Equity Analysis /
Pakistan

Hub Power: Unmatched merits but overlooked; Buy

    Yusra Beg
    Yusra Beg

    Senior Investment Analyst

    Intermarket Securities
    16 July 2019
    • We resume coverage on HUBC – Pakistan’s largest independent power producer – with a Buy rating and a Jun’20 TP of PKR130/sh. Our estimates incorporate all ongoing expansion projects and our thesis is premised on substantial improvement in HUBC’s cash-flows following (i) the timely completion of expansion projects and (ii) the issuance of second energy Sukuk by the GoP, which should alleviate the burden on both earnings and payouts stemming from the large debt taken for equity financing. 
    • FY 20f will be another year of weak dividends (DPS: PKR5.0/sh), but we expect HUBC to return to type from FY 21 onward. This is backed by expected bumper dividends from CPHGC (equating to two years of operations), and upcoming new projects, which should lead to sustainably high FCF yield of over 25% over the next five years.
    • We think the market has been quick to price in the negatives for HUBC (potential Shariah non-compliance and fears of revision in contractual ROE), while overlooking the sizeable expected dividends from FY 21f. HUBC trades at bottom-of-the-cycle valuations – FY 20f PE of 3.6x accompanied with a forward DY of 7%, which accelerates to 29% by FY 21f. Recommend Buy.

    All expansions incorporated – Buy
    We resume coverage on Hub Power Company (HUBC) with a Buy rating and a Jun’20 TP of PKR130/sh, where our new FY 19/20f EPS expectations are PKR8.9/21.0. Our earnings estimates include consolidation of all announced expansions, with the accompanying debt financing for equity stakes in these projects. We have assumed continued retention of dividends from the Hub base plant during FY 19-20f, but cash-flows will improve significantly as the ongoing projects come online. This should in turn lead to the resumption of large dividends from FY 21f as the new projects begin to generate return. We have used blended valuation methodology of SOTP and Distributable Dividends, with a Risk-free rate of 12% and beta of 1.0x (compared with 0.8x used for HUBC in the past) for plant-based DCFs.

    A growth stock for now, as dividends will take time to normalise
    Historically known for its reliable and steady dividend yield (avg. 11% since 2005), HUBC was thought of as a quasi-bond with a low risk profile (10-year beta: 0.8x). However, this has changed over the last two years, especially under the new management, with focus shifting towards aggressive expansion into high IRR projects (17-20%). We stress that, first the combination of growth potential and cheap valuations is unmatched in our Universe; second, the market is overlooking the merit of longevity that HUBC has ensured (cashflows until FY 51), unlike any other listed IPP.

    New coal projects add c50% to HUBC’s valuation...
    We have incorporated the upcoming coal projects (Thar Energy, ThalNova Power and SECMC) into our valuation, which together with China Power Hub Generation, contribute c50% to HUBC’s TP (see table overleaf). CPHGC has already achieved synchronisation with the national grid for both units (2x660 MW) with complete commissioning expected by Aug’19. Thar Energy (TEL) has received a one-year extension for financial close deadline to Feb’20 (COD Mar’21), while ThalNova is expected to achieve COD by Dec’21. While the base plant will contribute c50% to HUBC’s earnings until its PPA expiry in FY 27, the new projects will contribute c70% FY 28f onwards.

    …but equity financing necessitates dividend retention initially
    Equity financing for expansions has necessitated raising debt and retaining earnings (HUBC skipped dividends in 9M FY 19). HUBC obtained the first round of funding (US$258mn, of which PKR26.5bn are loans and PKR7bn rights) in FY 18-19. The second round of funding (FY 20f: US$144mn) is expected to be raised through issuance of commercial paper, TFC and internal cash-flows in FY 20f. The second sukuk issue by the GoP (currently under review) may improve cash-flows to allow minor payouts in FY 20f.

    Risks:(i) Volatile PKR/US$ may push project/finance costs upwards, (ii) GoP adopts tough stance against IPPs alleged to have overcharged in the past, (iii) project delays.