Sector Update: Over-Weight

PowerSector

Electricity November 2011

IPPs:Hedgedtonearperfection
The Power sector of Pakistan has been in the limelight for the past couple of years due to its inability to supply power and settle dues of energy chain. This has triggered lot of adjustments in the countrys energy mix and proved costly to some and indirectly beneficial for others. Consequently, we believe Power sector woes have opened investment opportunities at the local bourse. For example, FFC and FFBL in the fertilizer sector which have performed in the last couple of months due to urea price hike amid gas rationalization by the GoP. Similarly, we see a window of opportunity in the power sector mainly in Hub Power Company (HUBC) and Kot Addu Power Company (KAPCO). Their Power Purchase Agreement (PPA) with the GoP make their business model resilient to changes in consumer power tariffs, PKR/USD parity and the US CPI. Furthermore, the generation bonuses and guaranteed tariff structure also act as an added advantage for investment in the sector. Moreover, the recent 150bps cut in DR and the market expectations of further easing in the policy rate going forward also bodes well for the high dividend yielding stocks of the power sector.

JS Global Capital Limited

Power s ec tor v s . KSE 130% 115% 100% 85% 70% Jan-10 Apr-10 KSE Oct-10 Jul-10 Jan-11 Apr-11 Pow er Oct-11
1.5 5.9 17.4% 5.6% 25.0% 1.5 6.0 15.7% 6.8% 24.7%

Hub Power Company: Riding on power shortage

HUBC is our top pick in the power sector due to its rising Project Company Equity (PCE) component of Capacity Purchase Price (CPP) and generation bonuses amid supply shortfall in the country. Moreover, addition of the Narowal power project will further improve the top line of the company. In addition, HUBC has invested in Laraib power project and currently holds 75% of shareholding. It is expected to be operational by June 2013 and will provide more fuel to the profitability. Our liking for HUBC is also based on its attractive dividend yield of 16.1% which offers a spread of ~390bps and ~420bps over the 10-year PIB and 1-year T-Bill respectively. On a relative basis, HUBC is trading at FY12E PE of 6.2x compared to the JS Universe PE of 6.4x. We maintain our Buy call on it with a DDM based target price of Rs48 (potential upside of 29%).

So urce: KSE & JS Research

HUBC: Key statistics FY10A FY11A FY12E FY13F PBV (x) PE (x) Div.Yield (%) ROA (%) ROE (%) 1.2 6.7 15.6% 5.2% 18.7% 1.4 7.8 15.1% 4.0% 18.3% 1.5 6.2 16.1% 4.6% 23.6%

Source: JS Research

Kot Addu Power Company: Resilient earnings

Compared to HUBC, KAPCO lacks uptick in its tariff structure. However, the indexation factor that provides protection against the devaluation of PKR against USD and US CPI imply a low risk profile for the company. Although the company has shelved its expansion plan for the time being, we do not rule out a reversal in decision after the resolution of circular debt issue. KAPCO also seems attractive at current levels as it trades at a FY12E PE of 6.4x and offers a dividend yield of 14.5% compared to JS Universe PE and dividend yield of 6.4x and 8.4% respectively. We have a Buy call on the stock with a DDM based target price of Rs50 offering an upside potential of 21%.

KAPCO: Key statistics FY10A FY11A FY12E FY13F PBV (x) PE (x) Div.Yield (%) ROA (%) ROE (%) 1.8 8.0 10.8% 7.4% 22.3% 1.5 5.6 15.5% 7.5% 28.1% 1.5 6.4 14.5% 5.8% 23.7%

Source: JS Research

Completed on Nov 15, 2011 Distributed on Nov 16, 2011 All prices are as of Nov 15, 2011

Naveed Tehsin Senior Analyst naveed.tehsin@js.com 92 (21) 111-574-111 (ext. 3100) JS Research is available on Bloomberg, Thomson Reuters and CapitalIQ Please refer to the important Disclaimer on the last page

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Contents
Power supply shortfall Subsidies: Augmenting circular debt concerns IPPs are somewhat the safest investment Hub Power Company Riding on Power shortage Generation bonus from higher load factor Expansionary moves Favourable penal rates Valuation Key assumptions and risks to our thesis Financial highlights Kot Addu Power Company Resilient earnings Circular debt concerns Plant maintenance Valuation Key assumptions and risks to our thesis Financial highlights 04 05 06 07 07 08 08 09 09 10 11 11 12 12 12 14

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Power supply shortfall

Power shortfall in the country has become a major cause of concern for the economy. At present, the installed capacity of the Pakistans power sector is 20,922MW while production currently stands at 12,482MW and 14,840MW in winter and summer respectively. This results in respective power shortfall of 2,469MW and 5,022MW during winter and summer. The capability to produce is significantly lower than the installed capacity mainly due to seasonality factor in hydel generation coupled with limited life and inefficiencies of thermal power plants. Furthermore, inefficiencies pertaining to Transmission & Distribution (T&D) infrastructure are also adding to the woes of the power sector. In our view, the gap between demand and supply of electricity can be reduced, if the circular debt issue gets resolved.
Elec tr ic ity gener ation by c ompany 8.4% 3.0% 8.4% 4.3% 3.4% 9.2% 1.6% 11.7%

WAPDA KAPCO HUBC

KESC Uch Liberty

50.0% PAEC Rousch Other IPPs

So urce: Energy Yearbo o k

Ins t alled elec t ric it y generat ion c apac it y (MW)

21,000 18,000 15,000 12,000 9,000 6,000 3,000 0 FY05 FY06 FY07 FY08 FY09 FY10 Hydel Thermal (KESC) Termal (Private) Nuclear

Thermal (WAPDA)

Source: Energy Yearbook

Furnace oil based IPPs are not the long term solution
Though thermal power plants are cheaper and take less installation time compared to hydel power plants, they (especially furnace oil based plants) have higher operating costs. Operating costs for gas fired thermal power plants are low (power generation cost through gas is approx. one third the cost of furnace oil based plant), but due to unavailability of indigenous natural gas very few gas based power plants are in the pipeline.

Thermal elec t ric it y generat ion by f uel (GWh)

70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 FY05 FY06 FY07 FY08 FY09 FY10 Gas Oil Coal

Source: Energy Yearbook

November 2011

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Furthermore, GoPs gas allocation policy prioritizes requirements of domestic, commercial, fertilizer and industrial sectors. As a result, power sector consumed 29% of total gas production in FY10 versus 44% in FY05. Consequently, the GoP has relied on power production through furnace oil which has resulted in mounting pressure on the government in the form of higher subsidies.

S ec t or wis e gas c ons umpt ion

FY10 17% 8% 0% 14% 28% Gen.Industry Pow er 4% Cement Transport(CNG) 43% Fertz.(Fuel) Domestic 4% Fertz.(Feedstock) Commercial 13% 3% 26% 2% FY05 15% 2% 20% 1%

Source: Energy Yearbook

Alternatives
According to a World Bank report, energy source for worldwide electricity production in percentage terms is led by coal at 40% followed by gas, nuclear, hydel and oil at 19%, 16%, 16% and 7% respectively. In Pakistan, however, energy requirement are met through oil which constitutes 38%, followed by gas and hydel at 29% each. Coal and nuclear, on the other hand contributes only 0.1% and 3.3% respectively, leaving vast potential for growth. Although Pakistan has been blessed with ample water resources but it stores only 13% of the annual flow of its rivers. The storage is fast depleting due to sedimentation. The hydropower potential in Pakistan is over 55,000MW. At present, the projects that are under study include Diamer Basha (4,500MW), Bunji (7,100MW) and Kohala (1,100MW) amongst many others. With 185bn tons of coal reserves, the fourth largest in the world, utilization of this resource is non-existent. According to some estimates, if half of these resources are exploited properly, it would be sufficient for generating 100,000MW of electricity for 30 years.
Elec tr ic ity gener ation by s our c e Nuclear & Imported, 3.3% Hydel, 29.4%

Gas, 29.4%

Coal, 0.1% Hydel Coal Nuclear & Imported

So urce: Energy Yearbo o k

Oil, 37.8% Oil Gas

Subsidies: Augmenting circular debt concern

The huge amount of ~Rs1tn had been given by the GoP in the last three years on account of power subsidy. The government provided subsidies worth Rs342bn to the power sector in FY11 alone against the budgetary target of Rs84bn. Despite the recent increase in power tariff on account of fuel adjustments, we believe the GoP is likely to overrun its budgetary target. The actual Tariff Differential Subsidy (TDS) amounted to Rs31bn in 1QFY12 against the total allocation of Rs50bn for the full year.

Circular debt putting pressure on the entire energy chain

The lower availability of hydel resources for power generation, and shortage of gas in the country has skewed the fuel mix of power generation towards costlier
November 2011

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alternative i.e. furnace oil. Despite hefty increase of power tariff in recent years, a significant gap still exists between the generation cost and the power tariff charged from consumers. Therefore, the GoP provides a subsidy to bridge this gap which has been the root cause of the circular debt issue. This has caused liquidity concerns for the whole energy chain leading to fuel supply issues. In a recent development, the GoP has reportedly converted outstanding financing and accrued markup worth ~ Rs 313bn of public sector power companies (PHL, NTDC and WAPDA) into PIBs. The measure will primarily benefit banks, however, companies in the energy chain will also gain as additional credit will be available for the sector. Moreover, a fresh funding request of US$2bn for power sector from Asian Development Bank and World Bank shows GoPs commitment for the resolution of the issue. However, we still believe that reforms in form of cutting down the power sector subsidies are required to solve the circular debt issue permanently.

IPPs are somewhat the safest investment

Investment in IPPs offers decent returns amid high earnings certainty. Their Power Purchase Agreement (PPA) with the GoP has made their business model resilient to changes in power tariffs, PKR/USD parity and US CPI. As per PPA, IPPs can sell power only to one single customer, WAPDA. Therefore, GoP has provided sovereign guarantees to IPPs in case of default of contractual payments. On the whole, their earnings are somewhat resilient even in these adverse economic conditions and thus provide one of the safest investments at the local bourse. However, adversity of circular debt issue remains a key risk for the IPPs since it may intensify their cash flow problems.

Monetary easing to bode well for the sector

The 150bps ease in Discount Rate (DR) by the SBP on October 8, 2011 and the expectation of a further slash in DR, bodes well for the dividend yield nature of IPPs. IPPs, due to their guaranteed return formula are often compared with the GoP backed fixed income securities. The 1year T-Bill and 10year PIB currently offers 11.83% and 12.19% respectively compared to dividend yields of 16.1% and 14.5% of HUBC and KAPCO. The earnings yield of HUBC and KAPCO are 16.1% and 15.7% respectively.

Dis c out rat e impac t on t he s hare pric e of HUB C & K AP CO

80 70 60 50 40 30 20 10 0 HUBC KAPCO DR (RHS) 16 15 14 13 12 11 10 9 8

(Rupees)

Oct-07 Jan-08 Apr-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09

Aug-09 Nov-09 Feb-10 May-10 Aug-10 Oct-10 Jan-11 Apr-11

Source: KSE & JS Research

November 2011

Nov-06 Jan-07 Apr-07 Jul-07

Jul-11 Oct-11

(%)

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Hub Power Company Riding on power shortage

HUBC is our top pick in the power sector due to its rising Project Company Equity (PCE) component of Capacity Purchase Price (CPP) and generation bonuses amid supply shortfall in the country. Moreover, addition of the Narowal power project will further improve the top line of the company. In addition, HUBC has invested in Laraib power project and currently holds 75% of shareholding. It is expected to be operational by June 2013 and will provide more fuel to the profitability. Our liking for HUBC is also based on its attractive dividend yield of 16.1% which offers a spread of ~390bps and ~420bps over the 10-year PIB and 1-year T-Bill respectively. On a relative basis, HUBC is trading at FY12E PE of 6.2x compared to the JS Universe PE of 6.4x. We maintain our Buy call on it with a DDM based target price of Rs48 (potential upside of 29%).

Company Update: Target Price:

BUY

Rs48

KATS Code: HUBC Bloomberg Code: HUBC PA Reuters Code: HPWR.KA Market Price: Rs37.34

HUB C: Div idend y ield v ers us T-Bills & P IB s

18% 16% 14% 12% 10% 8% 6% 4% 2% 0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E 1yr T-Bill 10yr PIB HUBC

Market Cap: Rs43.2bn US$498.7mn 1-yr Avg. Daily Volume: 1.5mn shares Rs58.9mn US$0.7mn 1-yr High/Low: Rs42.57/35.54 Estimated free float: 810mn shares (70%)

Source: JS Research

HUBC v s KSE- 100 index 160% 140% 120% 100% 80% 60% 40% 20% 0%

HUBC with cash flows based on 30 year PPA, has a relatively predictable cash flow stream. According to the tariff structure of HUBC, the PCE component which is predefined in CPP ensures guaranteed earnings uptick till the validity of HUBCs agreement, leading to increased returns to equity investors even in real terms excluding changes in PKR/USD exchange rate and US CPI.

KSE-100 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

HUBC Jul-11
6.4 25.4 5.9 1.5 17.4%

PKR/USD rate and US CPI to augment indexation factor

HUBCs tariff payments are dollar based and US CPI adjusted. This gives an added advantage to the investors in depreciating PKR environment. Therefore it is likely to augment indexation factor going forward resulting in improved earnings and dividends.

So urce: KSE & JS Research

Generation bonus from higher load factor

According to PPA, HUBC is entitled to receive a generation bonus of Rs0.10/kWh if it produces more than 6,791GWh a year. An additional Rs0.05/kWh is paid for each kWh in excess of 7,358GWh. HUBC being a FO based IPP has proved to be expensive alternative for its buyer PEPCO, which limited buying electricity from HUBC when the country had an electricity surplus. However, with the rise in power shortage in the last few years, load factor demanded from HUBC has

Key statistics FY10A FY11A FY12E FY13F EPS (Rs) BV (Rs) PE (x) PBV (x) Div.Yield (%) 4.8 25.8 6.7 1.2 15.6% 4.7 25.5 7.8 1.4 15.1% 6.0 25.5 6.2 1.5 16.1%

Source: JS Research

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increased accordingly. Consequently, the company has taken advantage of this generation bonus which is likely to continue going forward.

P ower generat ion & load f ac t or

90% 80% 70% 60% 50% 40% 30% 20% 10% 0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 Load Factor-LHS Pow er Generation 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 (GWh)

Source: Company accounts & JS Research

Expansionary moves
Narowal Plant
After delays, HUBC finally announced its Narowal Plant Commercial Operation Date (COD) in April 2011 (initially targeted for March 2010). Its an oil fired power plant with capacity of 225MW. The term of power purchase agreement would be 25 years and the fuel supply agreement has been signed with PSO. As per the power policy, Narowal project will get 15% USD based IRR. The revenue from Narowal plant continues to be recognized on the basis of reference tariff as the NEPRA is yet to announce the post COD tariff for the plant. Therefore, the differential amount of revenue due to an agreed tariff adjustment will be recognized moving forward.

Laraib Energy Limited

HUBC has a 75% shareholding in Laraib Energy Limited. It is an 84MW hydel project located downstream from Mangla dam in Azad Jammu & Kashmir. The project is targeted to achieve COD by June 2013. It will be developed under BuildOwn-Operate-Transfer (BOOT) system and transferred free of cost to GoP at the end of the 25 year term. As per the power policy for hydro projects, it will get 17% USD based IRR.

Favorable Penal rates

HUBC supplies power exclusively to WAPDA. The company also has a special agreement for the supply of FO with Pakistan State Oil (PSO). The company used to have sufficient cash with no need of short term borrowing while trade debt and payables were also under control. In the last few years due to the circular debt issue, WAPDA has started delaying payments to the company resulting in liquidity problem. Under the PPA, delayed payments from WAPDA are penalized at SBP discount rate +200bps, while the company must pay PSO at the same penal rate for its late payments. Therefore, at the current rates short term financing cost of the company is less than the penal rate it charges from WAPDA so the company actually earns a small spread on short term financing. However, if things get worse HUBC has to transfer its delayed receivables into delayed payable.
November 2011

Effec ts of c ir c ular debt 100 80 (Rs bn) 60 40 20 FY05 FY06 FY07 FY08 FY09 FY10 FY11 0 Running Finance borrow ing Trade Payable Cash Trade Debt

So urce: Co mpany acco unts & JS Research

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Valuation
HUBC offers an upside potential of 29% to our target price of Rs48. HUBC at its current price offers a dividend yield of 16.1% for FY12E, compared to JS Universe average dividend yield of 8.4%. Its dividend yield is also considerably higher compared to the regional average of 5.4%. Moreover, it trades at a FY12E PE of 6.2x which is at a discount of 57% compared to its regional peers. We currently maintain a Buy stance on the scrip.
Regional PE c ompar is on
HUBC KAPCO Gujarat Ind Pwr Electricity Gen Co Dat ang Intl YTL Power PTC India Ltd Ratchaburi Elec Tat a Pwr India GD Pwr Dev Co China Rsrcs Pwr Huaneng Pwr Intl Glow Energy Ltd Huadian Pwr Intl Reliance Pwr India 0 10 20 30 40

Key assumptions and risks to our thesis

HUBC provides US dollar based and US CPI adjusted returns to its investors and we have assumed a 2.5% depreciation of PKR against the USD and US CPI of 2% per annum moving forward. The fair value of the stock is highly sensitive to these two assumptions.
PKR Depreciation 1.0% 37.2 39.4 41.9 44.6 47.6 51.1 54.9 1.5% 38.0 40.3 42.8 45.7 48.9 52.4 56.5 2.0% 38.7 41.1 43.8 46.8 50.1 53.9 58.1 2.5% 39.5 42.0 44.8 48.0 51.5 55.4 59.8 3.0% 40.4 43.0 45.9 49.2 52.9 57.0 61.6 3.5% 41.3 44.0 47.0 50.5 54.3 58.6 63.5 4.0% 42.2 45.0 48.2 51.8 55.9 60.4 65.5

So urce: B lo o mberg & JS Research

Hub Power 0.5% 1.0% US CPI 1.5% 2.0% 2.5% 3.0% 3.5%

Regional div . y ield c ompar is on

Tata Pwr India China Rsrcs Pwr PTC India Lt d Energy Dev Corp Datang Intl Gujarat Ind Pwr Glow Energy Lt d GD Pwr Dev Co YTL Power Ratchaburi Elec Gen Huaneng Pwr Intl Elect ricity Gen Co KAPCO HUBC 0% 5% 10% 15% 20%

Source: JS Research

The fair value of HUBC is highly sensitive to interest rate movements as well. In the current economic scenario, where the market expectation is for further easing in monetary stance by the SBP, may act as a catalyst for the stock.

HUB C: Fair v alue on t he bas is of ris k f ree rat e

60 50 (Rupees) 40 30 20 10 -2% -1% Base Case 1% 2%

So urce: B lo o mberg & JS Research

Source: JS Research

Key Risks
The key risk for HUBC in particular and power sector in general is the mounting circular debt. Although the GoP is trying to bridge this gap by increasing power tariffs, however, we still believe drastic measures by ways of eliminating subsidies are required. Nonetheless, given FY13 is the election year, the GoP may not raise power tariff by the required amount as a part of its populous measure, consequently worsening the circular debt issue.

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Hub Power Financial Highlights

(Rs m n) Incom e State m e nt Rev enue Operating Cos ts Gros s prof it Other inc ome General & A dminis trativ e ex pens es Operating Prof it Financ ial Charges PAT Balance She e t Is s ued, s ubs c ibed and paid-up c apital Unappropriated prof its Shar e holde r 's Equity Non c urrent liabilities Current Liabilities Total Liabilitie s & Equity Non-Current A s s ets Total Current A s s ets Total As s e ts Ratio Analys is V alu ation Earning / (Los s ) per s hare Div idend per s hare Book v alue per s hare Pric e to earning ratio (x ) Div idend Y ield (% ) Pric e to book v alue (x ) Pr ofitability Operating Margin Net margin Return on as s ets Return on equity M om e ntum Sales grow th Net prof it grow th Sourc e: J S Res earc h & Company Ac c ounts 33% 45% 20% 47% 24% -2% 29% 29% 9% 6% 9% 12% 7% 5% 5% 13% 7% 6% 5% 19% 7% 4% 4% 18% 8% 4% 5% 24% 7% 4% 6% 25% 6% 4% 9% 28% 3.3 3.4 25.5 6.7 15% 0.9 4.8 5.0 25.8 6.7 16% 1.2 4.7 5.5 25.5 7.8 15% 1.4 6.0 6.0 25.5 6.2 16% 1.5 6.4 6.5 25.4 5.9 17% 1.5 7.2 7.0 25.6 5.2 19% 1.5 11,572 17,961 29,532 11,356 49,297 90,186 39,196 50,990 90,186 11,572 18,310 29,881 23,501 69,313 122,696 52,874 69,821 122,695 11,572 17,949 29,520 27,251 89,469 146,240 53,619 92,620 146,240 11,572 17,978 29,550 24,208 103,300 157,057 52,118 104,939 157,057 11,572 17,837 29,409 20,979 54,923 105,310 49,838 55,472 105,310 11,572 18,014 29,585 16,750 26,808 73,143 47,561 25,582 73,143 82,784 76,687 6,097 138 360 5,876 2,095 3,781 99,694 92,006 7,688 53 392 7,350 1,794 5,556 123,310 114,093 9,217 27 437 8,807 3,382 5,425 159,018 145,085 13,932 29 491 13,470 6,498 6,972 173,821 160,587 13,234 31 525 12,739 5,359 7,380 189,736 177,779 11,957 427 562 11,823 3,546 8,277 FY09A FY10A FY11A FY12E FY13F FY14F

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Kot Addu Power Company Resilient earnings

Compared to HUBC, KAPCO lacks uptick in its tariff structure. However, the indexation factor that provides protection against the devaluation of PKR against USD and US CPI imply a low risk profile for the company. Although the company has shelved its expansion plan for the time being, we do not rule out a reversal in decision after the resolution of circular debt issue. KAPCO also seems attractive at current levels as it trades at a FY12E PE of 6.4x and offers a dividend yield of 14.5% compared to JS Universe PE and dividend yield of 6.4x and 8.4% respectively. We have a Buy call on the stock with a DDM based target price of Rs50 offering an upside potential of 21%.

Company Update: Target Price:

BUY

Rs50

KATS Code: KAPCO Bloomberg Code: KAPCO PA Reuters Code: KAPCO.KA Market Price: Rs41.38 Market Cap: Rs36.4bn US$420.4mn 1-yr Avg. Daily Volume: 0.4mn shares Rs17.8mn US$0.2mn 1-yr High/Low: Rs47.45/39.26

K AP CO: Div idend y ield v ers us T-B ills & P IBs

20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E 1yr T-Bill 10yr PIB KAPCO

Estimated free float: 176mn shares (20%)

Source: JS Research

The PPA for KAPCO also provides a hedge over major exogenous variables such as PKR/USD exchange rate, US CPI and fuel price changes. Although, the company is facing cash flow constraints in the near term but its predetermined tariff structure ensures profitability moving forward.

KAPCO v s KSE- 100 index 140% 120% 100% 80% 60% 40% 20% 0%

Indexation factor to result in improved earnings

Compared to HUBC, KAPCO lacks uptick in its tariff structure and is flat. However, the indexation factor which provides protection against the PKR/USD exchange rate and US inflation imply a low risk profile for the company and is expected to result in increased earnings moving forward.

KSE-100

KAPCO

Jul-08

Jan-09

Jul-09

Jan-10

Jul-10

Jan-11
6.5 27.7 6.4 1.5

The circular debt concerns

Due to the gas shortage in the country, the circular debt issue has worsened for KAPCO due to its energy mix tilt towards more expensive fuel. Gas being the cheaper alternative compared to FO, electricity generation through gas results in less cash burden on the company. Although the GoP is trying to bridge the gap between power generation cost and power tariff, through power tariff hikes but a lot more has to be done.

So urce: KSE & JS Research

Key statistics FY10A FY11A FY12E FY13F EPS (Rs) BV (Rs) PE (x) PBV (x) Div.Yield (%) 5.8 25.6 8.0 1.8 10.8% 7.4 27.2 5.6 1.5 15.5% 6.9 28.1 6.0 1.5 15.7%

Penal rates
The impact of circular debt is more severe for KAPCO compared to HUBC because it has a higher interest payment on delayed payments to PSO compared to interest receivable on payments from WAPDA. KAPCO manages its cash flow problems arising from delayed payments from WAPDA, by delaying payments to
November 2011

14.5%

Source: JS Research

Jul-11

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Expansion plan shelved

KAPCO has shelved its plans for the US$350mn, 280MW power project due to liquidity constraints amid circular debt issue. The company had earlier cut the proposed expansion project size from 450MW to 280MW due to liquidity constraints and other commercial considerations. The expansion was planned in the KAPCOs current facility that would have saved significant infrastructure development cost. If the circular debt issue gets resolved, it should result in improved liquidity for KAPCO and that the expansion plan may resume.

(Rs bn)

PSO and through short term borrowings. Under the PPA, delayed payments from WAPDA are penalized at DR+4%, while KAPCO pays PSO at a penal rate of 6M TBill+6%. As short term borrowing was cheaper, the company was able to earn a small spread on taking short term financing and charging higher penal rate from WAPDA. However, now due to its increased leverage position it is finding it difficult to get short term borrowing and has to take resort in higher penal payment.

Effec ts of c ir c ular debt 80 70 60 50 40 30 20 10 0 Running Finance borrow ing Trade Payable Cash Trade Debt

FY05

FY06

FY07

FY08

FY09

FY10

So urce: Co mpany acco unts & JS Research

Power gener ation & load fac tor Load Factor-LHS Pow er Gen.(GWh)

Plant maintenance
KAPCO has entered into US$14mn contract with GE for upgrading four gas turbines. When the total project is completed i.e. by the end of 2011, overall plant net combined-cycle efficiency is expected to increase by 0.44%, while the output of each gas turbine will increase by 3MW for a plant total of 12MW. The completion of the project will improve the bottom-line of the company going forward.

80% 60% 40% 20%

10000 8000 6000 4000 2000

FY05

FY06

FY07

FY08

FY09

FY10

Valuation
Although the relative attractiveness of the scrip is overshadowed by HUBC and it carries greater exposure to the circular debt issue, we believe most negatives are priced in at its current price. KAPCO at its current price offers a dividend yield of 14.5% for FY12E, compared to JS Universe average dividend yield of 8.4%. Its dividend yield is also higher compared to the regional average of 5.4%. Moreover, it trades at a FY12E PE of 6.4x which is at a discount of 55% compared to its regional peers. At the current price, we have a Buy stance on the scrip.

So urce: Co mpany acco unts JS Research

Regional PE c ompar is on
HUBC KAPCO Gujarat Ind Pwr Electricity Gen Co Dat ang Intl YTL Power PTC India Ltd Ratchaburi Elec Tat a Pwr India GD Pwr Dev Co China Rsrcs Pwr Huaneng Pwr Intl Glow Energy Ltd Huadian Pwr Intl Reliance Pwr India 0 10 20 30 40

Key assumptions and risks to our thesis

KAPCO provides US dollar based and US CPI adjusted returns to its investors and we have assumed a 2.5% depreciation of PKR against the USD and US CPI of 2% per annum moving forward. The fair value of the stock is highly sensitive to these two assumptions. Following is the sensitivity to the changes in assumption.
KAPCO 0.5% 1.0% US CPI 1.5% 2.0% 2.5% 3.0% 3.5% PKR Depreciation 1.0% 41.0 42.4 43.9 45.4 46.9 48.5 50.1 1.5% 42.4 43.9 45.4 46.9 48.5 50.1 51.8 2.0% 43.9 45.4 46.9 48.5 50.1 51.8 53.5 2.5% 45.3 46.9 48.5 50.1 51.8 53.5 55.3 3.0% 46.9 48.5 50.1 51.8 53.5 55.3 57.1 3.5% 48.4 50.1 51.8 53.5 55.3 57.1 59.0 4.0% 50.0 51.7 53.5 55.3 57.1 59.0 60.9

So urce: B lo o mberg & JS Research

Regional div . y ield c ompar is on

Tata Pwr India China Rsrcs Pwr PTC India Lt d Energy Dev Corp Datang Intl Gujarat Ind Pwr Glow Energy Lt d GD Pwr Dev Co YTL Power Ratchaburi Elec Gen Huaneng Pwr Intl Elect ricity Gen Co KAPCO HUBC 0% 5% 10% 15% 20%

Source: JS Research

So urce: B lo o mberg & JS Research

November 2011

FY11

0%

FY11

Power Sector

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The fair value of KAPCO is highly sensitive to interest rate movements. In the current economic scenario, where the market expectation is for further easing in monetary stance by SBP, may act as a catalyst for the stock. Following is the sensitivity analysis of KAPCOs fair value to changes in risk free rate.

K A P CO: Fair v alue on t he bas is of ris k f ree rat e

56 54 52 (Rupees) 50 48 46 44 42 40 -2% -1% Base Case 1% 2%

Source: JS Research

Key Risks
As per PPA, KAPCO is liable to pay higher interest on delayed payments to PSO compared to its interest receipts on delayed payments from WAPDA. Although the company manages this gap with short term borrowing, however, now due to its increased leverage position it is finding it difficult to get short term borrowing and things may worsen if the circular debt issue gets out of control.

November 2011

Power Sector

Page 14

Kot Addu Power Financial Highlights

(Rs m n) Incom e State m e nt Revenue Operating Costs Other income Operating Prof it Financial Charges PBT Tax PAT Balance She e t Issued, subscibed and paid-up capital Unappropriated prof it Shar e holde r 's Equity Non current liabilities Current Liabilities Total Liabilitie s & Equity Non-Current A ssets Total Current A ssets Total As s e ts Ratio Analys is V aluation Earning / (Loss) per share Dividend per share Book value per share Price to earning ratio (x) Dividend Y ield (% ) Price to book value (x) Pr ofitability Operating Margin Net margin Return on assets Return on equity M om e ntum Sales grow th Net prof it grow th Source: JS Research & Company Accounts 24% -29% 24% -10% -13% 28% 19% -12% 28% 6% 5% 27% 22% 8% 10% 26% 15% 6% 7% 22% 25% 9% 8% 28% 21% 6% 6% 24% 15% 5% 7% 25% 11% 6% 12% 31% 6.4 6.5 26.2 5.9 17% 1.5 5.8 5.0 25.6 8.0 11% 1.8 7.4 6.5 27.2 5.6 16% 1.5 6.5 6.0 27.7 6.4 14% 1.5 6.9 6.5 28.1 6.0 16% 1.5 8.8 8.5 28.4 4.7 21% 1.5 8,803 14,281 23,083 8,137 28,739 59,959 18,796 41,163 59,959 8,803 13,692 22,495 7,472 47,634 77,600 17,966 59,634 77,600 8,803 15,157 23,960 7,618 63,759 95,337 17,421 77,916 95,337 8,803 15,597 24,400 7,003 70,319 101,721 16,916 84,806 101,721 8,803 15,934 24,737 5,249 47,261 77,246 16,170 61,077 77,246 8,803 16,173 24,975 4,170 21,166 50,312 15,411 34,901 50,312 69,364 58,373 4,870 15,133 6,410 8,723 3,051 5,672 85,935 76,011 3,774 13,066 5,336 7,731 2,641 5,089 74,351 63,653 8,381 18,611 8,704 9,907 3,380 6,527 88,779 75,481 5,988 18,771 9,969 8,802 3,081 5,721 113,412 99,793 3,505 16,558 7,237 9,321 3,262 6,059 118,943 104,821 66 13,564 1,686 11,879 4,157 7,721 FY09A FY10A FY11A FY12E FY13F FY14F

November 2011

Research Team
Naveed Tehsin Syed Atif Zafar Bilal Qamar Muzzammil Aslam Furqan Ayub Raheel Ashraf Adeel Jafri Muhammad Furqan Power & Gas Distribution Strategy, E&P, OMCs, Refinery, Autos & Chemicals Banks, Fertilizer, Insurance & Textile Economy & Politics Cements & Telecom Technical Analyst Database Manager Librarian (92-21) 111574111 (ext. 3118) (92-21) 111574111 (ext. 3099) (92-21) 111574111 (ext. 3035) (92-21) 111574111 (ext. 3103) (92-21) 111574111 (ext. 3098) (92-21) 111574111 (ext. 3098) (92-21) 111574111 (ext. 3105) atif.zafar@js.com bilal.qamar@js.com muzzammil.aslam@js.com furqan.ayub@js.com raheel.ashraf@js.com adeel.jafri@js.com muhammad.furqan@js.com (92-21) 111574111 (ext. 3100) naveed.tehsin@js.com

Equity Sales
Junaid Iqbal Umer Bin Ayaz Murtaza Jafar M. Jawad Khan Sabahuddin Rizvi Ahmed Abdul Rauf Asim Ali Mujtaba Barakzai Shakir Padela Abdul Aziz Irfan Iqbal Irfan Ali (92-21) 32799511 (92-21) 32799511 (92-21) 32799516 (92-21) 32799518 (92-21) 32799518 (92-21) 32799518 (92-21) 32799509 (92-21) 32800152 (92-21) 32800152 (92-21) 32799507 (92-21) 32799502 (92-21) 32462567 junaid.iqbal@js.com umer.ayaz@js.com murtaza.jafar@js.com jawad.khan@js.com sabahuddin.rizvi@js.com ahmed.rauf@js.com asim.ali@js.com mujtaba.barakzai@js.com shakir.padela@js.com abdul.aziz@js.com irfan.iqbal@js.com irfan.ali@js.com

Head Office
6th Floor, Faysal House Main Shahra-e-Faisal Karachi, Pakistan

KSE Office
2nd Floor, Room No.75, Karachi Stock Exchange Stock Exchange Rd, KHI

Lahore Office
Plot 4, Bl-R, M.M.Alam Road, main Boulevard, Gulberg-III, Lahore Fax: +9242 35789109

Islamabad Office
Room No.413, 4th Floor ISE Towers, 55-B, Jinnah Avenue, Islamabad. Fax: +9251 2806328

Hyderabad Office
Office M-7, Rabbi Center, adj. Belair Hospital, Cantt. Saddar, Hyderabad Tel: +9222 111-574-111 Fax: +9222 2720581

Tel: +9221 111-574-111 Tel: +9221 32425692 Fax: +9221 32800163,66 Fax: +9221 32418106 Website: www.js.com

Tel: +9242 111-574-111 Tel: +9251 111-574-111

JS Global Capital Limited

ANALYST CERTIFICATION I, Naveed Tehsin, the author of this report, hereby certify that all of the views expressed in this research report accurately reflect my personal views about any and all of the subject issuer(s) or securities. I also certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. DISCLAIMER This report has been prepared for information purposes by the Research Department of JS Global Capital Limited. The information and data on which this report is based are obtained from sources which we believe to be reliable but we do not guarantee that it is accurate or complete. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors who should seek further professional advice or rely upon their own judgment and acumen before making any investment. This report should also not be considered as a reflection on the concerned companys management and its performances or ability, or appreciation or criticism, as to the affairs or operations of such company or institution. JS Global does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Warning: This report may not be reproduced, distributed or published by any person for any purpose whatsoever. Action will be taken for unauthorized reproduction, distribution or publication.