January 2013
Utility Sector: Poised to Be Driven By Nature Defensive Counters, Immense Growth Potential, Bright Future
Table of Contents
Executive Summary Pg. 2
Why the Incommensurable Bullish View from Consensus? Pg. 3
Energy Sector Analysis Pg. 4
KenGen: Investment Thesis Pg. 11
Valuation Pg. 16
Risks Pg. 20
KPLC: Investment Thesis Pg. 23
Valuation Pg. 27
Risks Pg. 30
Appendices Pg. 31
Research Team
Moses Waireri
+254 020 2774781
Anthony Kimani
+254 020 2774781
For trading queries kindly contact;
Carol Matu
Head Trader
Direct Line: +254 020 2774789
Mumbi Mbiyu
Head of Investment Advisory
Direct Line: +254 020 2774768
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Utility Sector: Poised to Be Driven By Nature
Executive Summary
We initiate coverage on Kenya’s Utility Sector with a bullish outlook informed by the following factors:
The Kenyan electricity market is characterized by surging power demand. This can be attributed to;
an expanding population,
increased connectivity of subscribers,
increase in per capita income and
Expansion of the manufacturing, agricultural and other economic sectors.
Historically supply has exceeded demand however it is worth noting that power plants have long lead
times and demand catches up with supply eventually. Furthermore the reserve margin is at 3% which is
below the recommended 15%.
Going Green... Diversification of the base load energy provider from Hydro energy to geothermal, wind
and solar implies that utility stocks which have historically behaved like cyclical stocks (due to the fact
that their performance is pegged on the amount of rainfall received) are now more likely to be viewed
as defensive stocks. Further we believe that these stocks provide a unique investment opportunity for
“green investors” who want to benefit from high growth coupled with reduced volatility.
Vast Untapped Natural Resources…It is estimated that the geothermal potential in Kenya is
approximately 10,000Mw with only about 198Mw being exploited. Even more surprising is Kenya’s
wind potential. DEWI, the German Wind Institute, has estimated that the Marsabit region has wind
speeds of up to 11.5 m/s representing some of the fastest and most consistent wind speeds they have
encountered in any one region. The estimated wind energy potential is between 4000Mw-10,ooo Mw.
Of this only 5.1Mw is harvested and fully exploited. We however note that applications received to
develop wind energy had totaled 650Mw as of December 2011.
Attractive Valuations… We have valued Kenya Electricity Generating Company Ltd (Bloomberg: KEGC
KN) and Kenya Power and Lighting Company Ltd (Bloomberg: KPLL KN) using a number of methods
and arrived at average target prices of Kes.20.90 and Kes.17.50 respectively. This represents 132% upside
and 5% headroom respectively relative to volume weighted average share prices as at 8th January 2013.
We further note that KEGC is operating at 75.6Million/MW of installed capacity against a sector
median of 157Million/Mw installed capacity. Other market based multiples support our
argument for undervaluation. EV/EBITDA of 10.6x vs. 12x industry average, P/E of 8.8x vs. 12.8x
and a P/B of 0.43x vs. 0.56x (regressed sector multiple).
As pertains to KPLL we note that the stock is currently trading at an EV/EBITDA multiple of
6.72x vs. a peer average of 16.71x. It is also trading at a P/E multiple of 8.5x below our justified
P/E multiple of 13x and the median P/E multiple of 15x.
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Utility Sector: Poised to Be Driven By Nature
Why the Incommensurable Bullish View from Consensus?
Utility Stocks Are Defensive Not Cyclical…
Historically these utility counters have had volatile earnings depending on whether it rains or not. Due to this
volatility investors treat them as cyclical stocks. In our view the switch to geothermal, wind and other green
energy presents a unique inflexion point for utility stocks in the country in that the switch significantly reduces
hydrological risk and will consequently reduce the volatility of earnings for power companies.
Discounted Cash Flow (DCF) Valuations Do Not Suffice…
We believe that the market has a preference for DCF valuations which result in a much lower target price
relative to our estimate. We reason that the heavy capital expenditure by power companies will in our view
result in negative cash flows during our comfortable forecast horizon (5 years). In the case of KEGC, we believe
that abnormal earnings models are more appropriate relative to DCF models. We also note that our multiples
have been adjusted using regression in order to factor in the different reinvestment needs of the various power
companies in our peer group.
Finance Costs Issue? No Problem…
Finance costs owing to the debt overhang will not materially impact on Earnings per Share (EPS) due to
capitalized interest on self constructed assets. We argue that since power utilities self-construct assets then a
proportion of their interest becomes avoidable; meaning they can move interest expense to the balance sheet
instead of recognizing it on the income statement. The effect of such an adjustment is obviously lower finance
costs though the question remains by what magnitude? In our view EPS will remain robust despite heavy finance
costs due to this capitalization of finance costs and will not be materially affected by debt overhang.
Government Controlled Companies Necessarily a Bad Thing?
Citing government interference, the market remains concerned about company ownership as the state has 51%
and 70% ownership in KPLL and KEGC respectively. Contrary to popular opinion we don’t believe that KEGC and
KPLL are/will be inefficiently run because of the vast government interest in them. Instead we think that this
fact plays out as an advantage in the sense that the can access funds to finance their CAPEX at concessional
rates. This is possible because the government acts as a guarantor to their borrowings.
Where is all the negative sentiment coming from? Have the fundamentals deteriorated?
We do not believe so. We attribute the negative investor sentiment to:
Heavy Regulation - Power remains a heavily regulated industry and producers and distributors cannot
determine their own prices. That role is left to Energy regulatory commission (ERC).
No Short Term Catalysts in Sight - A lack of short term catalysts to bridge the valuation gap. We
acknowledge the fact that short term catalysts are non-existent. We however believe that KPLL
switching to prepaid meters will act as a medium term catalyst. Additionally KEGC’s well generation will
facilitate the realization of revenues from geothermal energy even before the geothermal power plant
is complete. The growth on KEGC’s top line and increase in KPLL’s catalysts will definitely shore up the
share price in the medium term.
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Utility Sector: Poised to Be Driven By Nature
Energy Sector Analysis
Demand Side Analysis
We believe the expansion of key economic sectors like Tourism, Agriculture, Manufacturing, Wholesale and
Retail Trade, Business Processes Outsourcing (BPO) and Financial Service will put upward pressure on
electricity demand. Installed capacity is expected to grow at a CAGR of 19% from 1,180Mw to 22,985Mw by
2030. In the quest to meeting Vision 2030 goals we believe energy and electricity in particular will have a vital
role to play. Further, we also believe population growth will have a positive impact on electricity consumption.
Kenya’s population is expected to grow from the current 38.6Mn to 60.5Mn by 2030, which represents a CAGR
of 2%.
Current Peak Load Expected to Multiply
Peak demand is estimated to grow to 2,500Mw in 2015 and 15,026Mw in 2030 from the latest recorded peak
demand of 1,215Mw. This means that the current peak load is expected to grow by over 11 times. In terms of
units, 6,985GWh were sold in 2011. We expect this amount to rise to 22,685GWh in 2018 and 91,946GWh by
2030.
Lag of Mw Per Capita Consumption
Currently the national electrification rate averages 20% below the Sub Saharan (SSA) average of 28.5%, with 51 %
(57.5% SSA average) of urban households connected to the national grid as compared to only 8% (12% SSA
average) of the rural households. Informed by this we believe that customer growth will increase at a 17% CAGR
in our forecast horizon from the current 1.75Mn customers to 3.8Mn customers connected to the grid.
Fig 1: Mw per capita consumption in Kenya vs. African countries
0 200 400 600
South Africa
Libya
Botswana
Namibia
Egypt
Swaziland
Tunisia
Zimbabwe
Gabon
Kenya
Mw per Capita
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Utility Sector: Poised to Be Driven By Nature
Fig 2: Year on Year growth of the number of customers connected to the grid which is an indication of rising demand.
Source: KPLL financials
Supply Side Analysis
Supply has historically surpassed demand. We however believe that the excess supply will not affect power
prices negatively. We rationalize that power unlike other commodities has a regulated price and is not prone to
the vagrancies of supply and demand. Moreover we opine that there is need to increase power supply in spite
of the excess capacity because of two key reasons; first the reserve power margin is at 3% of peak demand
instead of the recommended 15%. Secondly, demand is growing at a much faster rate than supply due to limited
capacity additions and long lead times on any capacity additions. To this effect, the Kenyan government signed
a 50-year Kes.9.8Bn financing from African Development Bank for the construction of a high voltage
transmission line stretching 1,045km from Ethiopia. This ensures a cheaper access to power of Kes.6 (USD 0.07)
compared to the current Kes.8.10 per KwH for up to 1,500 units and Kes.18.57 per KwH for units greater than
1,500.
Fig 3: Demand vs. Supply Analysis. Supply has consistently been above Demand.
Source: KPLL financials
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The Going Green Phenomenon Explained…
Kenya derives over 97% of its energy from non-renewable resources. In line with global efforts Kenya aims to
reduce non-renewable fuel dependence and a viable alternative is renewable energy. Despite Kenya’s relatively
low carbon-intensive economy, the government is committed to implementing mitigation actions, which
include broadening Kenya’s renewable energy base.
Kenya has a National Climate Change Response Strategy (NCCRS), which has been designed to put in place
actions to address the challenges of climate change. Moreover, the government is planning to establish Green
Energy Fund, which will address the issues of high upfront cost and human resource constraints in renewable
energy development by providing concessional lending as well as capacity development support.
Fig. 4 below shows the most of Kenya’s energy is from non-renewable resources.
Source: Kanfor 2010 Household Energy Survey
Most notable are the plans to switch the base load energy source to geothermal from Hydro energy. This move
is informed by the following factors:
To reduce Hydrological risk - Hydro power remains the largest single source. With 51 % of grid
connected electricity being generated by hydro power, cuts are common during the dry seasons.
Silting of Hydro dams - Changes in rainfall intensity is leading to increased floods. These have lead to
the rapid build-up of silt in hydropower dams, reducing the amount of water for electricity generation.
The economic risk in hydropower projects can be large, because they are capital intensive. There is
uncertainty with regard to power prices in the future, and the costs of building and producing
hydropower vary strongly from power plant to power plant with some of the main variables being the
size and location of the plant.
Most areas where hydro-plants can be built are densely populated due to the availability of water
resources which are used for agriculture. This makes construction of hydro power plants difficult
because it would mean displacement or relocation of the local inhabitants.
Wood fuel36%
Charcoal40%
Petroleum21%
Electricity3%
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Reduce exposure to oil prices - At present, the response during power crises is to buy emergency
thermal electricity to meet the shortfall in power supply. But this is expensive and the price is unstable;
thermal energy is partly linked to world oil prices
The Green Energy Not Yet Untapped… Geothermal Kenya at 198Mw is the 10th largest geothermal producer in the world as shown in figure 5 below. It has a
potential of over 10,000 megawatts (MW) of geothermal energy resource located in various sites within the
Rift Valley. There are plans underway to increase geothermal capacity from the current 198MW to 5,530 MW by
2031 which would be equivalent to 26% of the system peak demand.
Source: Wikipedia
Geothermal is beneficial due to its lower cost of production as compared to other sources of energy. The huge
risks involved have however contributed to the under-utilization of this resource.
What are the risks in Geothermal Exploration? Geothermal resource exploration proceeds in phases. Following the first phase of surface level geophysical
reconnaissance, the subsequent phases are exploration drilling, appraisal drilling, production drilling and the
development of above ground steam field infrastructure. The high-risk phase is the exploration drilling because
it requires large investment and has relatively high probability that an individual well may not tap into the steam
resource. To mitigate the risks involved the government formed the geothermal development Company (GDC).
Its main tasks include drilling for geothermal wells and selling viable wells to Independent Power Producers
(IPP). This in effect transfers drilling risk to the government.
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Fig 6: Average Cost of Production (US Cents) per KwH for Different Energy Sources
Source: McKinsey and Company
Wind
Kenya’s estimated wind potential is 4,000Mw – 15,000Mw most of which is attributable to the
Marsabit/Turkana area. According to a DEWI study the estimated wind speeds average 11.5 m/s, some of the
fastest in the world. This region is unique from a geographical and meteorological point of view because of the
500Km southeast wind speeds. These winds are channeled through the Turkana-Marsabit Corridor bordered on
one side by the Kenyan and Ethiopian highlands on the other. Additionally because of two mountain ranges in
the corridor, Mt. Kulal to the North and Mt. Nyiru to the South the already fast winds are further accelerated
creating a venturi effect, similar to when you reduce the size of a pipe that water has to go through.
As of December 2011, the Ministry of Energy had received proposals to develop 650 Mw in wind capacity.
Currently the installed capacity is at 5.45Mw with 20Mw expected to be commissioned in 2012. The most
ambitious project is the 300Mw Lake Turkana wind development project. The project is expected to be
commissioned in 2014.
0 5 10 15 20 25 30 35 40
LARGE HYDRO
SMALL HYDRO
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US CENTS/ KWh
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Fig 7: Mean wind speeds Kenya
Source: Kenya 2004 Wind Atlas
Another favourable factor is that most potential wind sites in Kenya are sparsely populated. It is estimated that
only 2.3Mn households are in areas where wind speeds are 4 to 7 m/s. This provides an opportunity to develop
large wind farms with minimal interference.
Wind energy is however not without its short-comings. We note that wind is an interruptible power source and
as such requires a reserve power back-up which should be provided by geothermal or hydro sources. We
remain skeptical that any wind provider would be willing to develop 650Mw of reserve capacity.
Solar Power
Kenya’s location on the equator exposes it to 6Kwh/m2 of daily radiation. According to current estimates
Kenya has 200,000 solar photovoltaic panels installed, majority of which are rated between 10Mw and 20Mw.
Further it is estimated that 20,000 panels are to be installed per annum with an estimated 9Gwh of electricity
being produced each year. This figure is expected to grow to 22Gwh by 2020. The only short coming of solar
energy is that it is the most expensive form of renewable energy (see Figure 6). For instance While a 1.0 MW
wind farm costs less than US$1.4 million to set up, and displays 30% efficiency, a 1.0 MW solar plant costs about
US$3 million and displays much lower efficiency.
Hydro Power
50% of Kenya’s electricity comes from Hydro electric power with all large scale dams belonging to KEGC.
Kenya’s hydro electric potential is estimated to be 3,000 to 6,000Mw. According to the Energy Regulatory
Commission’s Least Cost Power Development Plan (LCPDP) only an additional 1,449Mw can be economically
exploited.
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Table 1: Kenya’s Hydro Potential
River Basins Hydro Potential
Lake Victoria 295Mw
Rift Valley 345Mw
Athi River 84Mw
Tana River 570Mw
Ewaso Ng’iro 146Mw
Apart from the near depletion of hydrological potential the dependence on Hydro electricity exposes Kenya to
hydrological risk. In periods of prolonged droughts, the power system which is heavily dependent on hydro
sources experiences reduced output. This was the case in 2009 and 2010. Our position remains that
geothermal presents a much safer, cheaper and more efficient energy source.
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Kenya Electricity Generating Company Ltd (Bloomberg KEGC KN)
We Initiate coverage on KEGC with a BUY recommendation over target price is Kes.20.90 representing 132%
upside headroom.
Kenya electricity generating company (NSE: KEGN) is the main electricity generator in Kenya producing about
76% of all electricity. The company is involved in the large scale development of hydroelectric and geothermal
power stations. Listed in 2006, the company is 70% owned by the government and was spun off Kenya Power
and Lighting Company Ltd (NSE: KPLL) in 1997 operating as a separate entity since then.
KEGC’s main sources of energy include hydro, geothermal, thermal and wind. Hydro is the leading source with
an installed capacity of 763 Mw which represents 64.6% of the installed capacity. In addition, it provides
geothermal and technical consultancy services to various Kenyan and international companies.
Table 2: KEGC’s Current Energy Mix
Energy Source
Installed Capacity (Mw)
Revenues Kes (Mn)
Hydro 763 3,412
Thermal 263 1,029
Geothermal 150 474
Wind 5.45 17.70
TOTAL 1,181.45 4,932.70 Source: Company Financials
Investment Thesis
KEGC’S to Double Installed Capacity from 1,181Mw to 2,164Mw by 2019 if Current Strategy is successfully
implemented.
KEGC’s project implementation pipeline is classified into two horizons: Horizon I (July 2009 - June 2013) and
Horizon II (July 2013 - June 2019).
The timeline of the status of the Strategy is shown below;
2011 - An effective capacity of 1,181Mw was available translating to approximately 4,900Gwh of
electricity produced.
2012 - Successful completion of Sang’oro Hydro and upgrading of their Kindaruma dam will see hydro
capacity increase by 53Mw (32Mw and 21Mw respectively). They also intend to commission the 80Mw
Muhoroni thermal plant within this period. Looking at the capacity load factors of these plants, we
estimate that they will be able to produce circa. 435Gwh of electricity.
We also note that 75% of the Sang’oro project has been financed by equity. KEGC would like to raise
financing for the 25% component. On the other hand KFW has committed to fund EUR. 30Mn towards
the Kindaruma project.
2013 – 2014 - During this period they intend to commission a 6.8Mw Ngong wind plant. They already
have a 5.1Mw plant in place in Ngong. We also expect to see the commissioning of the 50Mw Isiolo
Wind plant. We should also be seeing the final phases of the construction of the 280Mw Olkaria
geothermal projects. Overall we expect circa. 2,100Gwh to be added in the national grid during this
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period. The wind project has been funded 80% by Belgium Bank KBC and the Belgian government.
KEGC intends to refinance the balance of 20% through debt.
2015 – 2016 - KEGC plans to add an additional 140Mw geothermal plant in Olkaria. They intend to do so
every year until 2022. We also expect the commissioning of the Olkaria IV units 4 and 5 which have a
rated capacity of 170Mw.
The Kilifi Coal plant is also expected to come online during the half year of 2016. This plant has a rated
capacity of 600Mw. Based on our estimates we expect an increase to 4,215Gwh when these projects
are completed. The Kilifi coal plant shall be done with a joint venture partner. Under the arrangement,
KEGC will own between 40% and 49% of the JV partner’s Special Purpose Vehicle (SPV).
In our opinion the location of the plant next to the Indian Ocean is strategic because coal can easily be
transported by conveyor belt from the proposed jetty facility at Dongo Kundu Port. Investors should
also take note, that the plant will be on a Build Own Operate and Transfer basis (BOOT). The SPV will
become the signatory to a Power Purchase Agreement (PPA) and the plant will be transferred at the
end of the PPA.
According to management guidance on CAPEX, the company’s installed capacity should be 2,164Mw by 2019.
This implies a doubling of current installed capacity.
KEGC is Undervalued – Target Price of Kes.20.90 representing a 132% headroom at current prices of Kes.9
We note that DCFs are not usable owing to the fact that KEGC has negative cash flows due to its huge CAPEX
plans. Further we note that all comparable peers are from developing countries (Middle East and Asia).
Valuation Methodology Fair Value Estimate
EVA 17.39
EV/EBITDA Multiple 33.79
P/E Multiple 14.48
P/B Multiple 17.96
Average 20.91 Source: Genghis Estimates
KEGC possesses both Growth and Defensive Attributes
We view the SSA energy sector as a growth sector, more so the electricity sub-sector. We believe that SSA
(28.5%) continues to exhibit the lowest levels of electrification relative to other regions in the developing world
(66.79%) as exhibited by the table below. The goal of ensuring universal electrification means that the
electricity subsector will deliver above average returns for investors in the medium to the long-term.
REGION
ELECTRIFICATION RATE
OVERALL URBAN RURAL
North Africa 40.00% 66.80% 22.70%
China & Far East Asia 90.20% 96.20% 85.50%
South Asia 60.20% 88.40% 48.40%
Latin America 92.70% 98.70% 70.20%
Middle East 89.10% 98.50% 70.60%
SSA 28.50% 57.50% 11.90%
Average 66.79% 84.35% 51.55% Source: World Bank
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Additionally we argue that utility stocks will insulate investors from business cycles and the stock market
cycles. With reference to business cycles we note that unlike other commodities, consumption of electricity is
immune to business cycles. In our view we also believe that KEGC as a stock will insulate investor’s portfolio
from market downturns given that KEGC’s 6month beta is currently at 1.025 i.e. it exhibits beta neutrality.
KEGC to Benefit from Economies of Scale
KEGC controls over 70% of the market share among generating companies in Kenya. It is thus able to benefit
from economies of scale.
For instance, KEGC controls 100% of the large hydro dams in Kenya. This is cost competitive in two ways; the
headcount costs of running small hydro plants are similar to those of running large hydro plants meaning that
larger hydro power plants have lower costs per kilowatt. Secondly most of KEGC’s key competitors provide
thermal energy which is more expensive relative to hydro. Overall KEGC is able to benefit from price
competitiveness. This means ‘ceteris paribus’ the electricity they generate is given purchase preference by the
main distributor KPLL.
70% Stake by the State is a Positive Thing
The government still owns the majority stake in KEGC. We view this as a plus to the company vis-à-vis its
competitors because it enables them get concessional funding that is guaranteed by the government. Smaller
IPPs have a harder time raising funding for their projects because they lack such guarantees.
Competitive Analysis
KEGC to Retain Competitive Advantage due to High Capacity Factors and Barriers to Entry
Currently the bulk of KEGC’s power is provided by hydroelectricity, which has a high capacity factor (52%). We
are optimistic that the switch to geothermal which has an even higher capacity factor (80%) will only serve to
expand KEGC’s competitive moat among its competitors.
The construction of geothermal and hydroelectric plants requires huge capital investments. The high capital
requirements will continue to act as barriers of entry to smaller competitors forcing them to result to lower
capacity generation methods like thermal and wind.
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Source: Genghis Estimates
KEGC to Flow with the Wind…
KEGC in the near term appears less focused on developing wind energy. Management announced plans of
adding capacity by 28.5Mw; i.e. 15.5Mw Ngong upgrade and the 13Mw Kinangop farm. On the other hand
three massive competing wind projects in the 300Mw Turkana Wind power project, 100Mw Aeolous wind
project and the 100Mw Kipeto wind project have been announced.
We believe the reason for the reduced participation is first, wind power exhibits a lower capacity factor (38%)
relative to geothermal energy (80%) meaning all else equal implying a geothermal plant would produce double
the units of electricity of a similar wind plant in capacity. Additionally wind energy remains unsuitable for the
provision of base load power because wind reliability is impossible to predict and control. For instance, in the
absence of wind, a wind farm’s output could drop to zero in a matter of seconds. This means that utilities
should have reserve capacity equal to the size of the wind farms in order to prevent rolling blackouts.
Geothermal is the Game Changer…
With 150Mw installed geothermal power capacity, KEGC is the biggest producer of green energy in Kenya.
Orpower 4, a US energy firm, is KEGC’s sole competitor in the geothermal space. It operates a 48Mw binary
plant at Olkaria III which will be enhanced to 100Mw while KEGC operates a 45 MW power plant at Olkaria I, a
105 Mw power plant at Olkaria II and is currently undertaking a 280Mw geothermal project at Olkaria.
In our view, Orpower 4’s main competitive advantage is the fact that it is owned by the vertically integrated
Ormat technologies which designs, manufactures and sells geothermal power generating equipment. They’re
likely to benefit from cheaper and more effective plant operation. Case in point is the importation of defective
geothermal wellheads by KEGC from Norwegian firm green energy that resulted in project implementation
delays.
We however note that project finance will continue to remain a hindrance for smaller independent power
producers like Orpower 4. It will for instance cost Orpower 4 USD 306Mn (Kes. 26.06Bn) to increase its
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capacity from 48Mw to 100Mw. We note that they recently have secured a further Kes. 18.5Bn (USD 217Mn)
funding from Overseas Private Investment Corporation (OPIC). Furthermore the drawdown of the remaining
amount of USD 45Mn (Kes. 3.78Bn) is expected to occur mid next year. Under the terms of the loan a further
USD 45Mn (Kes. 3.78Bn) can be borrowed if Orpower 4 wishes to construct a further phase of 16Mw.
Thermal Energy is Costly…
Thirty percent (2,025Gwh) of all electricity in Kenya is provided from thermal generation. KEGC has two thermal
Heavy Fuel Oil (HFO) plants in Kipevu I (75Mw) and Kipevu III (115Mw) with an average load capacity of 85%.
Due to this efficiency, KEGC is able to charge USD 174 and USD 235 per Kwh making them the cheapest bulk
provider among thermal IPPs. Their main competitors in Iberafrica power, Rabai power and Tsavo power
(Kipevu II) charge USD 298, USD 270 and USD 255 respectively per Kwh.
Plants Capacity (Mw)
Cost/Kwh (USD)
KEGC Kipevu I 75 174
Kipevu III 115 235
IPPs
Iberafrica 108.5 298
Rabai 90 270
Tsavo (Kipevu II) 74 255 Source: KPLL Financials
New Kids on The Block…
In the near term we are expecting the entry of 3 additional thermal plants. These plants are Triumph Energy,
Gulf Power and Thika power. The first two plants will each have a capacity of 80Mw while Thika power will
have a name plate capacity of 87Mw.
Triumph Energy - Triumph Power Generating Company’s plant will operate a Medium Speed Diesel
(MSD) 81 MW Thermal power plant in Athi River. Their plant will consist of ten 9.0Mw MSD units and
will be among the few environmentally friendly thermal plants. It shall have the ability to generate
4Mw of electricity from exhaust fumes and the ability to treat its own sludge and solid wastes.
Thika Power - Melec Power Generators of Lebanon will construct an 87Mw MSD plant in Thika at a
cost Kes.12Bn. The funding will be raised from Citibank London with partial risk guarantees worth
approximately Kes.4Bn granted by the World Bank. The plant will increase efficiency by combining the
use of diesel engines and steam turbines resulting in 10% more electricity generation relative to similar
plants.
Gulf Power – It is owned by Gulf Energy, the largest private fuel importer (by volume) in Kenya. It
plans to build an 80Mw plant in Athi River. The project will cost EUR. 80Mn and 75% of the funding will
be from the International Finance Corporation (IFC) arm of the World Bank.
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Valuation
In obtaining our fair value estimates for KEGC, we utilised 2 valuation approaches - Economic Value Added
(EVA) and Market Multiples.
EV/EBITDA
Using our EV/EBITDA valuation we obtained a fair value estimate of Kes.33.79.
We selected six peers of non-integrated Generating Companies (GenCos) from the developing world that we
felt are more representative of KEGC’s operating environment and growth prospects. We wish to note that we
also adjusted our multiples using regression in order to adjust for risk, growth and different tax regimes.
Name EV/EBITDA ROC DEBT:CAPITAL Growth Effective Tax Rate
Retention Rate
KEGC 10.59 2.38% 48.99% 12.89% 43.03% 47.16%
CESC LTD 7.60 5.87% 52.22% 13.76% 37.89% 74.59%
Electricity Generating PCL 35.95 8.53% 33.21% 28.24% 4.74% 44.61%
First Generating PCL 8.28 6.45% 41.77% 6.08% 36.40% 100%
Glow Energy PCL 16.41 4.35% 65.71% 38.29% 21.65% 100%
Hub Power Company 6.43 11.28% 60.63% 41.69% 0.31% 37.67%
AES TIETE SA 6.70 32.02% 32.46% 30.82% 37.72% 20.81%
Average 13.14
EV MULTIPLE REGRESSED 12.07 Source: Bloomberg, Genghis Estimates
Source: Genghis Estimates
EV/EBITDA VALUATION
EV/EBITDA X 12.07
Multiple by FY2012 EBITDA
142,968,393
(Add) Cash and Equivalents 435,719
(Less)Total debt 69,115,720
Value of Equity 74,288,392
Target Price 33.79
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Utility Sector: Poised to Be Driven By Nature
P/E Valuation
Our fair value estimate using P/E multiples is Kes.20.27. As expected P/E yields the lowest valuation
attributable to our more prudent earnings estimate which have been adjusted for one off charges/incomes.
For our P/E valuation we again focused to emerging market peers and ignored GenCos in developed countries.
Unlike our EV/EBITDA multiple, we note that we expanded our comparable peers to get a more accurate
estimate recognizing that the earnings approach will not take into account the significant impact leverage will
have on earnings. In our opinion a larger sample would minimize that error.
Average P/E Multiple 12.83
FY 2012 Adjusted EPS 1.58
Estimated Fair Value 20.27 Source: Genghis Estimates
Name P/E ROE Dvd Yld (%) P/B Beta:M-6 Growth
KENYA ELECTRICITY GENERATING 8.82 2.97 5.95 0.43 1.00 12.89%
EMPRESA NAC ELEC-CHIL-SP ADR 17.10 15.71 5.19 2.46 0.81 1.19%
COMPAGNIE IVOIRIENNE D ELECT 11.14 27.56 8.11 2.00 N/A -39.41%
QATAR ELECTRICITY & WATER CO 10.61 38.83 4.83 4.61 1.02 -0.60%
ABOITIZ POWER CORP 10.83 35.81 3.85 3.21 1.27 91.54%
CESC LTD 16.08 5.15 1.60 0.70 1.06 13.76%
ELECTRICITY GENERATING PCL 6.11 16.31 4.55 0.87 0.71 28.24%
ENERGY DEVELOPMENT CORP 16.49 24.51 1.68 4.31 0.93 32.54%
FIRST GEN CORPORATION 12.18 10.96 0.00 0.94 0.67 6.08%
GLOW ENERGY PCL 24.41 10.97 3.33 2.43 0.87 38.29%
HUB POWER COMPANY 8.36 23.52 12.55 1.45 0.82 41.69%
AES TIETE SA 11.73 50.47 9.98 5.24 0.57 30.82%
Average 12.83 21.90 5.14 2.38 Source: Bloomberg
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Utility Sector: Poised to Be Driven By Nature
P/B Valuation
Our fair value estimate using P/B was Kes.17.96.
We used a regressed P/B multiple having adjusted it for ROE. We opine that ROE drives P/B multiples thus
justifying our approach. Our regressed P/B multiple is 0.5626 which is higher than the current multiple of
0.4291.
P/B Valuation
Adjusted P/B Multiple 0.56
Book Value 70,179,594
Fair Value of Equity 39,484,041
Estimated Fair Value 17.96
Source: Genghis Estimates
Economic Value Added (EVA) Valuation
Our EVA model yielded a fair value estimate of Kes.19.10.
We opted for an EVA model because of KEGC’s negative cash flows. In our comfortable forecast horizon we
assume KEGC will have negative cash flows due to its huge CAPEX expenditure. This would make Free Cash
Flow approaches inappropriate with the exception of FCFE (which is also slightly inappropriate if you take into
consideration the evolving debt requirements of KEGC)
Discount Factor Assumptions
We used a risk free rate of 11.86% which is the current yield of the 5year bond. A beta of 1.026. NB beta was
regressed for a period of a year. Hence slightly differs with the beta on the table above which is a 6 month
beta. We used a historical risk premium of 6% in our model
Risk Free Rate (5 year) 11.86%
Beta 1.026
Risk premium 6%
Cost of equity 18.01%
Source: Genghis Estimates
2012 2013E 2014E 2015E 2016E
Beginning book value of Equity 69,419 70,180 70,967 71,345 72,132
18.01% 18.01% 18.01% 18.01% 18.01%
Equity Charge 12,502 12,639 12,781 12,849 12,991
Abnormal Earnings (9,680) (9,167) (9,688) (9,509) (5,967)
PV factor 0.8476 0.7181 0.6085 0.5156 0.4369
PV Abnormal Earnings (8,203) (6,583) (5,895) (4,901) (2,607)
Ending Book Value 70,180
Total PV of Abnormal Earnings (28,191)
Value of equity 41,989
Fair Value Estimate 19.10
Source: Genghis Estimates
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Utility Sector: Poised to Be Driven By Nature
Free Cash Flow to Equity (FCFE)
Our FCFE valuation resulted in a fair value of Kes. 28. Recall however that the changing capital structure due to
additional debt will call for an evolving required return on equity. The implications of which would be an
unstable valuation model which was a key determinant to the weight we assigned our fair value vis-à-vis our
target price.
FCFE VALUATION 2012A 2013E 2014E 2015E 2016E
Net Income 1,860 3,472 3,093 3,341 7,024
(add) Depreciation 4,827 5,829 6,295 6,799 8,862
(Less) FCInv 3,879 25,062 11,658 12,591 51,585
(Less) WCInv (3,662) (4,823) (5,321) (2,607) (3,857)
Net borrowing (9,429.68) 28,572.80 4,058.04 8,139.73 51,471.55
FCFE (2,959.25) 17,635.84 7,109.86 8,295.77 19,629.35
0.8474 0.7181 0.6085 0.5156 0.4369
DISCOUNTED (2,508) 12,664 4,326 4,277 8,577
SUM HIGH GROWTH 27,336
Terminal Growth 34,260
61,596
FCFE FV Estimate 28.02
Source: Genghis Estimates
Financial Analysis
2012A 2013E 2014E 2015E 2016E
NPM MARGIN % 17.6% 19.1% 15.7% 15.7% 25.4%
ROA 1.7% 1.8% 1.5% 1.5% 2.4%
ROE 4.0% 4.9% 4.3% 4.6% 9.2%
DEBT RATIO 42% 50% 49% 49% 55%
INTEREST COVERAGE 2.4 2.4 1.8 1.8 2.2
CURRENT RATIO 1.5 2.1 1.9 1.5 1.5
Source: KEGC Financials, Genghis Estimates
Net Profit Margin and EPS Expected to Drop…We anticipate this to be due to increasing finance costs. We
opine that interest payments will continue to put downward pressure on NPM and also on EPS (albeit in
decreased measure due to allowable interest). We are cautiously optimistic that EPS will be shored up by non-
operational activities e.g. FOREX gains, however we have not included these assumptions in our model.
ROA to Decline… A drop in the Return on assets is also expected. We note that this drop will primarily be
driven by increase in assets that are not expected to be operational in the near term and hence will contribute
very little to the bottom line.
ROE Expected to Range…We expect the ROE to see-saw. On the one hand it will be driven up due to the
increased leverage and then brought back down due to increased finance costs resulting from the same
leverage.
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Debt Ratio to Exceed D/E Target of 60:40…Due to the increased employment of leverage we expect the debt
to equity ratio to reach 73% by 2016.
Stability in Interest Coverage…We expect a flat interest coverage ratio. In our view any increased cash flows
as a result of horizon I investments will go into ensuring that interest payments are made as debts begin to
reach maturity.
Current Ratio to Remain above Safe Levels…We expect the current ratio to remain 1 as we cautiously remain
optimistic that the company shall be in a position to meet its short term obligations as they come due.
Risks
Interest Rate Risk
Owing to the fact that KEGC needs to finance it CAPEX by borrowing, then interest rate risk is present. As a
result of the high inflationary environment in Kenya base lending rates have increased to as much as 18%.
KEGC’s publicly traded debt was offered at a fixed rate of 12.5% and if high interest rates persist, we could see
their borrowing costs on any additional debt increase. The fact that 63% of its debt financing is from
international institutions acts as a mitigating factor.
Fig 8: Sources of Project Finance
Source: KEGC Financials
Exchange rate risk
KEGC is exposed to FOREX risk due its foreign borrowings. It is most exposed to fluctuations in the Japanese
yen due to the fact that 41% of its borrowings are denominated in that currency. FOREX risk could also lead to
the increase in the price of imported diesel which is a key input in their thermal plants.
Fig 9: Currency Break-Down of Debt
Source: Company Financials
63%
37%
ORIGIN OF DEBT
INTERNATIONAL LOCAL
41%
10%12%
37%
JPY
USD
EURO
KES
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Political Risk
2013 being an election year presents political risk in the sense that a disputed election result might result in
violence like it did in 2007. This could result in international financiers withholding funding commitments
slowing down KEGC’s expansion plans. We could also see electricity infrastructure destroyed as a result of said
violence. We however believe that political risk is minimized due to the implementation of the new
constitution and more stringent electoral laws.
Fig 10: Composition of International Financiers
Source: Company Financials
Operating Risks KEGC faces significant risk arising from delayed completion and commissioning, costs escalation during the
construction period, logistical challenges etc. KEGC minimizes these risks by; first contracting experienced
contractors and entering into agreements that penalize contractors for delays e.g. through payment of
damages. Secondly they mitigate such risks by conducting thorough project feasibility studies.
Hydrological Risks Some of KEGC’s hydro electricity generation activities are significantly affected by weather conditions. For
example, dry years significantly reduce the water levels thereby impacting on the energy output and by
extension the revenues.
Liquidity Risk and Default Risk KEGC relies heavily on the timely payment by KPLL and KPLL meeting its legal obligations under the various
power purchase agreements between KEGC and KPLL
Any default by KPLL will have a direct impact on the KEGC’s liquidity and business.
41%
17%
3%
6%
EIB10%
JAPAN BANK OF INTERNATIONAL CORPORATION
INTERNATIONAL DEVELOPMENT CORPORTATION
KFW
KBC BANK BELGIUM
AFD
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Kenya Power and Lighting Limited (Bloomberg KPLL KN)
Company Description
Kenya power and Lighting Company (KPLL) is the sole electricity distributor in Kenya and is publicly listed. Its
core business is transmission and distribution of power generated by the main power producer KEGC and other
independent power producers. It is responsible for the construction and maintenance of existing electricity
transmission and distribution systems in Kenya. The Kenyan electricity supply industry structure is of the single
buyer model with all generators selling power in bulk to KPLL for dispatch and onward transmission and
distribution to consumers.
As of 2010 existing Transmission and Distribution Network Lengths are as follows:
• 1,331km of 220kV
• 2,211km of 132kV
• 655km of 66kV
• 13,812km of 33kV, and
•25,514km of 11kV lines
Source: KPLL Financials
Nairobi57%
Coast12%
West19%
Mt Kenya12%
Customer Distribution per Region
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Source: KPLL Financials
Investment Thesis We initiate coverage with a HOLD recommendation. Our target price is Kes.17.50 representing a narrow upside of 5% from the current price of Kes.16.70. Our views are in line with the market consensus. Our bear case growth assumptions remain at 7% in line with economic growth. In our view the Key value drivers for KPLL going forward are;
Increase in Customer Number…We expect customer growth to increase by a CAGR of 17% Y-o-Y. This
we believe will primarily be driven by increased connections under the Rural Electrification Programme
(REP), which seeks to increase the number of connections in rural areas. Currently only ~15% of total
customers are connected under the REP. We expect the growth of this customer segment to grow
driven by devolution of county governments at the district level.
Building Capacity in Both Distribution and Sub Station…In line with management guidance we expect
that during our forecast horizon 26,000Kms of transmission cables and 2,421MVA of substation
capacity will be added to the grid. These will result in increased transmission capacity which will
facilitate generation capacity and the increase in the number of customers the grid can support.
Better Cash Flow Management…Introduction of prepaid meters and automatic meter readings will
reduce expenses by reducing the provisions for bad debts, collection expenses and meter reading
costs. We also expect reduced working capital requirements as customers are migrated from the post
pay to the prepay service.
27%
22%
50%
1%
Revenue by Customer
DOMESTICSMALL COMMERCIAL/INDUSTRIALCOMMERCIAL INDUSTRIALOFF-PEAKSTREET LIGHTINGEXPORT
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Regional Interconnections…Regional interconnections will allow KPLL to benefit from excess
capacity of regional neighbours e.g. Ethiopia and Uganda, which means they will reduce their reliance
on thermal generators who sell electricity to them at a higher cost.
Leasing of Fibre Optic Capacity…We believe that KPLL’s ingress into the telecoms sector, through the
construction and leasing of their fiber optic cable, will have the dual effect of diversifying and
increasing revenues at the same time.
Tackling Vandalism…Vandalism continues to be a thorn in the flesh of KPLL. Damage to transformers
for transformer oil, illegal connections and stealing of cables for their copper continues to be an
everyday occurrence. We believe the mitigation measures KPLL has put in place e.g. Installation of dry
transformers and introduction of harsher penalties for vandals will in the medium term reduce
replacement expenses which continue to place downward pressure on the profit margin.
Company Positioning Customer Growth KPLL is the sole electricity distributor in Kenya. It has 1,753,348 Non REP customers which represents a CAGR of
4% for the last 5 years. This number is low because of the fact that KPLL has shifted its focus to rural
households. As of 2011, KPLL had connected 309,287 customers under the Rural Electrification Programme
(REP); a CAGR of 18.38% for the last 5 years. As part of its performance target agreement with the Government
of Kenya (GoK), KPLL is required to connect 200,000 new customers every year and reduce the number of
outages to below 3,000 per month.
We expect the number of customers connected to increase at a CAGR of 17%. We expect the customers
connected to increase at geometric rather than a linear manner. Our justification for this is that KPLL will
experience lower marginal costs as connectivity increases.
Currently only 15% of KPLL’s customers are connected under REP. Thus an opportunity is present for growth. In
our view rural electrification will experience rapid growth especially under the new constitution which has
advocated for devolved governments at the county level. Devolution in effect would mean that all services
inclusive of electricity will move closer to the people at the grassroots level.
Building Capacity of Distribution and Sub Stations In order to facilitate the number of customers KPLL’s grid can support they have embarked on a capacity
expansion drive. They intend to increase 26,000Km of transmission cables. They also intend to increase
substation capacity by 2421MVA by 2016.
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Type of Line Length in Km (2010) Length in Km by 2016
500kV 0 1,200
400kV 0 1,250
220Kv 1,331 2,269
132kV 2,211 3,119
66kV 655 1,311
13kV 13,812 20,177
11kV 25,514 40,365
TOTAL 43,523 69,690 Source: KPLL Annual Report
Improve Working Capital through Prepaid Meters Installation During the financial year 2009/10 KPLL rolled out 174,810 prepaid meters in a pilot project. Based on the success
of the pilot project the company has announced that it intends to retrofit 520,000 prepaid meters at a cost of
Kes.5.8Bn. The company intends to migrate all the postpaid customers to the prepaid system by 2015. This will
translate to 98% revenue collection as a percentage of billing.
Prepaid meters allow electricity consumers to pay for electricity before consuming it. In effect this means that
KPLL benefits from; reduced working capital requirements, reduced collection costs and reduced bad debt
provisions expense. Another added benefit will be reduction in headcount expenses as the number of meter
readers reduces to the point of near extinction.
We also view the installation of Automatic Meter Reading (AMR) as a strong positive for the company. The
AMR is a billing system that remotely obtains meter readings and disconnects customers with overdue bills.
The AMR system is targeted at 4,000 of KPLL’s largest customers (who represent 63% 0f revenues). In terms
of customer satisfaction it will lead to less billing errors. It also places KPLL at a better position to control loads
as the system reaches threshold capacity. KPLL will also be able to conduct system planning more easily due to
availability of actual data on large industrial customer load patterns; improve data reliability and accuracy;
eliminate wrong meter readings; reduce labour costs; improve employee safety; and accelerate cash flow
based on monthly billing.
Fibre Optic Capacity Lease As a way of leveraging on their extensive electricity network, KPLL have decided to augment it with a fibre
network that will run parallel with their transmission infrastructure. It has already built a 24 pair fiber cable
which is 1,200Km in length. It aims to lease out 18 pairs to Internet Service Providers (ISP). Safaricom, Wananchi
Online, Jamii Telcom and Kenya Data Network (KDN) are among the first ISPs to lease the fibre optic capacity.
The value proposition to ISPs is that they will no longer have to invest heavily in infrastructure instead they just
lease capacity from KPLL. In our view KPLL’s network has the additional benefit of being already networked
into people’s homes.
We also note that this project is an off-shoot of a much larger project known as the Supervisory Control And
Data Acquisition/Energy Management System (SCADA/EMS). The aim of SCADA/EMS was to provide an
efficient communication platform whose purpose was to help in managing KPLL’s power infrastructure
simultaneously providing a better media for tele-protection, and interconnection of radio and ripple systems.
Radio systems are used for communication between control centres, staff in the field, and sub-stations. We
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note further that the 800km KPLL fibre optic line installation on the western route, between Nairobi and
Tororo in Uganda, has been completed and is undergoing commissioning tests.
Distribution System Automation (DSA) DSA will enable KPLL to remotely locate and isolate faulty positions along its power distribution lines. Further it
will reduce operational costs associated with movement of staff as they seek to repair the faults. Currently,
KPLL technicians have to physically trace anomalies and repair them; which is a very time consuming process.
Another added benefit will be on the bottom line which will be shored up due to reduced electricity sales
during interruptions.
KPLL has launched a pilot power project automation in Mombasa at a cost of Kes. 300Mn.
Underground Cabling KPLL is currently undertaking an underground cabling project to the tune of Kes. 20Bn. The project involves the
conversion of overhead power lines to an underground cable system in Nairobi, Mombasa and Kisumu. We
expect the undergrounding of 645Km of 11kV lines, 1,570Km of low voltage power lines, and 1,235 pad mounted
substations in Nairobi, Mombasa and Kisumu. According to management the aim of this initiative is to improve
the quality of power supply owing to reduced transient faults and minimal system disturbances.
Financial Analysis
2007 2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E
EBITDA margin 16.7% 22.0% 21.5% 22.1% 25.2% 26.4% 22.6% 22.6% 22.6% 22.6%
ROA 4% 3% 5% 4% 3% 2% 3% 3% 3% 3%
ROE 8% 7% 12% 13% 10% 7% 9% 9% 9% 9%
Debt ratio 14% 22% 22% 17% 20% 20% 29% 28% 28% 32%
Interest Coverage 19.22 4.036 5.43 11.91 6.85 6.42 6.64 6.70 6.70 6.64
Current Ratio 1.07 1.12 1.15 1.09 1.16 0.86 0.69 0.70 0.71 0.91
Debtor days 65 58 54 50 62 56 51 51 51 51
Source: KPLL Financials, Genghis Estimates
EBITDA margin For our forecast horizon we expect the EBITDA margin to be maintained because KPLL is a monopoly in a
regulated industry; and thus cannot increase their prices.
Expectation of Flat performances for ROA and ROE We take the view that in the determination of prices the Energy Regulatory Commission (ERC) must consider
the Returns on Assets and Equity. We remain optimistic that price per unit will be set with the aim of achieving
a targeted return on assets/equity as is the case with international best practices.
Reduced Debtors Days informed by… As a base case we expect the debtor days to fall to 51 days. This will be in line with changes that are being
made to optimize collection of cash, namely the introduction of prepaid meters and automated billing.
CAPEX Borrowing Still at Acceptable Levels A debt ratio of circa 30% remains acceptable for a company that has KPLL’s level of capital investing. We
assume this level will be maintained during our forecast horizon. We also note that the current ratio which is
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below 1 will steadily rise to that level, primarily because of improved working capital as a result of prepaid
meters.
Valuation We have obtained a target price of Kes.17.50 representing a narrow upside of 5.42% from the share market
price of Kes.16.60 that the counter closed on 11th December.
Regression price and equity multiples yielded levels of significance < 40% meaning the regression approach
would not be valid. We settled on the computation of a justified P/E.
Source: Genghis Estimates
P/E Valuation Our Justified P/E multiple was 13x while the median P/E is at15x .This was above the observed P/E multiple of
8.5X and indicates a target price of Kes. 23.50. We assumed the required return on equity would be 17.5%.
Ticker Name P/E
KPLL KN Equity KENYA POWER & LIGHTING-RTS 5.28
CEC ZL Equity COPPERBELT ENERGY CORP PLC 7.12
DPSC IN Equity DPSC LTD 115.06
DESC BD Equity DHAKA ELECTRIC SUPPLY CO LTD 15.02
MER PM Equity MANILA ELECTRIC COMPANY 17.98
Median P/E 15.02 Source: Bloomberg It was computed using our FY 2012 earnings.
𝑟𝑒𝑡𝑒𝑛𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜 ÷𝐸𝑃𝑆
𝑅𝑒−𝑔=
72%÷𝐹𝑌2012 (1.79)
17.5%−12%=13.11X
Source: Genghis Estimates
Method Implied Value
Justified P/E 23.50
FCFF 15.90
DDM 11.36
EV/EBITDA 19.11
Average 17.47
P/E 13.11
EPS FY2012 (Kes.) 1.79
Fair Value (Kes.) 23.50
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As indicated above we can see that our required return on equity is 17.5% we have also assumed a dividend growth of 12% over
our forecast horizon. These are the same assumptions that have been used in our DDM model.
FCFF Valuation Our FCFF valuation is computed using a WACC of 12.31%. We obtain a fair value of Kes. 15.90.
WACC ASSUMPTIONS
Cost of Equity 17.50%
Cost of Debt (After tax) 6.00%
WACC 12.31%
Terminal Growth 8.00% Source: Genghis Estimates
Source: Genghis Estimates
FCFF Valuation 2012A 2013E 2014E 2015E 2016E 2017T
Net Income 3,192,000 4,536,199 4,869,182 5,216,358 5,576,440 6,134,084
Depreciation and Amortisation 4,051,676 3,313,660 3,545,017 3,792,548 4,057,384 4,463,123
Interest (1-30%) 851,200 797,474 845,379 903,900 975,534 1,073,087
CAPEX 18,987,561 22,543,189 64,135 7,403,397 7,920,989 8,474,771
Working Capital Changes (1,685,729) (6,012,399) (1,026,970) (1,098,766) (1,175,582) (1,269,134)
FCFF (9,206,956) (7,883,457) 10,222,412 3,608,174 3,863,951 4,464,657
PV factor 1.000 0.890 0.793 0.706 0.628 0.560
PV FCFF (9,206,956) (7,019,107) 8,103,707 2,546,731 2,428,244 (3,147,382)
PV. Terminal Value 57,904,101 Cash Balance 800,000 Debt 24,521,303 Equity Value 31,035,416 Fair Value Estimate 15.90
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Our terminal growth assumption of 8% is in line with the long term economic growth we expect. Dividend Discount Model Acknowledging that utility stocks are normally preferred due to their dividends, we have also estimated a fair value using the DDM model. Our assumptions for the required return on equity remains unchanged at 17.5% however our dividend growth rate has been assumed to grow at 12% to perpetuity.
2012A 2013E 2014E 2015E 2016E
Dividends (Kes. ‘000) 975,733 975,733 975,733 975,733 975,733
Discount Factor 1 0.85 0.72 0.61 0.52
PV Dividends (Kes. ‘000) 975,733 830,411 706,733 601,475 511,893
Sum (Y1 to Y5) 3,626,246 Terminal Value 17,740,609 Firm Value 21,366,856 (add)Cash 800,000 Fair Value Estimate 11.36 Source: Genghis Estimates
EV/EBITDA
Name EV/EBITDA T12M:Y Tax rate ROC Debt/Equity Growth
Kenya Power & Lighting Company 6.72 30.00% 8.56% 40.67% -5.39%
Copperbelt Energy Corporation 3.18 41.79% 10.56% 16.62% 7.55%
DPSC Ltd 53.85 32.12% 7.72% 57.17% -5.68%
Dhaka Electricity Supply Company 11.46 13.69% 10.10% 45.59% 13.69%
Manilla Electric Company 8.37 31.76% 16.57% 27.77% 18.20% Source: Bloomberg
The regressed EV/EBITDA multiple is 6.72. The multiple has been adjusted for differences in tax rate, return on
capital and growth. We have also included debt/equity ratio as one of the determinants of EV/EBITDA. We
opine that D/E will act as a good proxy for the measurement of enterprise risk. In our view beta will fail in this
regard because it is an equity measure of risk and not enterprise risk.
EV/EBITDA MULTIPLE 6.72X
EBITDA FY 2011 10,691,690
Enterprise Value 71,848,154
Less CASH & CASH EQUIVALENTS 10,029,213
Less DEBT 24,521,303
IMPLIED EQUITY VALUE 37,297,638
Fair Value Estimate (Kes.) 19.11 Source: Genghis Estimates
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Risks Vandalism Still a Thorn… In our view this remains the most incessant and most probable risk facing KPLL. The vandalism of copper wires
(which are later resold as scrap metal) and the vandalism of transformers for their oil remains a major concern
going forward. Associated replacement costs may slowly erode profit margins, which would lead to a
downward revision of our fair value estimates. We remain optimistic that this will not be the case. Our
optimism stems from 3 key things:
Introduction of stiffer penalties for those found vandalizing and in possession of vandalized
equipment.
Introduction of oil free transformers and the introduction of intrusion alarms in transformers will go a
long way in curbing transformer vandalism.
The underground cabling project and see it as one way of eradicating vandalism of copper wires.
Operational Risks Despite a clean record in terms of project implementation we remain concerned about project delays which
might affect the timing of cash flows and consequently our fair value estimates.
Regulatory Risk KPLL despite being a monopoly cannot set its own prices. Prices are set by the Energy Regulatory Commission
(ERC). This is however mitigated by the fact that most electricity costs are also regulated by power purchase
agreements. Further surcharges arising from fuel and FOREX costs are passed on the consumer.
Interest rate Risk In our view an increase in interest rates will have an adverse effect on KPLL’s interest payments. We remain
disquiet that increased interest rate volatility will push finance costs upwards but more severely reduce money
available for lending. This will consequently bear on KPLL’s planned CAPEX expenditures in terms of project
implementation time and in terms of cost. The ramifications would be a downward revision of our price
targets.
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Utility Sector: Poised to Be Driven By Nature
APPENDIX
KEGC’S Pro forma Income Statement (Kes. Mns)
Source: KEGC Financials, Genghis Estimates
2011A 2012A 2013E 2014E 2015E 2016E
Revenue 14,389 15,999 18,216 19,673 21,247 27,695
Interest Income 549 952 660 713 770 1,003
Other Income 284 485 193 208 225 293
15,222 17,436 19,068 20,594 22,241 28,991
Other Gains/(Lossses) 440 (153) - - - -
Operating Costs (10,014) (10,266) (11,087) (11,974) (12,932) (13,967)
EBITDA 10,198 11,844 12,933 13,968 15,085 19,663
Finance Costs (1,997) (2,972) (3,021) (4,201) (4,537) (4,990)
Profit Before Tax 3,651 4,045 4,960 4,419 4,772 10,034
Taxation (Charge)/Credit (1,571) (1,223) (1,488) (1,326) (1,432) (3,010)
Net Profit for the Year 2,080 2,822 3,472 3,093 3,341 7,024
Other Comprehensive Income/ (Loss) (633) (962) - - - -
Total Comprehensive Income 1,447 1,860 3,472 3,093 3,341 7,024
Adjusted EPS 0.66 0.85 1.58 1.41 1.52 3.19
DPS 0.50 0.60 0.50 0.50 0.50 0.50
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ASSETS (Kes. Mn) 2011 2012A 2013F 2014F 2015F 2016F
NON-CURRENT ASSETS
PPE 116,786 120,665 133,835 135,832 144,782 187,266
Prepaid Leases on Land 1 35 35 35 35 35
Intangible Assets 663 896 664 664 664 664
Amount Due From KPLL (Deferred Debts) 1,473 1,401 1,262 1,363 1,472 1,589
Treasury Bonds 9,611 8,051 11,384 11,691 12,626 17,943
Recoverable Foreign Exchange Adjustment 12,920 9,808 11,112 12,001 12,961 16,894
141,454 140,857 158,292 161,585 172,539 224,391
CURRENT ASSETS
Inventories 1,168 1,956 1,639 1,771 1,912 2,493
Trade and Other Receivables 1,594 6,077 6,922 7,476 8,074 10,524
Amount Due From KPLL 7,786 7,222 7,651 8,263 8,924 11,632
Tax Recoverable 385 231 223 199 215 452
Treasury Bonds 391 643 683 701 757 1,076
Geothermal Development Funds 4,574 5,318 - - - -
Bank and Cash Balances 3,116 436 3,898 4,210 4,547 5,927
Recoverable Foreign Exchange Adjustment 524 405 419 452 489 637
19,539 22,288 21,435 23,072 24,918 32,740
TOTAL ASSETS 160,993 163,145 179,727 184,657 197,456 257,132
EQUITY AND LIABILITIES
CAPITAL AND RESERVES
Share Capital 5,496 5,496 5,496 5,496 5,496 5,496
Share Premium 5,040 5,040 5,040 5,040 5,040 5,040
Capital Reserve 8,580 8,580 8,580 8,580 8,580 8,580
Investments Revaluation Reserve AFS 751,962 (210) - - - -
PPE Revaluation Reserve 19,038 17,955 16,159 14,543 13,089 11,780
Retained Earnings 30,513 33,320 35,693 37,686 39,928 45,852
KEGC’S PROFORMA BALANCE SHEET
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TOTAL EQUITY 69,419 70,180 70,967 71,345 72,132 76,748
NON-CURRENT LIABILITES
Borrowings 64,167 61,850 91,647 93,345 100,813 148,035
Operating Lease 7 5 3 1 15 13
Retirement Benefit 1,112 94 1,400 1,400 1,400 1,400
Deferred Tax Liability 15,032 16,016 4,819 5,127 5,531 7,336
TOTAL NON-CURRENT LIABILITIES 80,318 77,964 97,869 99,873 107,759 156,784
CURRENT LIABILITIES
Borrowings Due in the Year 4,480 7,266 6,041 8,401 9,073 13,323
Trade and Other Payables 3,645 4,370 3,738 3,925 7,379 9,160
Amount Due to KPLL 13 6. 10 11 12 16
Operating Lease Liability 2 2 2 2 2 2
Leave Pay Provision 191,387 160 - - - -
Dividends Payable 2,924 3,196 1,099 1,099 1,099 1,099
TOTAL CURRENT LIABILITIES 11,257 15,001 10,891 13,438 17,565 23,600
TOTAL LIABILITIES 91,575 92,965 108,760 113,311 125,324 180,384
TOTAL EQUITY AND LIABILITIES 160,993 163,145 179,727 184,657 197,456 257,132
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Utility Sector: Poised to Be Driven By Nature
KEGC P/B REGRESSIONS
P/B REGRESSION
Regression Statistics Multiple R 0.85 R Square 0.72 Adjusted R2 0.69 Standard Error 0.90 Observations 12
ANOVA
df SS MS F
Significance F
Regression 1 21.31 21.31 25.82 0.0005 Residual 10 8.25 0.83
Total 11 29.56
Coefficients
Standard Error t Stat P-value Lower 95%
Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.28 0.49 0.56 0.59 -0.82 1.37 -0.82 1.37
X Variable 1 0.10 0.02 5.08 0.0005 0.05 0.14 0.05 0.14
P/B = 0.275594 + (0.096552*ROE)
Regressed P/B = 0.56
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KEGC EV/EBITDA REGRESSION
Regression Statistics
Multiple R 0.99
R Square 0.97
Adjusted R2 0.83
Standard Error
4.37
Observations 7
ANOVA
df SS MS F Significance F
Regression 5 659.09 131.82 6.91 0.28
Residual 1 19.06 19.06
Total 6 678.16
Coefficients Standard Error
t Stat P-value Lower 95% Upper 95% Lower 95.0%
Upper 95.0%
Y 55.91 10.72 5.21 0.12 -80.35 192.17 -0.35 192.16
X1 -160.13 41.25 -3.88 0.16 -684.24 363.98 -684.25 363.98
X2 -140.54 29.57 -4.75 0.13 -516.23 235.15 -516.23 235.15
X3 123.67 38.52 3.21 0.19 -365.71 613.06 -365.71 613.06
X4 21.17 22.03 0.96 0.51 -258.73 301.06 -258.73 301.06
X5 8.00 8.13 0.98 0.50 -95.27 111.28 -95.27 111.28
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KPLL P/E VALUATION (Note R-SQUARE) is below 12%, indicating very little correlation between equity return
measures and P/E multiple.
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.34
R Square 0.12
Adjusted R2 -2.53
Standard Error 87.72
Observations 5.00
ANOVA
df SS MS F Significance F
Regression 3 1,023.40 341.13 0.04 0.98
Residual 1 7,694.89 7,694.89
Total 4 8,718.39
Name P/E ROE Beta Retention Ratio EV/EBITDA P/B
Median 15.02 12.32 0.65 81.50 8.69 3.58
Average 32.09 15.46 0.77 72.84 16.78 4.66
KENYA POWER & LIGHTING 5.28 12.32 0.33 81.50 6.72 0.94
COPPERBELT ENERGY CORP PLC 7.12 12.11 0.65 38.02 3.18 0.82
DPSC LTD 115.07 10.41 0.63 58.75 53.84 13.55
DHAKA ELECTRIC SUPPLY CO LTD 15.02 15.83 1.29 85.92 11.45 3.58
MANILA ELECTRIC COMPANY 17.98 26.65 0.95 100 8.68 4.43
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Utility Sector: Poised to Be Driven By Nature
KPLL’S PROFORMA INCOME STATEMENT (Kes. ‘000)
2012A 2013E 2014E 2015E 2016E
REVENUE
Electricity sales 45,008,000 48,158,560 51,529,659 55,136,735 58,996,307
Fuel cost recoveries 41,896,000 37,563,677 40,193,134 43,006,654 46,017,119
FOREX recoveries 8,759,000 963,171 1,030,593 1,102,735 1,179,926
95,663,000 86,685,408 92,753,387 99,246,124 106,193,352
Other income 1,788,000 1,569,068 1,670,587 1,778,674 1,893,754
97,451,000 88,254,476 94,423,973 101,024,798 108,087,106
OPERATING EXPENSES
Power purchase costs 21,080,000 24,079,280 25,764,830 27,568,368 29,498,153
Fuel costs 42,789,000 37,188,040 39,791,203 42,576,587 45,556,948
Distribution and Transmission 19,680,000 19,415,985 20,773,274 22,225,455 23,779,163
89,643,000 80,683,305 86,329,307 92,370,410 98,834,265
OPERATING PROFIT (EBIT) 7,808,000 7,571,171 8,094,667 8,654,387 9,252,841
Depreciation & Amortization 4,051,676 3,313,660 3,545,017 3,792,548 4,057,384
EBITDA 11,859,676 10,884,832 11,639,684 12,446,935 13,310,226
Finance income 489,000 61,857 68,251 72,395 73,472
Finance costs (1,216,000) (1,139,248) (1,207,684) (1,291,285) (1,393,619)
PROFIT BEFORE TAXATION 7,081,000 6,493,780 6,955,234 7,435,497 7,932,694
Taxation (3,889,000) (1,957,582) (2,086,051) (2,219,139) (2,356,254)
PROFIT FOR THE YEAR 3,192,000 4,536,199 4,869,182 5,216,358 5,576,440
DIVIDEND 975,734 975,734 975,734 975,734 975,734
EPS (ADJUSTED) 1.79 1.91 2.04 2.17 2.30
DPS 0.50 0.50 0.50 0.50 0.50
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KPLL’S PROFORMA BALANCE SHEET (Kes. ‘000)
ASSETS 2011A 2012A 2013E 2014E 2015E 2016E
NON-CURRENT ASSETS
PPE 83,298,047 105,841,236 105,905,371 113,308,768 121,229,757 129,704,528
Prepaid leases on land 131,764 131,764 131,764 131,764 131,764 131,764
Fixed Interest Investment 1,298,506
84,728,317 105,973,000 106,037,135 113,440,532 121,361,521 129,836,292
CURRENT ASSETS Inventories 8,960,830 9,863,181 10,402,249 11,130,406 11,909,535 12,743,202
Trade and other receivables 14,426,575 16,625,745 15,003,261 16,052,075 17,174,216 18,374,808
Tax recovarable 194,059 203,519 183,430 195,758 208,605 221,914
Short term deposits 1,539,999 666,556 773,212 853,132 904,934 918,404
Bank and Cash Balances 10,029,213 800,000 1,853,344 1,982,903 2,121,521 14,388,388
35,150,676 28,159,000 28,215,496 30,214,275 32,318,810 46,646,716
TOTAL ASSETS 119,878,993 134,132,000 134,252,631 143,654,808 153,680,331 176,483,008
EQUITY AND LIABILITIES CAPITAL AND RESERVES Ordinary Share Capital 4,336,593 4,336,593 4,336,593 4,336,593 4,336,593 4,336,593
Share premium 22,042,004 22,042,004 22,042,004 22,042,004 22,042,004 22,042,004
Reserves 13,191,002 16,383,002 20,919,201 25,788,383 31,004,741 36,581,181
Proposed Dividends 173,464 975,734 975,734 975,734 975,734 975,734
TOTAL EQUITY 39,743,063 43,737,333 48,273,531 53,142,713 58,359,071 63,935,511
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NON-CURRENT LIABILITIES Deferred tax 6,363,762 6,685,265 7,035,685 7,458,919 7,975,944 8,608,819
Trade and other Payables 16,394,340 17,810,131 10,714,316 11,464,319 12,266,821 13,125,498
Borrowings 19,757,132 20,815,850 27,520,852 28,602,487 29,693,021 39,267,815
Preference Shares 43,000 43,000 43,000 43,000 43,000 43,000
Deferred Income 7,207,089 12,362,000 - - - -
49,765,323 57,716,246 45,313,854 47,568,724 49,978,785 61,045,132
CURRENT LIABILITIES Trade and other Payables 24,156,111 25,560,726 27,885,951 29,690,172 31,611,126 33,656,366
Provision for leave pay 830,734 830,734 830,734 830,734 830,734 830,734
Borrowings 4,764,171 6,248,804 11,794,651 12,258,209 12,725,580 16,829,063
Dividends payable on ord. shares 353,768 38,158 153,911 164,255 175,034 186,201
30,370,607 32,678,421 40,665,247 42,943,370 45,342,475 51,502,365
TOTAL EQUITY AND LIABILITIES 119,878,993 134,132,000 134,252,631 143,654,808 153,680,331 176,483,008
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