Elixir Securities Limited – Elixir Insight

Karachi, September 13, 2018 (PPI-OT): Hub Power Company Limited – Closer to Becoming the “Hub” of Pakistan’s Power Landscape

HUBC is targeting to achieve COD of its 1,320MW imported coal project by Aug-19, which we expect to have an EPS contribution of PKR11.4 by FY21 and alone accounts for PKR50 in our Jun-19 PT

The company also commands a stake of 60% in 330MW coal project (TEL) for which it is targeting COD by Mar-21 (from Dec-20 earlier); we expect the project to contribute PKR2.9 in EPS by FY22.

HUBC owns 8% stake in SECMC, which the management is targeting to bring online by Jun-19; we have conservatively incorporated a six month lag in our estimates and project FY21 EPS impact of PKR0.95.

For current operations of the company, we expect further curtailment in generation bonus from Hub Plant; however higher Dividend Income from Laraib Energy (PKR2.2bn) should cushion the cash flows and unconsolidated profitability in FY19.

With a 3 year CAGR of 41% over FY18-21 and a total upside of 57% to our Jun-18 PT of PKR135, we feel that the market is yet to price in the growth projects that HUBC is closing in on.

With a number of landmark projects in the pipeline, we see Hub Power Company (HUBC) to be closing in on its goal of become the “Hub of Power” in the energy landscape of Pakistan. The company currently commands a combined power generation capacity of over 1,600MW (Hub Plant: 1,292MW, Narowal: 225MW and Laraib: 84MW) and is set to add another 1,650MW by FY21. We feel that the market is yet to appreciate these developments owing to short term concerns on declining Furnace Oil based generation and we thus outline below the details of each project, ongoing progress, expected timeline and their impact on profitability.

Hub Plant – Capacity Utilization to Drop to 20%: Hub Plant generated 5,201GWh of electricity during FY18 (vs. 6,793GWh in FY17). Capacity utilization of the plant declined from 65% in FY17 to 50% in FY18 due to new capacity additions as two hydel power plants came online (Neelum Jhelum-969MW, Tarbela 4th Extension-1,410MW) and three LNG plants became fully operational (Bhikki-1,180MW, Haveli-1,231MW and Balloki-1,223MW). Part of the decline in capacity utilization can also be attributed to abrupt closure of furnace oil based plants in Nov-17 by outgoing government as a mean to control oil imports (HUBC’s 3QFY18 capacity utilization dropped to 27%).

Going forward we anticipate further reduction in reliance on furnace oil power plants due to 1) government measures to curtail import bill and 2) new capacity additions (coal/LNG) to the national grid. Hence we maintain that capacity utilization for Hub Base Plant will drop to 20% in FY19 and will remain stable there onwards.

On the flip side, we expect a dividend income of PKR2.2bn (per share: PKR1.9) from Laraib Energy to cushion the bottom line till full impact of upcoming projects starts to flow in. The subsidiary paid out PKR1.4bn in FY17 and a mere PKR990mn in FY16.

Narowal Energy – Costs to Normalize in FY19

Narowal Energy Limited (NEL) comprises of 11 RFO engines and 1 steam turbine. Constructed in 2010, it is relatively new when compared to the Hub Base Plant, and thus has a higher rank in NTDC Merit Order List; resultantly we have assumed capacity utilization for NEL to remain flat at 63% going forward.

During FY18, the plant dispatched 1,200GWh of electricity with a capacity utilization of 64% (vs. 71% in FY17), due to low electricity demand by power purchaser. The plant also overhauled 3 engines and 7 alternators in the outgoing year while overhauls of 2 engines and 2 alternators are planned in FY19. The overhaul activity (to maintain fuel efficiency) has already resulted in a 2 year cumulative increase of 37% in Cost of Sales (for the segment) to PKR13.9bn in FY18. With a smaller degree of overhauls planned for FY19, the high cost base created in FY18 should allow NEL to deliver an EPS contribution of PKR3.5 for HUBC in FY19.

Update on Upcoming Projects

China Power Hub Power Generation: CPHPGC is undertaking construction of a 1,214MW coal based power plant project, in which HUBC is currently increasing its stake to 47.5% (from earlier 24%). However post financial close, the company will hand over 1.5% stake to the Government of Baluchistan, free of cost. Hence, HUBC will have a 46% stake in project’s earnings. The project has a 27.2% ROE on equity, with a 30 year Power Purchase Agreement, and an IRR of 17.0%. As per the latest accounts, the company achieved financial close in Jan-18 and targets Commercial Operation Date (COD) by Aug-19. The project alone contributes PKR50 to our Jun-19PT.

We expect HUBC’s EPS to jump by 1.8x in FY21 to PKR26.5 (project contribution: PKR11.4). Our DPS forecast for the stock also increases by 2.1x for the same year to PKR23.5.

Thar Energy Limited: TEL is setting up a 330MW mine mouth coal-based power plant at Block II, Thar. During the year, the company has signed a shareholders agreement with Fauji Fertilizer (FFC) and CMEC Tel Power Investments Limited (CMEC Dubai) with the latter two injecting equity investment of 30% and 10%, respectively. The company is targeting COD by Mar-21 (earlier timeline: Dec-20). We expect the project to contribute PKR2.9 in HUBC’s EPS and PKR1.3bn in dividend income by FY22 (per share impact: PKR1.2).

Sindh Engro Coal Mining Company: HUBC’s effective shareholding in SECMC is 8%. As per the latest accounts, management is expecting project COD by Jun-19 and also aims to enhance coal mining capacity to 7.6mt/annum to cater to two additional 330MW IPPs being set up by Thar Energy Limited (HUBC) and Thal Nova Power (House of Habib). Based on HUBC’s minority share in SECMC, we expect the project to contribute PKR0.95 in EPS and PKR860mn in dividend income by FY21 (per share impact: PKR0.74)

Circular Debt – Ambiguity on Resolution: HUBC’s overdue receivables stood at PKR84.6bn (up 15%YoY) as at Jun-18, with the situation likely to aggravate further unless structural reforms are enacted to trim down line losses and power theft. Moreover, unlike 2013, one off large payment to completely retire the current outstanding pile-up looks unlikely in the near term; nonetheless if this were to go through, HUBC will receive PKR76.9bn (91% of its overdue receivables) in cash. After paying overdue payables to PSO of PKR51.6bn (74% of total overdue receivables to PSO), net cash on Balance Sheet can improve by PKR20-25bn (per share: PKR17-22).

Investment Perspective – Market Yet to Appreciate the Progress on Expansion Projects

Short term concerns on declining production from Furnace Oil has withheld investors from appreciating the growth potential that HUBC is set to deliver over the next three years. With FY18-21 (3 year) profitability CAGR of 41% and EPS/DPS set to more than double by FY21, we believe HUBC should take a meaningful position in investors maintain long term growth portfolios. Our Jun-19 PT to PKR135/share offers capital upside of 49% from current levels while the stock perfectly fits into the overall theme of PKR Depreciation.