Gazprom Power Generation: Growing in Scope, but Still Nimble
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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