Power Industry Bet on quality Aleksey Serov
YTD sector dynam ic vs. RTS 22.12.2010
Max
Min
FEES HY DR
The electricity sector during 2010 has shown impressive growth. In fact two stories were played up: the efficiency in gencos in the run up to 100% liberalization of the wholesale electricity market and transition to RAB-regulation in grid sector. 2011 should be a pivotal year for both generation - 100% of market liberalization, and grid companies - the introduction of RAB-regulation and long-term tariff-indexation. In 2010 former shareholders of RAO UES resumed a subtotal of energy reform, because after the separation process the sector finally entered in a phase of consolidation, which will be the main story in the industry in 2011.
IRAO IRGZ LSNG MRKC MRKH MRKK MRKP MRKS MRKU
Sector reform is finishing. 2011 will be a year of full liberalization of the wholesale electricity market, launching a long-term capacity market power and transmission of grid companies to RAB-regulation and long-term tariffs-indexation, which in fact mark the end of the active part of the electricity reform. New regulation rules and market mechanisms qualitatively change the picture of the industry and will improve the financial performance of energy companies that generally increase their investment attractiveness.
MRKV MRKY MRKZ OGKA OGKB OGKC OGKD
Restoration of electricity consumption and rising energy prices. Most estimates on the annual growth of energy consumption in the country in the coming years are in the range from 2.2% to 3.5%, but even such modest by the standards of the pre-crisis figures could stably support the growth in electricity prices and, consequently, the financial performance of companies. In addition to the dynamics of electricity demand good support for prices will be provided by increase in domestic energy prices (gas and coal) on the background of the low level of commissioning capacities, so that we can expect a proportional increase in electricity prices and, accordingly, the company's revenues.
OGKE OGKF TGKA TGKB MSNG TGKD TGKE TGKF TGKG TGKI TGKJ TGKK KZBE TGKM TGKN -50%
0%
50%
100% 150%
RTS-Utilities vs RTS RTS Utilities
200 175 150 125 100 75 50 25 0
Oct 10
Nov 10
Sep 10
Jul 10
Aug 10
Jun 10
Apr 10
May 10
Mar 10
Jan 10
Feb 10
Source: RTS, MICEX, TKB Capital estimates
Electricity Tariff Structure Electricity Tariff
4%
64%
Retail Supply Companies
27%
32% Grid Companies
2011 – Year of selective purchases. Most of the positive, associated with the power industry sector transformation, has already priced in: the vanguard of cost effective and efficient companies were formed in generation, prospects and risks of grid companies have also become much clearer, so on the horizon of the year we can expect more moderate dynamics of stock price in power industry segment. Trend for consolidation became apparent in industry during 2010, which is accompanied by vertical and horizontal diversification and integration especially characteristic for state-owned companies. A series of events and transactions in 2011 could lead to formation of powerful energy conglomerates, but the creation of value for minority shareholders is an open question. Probability of SPO’s and the growth of debt burden. In the process of investment program realization will be accompanied by a significant increase in the debt burden of generating and grid companies. This trend was observed throughout 2010 and, according to our estimates, will continue in 2011. In some cases large-scale additional share placement could occur that first of all may concern companies under state control.
RTS Index
Dec 09
Power Industry Bet on quality
RTS Index
Distribution Companies (MRSK)
a.serov@tkbc.ru
Generating Companies
5% Federal Grid Company (FGC)
Source: Companies data, TKB Capital estimates
State control in the sector will be determinative on the horizon the next few years via tariff-regulation and market mechanisms («price cap» policy), as well as through state-owned companies. First of all restrictions will affect the capacity tariff for generating companies and distribution tariff for grid companies, since their contribution to the cost of electricity for the end user is the most weighty, which could lead to deterioration of the financial performance of these companies. Risks. Investment programs, primarily of the state-owned companies, could far exceed current estimates. Necessity of fund raising for investment programs realization means the absence of dividends and a greater likelihood of additional share placement in favor of the state or strategic investors, with the possible erosion of minority shares. In this regard, the risks of minority shareholders, especially large state-owned companies, can be assessed as high. In the generating sector we recommend to bet on the purchase of RusHydro (HYDR) shares, as the most cost-effective generator in industry, conducting organic development, which will benefit from full liberalization of the market and be able to fully capitalize on rising energy prices. In the segment of grid companies we bet on the purchase of common and preferred shares of MRSK Holding (MRKH), which minimize the risks of the individual regional discos and partly hedging the risks of investors in case of possible merger of assets and additional share placement of regional companies. We also like MRSK’s for all subsidiaries with already approved RAB-tariffs - MRSK of Center (MRKC), MRSK of Volga (MRKV), MRSK of Urals (MRKU) and MRSK of Center and Volga (MRKP).
STRATEGY 2011
31