Fixed Income Analysis /
Ukraine

DTEK: Low electricity prices challenge cash flows

    Tellimer Research
    18 December 2019
    Published byTellimer Research

    Reiterate Hold on DTEKUA 24s. DTEK bonds stand out as one of the cheapest ways to gain exposure to Ukraine’s corporate sector. Indicated at 473bps over the sovereign and 357bps over METINV, the bonds of its sister company, DTEKUA 24s’ wide credit spread could be viewed as a protection from potential downside. That side, DTEK’s financial performance is quickly deteriorating. The new electricity market launched on 1 July led to a steep fall in electricity prices, further exacerbated by imports from Russia and Belarus. In FY 19, we expect DTEK’s EBITDA to decline by c30% yoy to cUS$650mn and net leverage to increase to 3x. If KWh is priced at November levels in 2020, DTEK could see a further reduction in cash flows, EBITDA and profitability, and the company’s leverage will increase. In our view, DTEKUA 24s’ spread reflects expectations of weakening financial performance. If the winter season brings relief to falling electricity prices in Ukraine, DTEKUA 24s are likely to be supported at current levels. The long-term outlook remains uncertain as the new status quo in the electricity market is yet to be established. 

    New electricity market has brought new, significantly lower prices. 2019 started with prices for electricity generated by thermal power plants (TPP) set according to the so-called Rotterdam Plus, directly linking the tariff to the price of coal on the international market and shipping costs. In July, the old regulatory regime was abandoned and the new market model, with electricity prices determined by the balance of supply and demand, was introduced. As a result, wholesale electricity prices have been declining through 2019, reaching their lowest level in November – UAH1,320 (cUS$54) per MWh on the day-ahead market (DAM), c25% lower than the FY 18 average. In October, Ukraine resumed imports of electricity from Russia, where wholesale electricity goes for at least half the price than in Ukraine. Imports, therefore, put further pressure on prices. 

    Deteriorating profitability in 9M 19 and poor visibility for 2020. Falling production volumes and prices have hit cash flow and profitability (Table 1). The full-year results, however, are likely to look reasonably strong, due to relatively high prices in H1 19. If we annualise the Q3 19 financial results, the first period when the new pricing mechanism was applied, the estimated full-year EBITDA would be US$535mn, c40% yoy lower than in FY 18. Q3 is typically one of the weakest quarters for electricity generation in Ukraine as demand drops in spring-summer (Q2-Q3) and increases in autumn-winter (Q4-Q1). More time is needed to evaluate the full effect of the new market model on DTEK’s earning power and financial position.

    Leverage could increase to 4x, capitalisation of interest is a risk. DTEK has less than US$100mn of debt repayments due in 2020-22, suggesting liquidity risk is quite low. Then, in 2023-24, effectively all of the company’s US$2.2bn debt falls due. The terms of the restructuring agreement allow the company to partially capitalise interest on the bonds. In 2018-H1 19, this option was not used but, if pressure on cash flow persists, the company could capitalise 3.25% and pay 7.5% cash interest on the DTEKUA 24s in 2020.