31 July 2007 April 28th 2009
AKENR.IS – utility generators
Upgraded to Outperform
ZOREN.IS – non-utility generators
Downgraded to Marketperform
We now expect a 1.9% contraction in 2009 electricity demand versus our prior estimate of 6.2% growth.We are revising our electricity demand forecasts based on the slowdown in consumption and changes to our GDP growth estimates. A tight balance between supply and demand will continue until 2011 but by 2012 we expect excess capacity in the power generation sector despite delays and cancellations of some power plant projects (announced and licensed) that have had financing difficulties.
Our revised model suggests lower power prices because of lower natural gas prices (which are indexed to world crude oil prices) and subdued concerns about shortages. New projects will require higher equity financing, thus putting pressure on ROEs and limiting generation companies’ expansion plans. Our capacity projections incorporate a 25% and 50% haircut to all projects licensed in 2007 and 2008, respectively.
We also introduce our electricity distribution network operator valuations in this report. The government has tendered four distribution companies last year (please refer to table 1), three of which are acquired by listed companies and affiliates. AkCEZ (45% subsidiary of Ak Enerji), Enerjisa (50% subsidiary of Sabanci Holding) and Alarko are currently offering access to electricity distribution assets although only Ak Enerji is a pure-play power company.
Table 1: Privatised distribution regions Region
name Owner
DCF
(USDm) Total paid
Value created Equity (USDm) IRR (%) Licence start date License period License end date 2009 2010 2011 Ankara Enerjisa $1,150.3 $1,225.0 -$74.7 $612.5 9.7% 2009 27 2036 9.0x 6.4x 11.5x Sakarya AkCEZ $641.2 $600.0 $41.2 $300.0 12.6% 2009 27 2036 10.5x 8.0x 10.2x Meram* Alarko $678.4 $440.0 $238.4 $220.0 15.8% 2009 27 2036 4.8x 3.4x 8.2x
EV /EBITDA (acquistion price)
Source: TEDAS and Standard Unlu research; *Meram region equity portion is estimated
We find Alarko’s project the most lucrative. It offers the highest IRR, mostly thanks to higher temporary surcharge on distribution tariff (refer to the section titled “A peek at the electricity distribution”), but the region (Meram) is also the most likely to suffer from collection difficulties because of its higher share of irrigation consumption (23%). Ak Enerji’s region (Sakarya) is very susceptible to economic cycle due to high industrial consumption (55%). Churn rates will be a concern once retail competition is introduced. We expect regulator to follow the European model and start with large consumers, which would affect Ak Enerji’s region the most. Financial conditions have deteriorated dramatically in the post-Lehman world, and as debt financing become scarce equity financing becomes vital. We calculate that the short-term financing needs of Ak Enerji and Zorlu Enerji for new projects and debt amortisation amount to US$273m and US$512m, respectively. Zorlu Enerji probably needs to carry out a sizable rights issue; while Ak Enerji’s cash needs are manageable in 2009, possibility of a rights issue in 2010 exists. We upgrade Ak Enerji (AKENR) to Outperform, however lower our target price to TRY10.4 (implying 27% upside). We believethe addition of electricity distribution business would improve the company’s long-term prospects, however in the short-term would increase cash requirements.
We downgrade Zorlu Enerji (ZOREN) to Marketperform and reduce our price target significantly to TRY4.0 (implying 47% upside). We downgraded our rating for the company despite the healthy upside due to (i) uncertainty surrounding heat and power prices in Russia; (ii) yet-to-be finalised financing of Rotor; and (iii) ambiguity on geothermal power potential of Denizli project, while our lower price target is warranted because of (i) our revised outlook for the general and electricity markets; (ii) cost over-runs in Russia; (iii) the exclusion of Pakistan wind farm investment; and (iv) faster-than-expected declines in natural gas production volumes. The stock value is largely tied to the success of its Russian investment and the commitment of its parent to the energy business.
Introducing electricity distribution and a new look to the generation
Turkey
Power generation and utilities
Consumption estimates revised in line with the expected GDP growth rates
The fast-growing Turkish power demand (5.7% p.a. over the past 10 years) has started to show signs of slowing, because of the global economic turmoil. Power demand contracted by 4.4% and 6.6% y/y in 4Q08 and 1Q09, respectively.
Figure 1: Turkish monthly electricity consumption (GWh)
12,000 13,000 14,000 15,000 16,000 17,000 18,000 19,000 Ja n Fe b Mar Ap r May Ju n Ju l Au g Se p Oc t No v De c 2007 2008 2009 Source: TEIAS
Lower capacity utilisation in steel, textiles, automobiles, durables and other electricity intensive sectors has pushed consumption levels lower.
We are lowering our electricity demand estimates significantly, due to changes to our GDP forecasts; the manufacturing sector has been badly affected by the economic turmoil and is decreasing production levels and thus power consumption. Turkish Electricity Transmission Company (TEIAS) recently decreased its 2009 electricity consumption growth forecast to 4.5% y/y compared with our forecast of a 1.9% contraction. Note that our previous growth estimate for 2009 was 6.2%, slightly below TEIAS’s low scenario of 6.3% and significantly below high scenario of 8.3%.
Figure 2: Turkish peak demand estimates (MW) – our previous forecast vs. updated forecast
10,000 20,000 30,000 40,000 50,000
2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E
Previous Updated
We had previously predicted a supply shortage in 2009. While the supply situation may remain tight even under the decreased consumption forecast until 2015, our estimates do not point to a shortage. While we believe a new supply-demand balance would eliminate costly liquid-fuel-fired generation from the Turkish generation mix during excess capacity periods (2012-2014), renewable (wind and hydro) will continue to be relatively attractive because of its higher profit margins, given that Turkey’s generation portfolio is dependent on higher cost natural gas generation.
According to our projections, installed power capacity will be 19% above reserve capacity needs by 2012, but the excess capacity will only last for two years.
Power plant investments are capital intensive with long construction periods. Thus, we believe the realisation rate of the previously announced projects will be low because of the standstill in the debt markets and the lower electricity price forecasts. Our capacity projections incorporate 25% and 50% of projects licensed in 2007 and 2008, respectively, will not be realised.
We believe deadlines imposed by the regulator would not be sufficient to motivate the investors to finish on time given the tightness of the credit markets; force majeure clauses would likely be put forward to make the enforcement and license cancellation difficult. Accordingly, a portion of the capacity additions will almost certainly not be built within the projected schedules.
Figure 3: Turkish peak demand and reserve margin estimates and capacity projections by licence type (MW) -20 40 60 80 20 04 20 05 20 06 20 07 20 08 20 09 E 20 10 E 20 11 E 20 12 E 20 13 E 20 14 E 20 15 E 20 16 E GW EUAS TOR-BOT-BOO Autopro.&Mobile IPP
IPP Projects (not licensed) SU Demand Demand incld. 25% operating reserve
Source: TEIAS and Standard Unlu Estimates; TEIAS calculations indicate 29% as min. operating reserve required Realisation rate of power plant projects will likely decrease
In 2007 and the first half of 2008, the generation licence applications were treasured by all companies. Power generation was viewed as promising high returns with little risk, and many investors (from the sector and newcomers) had begun announcing their new power plant projects.
Although construction costs for power plants have come down considerably with the drop in steel and cement prices, investor interest is likely to diminish amid lower ROEs. Project IRRs are set to decrease because of even larger declines in power prices and the deteriorating outlook. Moreover, as the portion of the equity financing increases, ROEs come down even further. We believe that unless credit starts to flow again quite soon, most of the power plant project licences obtained (which have become a commodity in recent years) will be left to expire or sold at much lower prices than a year ago. Our sector contacts indicate that renewable generation
licence prices have already come down to below US$100,000 per MW from US$250,000 per MW a year ago.
In our forecasts, we only included capacity announcements by credible Turkish companies. However, given the tightness in credit markets and the financially stretched position of many companies, realisation rates could be much lower.
Table 2: Unlicensed (as of Dec. 2008) credible IPP capacity additions (MW)
Renewable NG Coal Total
Ak Enerji 227 882 0 1,109 Turcas- RWE JV 0 800 800 1,600 Enerjisa 1,285 919 450 2,654 Alarko 0 970 1,875 2,845 Gama-GE JV 701 400 1,200 2,301 Akfen 0 0 1,600 1,600 Eren Enerji 0 0 1,200 1,200 Total 2,998 3,971 7,395 14,364
Source: Company data
Lower power price estimates because of overcapacity concerns and lower oil prices We lower our 2009 regulated tariff and spot price estimates by 17% and 25% in USD terms, respectively. Our 2010 regulated tariff estimate is 2% higher y/y, while we forecast 29% increase in spot market prices due to higher power demand and higher NG prices.
Turkish companies have two sales channels, namely the spot market and bilateral contracts. Bilateral contracts are priced at a discount to benchmark regulated price. Turkish spot market is an open auction market operated by TEIAS where private generators submit their generation amount and pricing bids for every hour in a month. The main customers of the market are distribution companies and TETAS (Turkish Electricity Wholesale Company). The market was initially established to accommodate the imbalances in power procurements. The spot market quickly became a more profitable sales channel for power producers because of the low regulated power tariffs which had been held down by the Government until very recently, lower extra charges (such as distribution and transmission charges).
Figure 4: Turkish monthly peak spot market prices (TRL per MWh)
80 105 130 155 180 205 230 Ja n Fe b Ma r Ap r Ma y Ju n Ju l Au g Se p Oc t No v De c 2007 2008 2009 SU estimates
On the demand side, the spot electricity market mainly attracts participation by electricity distribution companies that wish to purchase the shortfall between their contracted power and the actual consumption (A recent change in spot market regulations now allows demand side participation starting October 2009). The recent drop in power demand is closing this shortfall, thus reducing the volumes traded in the spot market.
Likewise on the supply side, lower demand for electricity has affected sales volumes of the independent power generators. Although Turkey’s natural-gas-heavy generation mix thus far protected natural gas based private generators’ margins, lower capacity utilisation rates shrank the absolute profits.
Decreasing demand and lower oil prices will put pressure on electricity prices in 2009. We expect spot prices to weaken on average y/y mostly due to decreasing natural gas prices and lower consumption. Regulated prices will be more resilient compared with largely natural gas dependent spot prices, thanks to Turkey’s c55% exposure to NG and liquid-fired generation in total generation. Table 3: Turkish yearly average electricity prices (TRL per MWh)
2007 2008 2009E 2010E 2011E 2012E
Regulated 123.4 160.1 176.2 192.5 223.7 241.8
Spot 134.9 167.1 173.8 238.0 258.0 268.0
Source: TEDAS, TEIAS and Standard Unlu estimates; Spot prices are weighted for volume
We estimate spot market spark spreads1 will return to 2007 levels by 2011. We expect weaker spark spreads between 2012 and 2014, due to excess generation capacity.
Figure 5: Average yearly spot market spark spreads for CCGTs* (USD per MWh)
-10 20 30 40 2007 2008 2009 2010 2011 2012
Source: Standard Unlu estimates; *Combined cycle gas turbine
The situation is even worse for renewable power plants since, unlike natural-gas-fired plants, their cost items are not decreasing and profits are decreasing at a faster pace. Higher upfront investment costs caused renewable energy projects’ ROEs to decline more rapidly increasing risk of project cancellations.
Spot volumes could decline, making bilateral agreements more attractive
Since its inception, the electricity spot market in Turkey has become the main revenue source for independent power producers. However, recent falling demand in the spot market resulted in lower capacity utilisation rates. Thus, we believe the share of lower-margin bilateral power purchase contracts will increase in total generation.
In addition, despite TETAS’s second failed attempt to buy electricity under long-term contracts, the government appears determined to limit public exposure to the spot market. We believe a tender with improved terms would be attractive for large fossil fuel or renewable power generators, mainly because the future output of the plants currently under construction can be offered. This would provide the project owners with an important source of collateral for project financing.
A peek at electricity distribution
Publicly listed utility stocks have always been a safe harbour in turbulent times. With the completion of tender processes of four electricity distribution companies, ISE investors now have the opportunity to invest (although indirectly) in the Turkish electricity distribution sector.
The government has put out tenders for four distribution companies in 2008, three of which have been acquired by listed companies and affiliates. AkCEZ (45% subsidiary of Ak Enerji), Enerjisa (50% subsidiary of Sabanci Holding) and Alarko are currently offering access to electricity distribution assets although only Ak Enerji is a pure-play power company, while Kiler, which is the highest bidder for Aras region, is not affiliated with a listed company.
Table 4: Electricity distribution company tenders Region Buyer Price (USDm) (GWh) (2007) '000 USD per GWh Subscribers (2007)(mn) Theft/loss ratio (2007) SU Valuation (USDm) '000 USD per GWh IRR (%) Ankara Enerjisa $1,225 9,965 123 3.0 8.7% $1,150 115 9.7% Sakarya AkCEZ $600 7,889 76 1.3 6.2% $641 81 12.6% Meram Alarko $440 5,426 81 1.5 7.9% $678 125 15.8% Aras Kiler $129 1,494 86 0.7 29.4% Coruh 2,096 1.0 12.0% Osmangazi 4,769 1.2 6.3% Yesilirmak 3,830 1.4 9.1%
Source: TEDAS and Standard Unlu estimates
Enerjisa has paid the highest price with US$123,000 per GWh, while Sakarya was the least expensive region per GWh basis at US$76,000.
Ak Enerji and Enerjisa have financed their acquisitions with 50% equity by taking Privatisation Administration’s (PA) offer (PA requires 50% upfront payment and remainder in two equal payments in next two years with a LIBOR + 2.5% interest rate) due to scarcity of credit and higher financing costs, which increased WACC and depressed the valuations.
We believe yet-to-close Alarko deal could follow a similar approach, however the terms on instalment payment option offered by Privatisation Administration is less appealing than the previous two privatisations (PA asks for a 9% p.a. interest rate in Meram and Aras privatisations). The tenders are structured after transfer of operating rights model (TOR). Under the scheme, private companies received the operating rights of the distribution assets until 2036, but not the ownership.
Although all three privatised regions have different characteristics, we find Alarko’s region the most lucrative since it offers the highest IRR, mostly thanks to the higher upfront regional cash flow included in the distribution tariff (the transfer of the operating rights component collected in 2009 and 2010 in the Meram region will amount to TRY171m versus TRY69m in Sakarya in the same period, please refer to “Table 6” on page 12).
The regions will have a retail monopoly until the introduction of retail competition in 2013. Churn rates would be the largest concern after 2013, and we expect retail competition to follow the European model and start with large consumers. Once the competition starts, the Sakarya electricity distribution company is likely to face the toughest competition with its 55% industrial consumption share, since large users are more sensitive to power prices.
With high share of industrial consumption Ak Enerji’s region (Sakarya) is more susceptible to state of the economy, while the Meram region is also the most likely to suffer from collection difficulties due its higher share of irrigation consumption (23%).
Background
Utility businesses are defensive in nature but do have some growth potential. Historically, Turkish power consumption has been increasing faster than Turkish GDP and has proven to be resilient during economic downturns. In the economic crises of 2001, electricity consumption contracted by 1.8% despite the 5.7% decrease in GDP; this was mainly thanks to unaffected power demand from exporters. However, unlike in 2001, there is now no strong EU economy to support exporters so we expect electricity consumption to contract by 1.9% in 2009, while GDP decreases by 3.3%.
Figure 6: Turkish GDP versus electricity consumption growth rate (%)
-8.0% -4.0% 0.0% 4.0% 8.0% 12.0% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008E 2009E Electricity Consumption GDP
Source: TEDAS, Turkstat and Standard Unlu estimates
Previously, TEDAS (Turkish Electricity Distribution Company) grouped 81 cities under 21 regional distribution companies.
Figure 7: Turkish distribution regions
The ‘transfer of operating rights’ method (as opposed to direct asset sale) was selected for the privatization of distribution companies due to legal issues and possible land expropriations required. The method grants the operational rights to the private sector but ownership of the current and new distribution network assets is kept by TEDAS. EMRA (Energy Market Regulatory Authority) has been assigned the task of overseeing the regions and issuing distribution licenses, auditing investments, and reviewing and approving various costs and margin levels.
Thus far, four privatisation tenders have been completed in 2009 (Ankara, Sakarya, Meram and Aras), while two others are still being processed (Osmangazi and Coruh). Note that in the 1990s three distribution regions (Kayseri, Menderes and Goksu) were previously transferred to the private sector in prior attempts to privatise electricity distribution companies.
New tenders will also take the form of TOR for 30 years. However, due to the delays in the privatization processes, the license period will be limited to 27 years (until the end of 2036) for the regions to be privatised in 2009.
Figure 8: Recently privatised Turkish distribution companies’ share of total consumption (2007)
Other 82% Ankara 7% Sakarya 6% Meram 4% Aras 1%
Other Ankara Sakarya Meram Aras
Source: TEDAS
Unbundling of retail and distribution activities
Unbundling is the process of organisational and legal separation of the regulated distribution activities from the retailing2. Unbundling is currently being implemented in all liberalizing energy markets in Europe and should secure a level playing field for all market participants.
While distribution activities are related to physical delivery of electricity, power retailers provide financial contracts to their customers and manage the risk involved in supplying electricity. Thus retailers’ only competition tool is the price (that said some retailers provide renewable power only contracts at higher prices).
The regulation envisions retail competition in each region after 2013 (end of extended transition period). Distribution companies are free to set-up retail arms and compete with other retailers. At this point energy procurement costs becomes very important, thus lowest cost provider will be able to pass on the saving to end-customers and gain market share.
Currently all distribution companies enjoy high market shares for these reasons:
• No retail competition
• Low self generation due to high liquid fuel and natural gas prices
Retail business for small and medium consumers is a new concept in Turkey and would require significant investment to develop a market. With the introduction of retailers to the market, a drop in the market share of the distribution network operators’ retail operations would be unavoidable. However, it is highly likely that they would be compensated for the loss revenue by gaining market share in other regions.
The most significant obstacle (after gaining customer preference) would be gaining access to electricity because currently most of the capacity in Turkey is state-owned. In our opinion, true competition in the retail market can only start after the privatisation of public generation assets. We should also note that distribution companies could lose market share even in the absence of retail competition. A combination of high regulated tariffs and low fuel prices (i.e. low cost of generation) would motivate large industrial consumers with self-generation capabilities to bring online their generators, which would decrease the purchases from the grid and lower distribution company profits.
Revenue generation
Under the current structure, retail and distribution operations are combined in the distribution company structure. The major portion of distribution company profits comes from regulated retail electricity sales (gross margin component). On the distribution side, the main contributions to profits are outperforming target theft/loss and other operational targets set by the regulator We identified six sources of revenue for the distribution companies under the current system:
- Gross margin – retail component: Under the current methodology, a 2.23%3 gross margin is charged on top of the costs. The gross margin rate is fixed until 2012, after which time it will be determined by Energy Market Regulatory Authority (EMRA) in consultation with distribution network operators and retailers, either for individual regions or all regions.
After the unbundling of retail operations (2013) and when the competition is established, the margin should be determined by competitive market forces under the supervision of EMRA We believe a single margin for all customers approach is not feasible after 2013 and different margins could be set according to the customer segments; residential being the highest and industrial the lowest-benefiting regions with high residential consumption (i.e. Ankara).
In our model, we assumed after 2012 residential margins will go up to 5%, while industrial margins will decrease to 2%. Commercial and Other segment margins assumed to stay at 3% going forward. Thus we determined different average margins for each region according to their consumption composition. Accordingly Ankara region will have the highest average margin with 3.9% thanks to high share of residential consumption.
Table 5: Distribution regions’ average retail margins
Region
Average margin
after 2013 Residential Commercial Industrial Other
Ankara 3.9% 35.4% 18.2% 25.7% 20.7%
Sakarya 2.8% 19.2% 12.5% 55.2% 13.1%
Meram 3.7% 22.4% 10.3% 32.0% 35.3%
Consumption composition
Source: TEDAS and Standard Unlu Research
The margin level is difficult to estimate because it is a moving target that is affected by prevailing electricity prices and fixed costs associated. However, we expect residential margins to go up, while industrial margins to decrease. Note that current flat margin is calculated as the minimum applicable level and a higher margin will be required to spur retail competition in residential and commercial segments. Moreover, our sector contacts indicate that they expect a range between 4% and 5%, which indicates our margin assumption stays on the conservative side.
Although we assumed a flat margin until the end of the licence period for each segment, we are aware that it would be unrealistic to assume a flat retail margin for a long period of time and we expect the figure to fluctuate over the years according to: i) the intensity of retail competition; and ii) electricity prices.
The bulk of the Sakarya region’s consumption comes from industrial customers (55%). Retail competition in other countries have shown that large users are more sensitive to prices and more likely to switch retailers, so it would be more costly for Ak Enerji to defend its industrial customer base against competition.
However we believe incumbent retailers4 will make up for market share lost in their own region by gaining market share in other regions, so we assumed flat retail market share in our valuation but no growth beyond the respective regions’ organic growth rates.
Figure 9: Selected distribution regions electricity consumption by segment (2007)
0 3,000 6,000 9,000 12,000
Ankara Sakarya Meram
Residential Commercial Industrial Other Source: TEDAS;” Other” is mostly irrigation consumption in Meram region
- Decreasing loss/theft ratio below the target set by EMRA: Distribution companies are allowed to retain excess value derived from outperforming pre-determined loss/theft targets approved by EMRA. We assumed a gradual decrease in the actual-target loss spread to 1pp; - Increasing operational efficiency: Distribution companies will retain savings from improving operational efficiency by outperforming operational targets set by EMRA. The regulator has already set fee ceilings (i.e. operating expenditure allowances) for 2009 and 2010 and disclosed a methodology to calculate future allowances (based on CPI and efficiency coefficient). The companies will retain any underspend on opex, but bear the costs of any overspend within the price control period. We assume 30% savings in 2009 and 2010 and 10% savings over the life of the licence.
- Subscription fee, security deposit and collected taxes: The company will charge a subscription fee to each additional customer and is allowed to collect a security deposit. The deposits will be returned to each customer when the subscription is ended, however they will be managed by the distribution company, thus creating negative working capital. Note that the security deposits will be an interest-bearing liability because it will be returned to the subscriber with interest.
Moreover, the distribution company will collect taxes and charges on the power price such as TRT fee (2%), energy fund (1%), VAT (18%) and municipal consumption tax (5% for residential subscribers and 1% for industrials), which are retained for around two months after collection.
- Transfer of operating rights component on tariff (a temporary surcharge on tariff): The contracts grant the companies the right to charge an additional fee for 2009 and 2010, ostensibly to allow the company that wins the tender to recoup some of the payment it made in an accelerated fashion. The amount is determined by PA and varies widely between regions (see table 5). Note that the figures provided in tender documents are in 2006 figures, thus should be adjusted by CPI.
In two years, Ankara region will claim the highest payment among privatised regions (with TRY212m), followed by the Meram region (TRY171m) and Sakarya (TRY69m). These amounts will be spread over the total consumption in the region and will boost monthly bills for the consumer.
Table 6: Distribution companies’ TOR surcharges (TRYm)
Region 2009 2010 Total Ankara 82 130 212 Sakarya 26 42 69 Meram 66 105 171 Aras 46 73 119 Coruh 39 62 101 Osmangazi 35 56 92 Yesilirmak 41 66 107
Source: EMRA and Standard Unlu estimates
Power procurement
Distribution companies have four sources for power procurement:
- Bilateral contracts with TETAS (wholesaler) and/or EUAS (generator): Distribution companies have already signed five-year power purchase agreements with these two state-owned entities, which will expire in 2011. Given the delays in the privatization process on the generation front, we expect these agreements to be extended and state-owned companies to be the major suppliers for distribution companies in the medium term.
- Bilateral contracts with private generators: The companies will be able to launch tenders to procure power from the private sector, without any cap on the bids. We expect the tender process to become the main source for power procurement with the completion of the privatization of the state generation assets.
- Spot market: Distribution companies will use the spot market if electricity demand in the region exceeds the bilaterally contracted amounts mentioned above. Given the relatively higher prices in the spot market, we believe the spot market will continue to be the last resort for power supply purchasing.
- Procurement from its owngeneration company: The law bans generation companies from bidding for the power purchase auctions launched by their related distribution companies during transition period. In addition, the tariffs in the bilateral contracts between these related companies is capped by the Turkish electricity wholesale price set by TETAS, in order to prevent transfer pricing.
Collection problems
Non-collectable invoices could be a major concern, especially in rural areas because of lax enforcement mechanisms and frequent pardons granted on accumulated power bills. Most of the Turkish electricity distribution regions are struggling with high unpaid account receivables. The collection rate is highest among industrial customers and lowest in irrigation consumption (previously public consumption was the largest non-collectable item but a Treasury guarantee was granted to most public receivables as part of the privatisation process).
Although we do not have information on regional collection rates, a recent report by the State Planning Organisation points out the mounting collection problems for TEDAS on billed power sales, excluding theft/loss.
The companies are currently not able to reflect the non-collectables on the end-customers. Given their thin gross margins, we believe the largest risk for the business is non-collectables and legal fees (on numerous non-payment cases). There is a possibility that after 2010 a new system could be introduced to grant distribution companies partial recovery of some of the non-collectibles by treating them as a cost and allowing paying customers to subsidise the non-payers. However, we did not incorporate this assumption in our model.
Under private ownership, distribution companies will be faster to act on non-collectable invoices, but it could take some time to find the means to achieve this, while we believe easiest response would be to increase security deposit amount, which is set by EMRA.
31 July 2007
April 28th 2009
Company update
Alen Bebiroglu*
Foreign Holding Current -1m -3m -12m
32% 31% 35% 33%
Stock Performance 1-mo 3-mo 12-mo Ytd
Absolute YTL 35% 57% -21% 34% Absolute USD 38% 56% -37% 26% Relative to ISE-100 17% 37% 17% 21% 3.00 6.00 9.00 12.00 US $ 30% 60% 90% 120% 150% 180% 210% AKENR Relative Share Data
Price Target (TRY): 10.36
Price (TRY), Close (Apr 27,2009): 8.15
Upside (Downside) 27%
52-week range (TRY): 4.26 - 11.80
Bloomberg / Reuters Ticker AKENR TI / AKENR.IS
ISE-100: 29,552
ISE-100 (US¢) : US¢ 1.83
Weight in ISE-100 0.5%
Avg. Daily Turnover (1 mo.) US$2.6m
# of outstanding shares (m) 65
Reported Free Float 53%
Actual Free Float 25%
Capitalization (US$) MCAP 329 Target MCAP 419 Net Debt 128 Enterprise Value 457 Ownership Structure Akkok group 41% Dinckok family 24% Other 10% Free Float 25%
Key Figures (US$) 2007 2008 2009F 2010F
Net Sales 348 469 842 1,346 EBITDA* 32 74 82 158 EBITDA Margin 9.1% 15.8% 9.8% 11.8% Net Earnings* -8 66 17 47 Net Margin -2.2% 14.2% 5.9% 3.5% EPS -0.12 1.02 0.27 0.72 Market Multiples 2007 2008 2009F 2010F EV/Sales 0.9 1.0 0.5 0.3 EV/EBITDA 10.0 6.2 5.5 2.9 P/E n.m. 5.0 19.0 7.0 P/Cash Earnings 11.5 3.6 8.1 174.4 P/BV 1.1 1.0 0.6 0.6 ROE -2% 20% 4% 9%
* 2007 EBITDA and NI are adjusted for one-off asset sale loss
AK ENERJI
OUTPERFORM
AKENR.IS —
utility generators
Upgraded from Marketperform
Diversified power company
We upgrade our rating for Ak Enerji to “Outperform”, but lower our price target to TRY10.4 per share from TRY11.9 per share, implying 27% upside potential. We incorporate following factors in our new valuation: (i) the changed sector outlook; (ii) the acquisition of Sakarya electricity distribution company; (iii) new capacity plans; and (iv) a higher COE.
The acquisition of Sedas (Sakarya Electricity Distribution Company) has fortified the company’s position in the Turkish power sector. We calculate the IRR of the project at 12.6%, which corresponds to an equity value of US$641m (compared with US$600m acquisition price). The distribution region provides a good platform to lunch retail electricity business of small and medium size customers, plus it also provides a captive market for generation business in the future. Ak Enerji continues to be the only pure power play on the ISE.
Possibility of a rights issue in 2009 is low: We calculate the company needs negligible amounts (US$4m) of debt or equity financing in 2009. However we believe probability of rights issue is high in 2010, even excluding natural gas fired power plant project. Maturing debt financing secured from group companies (US$83m) for one year term and next instalment for distribution region (US$68m) increases financing needs in 2010 to US$276m, and probability of a rights issue next year. Thus we incorporated a possible rights issue of US$100m in our valuation.
CEZ acquisition is not closed yet and still pending necessary permits and approvals and there could be a positive surprise if a tender exemption is not granted: Ak Enerji announced that it will convene its extraordinary general assembly on May 12 to approve 37.4% stake sale to CEZ AS of Czech Republic and request for share call exemption.
The deal is still pending necessary permits and approvals. After the general assembly approval of the deal Ak Enerji will apply for share call exemption which would have been granted under current regulation. However, CMB recently issued a draft new communiqué on tender calls, which proposes to change 2/3 majority rule for exemptions, if the deal and eventual exemption application is delayed until after the introduction of the communiqué, there could be significant upside as the deal priced the company at USD810m vs. current mcap of USD329m.
The company’s first two hydropower plants (total capacity of 181 MW) and its wind farm (capacity of 15 MW) will come online in 2010. Generation EBITDA margins will jump to 22% in 2010 from 13% in 2009 due to the inclusion of renewable power plants in the generation mix.
We upgrade our rating for Ak Enerji to “Outperform” , but lower our price target to TRY10.4 per share from TRY11.9 per share, implying 27% upside potential. We incorporate following factors in our new valuation: (i) the changed sector outlook; (ii) the acquisition of Sakarya electricity distribution company; (iii) new capacity plans; and (iv) a higher COE. The company currently trades at a 70% discount to CEZ’s acquisition value. We believe the utility business is defensive in nature, although Sedas is one of the least defensive electricity distribution companies because of its highly industrialised nature (industrial customers accounting for 55% of unit sales). We believe the contraction in unit sales in the region will be around 5%, compared with our Turkish electricity demand contraction estimate of 1.9%.
Although in 2009 external financing requirements are negligible, we incorporated a possible rights issue of US$100m in our valuation, since we believe probability of rights issue is high in 2010, due to maturing in group loans (US$83m) and next instalment payment for distribution region (US$68m) (please refer to page 17 for detailed discussion).
Table 7: Ak Enerji valuation (USDm)
Business MCAP Owned (%)
Generation 427 100
Distribution 41 45
Target MCAP (a) 446
Current MCAP (b) 329
Size of potential rights issue (c) 100
Upside after rights issue* 27%
Current share price TL8.15
Target share price TL10.36
Source: Standard Unlu research; *Upside calculated using [ (a+c)/(b+c)] formula
Table 8: Summary of forecast changed – generation business only (USDm)
2009 2010 2009 2010 2009 2010 2011 2012
Capacity (MW) 364 560 614 623 -250 -63 -41% -10%
Sales 294 372 383 386 -89 -14 -23% -4%
EBITDA 38 82 82 85 -43 -3 -53% -3%
Net income -3 26 7 10 -10 16 -140% 166%
New Old Change Change (%)
Source: Standard Unlu research
Grants exposure to utility business in the listed space: The acquisition of Sedas (Sakarya Electricity Distribution Company) has fortified the company’s position in the Turkish power sector. We calculate the IRR of the project at 12.6%, which corresponds to an equity value of US$641m. Ak Enerji continues to be the only pure power play on the ISE.
Currently, Ak Enerji and Akkok Holding (parent of Ak Enerji) have 45% and 5% stakes in AkCEZ, respectively, while CEZ holds the remaining 50%. The management have stated that after the closing of Ak Enerji stake sales, CEZ and Akkok Holding will have equal stakes in the distribution region (via transfer of 22.5% of Akkok shares to CEZ, which is part of the Ak Enerji-CEZ deal), while Ak Enerji continues to hold 45%.
The valuation of the distribution company is sensitive to retail gross margin, which is set at 2.23% until 2013, after which it will be determined by EMRA. In our calculations, we assumed the gross margin would stay at 2.8% between 2013 and 2036. Sector players see the current margin as a floor and expect some improvement from this level. The general average retail margin expectations among distribution companies are between 4% and 5%, which leads us to believe that our 2.8% assumption is on the conservative side, since a further increase could be needed to stimulate retail competition. Note that Sakarya region average retail margin is lower than other
recently privatised regions after 2012 due to high share of industrial consumption as we assumed retail margins will vary between customer groups after 2013 (please refer to page 11) residential being the highest (5%) and industrial is the lowest (2%).
Our valuation is also unfavourably affected by the high equity financing in the acquisitions. AkCEZ paid 50% of the acquisition price of US$600m with equity, while the rest was payable to PA in equal instalments in two years with an annual interest rate of LIBOR + 2.5%.
In the table below we analysed the sensitivity of the distribution company’s valuation with respect to industrial retail margin and savings in operational expenses. We assumed a 10% savings over the regulated operational ceilings until the end of the licence period, while savings are 30% in 2009 and 2010, due to overstaffing and inefficient outsourcing in current state.
Table 9: Sensitivity matrix of distribution region valuation (USDm) (2013-2036)
1.00 2.00 3.00 4.00 5 522 577 632 686 10 587 641 694 748 15 651 703 756 808 20 713 764 816 867 Annu al operat ional savings (%)
Industrial retail margin (%)
Source: Standard Unlu estimates
The region’s valuation could change cUS$50m with every 1pp change in industrial retail margin and cUS$60m with every 5pps change in operational savings.
The Sakarya region is heavily industrialised. Some 55% of the consumption comes from industrial consumers and only 20% from residential consumers so its consumption is very sensitive to the general state of the economy. Moreover, large consumers have self-generation capabilities and could stop receiving power from the distribution network when self-generation becomes more profitable (i.e. lower natural gas or fuel oil prices). However, the region’s high share of industrial customers also benefits the company in terms of higher than average growth, higher collection rates, and lower maintenance costs.
The loss/theft ratio is reported to be 6.2% in 2007, however our company contacts indicate that the real rate is around 7%, so we used the figure as our starting point. Loss/theft targets approved by EMRA are currently set to 9.5% and 8.5% for 2009 and 2010, respectively. The company will increase its profits if it outperforms these targets and we assumed the spread between the target and actual losses will shrink gradually to 1% by 2030.
Table 10: Sakarya distribution region DCF valuation (USDm)
2009E 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2026E 2036E
Loss spread (%) 2.5% 2.0% 2.2% 2.3% 2.4% 2.4% 2.4% 2.3% 1.4% 1.0% Retail margin (%) 2.2% 2.2% 2.2% 2.2% 2.8% 2.8% 2.8% 2.8% 2.8% 2.8% Sales (GWh) 7,593 8,054 8,798 9,332 10,321 11,060 11,850 12,445 18,282 25,292 Sales growth 6% 9% 6% 11% 7% 7% 5% 4% 3% Subscriber number ('000) 1,309 1,315 1,331 1,350 1,370 1,391 1,411 1,432 1,645 1,883 Subscriber growth 0% 1% 1% 1% 1% 1% 1% 1% 1% Revenues 730 974 1,071 1,135 1,280 1,523 1,577 1,682 3,416 7,185 Revenue growth -16.9% 33.3% 9.9% 6.0% 12.8% 19.0% 3.6% 6.6% 8.3% 7.5% EBIT (USDm) 52.2 68.4 51.7 56.4 69.1 81.8 84.1 88.7 146.9 277.6 EBITDA (USDm) 58.7 76.1 59.5 64.3 77.3 90.5 93.3 98.1 159.1 293.1 EBITDA margin 8.0% 7.8% 5.6% 5.7% 6.0% 5.9% 5.9% 5.8% 4.7% 4.1% -Tax on EBIT -10.4 -13.7 -10.3 -11.3 -13.8 -16.4 -16.8 -17.7 -29.4 -55.5 -Change in WC -1.2 -0.4 0.2 -0.2 -0.4 -0.4 -0.2 -0.2 -0.3 -0.5 -CAPEX -8.9 -9.0 -9.3 -9.6 -9.8 -10.0 -10.2 -10.4 -13.2 -16.8 FCF 38 53 40 43 53 64 66 70 116 220 WACC 9.5% 11.1% 10.6% 10.6% 10.6% 10.7% 10.7% 10.7% 11.2% 11.7% PV of FCFs 639.5
Not amortised investment rebate 1.5 Net Debt (2008/12) 0.0
Possibility of a rights issue in 2009 is low: We calculate the company needs negligible amounts (US$4m) of debt or equity financing in 2009. Even excluding natural gas fired power plant project, short-term debt financing secured from group companies (US$83m) for one year term and next instalment for distribution region (US$68m), which is due in 2010, increases financing needs in 2010 to US$276m (assuming long term debt service is US$30m plus repayment of US$83m to group companies), increasing probability of a rights issue in 2010. Thus we incorporated a possible rights issue of US$100m in our valuation.
Ak Enerji’s ongoing generation investments and distribution acquisition have significantly increased its financing needs. We calculate total financing needs sum up to US$273m in 2009. US$600m acquisition of Sedas was financed by 50% equity, considering the company’s 45% stake in the consortium, the distribution asset alone has created an immediate funding need of US$135m. Ak Enerji already partially financed it with an intra-group loan of US$83m, while the rest was financed using cash at hand. The company currently has ten power plant projects with total capacity of 388 MW, we calculate 2009 capex requirements for generation projects at US$117m, which already has 70% secured financing. Ak Enerji has low debt levels and has a short term debt payment of US$21m.
Although we calculate Ak Enerji’s generation and distribution businesses will create a combined US$82m EBITDA in 2009, it would be of little help to the company’s cash flow due to delay in the transfer of proceeds to parent and Turkish law limiting dividend payments above net income. We incorporated AkCez dividend payment in 2010.
Table 11: Ak Enerji financing needs in 2009 and 2010 (USDm)
2009 2010
Capacity expansions 117 95
Distribution privatisation 135 68
Total planned capex 252 163
Short term debt payment 21 113
Total financing needs 273 276
EBITDA generation* 38 102
Cash position 66 5
Financing secured from group companies 83 0 Financing secured for ongoing project 82 67
Additional financing required 4 102
Source: Standard Unlu research; *Generation EBITDA plus dividend payment from AkCez
However despite high cash requirements in 2010, there is a possibility that the group could prefer intra group financing, since when CEZ AS has agreed to purchase 37.4% stake in Ak Enerji in October 2008 for a consideration of US$302m the partners have stated that they intend to reinvest the sales proceeds back into the company, which could be in form of shareholder’s loan, instead of a rights issue, since in a rights issue CEZ would also need to commit more funds to stay undiluted.
The company’s future hydropower plant capacity is lowered: The companyhas applied to EMRA for license amendments decreasing its planned hydropower capacity by 30 MW to 373 MW. Moreover the company has shut down Alaplı (6 MW) plant. The plant was the last small turbine capacity natural gas fired plant in the portfolio. Ak Enerji had sold or taken offline other small turbine capacity plants totalling to 140 MW. Note that the plant was selling power and steam to a group company under a bilateral contract. The company also has a 170 MW wind farm and a 882 MW natural gas fired power plant among the projects in consideration. However since details of the projects were unavailable, we excluded them from our valuation.
Renewable capacity under the absolute lower power prices is less meaningful: The company’s first two hydropower plants (total capacity of 181 MW) and its wind farm (capacity of 15 MW) will come online in 2010. Generation EBITDA margins will jump to 22% in 2010 from 13% in 2009 due to the inclusion of renewable power plants in the generation mix.
Figure 10: Ak Enerji power generation (GWh)
0 1,250 2,500 3,750 5,000 2007 A 2008 A 20 09E 20 10E 20 11E 20 12E
Fossil fuel (GWh) Renewable (GWh) Source: Ak Enerji and Standard Unlu estimates
However, falling natural gas prices has greatly affected seemingly unrelated valuations of renewable power plants by decreasing power prices. In Turkey marginal prices are set by natural gas and fuel oil fired power plants, which account for 55% of Turkish generation. A decrease in natural gas prices and oil prices, although has a small effect on natural gas plants’ margins, through decreasing also its costs, significantly lowers the renewable power plant margins. CEZ partnership is promising: CEZ AS has shown its intentions to grow in Turkey by partnering with Ak Enerji and acquiring Sedas. We believe the partnership will be fruitful for Ak Enerji going forward both in terms of financial support and know how. Recently CEZ management stated that the company is interested in energy business-related acquisitions in Central and Eastern Europe and also in Turkey. Experience of CEZ in distribution was useful for Ak Enerji, in the future the company could also get a slice (although small) from the nuclear pie. Our industry contacts informed us that currently Ak Enerji pursuing a technology partner for the next nuclear tender. Moreover once the retail electricity sale business picks up, we believe the company will be active outside of their distribution regions as well.
CEZ acquisition is not closed yet and still pending necessary permits and approvals and there could be a positive surprise if a tender exemption is not granted: Ak Enerji announced that it will convene its extraordinary general assembly on May 12 to approve 37.4% stake sale to CEZ AS of Czech Republic and request for share call exemption.
The deal is still pending necessary permits and approvals. After the general assembly approval of the deal Ak Enerji will apply for share call exemption which would have been granted under current regulation. However CMB recently issued a draft new communiqué on tender calls, which proposes to change 2/3 majority rule for exemptions, if the deal and eventual exemption application is delayed until after the introduction of the communiqué, there could be significant upside as the deal priced the company at USD810m vs. current mcap of USD328m.
Table 12: Ak Enerji plants Plant Capacity (MW) Type Status Expected Completion License Status
Yalova I 60 Natural Gas Online - to-be-sold Cerkezkoy 98 Natural Gas Online
Bozuyuk 132 Natural Gas Online Alaplı 6 Natural Gas Offline
Yalova II 10 Natural Gas Online - to-be-sold Kemalpasa 128 Natural Gas Online
Usak 16 Natural Gas Offline- to-be-sold Corlu 11 Natural Gas Offline- to-be-sold Bursa 16 Natural Gas Offline- to-be-sold Denizli 16 Natural Gas Offline- to-be-sold Alapli 6 Natural Gas Offline- to-be-sold
Uluabat 100 Hydro Under Construction 2010 Licensed Akocak 81 Hydro Under Construction 2010 Licensed Burc 28 Hydro Under Construction 2011 Licensed Feke 1 30 Hydro Under Construction 2012 Licensed Feke 2 70 Hydro Under Construction 2012 Licensed Gokkaya 30 Hydro Planning Phase 2012 Licensed Himmetli 24 Hydro Planning Phase 2012 Licensed Saimbeyli 3 Hydro Planning Phase 2012 Licensed Bulam 7 Hydro Planning Phase 2011 Licensed Ayyıldız 15 Wind Under Construction 2010 Licensed Canakkale 170 Wind Planning Phase TBD Pending Hatay 882 Natural Gas Planning Phase 2013 Licensed
Total 1,867
Financials
Ak Enerji FY08 net income and EBITDA were TRY89m and TRY96m, respectively, compared with net loss of TRY40m and negative EBITDA of TRY4m in 2007. Net income has exceeded consensus estimate of TRY65m, while EBITDA was in-line with the consensus of TRY97m. Net income in 4Q08 increased by 12% q/q to TRY21m, while EBITDA was down by 82% q/q to TRY5m. Net income was positively affected by FX gains recorded in the quarter despite short net FX position of the company, thanks to capitalization of FX losses on investments in progress (TRY41m).
The drop in the EBITDA is not surprising and stemmed from falling spot market prices (reference electricity spot price has decreased by 19% q/q) due to lower power demand in the quarter, lower unit sales (down 11% q/q) and higher natural gas prices (higher 27% q/q).
FY08 revenue increased 34% y/y to TRY607m (matching previously posted tax financial results and in-line with the consensus estimate of TRY600m), while 4Q08 revenue was TRY159m (up 30% y/y, but down 4% q/q). The slight q/q decrease in revenue, despite lower unit sales and spot market prices, indicates that the company still able to sell its power at higher prices than the average spot market prices, however it was only able to reflect higher cost of natural gas partially to its spot market prices due to lower demand.
Table 13: Ak Enerji FY08 financials
AKENR (TRYm) 3Q08 4Q08 Q/Q 4Q07 Y/Y % FY07 FY08 Y/Y %
Net Sales 164.8 158.5 -4% 121.9 30% 452.1 607.1 34% Domestic, gross 164.8 158.5 -4% 121.9 30% 452.1 607.1 34% Exports, gross 0.0 0.0 n.m. 0.0 n.m. 0.0 0.0 n.m. Export/Gross Sales 0% 0% 0% 0% 0% Gross Profit 30.4 8.8 -71% 11.2 -21% 13.5 99.6 636% Operating Expenses -10.1 -11.5 14% -7.1 62% -68.9 -35.4 -49% Operating Profit 20.3 -2.7 n.m. 4.1 n.m. -55.4 64.2 n.m. EBITDA 28.2 5.0 -82% 14.0 -64% -4.0 95.7 n.m.
Income (expense) from other operations -1.1 3.0 n.m. 0.3 790% 0.3 3.0 845%
Net Other Income 0.0 0.0 n.m. 0.0 n.m. 0.0 0.0 n.m.
Net financial income (expense) 1.6 22.0 n.m. 0.7 n.m. 0.6 31.9 4951%
EBT - Continuing Operations 20.8 22.4 8% 5.1 338% -54.5 99.1 n.m.
Tax -1.8 -1.1 -41% 0.0 n.m. 14.8 -9.9 -167%
Net Profit - Continuing Operations 18.9 21.3 12% 5.1 317% -39.7 89.2 n.m. Net Profit - Discontinued Operations 0.0 0.0 n.m. 0.0 n.m. 0.0 0.0 n.m.
Profit After Tax 18.9 21.3 12% 5.1 317% -39.7 89.2 n.m.
Minorities 0.1 -0.2 -302% 0.1 -260% 0.2 -0.2 -217%
Net Profit after Minorities 19.0 21.1 11% 5.2 306% -39.5 89.0 n.m.
Gross margin 18.5% 5.6% 9.2% 3.0% 16.4%
EBITDA margin 17.1% 3.2% 11.5% n.m. 15.8%
Net margin 11.5% 13.3% 4.3% n.m. 14.7%
Financial Structure
Cash & Equivalents 116.3 100.9 -13% 87.6 15% 87.6 100.9 15%
S/T Fin. Debt 17.2 34.5 100% 8.2 321% 8.2 34.5 321%
L/T Fin. Debt 195.5 260.4 33% 147.5 77% 147.5 260.4 77%
Net debt (cash) 96.4 194.1 101% 68.1 185% 68.1 194.1 185%
Book Value 456.7 477.8 5% 390.0 22% 390.0 477.8 22%
The company has not disclosed the consolidation method for Sedas, thus we applied proportionate consolidation in our calculation.
Table 14: Ak Enerji forecasts
Condolidated financials (USDm) 2009E 2010E 2011E
Revenue 842 1,346 1,481 Generation 294 372 410 Distribution 548 974 1,071 COGS (730) (1,146) (1,297) Generation (258) (289) (330) Distribution (473) (857) (967) Gross Profit 112 200 184 Generation 37 83 80 Distribution 75 117 103 OPEX (55) (73) (82) Generation (22) (28) (31) Distribution (33) (45) (51) EBIT 57 127 102 Generation 15 55 50 Distribution 42 72 52 EBITDA 82 158 139 Generation 38 82 79 Distribution 44 76 59 EBITDA Margin (%) 10% 12% 9% Net Income 17 47 31 Generation (3) 26 14 Distribution 20 21 16
