Fixed Income Analysis /
Ukraine

DTEK: Attractive valuation despite weakening financials

    Kiti Pantskhava
    Kiti Pantskhava

    Senior Credit Analyst

    Tellimer Research
    16 July 2019
    Published by

    We upgrade the DTEKUA 24s to Buy on a combination of valuation and fundamentals. DTEKUA has started to catch up with the rest of the corporate space in Ukraine, but the DTEKUA spread to the bonds of its sister-company Metinvest is still barely off its 12-month highs. We see signs that DTEK’s revenue and EBITDA are likely to weaken compared with 2018 due to lower electricity prices, but it is unlikely to affect the company’s willingness and ability to continue paying cash interest on bonds and loans, and prioritise deleveraging. We expect DTEKUA to outperform the Ukrainian corporate space and the spread to METINV to tighten to 200-250bps from c300bps.

    Regulatory concerns resolved partially. As planned, the new market mechanism was implemented in the Ukrainian electricity market, enabling power generation companies to sell electricity at the market price determined by supply and demand. To avoid price spikes for the consumers, the regulator set a price ceiling for the power generation companies at UAH1,640/MWh for the first nine months. The price cap constrains the supply-demand driven market model and is below the UAH1,750/kWh realised by DTEK in FY 18. Moreover, electricity consumption in Ukraine is weakest in the summer, which is likely to affect prices drawing a more pessimistic picture of the first months of the new electricity market for DTEK. The uncertainty about the company’s ability to capitalise on its strong market position in thermal power generation therefore, is likely to persist. According to our back-of-the envelope estimates (Table 1), DTEK will continue to generate material EBITDA with average tariffs of UAH1,500/kWh and above. 

    Lower revenue and EBITDA from power generation in 2019. Electricity generation accounted for 63% of DTEK’s revenue in 2018 with the rest coming from the marginally profitable gas and coal trading and export of electricity. Due to its vertical integration into thermal coal (DTEK’s mines cover most of the fuel requirement of the power plants), the company has a high degree of control over costs. Electricity generation and coal mining are bundled for reporting purposes. According to our estimates, the segment delivered above 90% of EBITDA. Based on our assumptions on the average realised price per kWh, electricity output and cost inflation, we conclude that DTEK’s EBITDA could decline 20% yoy in 2019.

    Leverage could increase to 2.7x in 2019 from 2.2x in FY 18. According to our estimates, the interest coverage ratio will remain above 3x in 2019. We expect the company to continue prioritising debt repayment and believe that DTEK will generate enough cash flows in 2019 to continue paying interest in cash rather than capitalise the payment-in-kind portion. DTEK has four years free of scheduled debt repayment to address the peak maturities of 2023 and 2024, when effectively all of its US$2bn debt falls due. The small portion of unrestructured debt remains an inconvenience. While there is a tested mechanism of adding it to the pool of restructured bonds and loans under substantially similar terms, there has been no progress since H2 18.