Hub Power Company - Faysal Asset Management · PDF fileHub Power Company – Independent Power ... 9% of total electricity production in Pakistan whereas Wapda leading the slot with

Hub Power Company – Independent Power Producers

Hub Power Company Investment Report

“HUBCO Continues to Grow and add to its Power Generation

Capacity in spite of the Global Economic Downturn. It is

determined to face every adversity and come out stronger, realizing

the role it has to play in National Development“

“HUBCO – Deal of the Decade”


Company Background Often referred to as ‘The Deal of the Decade’ in the IPP universe, HUB Power Company commenced its operations in 1997 with a 1,292 MW thermal plant. The Power Purchase Agreement for HUBCO was concluded under the Power Policy of 1994 and is spread over a 30-year operating span (i.e. till 2027). Post 2027, the Government of Pakistan will have an option to either sign a new tariff agreement (PPA) with new policies, sell the plant or keep it shut. The original cost of the project clocked-in at USD 1.57bn, implying an average of USD 1.22mn/MW. The plant is comprised of four thermal-based generating units of 323 MW (gross output) each with an oil-fired single re-heat boiler and tandem compound, two cylinder condensing steam turbines directly coupled to a hydrogen cooled generator. The plant operates with a 38% thermal efficiency and supplies all of its electricity generation to National Transmission and Distribution Company (NTDC).

HUBC Timeline 1985 - The Government of Pakistan (GoP) issue an invitation to the private hsector to design, construct, finance, own and operate power plants for the national electricity system.

1986 - Initial investigations by Xenel, Nespak, Ewbank, Preece, Morgan Grenfell and Foster Wheeler Energy Ltd retained to conduct various studies.

1987 - Sponsor submit proposal for Private Power Generation to GoP in July.

1988 - Letter of Intent issued by GoP. Feasibility study carried out.

1989 - Negotiation of Implementation Agreement (IA), Power Purchase (PPA) and Tariff Agreements.

- Agreements initialed in December.

1990 - Hawker Siddeley Power Engineering Ltd withdraws from active participation.

1991 - Fuel Supply Agreement (FSA) initialled. Application made to NDFC for Private Sector Energy Development Fund (PSEDF) finance in March.

- New construction consortium formed in May.

- Construction Contract signed

- Project Company registered.

- Approval of ECO guarantee by World Bank Board in December.

1992 - IA, PPA, FSA finalised and signed in August. Shareholders Agreement signed.

- Ground-breaking ceremony held at the plant site in September.

- O&M Agrement signed.

- First disbursement of mobilisation funds from Al-Rajhi Bank made in December.

1993 - First disbursement from PSEFD facility takes place in April.

- National Power increases its equity in the project.

- Amendements to IA, PPA, FSA signed in November. PPA and FSA become effective.

- Loan Agreement signed with Commonwealth Development Coporation.

1994 - Reference Tariff agreed with GoP.

- CDC disburse US$ 33 million to construction contractor in September.

- All Equity underwritten and subscribed

1995 - Financial Closure ceremonies at Hubo site at the end of January.

1997 – Commercial Operation began

Company Data Date: 13thAug 2012 KSE – 14,898 HUBCO – PKR 46.30 KSE-100 (52 week): High – 14,937.15 Low –10,842.26 Average – 12,560.24 HUBCO (52 week): High – PKR 47 Low – PKR 32.73 Shares Outstanding: 1,157.15mn Free Float: 68.2% Market Capitalization: PKR 50,336mn FY11 EPS – PKR 7.42 9MFY11 BVPS – PKR 24.27 FY10 EPS – PKR 4.80

Board of Directors

Mohamed A. Alireza (Chairman, Non-Exec) Zafar Iqbal Sobani (Chief Executive) Yousuf A. Alireza (Non-Exec) Dr. Fereydoon Abtahi (Non-Exec) Robin A. Bramley (Non-Exec) Dr. Asif A. Brohi (NBP Nominee) Malcolm P. Clampin (Non-Exec) Taufique Habib (Non-Exec) Arshad A.Hashmi (Non-Exec) Qaiser Javed (Non-Exec) Iqbal Ahmed Khosa (Non-Exec) Ali Munir (Non-Exec) Philppe F.A.L. Salmon (Non-Exec) Nizam A. Shah (Non-Exec) M. Ashraf Tumbi (Non-Exec)


Tariff Structure As per the 1994 policy, all power generation-related expenses incurred by the power producer are to be pass-through items, with expense components to be bifurcated into Energy Purchase Price (EPP) and Capacity Purchase Price (CPP). The EPP component covers (i) Fuel Cost and (ii) Variable Operation & Maintenance; while the CPP component covers (i) Debt Servicing (ii) Insurance Cost (iii) Fixed Operation & Maintenance and (iv) Project Company Equity.

The tariff structure allows for all of the aforementioned expense components of HUBCO to be passed onto the NTDC except for Project Company Equity, which serves as the main source of gross profit (and eventually bottom-line). The other source emerges in the form of Principal Retirement, which creates a major difference between accounting net income and the actual operational cashflow. The Principal retirement component is incorporated into net sales without any deduction in subsequent stages - enhancing the company’s bottom-line (but not Free Cash Flow to Equity - FCFE). In essence, HUBCO’s gross profitability is mainly derived from Project Company Equity (PCE) and the Principal Retirement component, with firm value being driven by PCE and non-operating income.

Key Drivers

1) 12% USD-IRR for Original Plant and 15% USD-IRR for Narrowal Plant 2) Complete Tax Exemption for entire lifespan of 30-years (Tax Rate = 0%) 3) U-Shaped Project Company Equity to boost earnings 4) CPP Component indexed with Pakistan Inflation (Safeguarded against erosion of

purchasing power) 5) CPP Component indexed with PKR/USD movement (Safeguarded against loss of

currency value) 6) CPP Component indexed with U.S Inflation (Added benefit)


Industry Dynamics

During 2010-11, 94,385GWh electricity was produced as against 95,358 GWh in 2009-10, which included 68% thermal, 29% hydel and 3% nuclear. However, the consumption increased by 3.7% and reached 77,099GWh from 74,348GWh last year.

Chart above illustrates company wise contribution of electricity in Pakistan. HUBCO contributes 9% of total electricity production in Pakistan whereas Wapda leading the slot with contribution of 51%.


Company Fundamentals HUBCO is a purely defensive play since all of the company return components are pre-determined as per respective Purchase Power Agreements (PPA). The fixed returns make future cashflows highly predictable and equate the stock with a typical fixed income bond. HUBCO’s >90% dividend payout ratio draws further similarities between the two.

The company is presently operating its flagship 1,292 MW plant after the commencement of 225 MW oil-fired Narrowal plant (in April 2011). A third 84 MW hydroelectric plant, Laraib Energy, is scheduled for June 2013 and will take the total installed gross capacity to 1,601 MW. All three plants are based on different PPAs and vary in their defensive prospects due to varying indexation.

1,292 MW Hub Power Plant Having commenced in 1997, the project is commonly referred to as ‘The Deal of the Decade’ due to its tax exempt status and U-shaped Project Company Equity (PCE) component. The nature of the PCE essentially translates into a pre-determined upside in earnings for the plant.

The flagship plant’s defensive nature is underscored primarily by indexation with (i) Pakistan Inflation (ii) U.S Inflation (iii) Japanese Inflation (iv) Italian Inflation (v) U.K Inflation (vi) USD/PKR Currency Movement (vii) GBP/PKR Currency Movement and (viii) JPY/PKR Currency Movement.


225 MW Narrowal Power Plant Originally scheduled for April 01, 2010, the Narrowal plant has faced a 12-month delay due to reasons including, but not limited to, Capacitor Voltage Transformer (CVT) Malfunction, Security Issues and Contractor Delays. The delay is not expected to adversely impact future earnings since delay costs (liquidated damages from HUBCO to WAPDA) are to be reimbursed by contractor MANDIESEL. The plant has been financed with a 25:75 Equity-Debt combination, with the 25% equity contribution being raised by HUBCO through bank loans. Unlike the original 1,292 MW plant, Narrowal’s PCE component is flat. The only upside that the plant will witness in its PCE and CPP component is based on indexation. Moreover, the CPP component will record a significant drop over 2029-30, owing to complete repayment of debt principal (75% Debt Component).

As mentioned above, the only upside in PCE and CPP components stems from indexation. The plant’s defensive nature is owed to indexation with (i) Pakistan Inflation (WPI) (ii) U.S Inflation and (viii) USD/PKR Currency Movement.


84 MW Laraib Power Plant A USD 215mn run-on-the-river project, Laraib is being financed by a 25:75 Equity-Debt combination (similar to Narrowal). The project has a life span of 25-years (End: 2038) with HUBCO shareholding at 75%. The plant is expected to be indexed with (i) Pakistan Inflation (ii) U.S Inflation and (iii) USD/PKR Currency Movement.

Circular Debt Mainly attributable to (i) High Int’l Crude and POL prices (ii) Line Losses (iii) Theft and (iv) Over-

dues, Pakistan’s energy-based circular debt is growing ever more rampantly. The country has

observed two rescue attempts in the form of govt. issued TFCs to stem this growth (In Mar-09 and

Sep-09), which did little to control the swelling.

As of March 31 2012, HUBCO’s receivables stood at PKR 116.505bn (65.1% of total assets), out of

which PKR 100.517bn were overdue (86.28% of total receivables). On the other hand, HUBCO’s

payables stood at PKR 109.142bn (72% of total liabilities) against which over dues clocked-in at

PKR 88.622bn (81.19% of total payables). The overdue receivable from WAPDA carries a mark-up

of Discount Rate + 2% and form NTDC carries a markup of 3 months KIBOR + 4.5%; whereas, the

mark-up on payables to PSO carries stands at Discount Rate + 2%. In this case, the ‘piling debt’

scenario is overall positive for HUBCO’s earnings, since it allows the company to earn D+2% and

3M KIBOR+4.5% on net receivables (PKR 15.99bn net receivables as of Mar-12). That said, the

increase in earnings from net receivable penal mark-up is more than offset by the cash flow

constraints faced by the company due to these very receivables. Simply put, higher cash flow

constraints translate into lower dividends and greater cash conservation on management’s part.

As mentioned above, HUBCO’s overdue receivables and payables stand at PKR 116.505bn and

PKR 100.517bn, respectively.


Consistent Dividend Policy HUBCO, if not superior, is as good as any investment grade corporate bond available in the money market. With a forward 5-year discounted yield of 18.3% (5-yr Avg. DPS: PKR 8.0) at current stock price of PKR 43.52.

Ratio Analysis Profitability Margins


Return on Equity & Total Asset Turnover

The Return on Equity for shareholders has been experiencing an upward trend for the last three quarters solely on the back of

rising net income available to shareholders with net income growing at an average of pace of 25%. The range bound ROE during

the precious quarters can also be attributed to stagnant net income numbers.

The rise and fall in the total asset turnover ratio can be majorly attributed to HUBCO’s fluctuating revenue. The assets have

grown steadily with CAGR of 31%. Revenues have been fluctuating and caused the ratio to follow similar trend.

16.9%

21.2%

19.3% 17.8% 17.2%

24.2%

28.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

1QFY11 2QFY11 3QFY11 4QFY12 1QFY12 2QFY12 3QFY12

Retu

rn o

n E

qu

ity

0.8x

0.7x

0.8x

1.1x

1.0x

0.8x

0.9x

0.0x

0.2x

0.4x

0.6x

0.8x

1.0x

1.2x


To

tal A

sset

Tu

rno

ver


123.6% 129.5%

139.9% 154.0%

170.0%

194.8%

175.7%

0.0%

50.0%

100.0%

150.0%

200.0%

250.0%


Deb

t to

Eq

uit

y

Debt to Equity & Fixed Asset Turnover

Total debt has considerably increased over the past quarters with a CAGR of 14%. The last quarter was exception in which we

saw a HUBCO scrap off a certain portion of its total debt. Equity numbers remained relatively stable over the quarters.

The fixed asset turnover ratio showed similar trend as of asset turnover ratio; however, the fixed asset grew at a smaller pace

with CAGR of 4.5%; whereas revenues dominantly forced the ratio in both directions.

1.8x 1.7x

2.1x

2.9x 2.8x

2.6x

2.9x

0.0x

0.5x

1.0x

1.5x

2.0x

2.5x

3.0x

3.5x


Fix

ed

Ass

et

Tu

rno

ver


Risk Triggers

1. Delay in Narrowal / Laraib Commissioning – Narrowal has already been delayed by 12 months. Further

procrastinations will only serve to delay earnings from Narrowal, increasing forward P/Ex multiple and making the

stock overvalued.

2. Non-Coverage of Delays by Contractor – Although the 12-month Narrowal delay is expected to be covered by

MANDIESEL (contractor); any coverage denial going forward will erode future earnings.

3. Removal of Income Tax Exemption or Imposition of other Taxes – With the government under international pressure

to increase Tax-to-GDP ratio beyond 9.5% (one of the lowest in the world), one could never dismiss an unexpected

withdrawal of Income Tax exemption granted under PPA 1994. Minor tax imposition would also be slightly negative

for the bottom-line.

4. Build-up of Circular Debt – With Int’l Crude Oil / Furnace Oil prices on the rise, circular debt will continue to grow

despite rise in Tariffs.

5. Revision of Power Purchase Agreement – A key risk to HUBCO’s valuation, any reduction in the USD indexed IRR akin

to the one that occurred over 2000 will prove to be extremely detrimental to the company. That said, the power

supply shortfall provides a support against any downward revision.

6. Appreciation of PKR against the Greenback – Although higher domestic inflation ensures PKR depreciation against

the USD, an ironic change of tide causing PKR appreciation would reduce earnings potential.

7. Lower Operating Capacity (below required threshold) – With a 65% load-factor threshold, HUBCO will be penalized

for generation below the level.

8. Interest Rate Risk – With 25% equity for Narrowal having been raised through debt, the company is no longer fully

hedged from debt servicing costs (only 1,292 MW plant is fully hedged).

9. Curtailment in fuel supply from PSO

Recommendation HUBC currently stands at a price level of PKR 46.30, trading at a P/E of 5.78x against the market multiple of 6.72x. Being one of

the most defensive and high yielding stocks across the KSE-universe, the scrip ought to trade at a fair value that provides

100bps premium over the discount rate (conservative approach). With earnings and dividend expectation to the tune of PKR

8.0/sh. And PKR 7.5/sh., We deduce fair value of PKR 60 through extrapolation.

The company is expected to remain consistent with its dividend stream, with FY13 payout expectation of PKR 7.5/sh. This

translates into a dividend yield of 12.5% which is one of the highest fixed-income returns being provided in Pakistan

(considering HUBC as a fixed-income security due to its operational nature).


Shareholding Pattern

Top Shareholders- As of 30th Jun 2012

Name # of shares %

ALLIED BANK LIMITED 112,000,000 10.8%

DH FERTILIZERS LIMITED 102,260,000 9.9%

COMMITTEE OF ADMIN. FAUJI 98,391,000 9.5%

NATIONAL BANK OF PAKISTAN 60,845,515 5.9%

CYAN LIMITED 42,560,000 4.1%

DAWOOD HERCULES CORPORATION 35,480,000 3.4%

STATE LIFE INSURANCE 26,830,269 2.6%

EMPLOYEE'S OLD-AGE BENEFITS 19,650,000 1.9%

TRUSTEES OF ABL EMPLOYEES 17,942,241 1.7%

MCB PROVIDENT FUND PAK 15,367,500 1.5%

NATIONAL BANK OF PAKISTAN-TRUSTEE 14,869,297 1.4%

ALLIANZ GLBL INVS FD - ALNZ RCM ORT 14,313,500 1.4%

CDC - TRUSTEE MEEZAN ISLAMIC FUND 13,209,716 1.3%

THE BANK OF NEW YORK MELLON SA/NV 12,609,450 1.2%

HUSSAIN DAWOOD 10,900,500 1.1%

HABIB BANK AG ZURICH, DEIRA DUBAI 10,735,064 1.0%

UNITED BANK LIMITED - TRADING 10,500,000 1.0%

HABIB BANK AG ZURICH 10,123,009 1.0%

BATTERYMARCH GLOBAL EMERGING 9,605,922 0.9%

HABIBSONS BANK LTD 9,004,250 0.9%

SAAD IQBAL 7,829,000 0.8%

NATIONAL INSURANCE COMPANY 7,725,467 0.7%

EFU LIFE ASSURANCE LTD 7,408,000 0.7%

JUBILEE LIFE INSURANCE COMPANY 7,322,135 0.7%

PATEK (PVT.) LTD 6,450,000 0.6%

HABIB BANK LIMITED-TREASURY DIVISION 6,430,000 0.6%

MORGAN STANLEY & CO INT'L PLC 6,274,567 0.6%

FAYSAL BANK LIMITED 6,005,037 0.6%

MERRILL LYNCH INTERNATIONAL 5,879,913 0.6%

EATON VANCE TAX MANAGED EMERGING 5,794,400 0.6%

BANK ALFALAH LIMITED 5,500,000 0.5%

IQBAL ALI MOHAMMAD 5,459,195 0.5%

EATON VANCE STRUCTURED EMERGING 4,969,800 0.5%

STICHTING SHELL PENSIOENFONDS 4,552,887 0.4%

SHAZIA AFZAL 4,309,147 0.4%

CREDIT SUISSE ZURICH 4,200,000 0.4%

CDC - TRUSTEE AL MEEZAN MUTUAL 4,197,500 0.4%

CH. YAWAR ASAD 4,000,000 0.4%

MOHAMMAD ARIF KHAN 4,000,000 0.4%

NATASHA IQBAL 3,992,015 0.4%

Top 40 shareholders 759,496,296 73.5%

Total 1,033,175,286 100.0%


Documents

Hub Power Company - Faysal Asset Management · PDF fileHub Power Company – Independent Power ... 9% of total electricity production in Pakistan whereas Wapda leading the slot with