oil prices and inflation
as independent variables. Upon evaluation of the R square values in the regression, we assigned
the weights to each factor. The variables with higher R square values were allocated higher
weights.
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The sales were increased by 4% after evaluating the assigned weights and calculating the
expected growth rates of the regression variables. Similarly, COS was predicted using the growth
rate of -2%.

The percentage of sales method was applied to administrative expenses, other operating
expenses, and other income for the given data. The percentages for 2019-2023 were computed
using the moving averages method of the given data for the past five years. These percentages
were then multiplied with the respective year's sales to determine the expenses.

Finance cost was predicted using the percentage of long term financing. The long term financing
values from the balance sheet were used to calculate the percentages per year for the given data.
For years 2019-2023, we used moving averages of the past five years. These percentages were
then applied to the balance sheet's long-term financing to compute the finance cost in the income
statement.

Tax rates were calculated using the percentage of profit before tax (Taxation/profit before tax) of
the current data to speculate the future rates by using moving average fo the past five years.
Future rates were then applied to calculate the tax in the income statement.

PRESSURE POINTS

Revenue:

The company's revenue has spiked over the years from 2012 to 2018. Inflation fluctuating
between 9.68% and 2.53%, and revenue was significant in the beginning when inflation was on
its peak. The population growth of the country remained almost constant at the rate close to
2.53%. For a constant growth rate of population, revenue growth fluctuates, so the correlation
cannot be termed as a strong correlation. GDP growth is positive for the country over the years;
overall, it increased from 3.80% to 5.50%. Positive GDP growth implies the idea of revenue
growth; however, in reality, the revenue growth startled to -3.04% until it recovered in 2018 to
its peak. Revenue growth and real interest rate have a negative relation until 2014. According to
the trend depicted by the graph, when the interest rates fall, revenue increases.

COS:
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COS has a positive correlation with the change in gasoline prices. The graph depicts the crest and
trough of both the change of COS and the change in gasoline prices; an increase in gasoline prices
increased the COS as gas is the prominent input in the energy sector. The correlation between
inflation and COS is also positive, with a value of 0.467. Similarly, the correlation between the
real interest rate and COS is positive, as depicted by the graphs. GDP growth over the years in our
data set from the year 2012 to 2018. COS remains decreasing and increasing over time, with the
GDP giving less evidence of the relation between both variables. COS remained increasing and
decreasing despite the constant population growth sample.

PRO FORMA BALANCE SHEET

Non-current assets

Starting with PPE, we used the percentage of sales method to calculate for the current years and
the moving average of these percentages to predict for the future years. These percentages were
applied to revenues in the income statement to calculate the PPE.

Intangible assets, long term investments, long term loans, deferred tax assets, and long term
deposits were assumed to follow the same figure as of the year 2018.

Current assets

Stores and spare parts were predicted using the percentage of the COS for current years and the
moving average of these percentages to predict till 2023. These percentages were applied to the
COS in the income statement to predict stores and spares for yeara 2019-2023. Like PPE, Trade
debts were calculated using the percentage of sales.

Loans and Advances, trade deposits, other receivables, short term investments, derivative
financial asset, cash, and bank balances, and non-current assets held for sale were carried
forward as of 2018.

The taxation net followed the previous year's values and the tax amount calculated in the income
statement.

Equity and liabilities

Issued, subscribed, and paid-up capital was assumed to follow the trend over the years of being
constant at 96,261,551. The revenue reserves were predicted using a simple linear regression
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method in which we calculated the intercept and slope of the given revenue reserves and then
used this slope and intercept to predict the revenue reserves from 2019-2023 with the help of
ROUND in-built function in excel. This same method was used to predict the long term deposits
from 2019-2023.

Except for trade and other payables and long term deposits, all current and non-current liabilities
values followed the same trend as in 2018. Trade and other payables were predicted using the
same percentage of the COS method we used for stores and spare parts.

FREE CASHFLOWS

EBIT and taxes were taken from the income statements to calculate the NOPAT. Depreciation, net
working capital, and CAPEX for 2019-2023 were calculated using the moving average of the
existing data. FCF fro 2015-2022 were negative; however, 2022 onwards, they were predicted to
be positive.

BETA CALCULATIONS

KSE –100 index and K – electric index weekly prices from 2012-2018 were extracted. The
percentage changes of both the index were calculated. Afterward, the average annual returns
were determined for both of them; the annual return for KE was 19.54%, which is higher than
13.54% of KSE 100.

For the calculation of beta, we used the covariance of the percentage change in the price of KE
and KSE-100 and the variance of the market. KE's beta is 1.0176, indicating that KE's price is
theoretically more volatile than the market. The price is assumed to be 1.176% more volatile
than the market, implying that adding this stock to a portfolio increases the portfolio risk but
may also increase the expected return.

RATIO ANALYSIS

The current ratio of KE is less than one and shows a declining trend from 2019 to 2022; This is
because current liabilities show an increasing trend, majorly because of increasing provisions.
The quick ratio shows a similar trend as the current ratio due to similar reasons.
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The inventory turnover ratio also shows a declining trend due to the decrease in COS, which can
be associated with the current COVID-19 situation. The average collection period shows a decline
until 2022, but a drastic increase is seen in the year 2023 as trade debts increase. The average
payment period ratio is affected as the trade payables fluctuate. The asset turnover ratio has
negligible change, but the low number indicates that assets should be better managed.

The debt ratio is increasing from the year 2019 to 2023 due to the increase in the liabilities of KE
in those years. KE signed a loan agreement in 2019 and started new projects, such as providing
for GETZ pharma. A positive increase in time interest ratio suggests that the company will be able
to pay off the interests.

The gross profit margin is increasing every year, with a noticeable increase from 2019 to 2020.
This is because revenues and profits are increasing, which reflects a healthy financial standing of
the company. The increasing operating margin ratio would increase investor trust and shows
that KE is managing to earn profits. Net profit margin ratio and earning per share ratio backs this
claim by an increase every year, depicting profits. Return on total assets and total equity is also
increasing positively.

VALUATION OF KE:

DCF Method

Discounted cash flow analysis is used to value a project, company, or asset applying the concepts
of the time value of money.

First, we calculated the CAPM by using the beta value and the market return from beta
calculations. Next, we used investing.com to find the risk free return of 11.19%. CAPM formula
was then applied, and the cost of equity came was around 13.58%.

After calculating CAPM, we tabulated the cost of debt before tax (c.d)

(interest payments/total debt taken in that year). The cost of debt after tax (c.t) was calculated
using the tax rate (t) predicted in the pro forma income statement for the year 2018.

c.t = c.d (1-t)

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We calculated the weights of debt and equity now that we had the cost of debt and equity. For the
weight of equity, we used the share price of 5.68 taken as of 29th June 2018. Similarly, debt from
financial statements was used to calculate the weight of debt.

These weights, the cost of equity and debt, were then used to calculate the weighted average cost
of capital (WACC), which came out to be 11.1%.

Additionally, the free cash flows were discounted using the WACC. Discounted cash flows from
2019-2023 resulted in the total value of the company (148,373,089). Terminal cash flows were
determined using the growth rate of 4%.

Finally, the value of the stock was calculated by reducing the value of the debt from the
company's total value. The estimated share price was 2.43, which is less than the actual market
share price of Rs. 2.98 as of 13th May 2019.

MULTIPLES METHOD

PE Multiple

The competitors chosen were done so upon the availability of their online data. The competitor
companies chosen were Faisalabad ESPC, Southern EPSC, and Kot Addu Power Company. Their
PE ratios were taken from their financial statements, and the EPS of KE was acquired from PSX.
The average of the competitor's PE's (0.29) was multiplied to KE's EPS (0.45) to deduce an
estimated stock price of 1.31.

EBIDTA Multiple

Similar to the PE Multiple, competitor companies of KE were identified based on available online
data, and their EBITDA Multiple was taken. KE's competitor companies chosen were Faisalabad
ESPC, SEPCO, Pakgen Power Limited, and TESCO. The average of the EBITDA multiple was taken,
and the estimated industry proxy for EBIDTA multiple came to be 7.665.

We then tabulated the enterprise value (EV) of KE by using the following formula:

EBIDTA Multiple of KE * Average EBITDA Multiple of industry

Next, equity of KE was calculated using the following formula:

Equity = EV- long term debt – net operating cash + cash and bank balances
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The estimated stock price was determined by equity/number of outstanding shares, and the
share price came out to be 0.36.

SHARE PRICES AND EVALUATION

The market share price of K electric as of 13th May 2020 was 2.98, and the company is evaluated
to have a lower share price by the DCF (2.43) and Multiples method (PE Multiple= 1.31, EBITDA
Multiple= 0.36), indicating that the stock is overvalued.

A stock that is considered to be over-valued may experience a price decline to return to a level
that will better depict its financial position. Investors tend to avoid over-valued stocks; hence, it
is recommended to sell the stocks of K-Electric.

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