UPDATE Utilities / 15 September 2010 Gazprom Power Generation: Growing in scope, but still nimble
Summary ratings We are upgrading our financial forecasts for the power generation companies owned by Gazprom following a very upbeat Analyst Day the company held on 6 Company TP, ¢ Upside Rating September, during which it presented detailed medium-term plans and a long-term Mosenergo (from 19) 21 97% BUY strategy for its utilities business. The synergies from the upcoming merger of OGK- TGK-1 (from 0.12) 0.14 83% BUY 2 and OGK-6 prompted us to upgrade our target prices for them: +10% for OGK-2 OGK-2 (from 8.6) 9.5 77% BUY to ¢9.5 and +29% for OGK-6 to ¢5.4. We maintain our BUY recommendation for OGK-6 (from 4.2) 5.4 33% (from HOLD) BUY OGK-2 and raise our rating for OGK-6 from a HOLD to a BUY. Likewise, improving Source: OTKRITIE Research prospects for the heat generation business prompted us to upgrade our target price for Mosenergo by 11% to ¢21, and for TGK-1 by 17% to ¢0.14. We reiterate our BUY Comparative valuation ratings for both of these stocks. EV/EBITDA P/E EV/inst. Company ‘10E ‘11E ‘10E ‘11E capacity Investment case Mosenergo 6.8 4.7 23.4 11.3 411 A merger of OGK-2 and OGK-6 is almost a certainty, and will be beneficial. The operating synergies are numerous and we upgrade our 2015E operating margin TGK-1 7.4 4.4 14.4 8.2 494 forecasts by 4 ppt for OGK-6 and by 1 ppt for OGK-2. A final decision on the merger OGK-2 11.6 6.9 32.4 21.8 222 is expected this month. OGK-6 8.4 4.4 68.9 48.1 138 The heat generation business holds vast potential for TGK-1 and Mosenergo. We OGK avg. 9.2 5.9 29.3 21.3 254 upgraded our forecasts on heat output and tariffs growth, as the companies are TGK avg. 5.9 4.1 15.4 15.3 269 winning consumers from municipal boilers and awaiting the shift to a RAB-based EM peers 6.1 5.5 8.6 7.8 1,068 tariff system. We see a total $1.6bn additional '10-'15 EBITDA from these changes. DM peers 8.5 8.0 13.8 12.4 1,123 Detailed investment program reduces uncertainty. Providing the exact parameters Source: Bloomberg, OTKRITIE Research of mandatory capex through 2016 significantly decreases uncertainty and improves predictability. The new capacity tariffs under the Capacity Delivery Agreements are Growth potential and valuation the last parameter that remains unknown. 60% Merge all four gencos and make an IPO. Increased size and better liquidity could OGK-6 50% give a boost to shares, while the share swap process could stoke interest on the OGK-2 stock market. A final decision on the merger has yet to be made, which leaves vague 40% the potential timing and details of a merger. OGKs avg TGK-1 30% TGK-1 will keep its hydro generation assets. Rumors of a spin-off and sale of TGK- Mosenergo 20% EM peers 1’s hydro assets were proven wrong by Gazprom. We view this as positive, as low- TGKs avg 10% cost hydro generation comprises the primary element of TGK-1’s investment case. DM peers 2010-2015 EBITDA CAGR, % 2010-2015 EBITDA CAGR, 0% 0 500 1,000 1,500 Valuation EV/Installed capacity, $/kW Asset-based multiples at a huge discount to international peers. Gazprom’s gencos Source: OTKRITIE Research trade at an average EV/installed capacity multiple of $312/kW vs. $280/kW in Russia, and international average $1,096/kW. Stock performance The financial multiples are beginning to look attractive. As the reform of the 150% Russian power sector unwinds, we are witnessing improvements in the financials of numerous companies in the sector. Gazprom’s gencos trade on a 2011E EV/EBITDA 100% and on a P/E of 5.0x and 21.9x vs. 6.8x and 10x for international peers, respectively. 50%
0% Catalysts • Signing of Capacity Delivery Agreements by YE10 -50% • Valuations of OGK-2 and OGK-6 for the merger -10 -10 -10 -10 -10 -10 -10 -10 -10 -10 -10 Jul Jul Jan-10 Jan-10 Jun Jun • Dividend policy approval in the end of 2010 Apr -10 Apr -10 Feb Feb Aug -10 Aug -10 Sep-10 Mar Mar May May May
MSNG OGK2 OGK6 • Approval of 2011 regulated tariffs for electricity, capacity, and heat TGK1 MICEXPWR • 3Q10 IFRS financials Source: OTKRITIE Research Risks • Price caps for the ‘old’ generation capacity • Drop in electricity demand and/or spot prices in 2H10 • Reversal/disapproval of the OGK-2/OGK-6 merger +7 (495) 777-56-56 Research analysts • Delayed introduction of the heat RAB tariffs Pavel Popikov [email protected] Vadim Palamarchuk [email protected] OTKRITIE Investment Bank (JSC) Utilities / Gazprom Power Generation / 15 September 2010
Table of contents
Investment case ...... 3 Detailed investment program reduces uncertainty ...... 3 Upgrading Mosenergo and TGK-1 on heat business outlook ...... 3 Upgrading OGK-2 and OGK-6 on consolidation synergies ...... 3
New investment program assumptions ...... 4 Detailed plans for mandatory capex ...... 4 Capacity additions – source of value ...... 5
Consolidation prospects ...... 7 OGK-2 / OGK-6 merger: Mechanics of the deal and opportunities ...... 7 OGK-2 / OGK-6: Fundamental upside arising from synergies ...... 7 Consolidation of all of Gazprom’s gencos down the road ...... 9
Heat generation business offers value ...... 11 Taking over heat production from municipal boilers ...... 11 Transfer to RAB-based heat tariffs is on the cards ...... 11
Valuation ...... 13 Changes in Target Price ...... 13 Changes to our financial forecasts ...... 14 Growth rate and profitability comparison across the sector ...... 15 Relative valuation ...... 16 Risks ...... 17
Mosenergo ...... 18 TGK-1 ...... 20 OGK-2 ...... 22 OGK-6 ...... 24
OTKRITIE Investment Bank (JSC) 2 Utilities / Gazprom Power Generation / 15 September 2010
Investment case Detailed investment program reduces uncertainty Mandatory capex was a key question. The total installed capacity of Gazprom’s generation companies will increase by 9GW through 2016, from their current 36GW to 44GW. Our previous expectations were for additional capacity of 9.4GW. Although we see a mixed effect of change in the capex plan for individual companies from the fundamental perspective, overall there is a positive impact of reduced uncertainty regarding the long-term plans of these companies. We have duly updated our DCF models with revised investment program parameters.
Fig 1. New investment program of Gazprom's gencos vs. old forecasts, RUBbn
120
100
80
60
40
20
0 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E
OGK-2 OGK-6 Mosenergo TGK-1 Total Capex old
Source: OTKRITIE Research
Upgrading Mosenergo and TGK-1 on heat business outlook Higher heat tariffs and increased output projections. The ongoing discussion of the introduction of the new RAB tariff principle for the heat distribution and generation businesses is extremely positive for both Mosenergo and TGK-1, as they obtain about half of their revenue from heat. Gazprom reps highlighted the fact that the new heat business regulations allow consumers to switch from less efficient heat producers (like boilers) to more efficient TPPs, such as those owned by Mosenergo and TGK-1. We calculate that this improved heat business outlook will bring additional RUB41bn of EBITDA to Mosenergo and RUB9bn EBITDA to TGK-1 during 2010-2015, hence we have upgraded our target price for both companies.
Upgrading OGK-2 and OGK-6 on consolidation synergies Lower operating costs from economies of scale. Gazprom plans to make a final decision on the merger of OGK-2 and OGK-6 in September. Consolidation of the two OGKs could be complete by mid-2011. Gazprom management sees operating synergies as the main reason for the merger, anticipating an 18% reduction in operating costs due to economies of scale. While we are somewhat more conservative in our cost-cutting assumptions, we see the deal as especially beneficial for OGK-6, which prompted us to upgrade our rating of it from a HOLD to a BUY. We also upgraded our target prices for both OGK-2 and OGK-6.
Fig 2. Mosenergo, TGK-1: EBITDA from heat Fig 3. OGK-2/OGK-6 merger: EBITDA forecast business, RUBbn change, RUBbn
15 15
12 12
9 9
6 6
3 3
0 0 2010E 2011E 2012E 2010E 2011E 2012E Mosenergo old Mosenergo new TGK-1 old TGK-1 new OGK-2 old OGK-2 new OGK-6 old OGK-6 new
Source: OTKRITIE Research Source: OTKRITIE Research
OTKRITIE Investment Bank (JSC) 3 Utilities / Gazprom Power Generation / 15 September 2010
New investment program assumptions Detailed plans for mandatory capex
RUB366bn and 9GW in new capacity through 2016. The sector’s investment program has been under review for the past two years by the Energy Ministry. The initial capex program was developed by RAO UES in 2007. For Mosenergo, TGK-1, OGK-2 and OGK- 6, construction of 8.7GW and total spending of RUB401bn was envisioned through 2012. We base our initial forecast primarily on these figures, making adjustments to incorporate the likely delay of the capex due to the economic downturn. As of today, Gazprom’s gencos have already invested 42% of this projected capex spending and 1.5GW of the planned capacity.
Fundamentally we see a mixed effect on the gencos. We updated our DCF models with revised investment program parameters. Capacity additions by Mosenergo and OGK-6 went down by 900MW and 290MW, respectively, while for TGK-1 and OGK- 2 they remained almost the same. We see a two-sided effect of the capex cut on valuation: a positive medium-term effect from lower negative capex cash flows, and a negative effect from lower terminal value, as there is less capacity to generate free cash flow in 2020. In our view, the resulting overall impact from the changes was negative for Mosenergo and OGK-6, but positive for TGK-1 and OGK-2.
Fig 4. Changes to our investment program assumptions based on Gazprom’s new guidance Mosenergo TGK-1
1,000 35 800 40
30 700 35 800 25 600 30 500 25 600 20 400 20 15 400 300 15 10 200 10 200 5 100 5 0 0 0 0 2010 2011 2012 2013 2014 2015 2016 2010 2011 2012 2013 2014 2015 2016
old MWh, lhs new MWh, lhs old MWh, lhs new MWh, lhs old RUB bn, rhs new RUB bn, rhs old RUB bn, rhs new RUB bn, rhs
OGK-2 OGK-6
800 35 700 30 700 30 600 25 600 25 500 20 500 20 400 400 15 15 300 300 10 10 200 200 5 100 5 100 0 0 0 0 2010 2011 2012 2013 2014 2015 2016 2010 2011 2012 2013 2014 2015 2016
old MWh, lhs new MWh, lhs old MWh, lhs new MWh, lhs old RUB bn, rhs new RUB bn, rhs old RUB bn, rhs new RUB bn, rhs
Source: Gazprom Energy Holding, OTKRITIE Research
OTKRITIE Investment Bank (JSC) 4 Utilities / Gazprom Power Generation / 15 September 2010
Mosenergo: We assumed a more ambitious capex program. Considering the high demand potential of the Moscow region and plans to continue replacing old depreciated capacity, we incorporated ambitious capex plans into our model based upon RAO UES’ investment program. Namely, we expected an additional 400MW at TPP-27, 370MW at TPP-12 and 420MW at TPP-25. At an analyst meeting Gazprom stateed that additional investment projects (aside from the mandatory investment program) are likely for the company. However, the financing scheme for such projects is unclear at the moment, hence we eliminated those projects from our forecasts.
TGK-1: Investment program generally in line with our forecasts. The company’s overall capacity addition plan is in line with our expectations. One reshuffling that took place concerns the secibd 180MW energy block at the Pervomayskaya TPP-14 (first one will be commissioned this year): in our model we delayed its commissioning to 2014, however the new capex plan sees its addition already in 2011.
OGK-2: New project in the Sochi region. The general structure of OGK-2’s investment program is similar to what we had projected in our model. One notable change was that the commissioning of a 390MW block at Stavropolskaya GRES will take place in 2016 rather than in 2014. However, there has been the addition of a new project: a 360MW block at the Adlerskaya TPP in the Sochi region. This plant should be commissioned in the end of 2012, ahead of the 2014 Winter Olympics. We believe that this project is value accretive for the company and positively impacts our target price.
OGK-6: Significant delays vs. our previous assumptions. In OGK-6, the key difference from our previous forecasts is that the company will commission large energy blocks at the Novocherkasskaya GRES and the Cherepovetskaya GRES from 2011 and 2013, respectively, to beyond 2014. This lowers the medium-term capex level, but also postpones the cash flow generation of the new blocks. On balance, this is likely to have a negative impact on our target price for the company.
OTKRITIE Investment Bank (JSC) 5 Utilities / Gazprom Power Generation / 15 September 2010
Capacity additions – source of value
The signing of capacity delivery agreements remains a trigger. Approval of the mandatory investment program opens the path for Gazprom’s gencos to sign Capacity Delivery Agreements (CDAs) with the state. CDAs will specify the level of new capacity tariffs aimed at providing an adequate return on investment. The methodology for calculating capacity tariffs was approved by the government in April 2010 (see our report entitled, Russian Thermal Generation: Last puzzle piece falls into place). We are not altering our assumptions regarding these tariffs. Still, the signing of CDAs should serve as a positive catalyst for the market, we think.
An average 18% fundamental upside from investment program. The new capacity tariffs to be fixed in CDAs should provide a 15% IRR and 15-year breakeven period for the investment projects, parameters that we find value creative for minority shareholders. Our sensitivity analysis of Gazprom’s gencos shows the following downside effect on target prices in the event that there are no investment programs: 15% downside for Mosenergo, 22% for TGK-1, 20% for OGK-2 and 13% for OGK-6.
Fig 5. Gencos revenues breakdown into different business lines, RUBbn Mosenergo TGK-1
450 250 400 350 200 300 250 150 200 100 150 100 50 50 0 0 '09 '10E '11E '12E '13E '14E '15E '16E '17E '18E '19E '20E '09 '10E '11E '12E '13E '14E '15E '16E '17E '18E '19E '20E
New Capacity revenues Old Capacity revenues New Capacity revenues Old Capacity revenues Heat output revenues Electricity output revenues Heat output revenues Electricity output revenues
OGK-2 OGK-6
250 200
200 150
150 100 100
50 50
0 0 '09 '10E '11E '12E '13E '14E '15E '16E '17E '18E '19E '20E '09 '10E '11E '12E '13E '14E '15E '16E '17E '18E '19E '20E
New Capacity revenues Old Capacity revenues New Capacity revenues Old Capacity revenues Heat output revenues Electricity output revenues Heat output revenues Electricity output revenues
Source: OTKRITIE Research
OTKRITIE Investment Bank (JSC) 6 Utilities / Gazprom Power Generation / 15 September 2010
Consolidation prospects OGK-2 / OGK-6 merger: Mechanics of the deal and opportunities
Almost a done deal. Gazprom announced on 6 September that a final decision on the merger of OGK-2 and OGK-6 will be made by the end of September. If the merger receives a go-ahead, we expect the consolidation process to be complete by mid-2011. In our view, a merger is extremely likely to occur, especially since the consolidation process is already in evidence at the top management level: Gazprom recently named a single CEO and CFO for OGK-2 and OGK-6.
Corporate procedures may produce speculative opportunities. We expect the following landmarks along the path to a consolidated OGK-2/OGK-6: • A final decision on the merger (September 2010). • Approval of the list of consultants and appraisers for the deal (September- October). • Valuation of each company and calculation of swap ratios that will be used to convert the shares of OGK-2 into shares of OGK-6, assuming that OGK-6 will be the base for consolidation (4Q10-1Q11). • AGMs of OGK-2, OGK-6 and Gazprom Energy Holding, in which the shareholders of each company will approve the final parameters of the deal (Summer 2011).
We believe that there will be a number of speculative opportunities on the stock market in the shares of OGK-2 and OGK-6. Once the appraised valuation of the companies is announced, their stocks will effectively become derivatives of each other, and the market will adjust quickly.
The cheapest entry point is not yet clear. In order to determine the cheaper entry point into the consolidated company one needs to know the method of valuation that will be used for calculating swap ratios. If a DCF-based valuation is applied to calculate the swap ratios, then we see higher upside in the shares of OGK-2 (77% vs.33% in OGK-6), since we also calculate our fundamental target price based on a DCF model. On the other hand, if a multiple-based valuation is used, then we see higher upside in OGK-6 because the company trades with a significant discount both to its peers and to OGK-2: OGK-6 trades at an EV/installed capacity of $139/kW vs. $219/kW for OGK-2 and an OGK average of $250/kW. On a 2011 EV/EBITDA OGK-6 trades at 4.2x vs. 6.6x for OGK-2, and 5.9x for OGKs.
OGK-2 / OGK-6: Fundamental upside arising from synergies
Creating the largest thermal genco. The combined company resulting from a merger of OGK-2 and OGK-6 would be the largest fossil-fuel generation company in Russia. With 17.8GW of combined installed capacity, the new company would stand behind only RusHydro (25.4GW, hydro generation), Rosatom (24.2GW, nuclear generation) and Eurosibenergo (19.5GW, 75% hydro and 25% thermal generation). The closest runner-up in thermal generation would be Gazprom’s Mosenergo, at 11.9GW.
OTKRITIE Investment Bank (JSC) 7 Utilities / Gazprom Power Generation / 15 September 2010
Fig 6. Installed capacity of Russia's largest generators, GW
25
20
15
10
5
0 2 -1 -7 -4 -1 -5 -4 -3 - 12 - TGK TGK TGK OGK OGK OGK OGK -6 TGK Rosatom RusHydro Mosenergo EuroSibEnergo and OGK Consolidated OGK
Source: Company data
Increased size brings better liquidity and a lower cost of capital. A merger of OGK-2 and OGK-6 would create a $3.1bn market cap company, while Gazprom management sees a further 25% upside coming from synergies. The table below summarizes the new parameters of a combined company. We see two main positive effects for the shares: • better liquidity, as there will be a single company with a doubling of the free float in absolute terms; • lower cost of capital, both in terms of lower interest rates on the company’s debt as it becomes larger and more financially stable; and in terms of cheaper equity capital, because for investors liquidity effectively represents a risk measure.
Fig 7. Comparison OGK-2 and OGK-6 vs consolidated company OGK-2 (pre-merger) OGK-6 (pre-merger) Consolidated Inst capacity, MW 8,695 9,162 17,857 Heat inst cap, GCal/h 1,834 2,704 4,538 Market cap, $m 1,724 1,334 3,058 EV, $m 1,902 1,269 3,171 Net debt, $m 177 (65) 112 Revenues 2009, RUBm 38,378 40,083 78,461 Revenues 2011E, RUBm 59,628 49,667 105,566 Revenues 2015E, RUBm 120,470 94,053 202,313 EBITDA 2009, RUBm 3,890 5,414 9,304 EBITDA 2011E, RUBm 7,753 6,310 17,401 EBITDA 2015E, RUBm 35,553 19,301 55,173
Target EV, $m 2,647 1,122 4,370 Source: OTKRITIE Research
OTKRITIE Investment Bank (JSC) 8 Utilities / Gazprom Power Generation / 15 September 2010
Fundamental synergies. Gazprom anticipates substantial synergy from a consolidation of OGK-2 and OGK-6, which would primarily come through economies of scale and cost cutting in the combined company. Below is a list of potential synergies: • geographic diversification of generation assets; • centralization of administrative and management activity; • centralization of fuel purchases; • optimization of investment program planning and relationship with suppliers.
Merger more beneficial for OGK-6. Gazprom announced its numerical targets summarizing the effect of the synergies: an 18% reduction in operating costs and a 25% fundamental upside for the combined company. However, we are less optimistic than Gazprom regarding the gains of operating cost cuts and see a higher upside potential of our profitability forecasts for OGK-6 than for OGK-2. In 1H10, OGK-2 posted a 9.7% EBIT margin, while OGK-6 showed only a 5% margin, which is explained mainly by the less efficient generation assets mix of the latter company. We expect post-consolidation synergies to lower OGK-6’s operating costs by 10% starting from 2011, and OGK-2’s operating costs by 8% for the same period. Our 2015E EBIT margin forecast rises from 12% to 16% for OGK-6, and from 21% to 22% for OGK-2.
Fig 8. OGK-2 EBIT margin: impact from consolidation Fig 9. OGK-6 EBIT margin: impact from consolidation
25% 20% 20% 15% 15%
10% 10%
5% 5%
0% 0% 2010E 2011E 2012E 2013E 2014E 2015E 2010E 2011E 2012E 2013E 2014E 2015E
Old forecast New forecast Old forecast New forecast
Source: OTKRITIE Research Source: OTKRITIE Research
Consolidation of all of Gazprom’s gencos down the road
Transfer to a unified share and IPO, but only in 2013. At its 6 September Analyst Day, Gazprom announced that its long-term strategy envisages the potential transfer of all 4 generation companies to a unified share, and then making an IPO of its entire power utilities holding. For now, this remains in the realm of possibilities since not even a preliminary timeframe is currently available. We believe that once the merger occurs and the go-ahead is given for the creation of Gazprom Energy Holding, it will take at least one year to complete the necessary corporate procedures, including a thorough valuation process and votes by the shareholders of each individual genco. Of course, the decision itself will largely depend upon the stock market performance of the gencos, hence initial assessment of the move will not take place before 2H11, that is, after the OGK-2/OGK-6 merger is complete. The preparation of an IPO will take at least another 6 months, in our view. We see the beginning of 2013 as the earliest timeline for the deal.
OTKRITIE Investment Bank (JSC) 9 Utilities / Gazprom Power Generation / 15 September 2010
We see numerous benefits from consolidation. We believe that the consolidation of Gazprom’s generation companies will be beneficial for the minority shareholders of all four companies – Mosenergo, TGK-1, OGK-2 and OGK-6. In our view, the following benefits should arise from the consolidation: • Higher market capitalization, greater liquidity, and improved financial stability will reduce the cost of capital, making the stocks more attractive. • Synergies in terms of operations and geographic diversification similar to those arising from the OGK-2/OGK-6 merger. Although the three remaining companies represent stand-alone businesses, in our view the potential for gains via centralization and optimization remains: administrative, marketing, relationships with suppliers, investment program planning etc. are all areas of potential synergy gains. • The preparation process for consolidation will offer numerous speculative market opportunities in the stocks of all the companies involved, which will likely attract additional interest from investors and improve liquidity in the names.
Positive market reaction to 3 recent consolidations. Following the restructuring of the country’s utility monopoly RAO UES in 2008 we have seen consolidation trend in the sector. Our analysis of the three latest consolidation stories in the sector shows that the market treats these processes positively. In all three cases there is a plan to make an IPO of the consolidated entity. Integrated Energy Systems Holding plans to consolidate TGK-5, TGK-6, TGK-9 and, probably TGK-7. All 4 of these stocks have shown an average 56% appreciation in the past 3 months, that is, after consolidation talks were renewed. Meanwhile, SUEK intends to consolidate Kuzbassenergo and TGK-13 in order to create a vertically consolidated energy company with a focus on coal. The SUEK IPO was planned for summer 2010. In the two months prior to that, Kuzbassenergo and TGK-13 stocks returned 50%, on average. The final addition to this list is Eurosibenergo, which aims to consolidate Oleg Deripaska’s utilities assets, mainly Irkutskenergo and Krasnoyarsk HPP, and make IPO in October of this year. Since the initial announcement in August, both stocks have returned 25%, on average. In the figure below we summarize the genco performances that were driven by consolidation plans.
Fig 10. Market return of gencos' stocks following the upcoming consolidation announcement
MICEXPWR YTD return
Krasnoyarsk HPP
Irkutskenergo
TGK-13
Kuzbassenergo
TGK-9
TGK-7
TGK-6
TGK-5
0% 10% 20% 30% 40% 50% 60% 70% 80%
Source: MICEX, OTKRITIE Research
OTKRITIE Investment Bank (JSC) 10 Utilities / Gazprom Power Generation / 15 September 2010
Heat generation business offers value Taking over heat production from municipal boilers
The heat markets of Moscow and St Petersburg. The heat market (selling of steam and hot water) in both the Moscow and St. Petersburg regions is divided mainly between the wholesale heat producers – like Mosenergo and TGK-1 – and local municipal boilers in approximately a 2:1 ratio. Mosenergo’s total heat installed capacity is 34.9K GCal/h, while the municipal boilers controlled by the company MOEK have 16.8K GCal/h of capacity. Similarly, in St. Petersburg TGK-1 has 11.6K GCal/h of heat capacity, while the municipal company has 7.8K GCal/h.
Mosenergo and TGK-1 to attract consumers away from less efficient boilers. The Russian government launched a program of energy savings and efficiency improvements this year. The main impact of this program on TGK-1 and Mosenergo is as follows: • An increase in heat demand, as customers gradually switch from less efficient boilers to significantly more efficient large TPPs owned by Mosenergo and TGK-1. • Streamlining of the ownership of heat transportation networks, which improves the efficiency of heat sales and will likely also increase output. • Expansion by attracting new heat consumers.
We have upgraded our heat output projections for 2010 and 2011. In 1H10, TGK-1’s heat output amounted to 17m GCal (+8.5% YoY), while Mosenergo’s heat output was 41m GCal, a 7.6% rise versus 1H09. Although part of this recovery in heat output is attributable to the abnormally cold winter in Central Russia, we believe that these numbers also reflect the success of Mosenergo and TGK-1 winning heat consumers from the municipal boilers. These figures, coupled with the new information provided at Gazprom’s Analyst Day, prompted us to upgrade our heat output growth forecasts for both companies in 2010 and 2011 (see figures below). In our view, the bulk of heat consumers will be switching to TPPs over the next two years.
Fig 11. Mosenergo heat output growth rate p.a. Fig 12. TGK-1 heat output growth rate p.a.
8% 8%
6% 6%
4% 4%
2% 2%
0% 0% 2010E 2011E 2012E 2013E 2014E 2015E 2010E 2011E 2012E 2013E 2014E 2015E
New forecast Old forecast New forecast Old forecast
Source: company data, OTKRITIE Research Source: company data, OTKRITIE Research
Transfer to RAB-based heat tariffs is on the cards
Heat generation and transportation: different tariffs. Just like for electricity, the heat business consists of two main parts: generation and transportation. Heat is produced in a cogeneration cycle of a power plant, together with electricity. Boilers do not produce electricity and hence they have much lower fuel efficiency. Once generated, the heat is transmitted via heat networks to end-consumers. Currently both parts of the business operate under the cost-plus tariff principle: once a year the regulator determines the next-year tariff level based upon expected operating costs. The state is discussing the switch from economically inefficient cost-plus principle to a more long-term and efficient system of regulation, similar to the RAB tariffs that are now being introduced in the electricity grids segment.
OTKRITIE Investment Bank (JSC) 11 Utilities / Gazprom Power Generation / 15 September 2010
RAB principle first in heat transportation. The heat transportation business is similar in nature to the businesses of electricity distribution and transmission, hence in our view it is likely to switch to the RAB tariff principles. Under the RAB system, first the value of the assets is calculated and then the company receives a fixed return on its assets in the form of operating income. We believe that both Mosenergo and TGK-1 will aim to increase their exposure in the heat transportation business going forward. (Mosenergo and TGK-1 receive the bulk of their revenue from heat generation.) As for heat generation, the new tariff principle is uncertain at the moment, however we believe that it will also be more economically efficient than the current cost-plus system.
We upgraded our heat tariff projections for Mosenergo and TGK-1. Our heat tariff forecasts for Mosenergo and TGK-1 were mainly inflation-driven figures, and for 2011 we expected only 8% growth. The current cost-plus tariffs do not provide sufficient return for the companies to maintain and repair the heat generation portion of their business. We believe that the introduction of a more economically efficient tariff system will necessarily result in higher heat tariffs. This prompted us to change our long-term view on heat tariffs, which we expect to see growth that exceeds inflation by 1-2% each year starting from 2011. The figure below shows the changes in our heat tariff forecasts for Mosenergo and TGK-1.
Fig 13. Mosenergo average heat output tariff, RUB/GCal Fig 14. TGK-1 average heat output tariff, RUB/GCal
1,800 1,800
1,600 1,600
1,400 1,400
1,200 1,200
1,000 1,000
800 800
600 600 '10E '11E '12E '13E '14E '15E '16E '17E '18E '19E '20E '10E '11E '12E '13E '14E '15E '16E '17E '18E '19E '20E Old forecast New forecast Old forecast New forecast
Source: OTKRITIE Research Source: OTKRITIE Research
We estimate EBITDA from the heat business based upon a breakdown of fuel costs. In order to calculate (separate out) EBITDA for the heat business from the electricity generation business for any genco, it is necessary to find a way to distribute the costs between these two businesses. This issue is important for the implementation of the new tariff principle, and the final mechanism for this has yet to be fixed by the regulator. Companies disclose separately how much fuel is used for heat and electricity generation, and we believe that the same proportion could also be used to split the fixed operating costs between the two businesses (including repairs, employee benefits, D&A etc.). Our new assumptions regarding heat output and tariffs will bring additional RUB41bn of EBITDA to Mosenergo and RUB9bn EBITDA to TGK-1 during 2010-2015 (see figure below).
Fig 15. Mosenergo: increase in heat business Fig 16. TGK-1: increase in heat business EBITDA EBITDA
40% 15 40% 15
30% 30% 10 10
20% 20%
5 5 10% 10%
0% 0 0% 0 2010E 2011E 2012E 2013E 2014E 2015E 2010E 2011E 2012E 2013E 2014E 2015E
Heat EBITDA old, RUBbn Heat EBITDA new, RUBbn Heat EBITDA old, RUBbn Heat EBITDA new, RUBbn % of Total EBITDA (old) % of Total EBITDA (new) % of Total EBITDA (old) % of Total EBITDA (new)
Source: OTKRITIE Research Source: OTKRITIE Research
OTKRITIE Investment Bank (JSC) 12 Utilities / Gazprom Power Generation / 15 September 2010
Valuation Changes in Target Price
Changes in company-specific assumptions. We made the following changes to our DCF models of Gazprom’s 4 gencos – Mosenergo, TGK-1, OGK-2 and OGK-6:
• new investment program parameters (projects, costs, timing, capacity additions);
• upgraded outlook for the heat business, which primarily concerns Mosenergo and TGK-1, as the bulk of their revenue comes from heat;
• the effects of positive operating synergies in the wake of a consolidation of OGK-2 and OGK-6.
We maintain our general sector and macro assumptions. We left untouched our general sector and macroeconomic assumptions (expressed in our report Russian Thermal Generation: Last puzzle piece falls into place), such as electricity demand growth projections, electricity prices, generation capacity tariffs (both old and new capacity), inflation, exchange rate, cost of capital and other forecasts.
Fig 17. New target price calculation for Gazprom’s generation companies, ¢ per share Mosenergo TGK-1
25 0.16 0.14 20 0.12
0.10 15 0.08
10 0.06
0.04 5 0.02
0 0.00 Old TP New capex Heat business New TP Old TP New capex Heat business New TP assumptions improvement assumptions improvement
OGK-2 OGK-6
9.6 6
9.4 5 9.2 4 9.0
8.8 3 8.6 2 8.4 1 8.2
8.0 0 Old TP New capex Synergies from New TP Old TP New capex Synergies from New TP assumptions consolidationt assumptions consolidationt
Source: OTKRITIE Research
OTKRITIE Investment Bank (JSC) 13 Utilities / Gazprom Power Generation / 15 September 2010
Changes to our financial forecasts
Upgrade of the financial outlook for all 4 gencos. Our update brings mostly positive changes to our financial forecasts for Gazprom’s gencos, which arise from an improved outlook on the heat business (Mosenergo and TGK-1) and operating cost-cutting via consolidation synergies (OGK-2 and OGK-6). We see the highest positive impact on EBITDA for OGK-6, as the company currently suffers from the lowest margins among the OGKs, mainly due to the low efficiency of its generation assets. Also, we made a significant upgrade of our estimates for the net income of OGK-2 and Mosenergo, taking into account the companies’ lower financial costs as was evident in their latest 1H10 IFRS financials. The negative changes that we made to our model are mostly seen in new capex assumptions (and impact mainly Mosenergo and OGK-6), however those changes do not have a negative effect for our estimates on P&L statements. The figure below summarizes the changes that we made to our models.
Financial forecasts changes, RUB mn 2010E 2011E 2012E 2013E New Old Diff New Old Diff New Old Diff New Old Diff Mosenergo Revenues 136,440 132,261 3% 157,913 152,100 4% 176,425 172,034 3% 191,596 196,417 -2% EBITDA 22,196 20,294 9% 32,062 29,603 8% 37,157 35,766 4% 40,172 43,819 -8% Net income 5,611 4,090 37% 11,659 8,362 39% 14,951 11,093 35% 17,003 16,028 6%
TGK-1 Revenues 48,106 46,999 2% 64,345 60,473 6% 78,906 74,313 6% 94,078 90,318 4% EBITDA 12,360 11,045 12% 20,442 17,897 14% 25,759 23,684 9% 33,303 30,777 8% Net income 6,319 5,219 21% 11,150 8,850 26% 14,201 12,072 18% 17,250 14,398 20%
OGK-2 Revenues 46,800 46,957 0% 55,900 59,628 -6% 68,734 72,979 -6% 80,618 84,477 -5% EBITDA 5,144 5,230 -2% 8,649 7,753 12% 12,965 12,363 5% 16,200 17,304 -6% Net income 1,672 1,741 -4% 2,491 1,144 118% 4,175 2,550 64% 5,545 4,914 13%
OGK-6 Revenues 42,506 42,506 0% 49,667 49,667 0% 58,060 58,490 -1% 69,827 73,098 -4% EBITDA 4,571 3,913 17% 8,753 6,310 39% 12,892 9,191 40% 15,996 12,712 26% Net income 560 (43) -1414% 805 (1,376) -158% 2,952 263 1023% 3,322 934 256% Source: OTKRITIE Research
Target prices above consensus for Mosenergo and TGK-1. Our outlook on Mosenergo and TGK-1 is more bullish than the consensus, with our target prices an average 37% higher for these stocks than the forecasts from the Street. We are 24% below on OGK-2, which is a function of our lower financial projections for that company. We are almost in line with the consensus in our target price for OGK-6. Finally, our short-term financial forecasts have already incorporated the positive effect of synergies in the form a merger with OGK-2, which is why are estimates are more bullish than the Street.
Our estimates vs. consensus Revenues, $m EBITDA, $m Net Income, $m TP, ¢ '10E '11E '12E '10E '11E '12E '10E '11E '12E Mosenergo Bloomberg consensus 4,714 5,407 5,856 687 888 1,002 153 315 388 15.63 OTKRITIE estimates 4,638 5,347 5,927 755 1,086 1,248 191 395 502 21.00 Difference -2% -1% 1% 10% 22% 25% 24% 25% 30% 34% TGK-1 Bloomberg consensus 1,696 2,163 2,364 413 707 773 173 364 423 0.10 OTKRITIE estimates 1,635 2,179 2,651 420 692 865 215 378 477 0.14 Difference -4% 1% 12% 2% -2% 12% 24% 4% 13% 40% OGK-2 Bloomberg consensus 1,644 2,030 2,250 170 318 355 59 143 171 8.37 OTKRITIE estimates 1,591 1,893 2,309 175 293 436 57 84 140 6.33 Difference -3% -7% 3% 3% -8% 23% -4% -41% -18% -24% OGK-6 Bloomberg consensus 1,529 1,785 1,512 124 202 122 6 29 84 5.63 OTKRITIE estimates 1,445 1,682 1,951 155 296 433 19 27 99 5.40 Difference -6% -6% 29% 26% 47% 254% 235% -6% 18% -4% Source: Bloomberg, OTKRITIE Research
OTKRITIE Investment Bank (JSC) 14 Utilities / Gazprom Power Generation / 15 September 2010
Growth rate and profitability comparison across the sector
Gazprom’s conservative ‘15-15-15’ strategy. During a presentation last week Gazprom announced a long-term strategy for its power utilities business. The financial goals may be summarized via a convenient ‘15-15-15’ formula: by 2015 Gazprom Energy Holding plans to reach EBIT margin of 15% and to have revenues CAGR of 15% during 2010-2015. We believe that Gazprom management used conservative forecasts in announcing these goals, with an aim to exceed them. Our models imply the following: 2010-2015E revenues CAGR of 15.4%, with EBIT margin already reaching 15% by 2013. The main drivers for growth are:
• appreciation of liberalized electricity prices (driven by natural gas prices and demand growth),
• roll-out of new energy blocks with new capacity tariffs,
• transfer of heat tariffs to the RAB principle.
In the figure below, we summarize our growth and margin forecasts for Gapzrom’s gencos, plotting them against and each other, as well as against other names in the sector and international peers.
Growth and Margin Comparison
25%
TGK-1 OGK-2 20% OGKs average RusHydro OGK-6 15% TGKs average Mosenergo 10% EM Average 2015E revenues CAGR revenues 2015E -
5% DM average 2010E
0% 10% 15% 20% 25% 30% 35% 40%
2015E EBIT margin
Source: Bloomberg, OTKRITIE Research
OTKRITIE Investment Bank (JSC) 15 Utilities / Gazprom Power Generation / 15 September 2010
Relative valuation
Russian generation sector Current Market Current EV/EBITDA P/E Installed EV/inst. Capac. EV/util. Company Ticker price, Cap, EV, capacity, capacity, utiliza capacity, ¢/shr $m $m '10E '11E '12E '10E '11E '12E MW ('09) $/kW tion**, % $/kW GazpromEnergoHolding's companies OGK-2 OGKB 5.4 1,752 1,929 11.0 6.6 4.4 30.8 20.8 12.5 8,695 222 62 358 OGK-6 OGKF 4.1 1,313 1,248 8.0 4.2 2.9 68.9 48.1 13.2 9,052 138 37 372 TGK-1 TGKA 0.08 2,942 3,117 7.4 4.5 3.6 13.6 7.8 6.2 6,315 494 50 991 Mosenergo MSNG 10.7 4,242 4,902 6.5 4.5 3.9 22.2 10.7 8.4 11,924 411 59 696 Rest of russian generation sector OGK-1 OGKA 3.6 1,594 1,891 7.7 5.7 3.7 18.4 12.5 11.2 9,861 192 52 372 OGK-3 OGKC 5.2 2,457 819 7.7 6.1 3.1 15.1 21.1 19.8 8,357 98 40 243 OGK-4 OGKD 8.1 5,118 4,336 11.6 6.8 5.1 20.4 13.1 10.2 8,630 502 71 704 OGK-5 OGKE 8.5 3,014 3,279 9.4 6.0 5.4 22.4 12.1 10.0 8,747 375 54 694 OGKs average 9.2 5.9 4.1 29.3 21.3 12.8 254 53 457 TGK-2 TGKB 0.03 405 671 5.0 2.4 1.8 neg. neg. 42.9 2,577 260 42 626 TGK-4 TGKD 0.05 1,008 847 4.4 3.5 2.7 16.6 24.0 61.2 3,420 248 62 400 TGK-5 TGKE 0.05 676 447 7.7 5.9 5.8 18.4 21.7 168.5 2,451 183 50 369 TGK-6 TGKF 0.05 940 696 7.0 7.1 6.1 12.0 12.0 14.2 3,123 223 44 510 Volga TGK TGKG 8.0 2,406 2,406 9.1 7.3 6.0 22.5 19.2 14.5 6,880 350 62 565 TGK-9 TGKI 0.02 1,369 1,295 6.7 5.1 5.0 14.3 13.5 111.8 3,283 394 53 743 Fortum TGKJ 143 1,259 381 3.2 1.7 1.5 11.3 10.4 neg. 2,785 137 65 211 TGK-11 TGKK 0.06 327 402 5.0 3.6 3.3 9.1 6.8 6.6 2,051 196 48 411 Kuzbassenergo KZBE 1.2 846 900 5.7 3.7 2.4 22.4 40.2 18.3 4,500 200 57 353 Yenisei TGK TGKM 0.4 618 778 7.4 3.4 2.8 neg. 12.5 8.2 2,530 307 51 603 TGK-14 TGKN 0.01 193 64 1.7 1.2 1.1 7.1 5.3 4.6 639 100 47 214 TGKs Average 5.9 4.1 3.5 15.4 15.3 38.8 269 53 515
Market Current EV/EBITDA P/E Installed EV/inst. Capac. EV/util. Company Country Cap, EV, capacity, capacity, utiliza capacity, $m $m '10E '11E '12E '10E '11E '12E MW* $/kW tio n**, % $/kW Emerging markets thermal generation NTPC India 34,224 40,254 13.0 11.4 9.6 17.6 16.5 14.8 27,350 1,472 84 1,756 Datang International Power China 17,294 37,616 16.8 14.2 12.0 62.2 45.8 36.3 17,600 2,137 61 3,526 Huadian International Power China 5,769 16,154 13.2 10.8 9.2 63.5 40.0 31.8 23,294 693 47 1,466 AES Gener S.A. Chile 1,758 1,758 3.6 2.8 n/a 6.4 5.1 n/a 3,559 494 54 911 Ratchaburi Electric Thailand 1,738 1,980 7.0 6.8 7.2 9.1 9.2 9.6 4,345 456 59 769 Glow Energy PCL Thailand 2,090 3,351 11.2 9.8 6.7 14.1 12.4 8.5 1,708 1,962 60 3,286 First Gen Corp Phillipines 454 642 2.6 2.5 2.5 4.8 4.4 4.3 2,669 241 73 332 Gujarat Industries Power India 380 608 n/a n/a n/a n/a n/a n/a 560 1,085 80 1,356 EM thermal generation average 6.1 5.5 5.5 8.6 7.8 7.5 1,068 65 1,675 Developed markets thermal generation International Power UK 8,583 12,393 6.3 6.5 6.6 12.6 10.1 8.7 17,018 728 60 1,219 Public Power Corp S.A. Greece 2,361 5,589 2.8 2.7 2.4 3.1 3.3 3.0 12,276 455 49 934 Allegheny Energy USA 3,737 7,993 6.8 6.7 7.7 10.2 9.9 11.5 9,700 824 0 n/a Southern Company USA 29,322 48,472 9.0 8.2 7.7 14.5 13.7 12.5 42,000 1,154 54 2,127 Drax Group plc UK 2,253 2,288 3.9 4.8 5.5 6.6 8.3 9.6 4,000 1,072 72 789 Contact Energy N Zealand 2,450 4,263 13.5 12.0 10.3 22.5 20.7 16.1 2,200 1,938 40 4,788 TransAlta Corporation Canada 4,253 8,871 9.2 8.2 8.1 17.9 15.8 14.9 6,932 1,280 81 1,589 Energy Developments Ltd Australia 359 845 7.1 6.7 6.3 11.7 10.4 9.0 552 1,530 0 n/a DM thermal generation average 8.5 8.0 7.6 14.6 13.8 12.4 1,123 45 1,908 Source: Bloomberg, OTKRITIE Research
OTKRITIE Investment Bank (JSC) 16 Utilities / Gazprom Power Generation / 15 September 2010
Risks
Price caps for the ‘old’ generation capacity. The capacity tariffs for the existing generation capacity that is not included in the mandatory capex list are currently determined on an annual basis by the Federal Tariff Service according to a cost- plus principle. Starting from 2011, these tariffs will also be determined via a market mechanism, parameters of which are still uncertain. The first auction for the existing capacity pricing should take place in September-October of this year, and it will likely clarify the pricing mechanism. We believe the main risk for the gencos is that these tariffs will be set below current levels, and hence the companies may lose part of their revenue. Also, the Energy Ministry previously announced that price caps of RUB115- 120/kW/month may be implemented in some cases, though the current average level of capacity tariffs is already higher for all of Gazprom’s generation companies.
Drop in electricity demand and/or spot prices. As we saw at the end of 2008 and in 2009, the economic downturn had a significant impact on electricity producers, as conditions compelled them to postpone their investment programs. This remains an key risk for the future, because now that the mandatory capex is fixed the companies are obliged to commission new energy blocks. Another substantial drop in demand could thus result in the underutilization of those new capacities. Still, we think that construction of new power units is economically viable as they will replace old and inefficient blocks. The main risk in terms of a decline in electricity demand and diminished spot prices is that the return on the capex projects could be rendered lower than expected.
Reversal of OGK-2/OGK-6 merger. We regard the probability of merger a OGK-2/OGK- 6 as very high, though we do consider the risk involved in a reversal of merger plans. The merger itself will be beneficial for both companies in our view, and it constitutes the underlying reason for our upgrades of both names. A reversal of the merger would increase the uncertainty regarding the ultimate operating structure of both companies. On a positive note, if the merger does not occur in the near term, the companies could still merge during a consolidation of Gazprom’s gencos a few years down the road. If that happens, the future operating synergies could be even higher.
Delayed introduction of a new heat tariff system. At this point there are still questions regarding the future of the regulation of heat tariffs in Russia. In the heat transportation segment, we think that a shift to a RAB-based principle is quite likely, however this represents only a minor portion of the revenues of generation companies like TGK-1 and Mosenergo. In heat generation the tariff method is still uncertain, although it is evident to government authorities that the current cost-plus system must be replaced. While the momentum of change appears quite positive, we believe that any delay of the heat tariffs reforms could be taken negatively by the market.
OTKRITIE Investment Bank (JSC) 17 Utilities / Gazprom Power Generation / 15 September 2010 Mosenergo: Prime Assets, Prime Location
Rating (from BUY) BUY We like Mosenergo in the Russian power generation space as its generation plants are among the highest in the sector in terms of fuel efficiency, while Target price, ¢ (from 19) 21 the company possesses the sector’s ‘youngest’ assets. Mosenergo will Upside potential 97% benefit from the higher level of new capacity tariffs, which will exceed the current regulated tariff by 3-4 times. The main short-term catalyst that we see for Mosenergo is the signing of the Capacity Delivery Agreements Basic information (CDAs) with the Energy Ministry, anticipated for this fall. We upgrade our RTS MSNG target price for Mosenergo by 11% to ¢21 and reiterate our BUY rating on MICEX MSNG the stock. ADR/GDR Number of shares per ADR /GDR 100 Investment case Last price of common shares, ¢ 10.7 Most efficient assets in thermal generation. Mosenergo’s fuel rate for Number of common shares, m 39,749 electricity and heat generation amount to 274goe/kWh and 141kgoe/Gcal Market cap, $m 4,242 respectively, which are below the generation average of 341goe/kWh for Net debt, $m 660 electricity and 148kgoe/Gcal for heat. The average age of the company’s assets is 27 years vs generation average of 37 years. EV, $m 4902 Free float 16.5% Margins higher than the average. Mosenergo’s EBITDA margin is expected 52-week min, ¢ 7.5 to reach 15% in 2010 and 21% in 2012, which is slightly above the anticipated thermal generation average of 14% in 2010 and 20% in 2012. 52-week max, ¢ 13.6 Sources: Bloomberg, OTKRITIE Research Among the first dividend stories in the sector. Mosenergo paid out dividends for a total of RUB500m for 2009, which amounts to 11% of its RUB4.5bn net income. The dividend yield was only 0.4%, but this puts the Key metrics company among the first in the Russian utilities sector to undergo a heavy 2010E 2011E 2012E capex period and still be able to pay dividends to shareholders. Revenue, $m 4,638 5,347 5,927 Protection and supply provided by its major shareholder. Mosenergo’s major EBITDA, $m 755 1,086 1,248 shareholder (53.5% stake) is the state monopoly “GazpromEnergoholding,” Net income, $m 191 395 502 which provides the company with strong corporate governance and stability. P/E 22 11 8 Gazprom provides a stable supply of gas fuel for Mosenergo, (98% of its EV/EBITDA 6.5 4.5 3.9 fuel consumption is based on gas). Also CEO Denis Fedorov stated that EV/S 1.1 0.9 0.8 Gazprom does not put pressure on its energy subsidiaries and does not use Sources: Company data, OTKRITIE estimates it monopolistic strength to compel them to purchase its fuel at higher than market prices.
Equity structure Valuation Gazprom 53.50% Undervalued on $/kW and EV/EBITDA multiples. Mosenergo trades at an Moscow authorities 26.45% EV/Installed capacity multiple of $398/kW versus the $1670/kW average FGC UES 3.37% of foreign peers. The company’s 2010 EV/EBITDA multiple amounts to 9.5X, State 0.15% compared with the 11x average of foreign peers. Others 16.53% Source: Company data Catalysts The signing of CDAs and new heat tariffs. The signing of CDAs serves as the short-term trigger while transferring of heat business to RAB-system serves as a long-term trigger
Action Our top pick. We view Mosenergo as one of our favorites in the generation sector, assigning it a BUY rating and a target price of ¢21, which implies an 97% upside. We think that the upcoming signing of CDAs is the key driver that will bring clarity at the same time realizing the implied upside.
OTKRITIE Investment Bank (JSC) 18 Utilities / Gazprom Power Generation / 15 September 2010
APPENDIX: Mosenergo Financial forecasts
$m unless otherwise stated 2009 2010E 2011E 2012E 2013E 2014E 2015E Income statement Profitability Revenues 4,638 5,347 5,927 6,209 7,107 8,045 8,683 Depreciation 425 455 474 474 501 502 501 2,000 25% EBITDA 755 1,086 1,248 1,302 1,541 1,711 1,754 20% Operating profit (EBIT) 329 630 774 828 1,040 1,208 1,253 1,500 Net Interest expense -94 -140 -150 -143 -139 -119 -109 15% Non-op. expenses ------1,000 Pretax Profit 235 490 624 685 901 1,090 1,144 10% Taxes -44 -95 -122 -134 -177 -215 -226 500 5% Minority interest ------Net Profit 191 395 502 551 724 875 918 0 0% Cash flow statement 2009 2011E 2013E 2015E Net Change in work. cap. -159 -143 -122 -97 -141 -184 -125 Provisions and write-offs ------EBITDA, $m EBITDA margin Other ------Operating cashflow 552 848 1,004 1,071 1,222 1,311 1,403 Capex -819 -734 -685 -632 -519 -487 -419 Cash flows, $m Acquisitions (Disposals) ------Investing cashflow -819 -734 -685 -632 -519 -487 -419 2,000 Equity ------Debt 510 ------1,500 Financing cashflow 419 -222 -300 -377 -486 -731 -752 1,000 Net change in cash 151 -109 19 62 217 93 232 500 Balance sheet Cash & equivalents 252 144 163 225 442 535 767 - Current assets 1,952 2,081 2,327 2,415 3,037 3,473 3,938 -500 PP&E 5,656 5,847 6,054 5,795 6,189 6,174 6,092 -1,000 Goodwill and other 98 97 97 90 96 96 96 2009 2010E 2011E 2012E 2013E 2014E 2015E Total Assets 7,707 8,025 8,478 8,301 9,322 9,743 10,126 Current liabilities 1,212 1,316 1,420 1,404 1,616 1,775 1,882 Operating cashflow Investing cashflow S-T Debt 427 420 420 391 417 417 417 L-T Debt 962 948 947 883 940 940 940 Other L-T Liabilities 638 629 628 586 624 624 624 Shareholders Funds 4,894 5,133 5,482 5,429 6,142 6,405 6,680 Momentum, % Total Liabilities & Equity 7,707 8,025 8,478 8,301 9,322 9,743 10,126 Net Debt 1,136 1,224 1,204 1,049 915 822 590 120% Margins and profitability 100% EBIT margin 7% 12% 13% 13% 15% 15% 14% 80% EBITDA margin 16% 20% 21% 21% 22% 21% 20% 60% Net margin 4% 7% 8% 9% 10% 11% 11% ROE 4% 8% 9% 10% 12% 14% 14% 40% ROA 2% 5% 6% 7% 8% 9% 9% 20% ROIC 4% 8% 9% 10% 11% 12% 12% 0% Momentum 2010E 2011E 2012E 2013E 2014E 2015E Revenue growth 30% 15% 11% 5% 14% 13% 8% EBITDA growth 51% 44% 15% 4% 18% 11% 3% Revenue growth EPS growth EPS growth n/m 107% 27% 10% 31% 21% 5% Liquidity and solvency Cash ratio 0.2 0.1 0.1 0.2 0.3 0.3 0.41 Current ratio 1.6 1.6 1.6 1.7 1.9 2.0 2.09 Valuation Interest cover -3.5 -4.5 -5.2 -5.8 -7.5 -10.2 -11.5 Debt / Equity 0.3 0.3 0.2 0.2 0.2 0.2 0.2 25 Debt / Total assets 0.2 0.2 0.2 0.2 0.1 0.1 0.1 20 Net debt / EBITDA 1.2 1.1 1.0 0.9 0.6 0.5 0.4 Valuation 15 P/E 22.2 10.7 8.4 7.7 5.9 4.8 4.6 P/CE 6.9 5.0 4.3 4.1 3.5 3.1 3.0 10 P/BV 0.9 0.8 0.8 0.8 0.7 0.7 0.6 5 EV/Sales 1.1 0.9 0.8 0.8 0.7 0.6 0.6 EV/EBITDA 6.5 4.5 3.9 3.8 3.2 2.9 2.8 0 Dividends 2009 2010E 2011E 2012E 2013E 2014E 2015E DPS, ords - 0.00 0.00 0.01 0.01 0.02 0.02 DPS, prefs n/a n/a n/a n/a n/a n/a n/a P/E EV/EBITDA Yield, % (ords) 0.0% 0.0% 0.1% 0.1% 0.1% 0.3% 0.3% Yield, % (prefs) n/a n/a n/a n/a n/a n/a n/a
Source: Company data, OTKRITIE estimates Company description Territorial Generating Company TGK-3 registered as OAO Mosenergo was created in April 2005 in the process of privatization of the former state power monopolist RAO UES. The company owns and operates facilities in Moscow and Moscow Region. The facilities include 16 CHP (Combined Heat and Power) plants and 1 TPP (Territorial Power Plant). In terms of installed capacity, TGK-3 is the largest of the 14 TGKs, having a total of 11,9 thousand MW. It can also supply 34,9 thousand GCal/h of heat.
OTKRITIE Investment Bank (JSC) 19 Utilities / Gazprom Power Generation / 15 September 2010 TGK-1: Efficient assets. Attractive opportunities
Rating (from BUY) BUY TGK-1 is our top pick in the Russian power generation space as almost half of its assets consist of hydro generation. The company thus presents Target price, ¢ (from 0.12) 0.14 investors with an opportunity to participate in two crucial reforms slated Upside potential 83% for the upcoming years: the transfer of heat tariffs to a RAB-based system and the establishment of tariffs for newly-built hydro capacity. The main short-term catalyst that we see for TGK-1 is the signing of the Capacity Basic information Delivery Agreements (CDAs) with the Energy Ministry, anticipated for this RTS TGKA fall. We have upgraded our target price for TGK-1 by 17% to ¢0.14 and MICEX TGKA reiterate our BUY rating on the stock. Last price of common shares, ¢ 0.076 Number of common shares, m 3,850,960 Investment case Market cap, $m 2,939 Low-cost hydro generation. 46% of TGK-1’s generation capacity comes Net debt, $m 175 from hydropower, which outpaces heat generation in efficiency due to the EV, $m 3114 absence of fuel costs. Free float 20.5% Play two coming unexposed stories through one stock. TGK-1 embodies the 52-week min, ¢ 0.03 potential of both upcoming stories: heat reform, which implies improvement 52-week max, ¢ 0.08 of heat-business margins via shift to a RAB-system and the establishment Sources: Bloomberg, OTKRITIE Research of tariffs for newly-built capacity. Favorable minorities. We view the presence (25.7% stake) of a Finnish Key metrics energy holding Fortum in TGK-1’s capital positively since that minority shareholder can combat possible negative decisions of Gazprom. 2010E 2011E 2012E Revenue, $m 1,635 2,179 2,651 Hydro sell-off: rumors are rejected. One of the major risks we saw was a sell-off of the hydro assets. During the Analyst Day held by Gazprom it was EBITDA, $m 420 692 865 mentioned that the company does not plan to sell its hydro business in the Net income, $m 216 379 478 nearest future. P/E 14 8 6 Protection and supply provided by its major shareholder. TGK-1’s major EV/EBITDA 7.4 4.5 3.6 shareholder (52% stake) is the state monopoly “GazpromEnergoholding”, EV/S 1.9 1.4 1.2 (GEH), which provides the company with strong corporate governance and Sources: Company data, OTKRITIE estimates stability. GEH’s CEO Denis Fedorov stated that Gazprom does not use it monopolistic strength to compel them to purchase its fuel at higher than Equity structure market prices. Gazprom 51.8% Fortum 25.7% Valuation State 2.0% Undervalued on $/kW and EV/EBITDA multiples. TGK-1 trades at an EV/ Others 20.5% Installed capacity multiple of $445/kW versus $555/kW for RusHydro and
Source: Company data $1670/kW for foreign peers. The company’s 2010 EV/EBITDA multiple amounts to 12X, compared to the 11x average of foreign peers.
Catalysts The signing of CDAs and new heat tariffs. The signing of CDAs serves as the short-term trigger while transferring of heat business to RAB-system serves as a long-term trigger.
Action Our top pick. We view TGK-1 as one of our favorites in the generation sector, assigning it a BUY rating and a target price of ¢0.14, which implies a 83% upside.
OTKRITIE Investment Bank (JSC) 20 Utilities / Gazprom Power Generation / 15 September 2010
APPENDIX: TGK-1 Financial forecasts
$m unless otherwise stated 2009 2010E 2011E 2012E 2013E 2014E 2015E Income statement Profitability Revenues 1,210 1,635 2,179 2,651 3,049 3,507 3,901 Depreciation 103 133 167 226 281 329 335 1,600 40% EBITDA 233 420 692 865 1,079 1,295 1,453 1,400 35% Operating profit (EBIT) 131 287 525 640 798 966 1,118 1,200 30% Net Interest expense 14 -13 -47 -37 -94 -107 -53 1,000 25% Non-op. expenses ------800 20% Pretax Profit 144 274 478 602 704 859 1,065 600 15% Taxes -33 -60 -100 -125 -145 -176 -218 400 10% Minority interest -1 -1 -1 -1 -1 -1 -1 200 5% Net Profit 112 216 379 478 560 684 849 0 0% Cash flow statement 2009 2011E 2013E 2015E Net Change in work. cap. -21 -47 -78 -70 -70 -53 -56 Provisions and write-offs ------EBITDA, $m EBITDA margin Other ------Operating cashflow 179 313 514 671 864 1,066 1,179 Capex -421 -676 -1,095 -1,233 -875 -418 -365 Cash flows, $m Acquisitions (Disposals) ------Investing cashflow -421 -676 -1,095 -1,233 -875 -418 -365 1,500 Equity - - 677 - - - - Debt 95 189 34 504 178 - - 1,000 Financing cashflow 92 182 663 467 81 -102 -732 500 Net change in cash -150 -181 82 -96 70 545 82 - Balance sheet Cash & equivalents 204 24 106 10 81 626 708 -500 Current assets 673 631 906 991 1,171 1,924 2,152 -1,000 PP&E 1,986 2,595 3,476 4,481 4,750 5,147 5,178 -1,500 Goodwill and other 63 65 64 64 60 64 64 2009 2010E 2011E 2012E 2013E 2014E 2015E Total Assets 2,723 3,291 4,446 5,536 5,980 7,135 7,393 Current liabilities 402 545 661 940 1,047 1,199 1,289 Operating cashflow Investing cashflow S-T Debt 114 171 168 336 376 400 400 L-T Debt 142 283 312 648 713 759 759 Other L-T Liabilities 106 109 108 108 100 107 107 Shareholders Funds 2,073 2,354 3,365 3,841 4,120 5,069 5,238 Momentum, % Total Liabilities & Equity 2,723 3,291 4,446 5,536 5,980 7,135 7,393 Net Debt 51 430 374 973 1,008 533 451 100% 90% Margins and profitability 80% EBIT margin 11% 18% 24% 24% 26% 28% 29% 70% EBITDA margin 19% 26% 32% 33% 35% 37% 37% 60% 50% Net margin 9% 13% 17% 18% 18% 19% 22% 40% ROE 5% 9% 11% 12% 14% 13% 16% 30% ROA 4% 7% 9% 9% 9% 10% 11% 20% 10% ROIC 5% 8% 11% 11% 13% 13% 15% 0% Momentum 2010E 2011E 2012E 2013E 2014E 2015E Revenue growth -11% 35% 33% 22% 15% 15% 11% EBITDA growth 122% 80% 65% 25% 25% 20% 12% Revenue growth EPS growth EPS growth n/m 92% 75% 26% 17% 22% 24% Liquidity and solvency Cash ratio 0.5 0.0 0.2 0.0 0.1 0.5 0.55 Current ratio 1.7 1.2 1.4 1.1 1.1 1.6 1.67 Valuation Interest cover 9.7 -21.9 -11.1 -17.1 -8.5 -9.0 -21.0 Debt / Equity 0.1 0.2 0.1 0.3 0.3 0.2 0.2 30 Debt / Total assets 0.1 0.1 0.1 0.2 0.2 0.2 0.2 25 Net debt / EBITDA -0.3 0.6 0.6 0.8 0.9 0.6 0.3 20 Valuation P/E 26.2 13.6 7.8 6.1 5.2 4.3 3.5 15 P/CE 13.7 8.4 5.4 4.2 3.5 2.9 2.5 10 P/BV 1.4 1.2 0.9 0.8 0.7 0.6 0.6 EV/Sales 2.6 1.9 1.4 1.2 1.0 0.9 0.8 5 EV/EBITDA 13.3 7.4 4.5 3.6 2.9 2.4 2.1 0 Dividends 2009 2010E 2011E 2012E 2013E 2014E 2015E DPS, ords ------0.00 DPS, prefs n/a n/a n/a n/a n/a n/a n/a P/E EV/EBITDA Yield, % (ords) 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Yield, % (prefs) n/a n/a n/a n/a n/a n/a n/a
Source: Company data, OTKRITIE estimates Company description Territorial Generating Company No.1 Open Joint Stock Company (TGK-1) was created in March 2005 in the process of privatization of the former state power monopolist RAO UES. The company owns and operates 55 facilities in St Petersburg, the Republic of Kareliya and the regions of Leningrad and Murmansk. The facilities include CHPs (Combined Heat and Power) plants, hydroelectirc plants and a diesel generator. In terms of installed capacity, TGK-1 is the third largest of the 14 TGKs, having a total of 6,266.5 MW. It can also supply 14,608 GCal/h of heat. TGK-1 is the largest producer of electricity and heat in the North-West of Russia.
OTKRITIE Investment Bank (JSC) 21 Utilities / Gazprom Power Generation / 15 September 2010 OGK-2: Bet on the Urals region
Rating (from BUY) BUY OGK-2 ranks second among OGKs in terms of capacity load factor, though it has assets with below average efficiency levels. Consequently, the company’s Target price, ¢ (from 8.6) 9.5 1H10 margins were a bit lower than the OGK average. We expect essential improvements in company’s efficiency and margins after consolidation with Upside potential 77% OGK-6. The synergy effect should unlock OGK-2’s value and move the united company close to the sector leaders in terms of efficiency. The signing of the Basic information Capacity Delivery Agreements (CDAs) with the Energy Ministry, anticipated for RTS OGKB this fall, will also have a positive impact on the stock. We upgrade our target price for OGK-2 by 10% to ¢9.5 and reiterate our BUY rating on the stock. MICEX OGK2 ADR/GDR Investment case Number of shares per ADR /GDR 100 The load factor of OGK-2 amounts to Last price of common shares, ¢ 5.4 Second highest load factor among OGKs. 62%, which is the highest figure among OGKs after OGK-4. Number of common shares, m 32,733 Market cap, $m 1,752 Margins lower than the average. The company’s EBITDA margin is expected to reach 11% in 2010 and 17% in 2012, underperforming than anticipated Net debt, $m 177 thermal generation averages of 14% in 2010 and 20% in 2012. EV, $m 1929 Consolidation with OGK-6 is the main driver. During the Analyst Day Free float 38.2% mentioned above, the Gazpromenergoholding CEO said that a final decision 52-week min, ¢ 2.4 on consolidation will be taken by the end of September. It was also mentioned 52-week max, ¢ 6.6 that preliminary calculations show that the synergy effect from consolidation Sources: Bloomberg, OTKRITIE Research of two companies will result in cost cutting savings of 18% and a 25% increase in the market capitalization of united company. Key metrics Protection and supply provided by its major shareholder. OGK-2’s major 2010E 2011E 2012E shareholder (50% stake) is the state monopoly “Gazpromenergoholding,” which provides the company with strong corporate governance, stability Revenue, $m 1,591 1,893 2,309 and bargaining power in relations with the government. Moreover, Gazprom EBITDA, $m 175 293 436 provides a stable supply of gas fuel for OGK-2, (76% of its fuel consumption is Net income, $m 57 84 140 based on gas). P/E 31 21 12 Management promised the absence of pressure. During the Analyst Day held EV/EBITDA 11.0 6.6 4.4 by Gazprom on 6 September, Gazpromenergoholding CEO Denis Fedorov EV/S 1.2 1.0 0.8 stated that Gazprom does not put pressure on its energy subsidiaries and does Sources: Company data, OTKRITIE estimates not use it monopolistic strength to make them purchase its fuel at higher than market prices.
Equity structure Valuation Gazprom 50.30% Undervalued on $/kW, overpriced on EV/EBITDA multiples. OGK-2 trades at State 0.27% an EV/Installed capacity multiple of $216/kW, versus the $250/kW average of GDR 4.62% foreign peers. However, the company looks overpriced on the 2010 EV/EBITDA Others 45% multiple, which amounts to 11x compared with the foreign peers average of Source: Company data 7.5x.
Catalysts The signing of CDAs serves as the short-term trigger. Consolidation with OGK-6 will serve as a medium-term trigger.
Action Improvement is expected. We view the consolidation process with OGK-2 as the primary trigger for improving the company’s operational efficiency and increasing its margins. We assign a BUY rating for the stock, with the target price of ¢9.5.
OTKRITIE Investment Bank (JSC) 22 Utilities / Gazprom Power Generation / 15 September 2010
APPENDIX: OGK-2 Financial forecasts
$m unless otherwise stated 2009 2010E 2011E 2012E 2013E 2014E 2015E Income statement Profitability Revenues 1,211 1,591 1,893 2,309 2,612 3,105 3,695 Depreciation 58 95 147 205 228 278 317 1,200 30% EBITDA 123 175 293 436 525 784 1,050 1,000 25% Operating profit (EBIT) 65 80 145 231 297 506 733 800 20% Net Interest expense 22 -9 -40 -56 -73 -71 -60 Non-op. expenses ------600 15% Pretax Profit 87 71 105 175 225 436 673 400 10% Taxes -29 -14 -21 -35 -45 -87 -135 Minority interest ------200 5% Net Profit 58 57 84 140 180 348 538 0 0% Cash flow statement 2009 2011E 2013E 2015E Net Change in work. cap. 5 -22 -24 -34 -30 -33 -46 Provisions and write-offs ------EBITDA, $m EBITDA margin Other ------Operating cashflow 99 138 248 367 450 664 870 Capex -476 -839 -965 -642 -821 -825 -317 Cash flows, $m Acquisitions (Disposals) ------Investing cashflow -476 -839 -965 -642 -821 -825 -317 1,000 Equity - - 508 - 486 333 - Debt - 612 220 336 - - - 500 Financing cashflow -11 609 686 280 405 271 -545 - Net change in cash -389 -91 -31 5 34 110 8 Balance sheet -500 Cash & equivalents 212 121 90 95 129 239 247 Current assets 403 360 371 441 507 704 800 -1,000 PP&E 1,281 2,068 2,848 3,285 3,635 4,418 4,418 -1,500 Goodwill and other 159 164 162 161 151 160 160 2009 2010E 2011E 2012E 2013E 2014E 2015E Total Assets 1,842 2,593 3,381 3,887 4,292 5,282 5,378 Current liabilities 181 309 326 357 359 413 455 Operating cashflow Investing cashflow S-T Debt 90 195 192 192 179 190 190 L-T Debt 162 679 887 1,223 1,140 1,214 1,214 Other L-T Liabilities 96 100 98 98 91 97 97 Shareholders Funds 1,403 1,505 2,070 2,209 2,702 3,559 3,613 Momentum, % Total Liabilities & Equity 1,842 2,593 3,381 3,887 4,292 5,282 5,378 Net Debt 40 753 989 1,320 1,190 1,165 1,157 100% Margins and profitability 80% EBIT margin 5% 5% 8% 10% 11% 16% 22% 60% EBITDA margin 10% 11% 15% 19% 20% 25% 28% 40% Net margin 5% 4% 4% 6% 7% 11% 15% ROE 4% 4% 4% 6% 7% 10% 15% 20% ROA 3% 2% 2% 4% 4% 7% 10% 0% ROIC 3% 3% 4% 5% 6% 8% 12% -20% Momentum 2010E 2011E 2012E 2013E 2014E 2015E Revenue growth -26% 31% 19% 22% 13% 19% 19% EBITDA growth 405% 42% 67% 49% 21% 49% 34% Revenue growth EPS growth EPS growth n/m -2% 48% 66% 28% 94% 54% Liquidity and solvency Cash ratio 1.2 0.4 0.3 0.3 0.4 0.6 0.54 Current ratio 2.2 1.2 1.1 1.2 1.4 1.7 1.76 Valuation Interest cover 2.9 -8.7 -3.6 -4.1 -4.1 -7.2 -12.1 Debt / Equity 0.2 0.6 0.5 0.6 0.5 0.4 0.4 35 Debt / Total assets 0.1 0.3 0.3 0.4 0.3 0.3 0.3 30 Net debt / EBITDA -1.2 2.3 3.0 2.7 2.4 1.5 1.1 25 Valuation 20 P/E 30.2 30.8 20.8 12.5 9.7 5.0 3.3 15 P/CE 15.1 11.6 7.6 5.1 4.3 2.8 2.0 P/BV 1.2 1.2 0.8 0.8 0.6 0.5 0.5 10 EV/Sales 1.6 1.2 1.0 0.8 0.7 0.6 0.5 5 EV/EBITDA 15.7 11.0 6.6 4.4 3.7 2.5 1.8 0 Dividends 2009 2010E 2011E 2012E 2013E 2014E 2015E DPS, ords ------0.01 DPS, prefs n/a n/a n/a n/a n/a n/a n/a P/E EV/EBITDA Yield, % (ords) 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.2% Yield, % (prefs) n/a n/a n/a n/a n/a n/a n/a
Source: Company data, OTKRITIE estimates Company description Wholesale Generating Company OGK-2 was created in September 2006 in the process of privatization of the former state power monopolist RAO UES. The company owns and operates five Territorial Power Plants (TPPs): Pskovskaya (Pskov), Serovskaya (Ekaterinburg), Stavropolskaya (Stavropol), Troitskaya (Chelyabinsk) and Surgutskaya TPP-1 (Tyumen). The core business of OGK-2 is electricity production and sale; though it also supplies heat to customers in the immediate vicinity of the plants. In terms of installed electric capacity, OGK-2 is the third of the six OGKs, having a total of 8,695 MW. It can also supply 1,834 GCal/h of heat.
OTKRITIE Investment Bank (JSC) 23 Utilities / Gazprom Power Generation / 15 September 2010 OGK-6: Unlocking the potential
Rating (from BUY) BUY OGK-6 reported one of the lowest 1H10 EBITDA margins in the sector. Its current assets have below average efficiency levels due to old age and high fuel rate. Target price, ¢ (from 4.2) 5.4 We expect essential improvements in company’s efficiency and margins after consolidation with OGK-2. The synergy effect should unlock OGK-6’s value and Upside potential 33% move the united company close to the sector leaders in terms of efficiency. Moreover, OGK-6 will gain more from this consolidation due to lower current Basic information efficiency. The signing of the Capacity Delivery Agreements (CDAs) with the RTS OGKF Energy Ministry, anticipated for this fall, will also have a positive impact on the stock. We upgrade our target price for OGK-6 by 29% to ¢5.4 and upgrade MICEX OGK6 our rating for the stock to a BUY from a HOLD. Last price of common shares, ¢ 4.1 Number of common shares, m 32,263 Investment case Market cap, $m 1,312 One of the lowest margins among OGKs. The company reported a 9% EBITDA Net debt, $m -65 margin for 1H10, which is lower than the OGK average of 17%. Such results are EV, $m 1247 primarily due to the low efficiency of its assets. Free float 30.4% Low assets efficiency. The fuel rate for electricity generation amounts to 364 52-week min, ¢ 2.1 goe/kWh vs OGKs average of 341goe/kWh. The average age of its assets is 36 52-week max, ¢ 5.7 years, compared to a 32 years average for OGKs. Sources: Bloomberg, OTKRITIE Research Consolidation with OGK-6 is the main driver. During the Analyst Day mentioned above, the Gazpromenergoholding CEO said that a final decision on consolidation will be taken by the end of September. It was also mentioned that preliminary calculations show that the synergy effect from consolidation will result in cost cutting savings of 18% and a 25% increase in the market Key metrics capitalization of united company. We view consolidation as the main driver 2010E 2011E 2012E which will improve company’s business. Revenue, $m 1,445 1,682 1,951 Protection and supply provided by its major shareholder. OGK-6’s major EBITDA, $m 155 296 433 shareholder (50% stake) is the state monopoly “Gazprom Energoholding,” Net income, $m 19 27 99 which provides the company with strong corporate governance, stability P/E neg. neg. 13 and bargaining power in relations with the government. Moreover, Gazprom EV/EBITDA 8.0 4.2 2.9 provides a stable supply of gas fuel for OGK-6, (50% of its fuel consumption EV/S 0.9 0.7 0.6 is based on gas). Also CEO Denis Fedorov stated that Gazprom does not put pressure on its energy subsidiaries and does not use it monopolistic strength Sources: Company data, OTKRITIE estimates to compel them to purchase its fuel at higher than market prices.
Equity structure Valuation Gazprom 50.29% Undervalued on $/kW but in line with EV/EBITDA multiples. OGK-6 trades at FGC UES 9.60% an EV/Installed capacity multiple of $134/kW, versus the $250/kW average of State 0.32% foreign peers. However, the company looks overpriced on the 2010 EV/EBITDA Others 39.79% multiple, which amounts to 9.3X compared with the foreign peers average of
Source: Company data 7.5x. Catalysts The signing of CDAs serves as the short-term trigger. Consolidation with OGK-6 will serve as a medium-term trigger.
Action Improvement is expected. We view the consolidation process with OGK-2 as the primary trigger for improving the company’s operational efficiency and increasing its margins. We upgrade our rating for the stock from HOLD to BUY, with the target price of ¢5.4.
OTKRITIE Investment Bank (JSC) 24 Utilities / Gazprom Power Generation / 15 September 2010
APPENDIX: OGK-6 Financial forecasts
$m unless otherwise stated 2009 2010E 2011E 2012E 2013E 2014E 2015E Income statement Profitability Revenues 1,265 1,445 1,682 1,951 2,263 2,637 3,049 Depreciation 95 121 189 240 274 305 305 900 30% EBITDA 171 155 296 433 518 666 789 800 25% Operating profit (EBIT) 76 35 107 193 245 361 484 700 600 20% Net Interest expense -8 -23 -96 -92 -132 -164 -159 500 Non-op. expenses ------15% 400 Pretax Profit 68 12 11 101 112 197 325 300 10% Taxes -5 7 16 -2 -5 -21 -47 200 Minority interest ------5% 100 Net Profit 63 19 27 99 108 176 278 0 0% Cash flow statement 2009 2011E 2013E 2015E Net Change in work. cap. 19 -22 -66 -77 -104 -84 -112 Provisions and write-offs ------EBITDA, $m EBITDA margin Other ------Operating cashflow 185 140 247 355 410 561 630 Capex -283 -902 -777 -732 -529 -305 -305 Cash flows, $m Acquisitions (Disposals) ------Investing cashflow -283 -902 -777 -732 -529 -305 -305 800 Equity - - 677 - - - - 600 Debt 158 748 - 420 308 - - 400 Financing cashflow 152 727 580 328 171 -159 -159 200 Net change in cash 54 -35 50 -49 52 97 166 - Balance sheet -200 Cash & equivalents 71 36 86 37 89 186 352 -400 Current assets 563 574 705 760 899 1,164 1,483 -600 PP&E 1,316 2,143 2,693 3,184 3,214 3,423 3,423 -800 -1,000 Goodwill and other 20 21 20 20 19 20 20 2009 2010E 2011E 2012E 2013E 2014E 2015E Total Assets 1,899 2,738 3,419 3,964 4,132 4,607 4,925 Current liabilities 131 211 232 394 419 477 517 Operating cashflow Investing cashflow S-T Debt - 68 67 202 203 217 217 L-T Debt 231 921 907 1,192 1,393 1,483 1,483 Other L-T Liabilities 153 158 155 155 145 154 154 Shareholders Funds 1,384 1,447 2,124 2,222 2,175 2,492 2,770 Momentum, % Total Liabilities & Equity 1,899 2,738 3,419 3,964 4,132 4,607 4,925 Net Debt 160 953 888 1,357 1,508 1,514 1,348 300% Margins and profitability 250% EBIT margin 6% 2% 6% 10% 11% 14% 16% 200% 150% EBITDA margin 14% 11% 18% 22% 23% 25% 26% 100% Net margin 5% 1% 2% 5% 5% 7% 9% 50% ROE 5% 1% 1% 4% 5% 7% 10% 0% ROA 3% 1% 1% 3% 3% 4% 6% -50% ROIC 3% 1% 3% 4% 5% 7% 9% -100% Momentum 2010E 2011E 2012E 2013E 2014E 2015E Revenue growth -26% 14% 16% 16% 16% 17% 16% EBITDA growth 1640% -9% 91% 46% 20% 29% 18% Revenue growth EPS growth EPS growth n/m -70% 43% 264% 9% 63% 58% Liquidity and solvency Cash ratio 0.5 0.2 0.4 0.1 0.2 0.4 0.68 Current ratio 4.3 2.7 3.0 1.9 2.1 2.4 2.87 Valuation Interest cover -10.0 -1.5 -1.1 -2.1 -1.8 -2.2 -3.0 Debt / Equity 0.2 0.7 0.5 0.6 0.7 0.7 0.6 80 Debt / Total assets 0.1 0.4 0.3 0.4 0.4 0.4 0.3 70 Net debt / EBITDA 0.6 3.6 3.1 2.6 2.8 2.3 1.8 60 Valuation 50 P/E 20.8 68.9 48.1 13.2 12.2 7.5 4.7 40 P/CE 8.3 9.4 6.1 3.9 3.4 2.7 2.2 30 P/BV 0.9 0.9 0.6 0.6 0.6 0.5 0.5 20 EV/Sales 1.0 0.9 0.7 0.6 0.6 0.5 0.4 10 EV/EBITDA 7.3 8.0 4.2 2.9 2.4 1.9 1.6 0 Dividends 2009 2010E 2011E 2012E 2013E 2014E 2015E DPS, ords ------DPS, prefs n/a n/a n/a n/a n/a n/a n/a P/E EV/EBITDA Yield, % (ords) 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Yield, % (prefs) n/a n/a n/a n/a n/a n/a n/a
Source: Company data, OTKRITIE estimates Company description Wholesale Generating Company OGK-6 was created in March 2005 in the process of privatization of the former state power monopolist RAO UES. The company owns and operates six Territorial Power Plants (TPPs): Novocherkasskaya (Rostov), Kirishskaya (St. Peterburg), Ryazanskaya (Ryazan), GRES-24 (Ryazan), Cherepovetskaya (Vologda) and Krasnoyarskaya TPP-2 (Krasnoyarsk). The core business of OGK-6 is electricity production and sale; though it also supplies heat to customers in the immediate vicinity of the plants. In terms of installed electric capacity, OGK-6 is the second of the six OGKs, having a total of 9,052 MW. It can also supply 2,704 GCal/h of heat.
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