KenGen Company Ltd (NSE: KEGN) FY18 Earnings Note

KenGen Ltd (NSE: KEGN) released better than expected FY18 revenue and net earnings. FY18 revenue grew 4.3% y/y against our expected growth of 2.5% buoyed by faster growth in steam revenue (19.9% y/y). EPS fell 12.4% y/y to KES 1.20 against expected KES 1.16, mainly due to lower tax expense in FY17 on account of tax incentives (investment deductions allowances) on new geothermal wellhead plants in FY17. The 2.5% y/y growth in earnings before tax was due to a 150.7% y/y increase in finance income from investments in government securities and fixed deposits.

Against expectations, a dividend of KES 0.40 per share was declared, payable to shareholders on register by 7th December 218.

On the back of the solid results, we maintain our BUY recommendation at a target price of KES 9.84.

Positives:

  1. Total revenue records solid 4.3% y/y growth. Unit sales increased in line with long term growth in power demand by 5.7% y/y to 7.0GWh. This was due to a faster rise (+17.8% y/y) in geothermal contribution, offsetting hydro’s 4.6% y/y decline. Geothermal contribution was supported by increased evacuation following completion of Olkaria–Suswa transmission line and additional wellhead plants during 1H18. Geothermal contribution to revenue stands at 58% compared to 29% from hydro and is expected to increase to 77.8% after commissioning of the planned 631MW by 2022F. Overall, electricity revenue rose 1.0% y/y. Net steam revenue rose by 11.7% y/y due to improvement in geothermal availability and additional contribution from wellhead plants.
  2. Finance income, +150.7% y/y to KES 3.3Bn. This was ahead of our FY18 projections of KES 681Mn. This was due to its large financial assets book (treasury bonds and fixed deposits) with assets totalling KES 12.9Bn. We do not see finance income sustaining at these levels given the decline in yield on Treasury securities and bank’s downward revision of their rates paid on deposits.
  3. Dividend at last, KES 0.40 (33% pay-out). This was a surprise given the planned large capital expenditure (KES 135Bn) under its 2016 – 2020 growth plan. The dividend pay-out is a result of a healthy 32.6% y/y growth in operating cash flow to KES 17.5Bn and moderate spend in capital expenditure (KES 14.6Bn). This is positive for investors and could give the share price an additional momentum from the current dividend yield of 5.3%. In our view, the company will have to find a balance between the planned large Capex and offering a dividend.
  4. Decline in receivables from KPLC post balance sheet. Fundamental issues on its single buyer KPLC, have been a concern especially this year. As at the balance sheet date, KPLC owed record high level of KES 21.9Bn. This would be a concern given the challenges KPLC has had this year. However, post balance sheet, the amount has declined significantly to KES 3.3Bn which is below historical averages of about KES 10Bn. With active steps to improve leadership at KPLC, we do not see issues at KPLC affect KenGen’s cash flow significantly. 
Negatives:
  1. Operating expenses including depreciation rising faster than revenue (5.8% y/y). Depreciation costs rose fast to KES 10.1Bn against expected KES 9.5Bn (+9.8% y/y). This was mainly due to capitalization of costs related to completed wells and a 25MW wellhead plant. Operating earnings before depreciation declined 5.3% y/y from a 2.1% rise in operating expenses. In FY19F, the observed trend may place these expenses marginally ahead of our estimates unless revenue grows buoyantly. Overall, operating margin softened 631bps y/y to 32.4%, against our estimated 39.4% in FY18F.

Our View:

We are bullish on its 2016–2022 geothermal ‘Good to Great plan’ which we expect to bolster revenue by 10.9% especially from 2019 when 158MW from Olkaria V is connected to the grid. Other geothermal and wind power plants with a capacity of 563MW will be connected from FY20F. This generation plan anchors our outlook of the business which hinges it as a solid long term stock pick at current prices. We maintain our BUY recommendation at a target price of KES 9.84.

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by Gerald Muriuki

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