We upgrade the DTEKUA 24s to Hold on valuation. DTEKUA has underperformed the Ukraine corporate space through most of 2019. The tenor-adjusted DTEKUA-METINV spread has widened above 300bps, while the DTEK 24s Bloomberg mid-yield to maturity is at 10.72%. Given the company’s strong credit fundamentals, we think the bond prices incorporate generous premia for regulatory and FX risks. Once regulatory concerns are dealt with, we see the DTEKUA-METINV spread tightening.
Strong financials. DTEK is the biggest thermal power producer in Ukraine, accounting for more than 70% of coal-based electricity generation in 2018. The company has high profitability, moderate net leverage of 2.1x, interest coverage of 4.6x and no debt maturities until 2023, and has been free cash flow positive since 2016. DTEK operates in a highly regulated industry and its profitability and cash flows depend on electricity tariffs. In 2016, the so-called Rotterdam Plus electricity tariff formula for coal-based generation was introduced, helping DTEK capitalise on its thermal coal production. The formula incorporated international coal price and shipping costs with a 12-month lag, thus approximating the market price of coal.
Regulatory concerns. Electricity market reform, if implemented in its current shape, will benefit DTEK, enabling it to sell electricity at competitive prices in the bilateral, day-ahead and balancing markets. President Zelenskiy’s recent legislative initiatives, if parliament supports them, will postpone the transition to competitive pricing to 1 July 2020 from 1 July 2019 and may also result in the revision of the Rotterdam Plus mechanism, reducing the coal price included in the tariff during the extended transition period. We believe that a short delay of reform implementation is not a game-changer for DTEK; however, the company could suffer from a decline in its profitability over the next 12 months because of the tariff formula revision, lower international coal prices or both.