utility sector - poised to be driven by nature

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

[email protected]

+254 020 2774781

Anthony Kimani

[email protected]

+254 020 2774781

For trading queries kindly contact;

Carol Matu

Head Trader

[email protected]

Direct Line: +254 020 2774789

Mumbi Mbiyu

Head of Investment Advisory

[email protected]

Direct Line: +254 020 2774768

mailto:[email protected]




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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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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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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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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.

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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


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

17 | P a g e


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

18 | P a g e


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


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%


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


19 | P a g e


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


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.

20 | P a g e


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

21 | P a g e


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

22 | P a g e


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

23 | P a g e


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

24 | P a g e


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.

25 | P a g e


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

26 | P a g e


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

27 | P a g e


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.


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


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

28 | P a g e


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


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

29 | P a g e


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

30 | P a g e


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.

31 | P a g e


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

32 | P a g e


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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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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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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Disclaimer: The content provided on this document is provided as general information and does not constitute advice or recommendation by Genghis Capital Ltd

and should not be relied upon for investment decisions or any other matter and that this document does not constitute a distribution recommending the purchase

or sale of any security or portfolio. Please note that past performance is no indication of future results. The ideas expressed in the document are solely the opinions

of the author at the time of publication and are subject to change without notice. Although the author has made every effort to provide accurate information at the

date of publication all information available in this report is provided without any express or implied warranty of any kind as to its correctness. You should consult

your own independent financial adviser to obtain professional advice before exercising any decisions based on the information present in this document. Any

action that you take as a result of this information, analysis, or advertisement is ultimately your responsibility.

Genghis Capital Ltd, Prudential Assurance Building, Wabera Street, Nairobi. Tel: +254 20 2774760Fax: +254 20 246334

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