Kenya Power & Lighting Company Ltd (NSE: KPLC) 1H19 Earnings Note

Kenya Power Ltd (NSE: KPLC) announced a negative growth of 16.7% y/y in 1H19 EPS to KES 1.25 despite a strong y/y growth in electricity sales (21.4%). Other key revenue lines; Forex adjustment and fuel costs recovered, declined 82.0% y/y and 34.0% y/y respectively, driving total revenue to grow by a marginal 3.4% y/y. Cost management remains a formidable challenge with transmission costs rising 37.3% y/y. This is majorly on account of 100.0% y/y increase in provisions (KES 2.46Bn) and accelerated depreciation costs (+16.4% y/y). Additionally, finance costs grew 23.5% y/y. The current fundamental challenges noted in this note together with concerns raised by the Auditor General with regards to F18 results, form our basis of a SPECULATIVE BUY recommendation.

Positives:

  1. Electricity revenue on strong growth, 21.4% y/y. We attribute this mainly to the August 2018 power tariff review by the Energy Regulatory Commission. For instance, the commercial industrial band had on average, an effective increase of 37.6% in the energy (consumption) charge per unit. Under the new tariff, this consumer band is charged an average of KES 10.76/unit compared to the pre-existing (2015/16 tariffs) average energy charge of KES 7.82/unit. We also peg the growth in electricity sales to uptake of the 50% discounted tariff (time of use tariff) by large power users. Under this tariff, subject to meeting certain thresholds, the users pay a subsidized rate for power consumed during off peak hours (10pm and 6am). In off-peak periods, power demand can drop to a low of 1,000MW compared to peak demand of 1,802MW in July last year. The December season is also a factor as manufacturers tend to ramp up production during the 4thquarter to meet the high consumer spending during the holiday period.
  2. Stronger gross margin, 38.9%. With the higher tariffs and the drop in fuel costs (34.0% y/y), gross margin settled above the 5-year average of 33.1%. The displacement of thermal power by the recently connected Lake Turkana Wind Power coupled with upcoming renewable energy power should sustain the high level of gross margin in the long term. Units purchased from thermal sources dropped by 54.6% y/y to 548 GWh while power purchased from wind generation grew 1,214.8% y/y to 355 GWh. 

Negatives:

  1. Operating costs, +37.3% y/y. Operating expenses rose steeply majorly worsened by provisions for receivables (+100.0% y/y) and accelerated depreciation (16.4% y/y). We still expect provisions to remain a major headwind but to ease going forward as the company aggressively pursues its debtors (electricity receivables fell to KES 14.1Bn from KES 22.2Bn in FY18).
  2. Finance costs, +23.5% y/y. Finance costs rose mainly due to high reliance on overdraft and short-term funding which stood at KES 24.6Bn (from KES 28.9Bn in FY18). The effective cost of debt averages 6.5% compared to 6.2% in FY18 and a 5-year average of 4.2%. Long-term financing rose by KES 2.1Bn in what we attribute to renegotiated maturities (as management had indicated) on some short-term facilities. Total debt levels declined to KES 123.6Bn from KES 125.9Bn in FY18 and KES 130.8Bn in 1H18. We believe management is still in discussions with lenders to restructure the debts to prolong maturities and ease pressure on working capital and finance costs on the P&L.
  3. Working capital challenges. Current ratio sits at acute levels, 0.5x from 0.8x in 1H18. The ratio has steadily been declining from 1.4x in FY15 due to higher short-term funding reliance occasioned by cash crunch. In the short-term, it will remain a challenge to achieving a good balance of 1.0x despite heightened efforts to boost cash collection and pay suppliers promptly. However, the aggressive collection efforts are good indications and we expect that if the debt restructuring succeeds in moving a significant portion of the short-term to long-term debt, current ratio will improve from current levels.

Our View:  

Fundamentals of the business are significantly weak but the new interim management has exuded a zeal in resolving the past corporate challenges. This will pay off in the long-term but the business should be in urgent need of managing working capital, cash flow and the debt levels. Additionally, the auditor issued a qualified opinion on FY18 financial results citing inadequate provisioning, negative working capital, default of debt covenants and significant amounts of undeclared financial assets with possibilities large penalties. These will take time to be resolved.

The current fundamental challenges in the business together with concerns raised by the Auditor General with regards to F18 results, form our basis of a SPECULATIVE BUY recommendation.

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by Genghis Research

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