Hub Power Company Limited AKD Securities...

AKD Securities Limited Hub Power Company Limited

Starting afresh on strong footing

September 2019

HUBC: Starting afresh on strong footing

AKD Securities Limited

We reinstate our Buy stance on Hub Power Company Ltd (HUBC) with TP of PKR140/sh (right adjusted), implying an upside of 91% on last close. HUBC’s successful foray in coal power projects (CPHGC, TEL and SECMC c. EPS contribution: PKR14.07/sh, 50% of FY22F EPS) is expected to translate into 3 year earnings CAGR of 42%. Additional value accretion may emanate from: (i) financial close of HUBC’s 38.3% owned ThalNova Power project (EPS impact of PKR1.20 post CoD, not yet incorporated), and (ii) clarity on desalination project. Meanwhile we expect piecemeal payouts to resume in 2HFY20, which are then expected to steadily increase as power plants move past their gestation stage. With HUB-C’s D/A breaching Shariah compliant level in 3QFY19, potential sell-off from Islamic mu-tual funds has kept a cap on HUBC’s price performance. Meeting further CAPEX financing (PKR8bn) through shariah compliant methods, and partial conversion of existing debt into Sukuks may potentially keep HUBC Shariah compliant in the upcoming review, cata-lyzing price performance.

Dominating Pakistan’s Power space: Amid a stream of new power plants, HUBC is ex-pected to continue to dominate Pakistan’s power space, with 1,980+ MW of generation capacity addition to its portfolio over FY19-21F. HUBC’s 47.5% owned 2x660MW imported coal based power project (China Power Hub Generation Co. – CPHGC) has already com-menced operations in Aug’19 (Jun’19 load factor of ~40%), while 60% owned 330MW Thar Energy Ltd (TEL) will commence operations in FY21F. HUBC’s successful foray in coal power projects (CPHGC, TEL and SECMC - c. EPS contribution: PKR14.07/sh, 50% of FY22F EPS) is expected to translate into 3 year earnings CAGR of 42%. HUBC has also bought 38.3% stake in ThalNova power project in Mar’19, which is expected to achieve financial close by 1HFY20 (CoD: FY21). The project will add PkR1.2/sh to HUBC’s bottomline, assuming 100% debt financed equity investment in the project. However, we await financial close of the project before incorporating the same in our estimates.

Payouts to improve in medium term: HUBC’s CAPEX requirements imply a financing gap of PKR7-8bn, post 12.1% right issue in Apr’19 and after taking complete drawdown of long term finance facility into account. We expect payouts to resume in 2HFY20, in the best case scenario, where elevated leverage levels - D/A at ~40% on average over FY19-21F - shall constrain payouts in the medium term. The payouts are however, expected to steadily in-crease as power plants move past their gestation stage. We foresee FY20/21/22F DPS of PKR2.0/8.0/11.0, based on improving consolidated FCFE, implying D/Y of 2.7/11.1/15.3%., at last close vs. 10yr PIB rate of 12.1%.

From IPP to IPWP? The company’s management is considering to convert its 1,292MW Hub Base plant into a non-recycled waste based desalination plant. Karachi’s non-recycled waste (13,240 TPD) could generate around 200 MW electricity which could be used to run desalination plants to produce 175-190 million gallons per day (MGD) of potable water (550 MGD of water shortage in Karachi). While non-recycled waste may utilize only one out of four 300MW units of the Base plant, a new water desalination plant of 200 MGD capaci-ty would cost US$400mn (PKR62bn), where project financing appears to be a herculean task for HUBC at the moment, given its cash-stressed B/S. Assuming HUBC’s 50% stake in the US$400mn water desalination plant, with 25% RoE, it would translate into a positive EPS impact of PKR0.81/sh on its bottomline, assuming 100% debt-financed equity.

Investment Perspective: With HUBC’s D/A breaching Shariah compliant level in 3QFY19, potential sell-off from Islamic mutual funds has kept a cap on the scrip’s price performance (3M: -ve10.04%). Meeting further CAPEX financing through shariah compliant methods (similar to PKR8.5bn raised in 3QFY19), and partial conversion of existing debt in Sukuks may potentially keep HUBC’s leverage levels compliant in upcoming review (Nov’19), cata-lyzing price performance. Our TP of PKR140/sh implies an upside of 91% on last close—Buy!

Find AKD research on Bloomberg, firstcall.com, Reuters Knowledge and ResearchPool www.jamapunji.com.pk

September 25, 2019

REP-019

The Hub Power Company

Ailia Naeem Senior Investment Analyst [email protected] UAN: +92 111-253-111

Source: Company Reports & AKD Research

HUBC: Valuation Glance Key metrics FY19 FY20F FY21F FY22F EPS (PkR) 9.4 16.0 20.7 26.8 EPS Growth -2.0% 70.7% 29.7% 29.4% DPS (PkR) - 2.0 8.0 11.0 Dividend yield - 2.8% 11.1% 15.3% PER (x) 7.82 4.50 3.47 2.68 BVS (PkR) 46.8 65.3 82.6 103.2 P/BVS(x) 1.6 1.1 0.9 0.7 ROE 18.2% 24.9% 26.0% 27.3% ROA 6.4% 7.9% 10.3% 10.6%

TARGET PRICE (PkR) SHARE PRICE (PkR)

140.0 73.21

UPSIDE/DOWNSIDE DIV. YIELD

91% 2.8%

BUY

KATS Code HUBC

Bloomberg Code HUBC.PA

Price PkR 73.21

Market Cap (PkRmn) 94,964.7

Market Cap (US$mn) 608.7

Shares (mn) 1,297.2

Free Float Share (mn) 972.9

3M High (PkR) 81.5

3M Low (PkR) 60.7

1Yr High (PkR) 95.7

1Yr Low (PkR) 60.7

3M Avg Turnover '000 1,388.5

1 Yr Avg Turnover '000 1,072.1

3M Avg DT Value (PkR'000) 100,288.2

3M Avg DT Value (US$'000) 642.9

1Yr Avg DT Value (PkR'000) 86,529.0

1Yr Avg DT Value (US$'000) 554.7

Table of

Contents

04 Background

06 Dominating Pakistan’s

Power space

08 Payouts to

improve over medium term

10 From IPP to

IPWP?

12 Valuation

13 Risks to

valuation

14 Annual Financial

Databank

15 Quarterly Financial

Databank

AKD RESEARCH

About the company: The Hub Power Company Ltd (HUBC) owns an oil-fired 1,292MW power plant in Balochistan (Hub plant), oil-fired 213MW power plant in Punjab (Narowal plant) and 75% holding in 84MW hydel power plant (Laraib plant), taking cu-mulative existing capacity to ~1,500MW. The company has also partaken in a stream of coal power projects under China Pakistan Economic Corridor (CPEC), amounting to ~2000MW – all projects expected to have commenced operations by Mar’21. HUBC’s previous sponsors, Dawood Hercules, including its other businesses and family holdings, offloaded 17.37% stake in HUBC in Feb’18 at a transaction price of PKR106.5/sh to Mega Conglomerate.

Background

COD 17/8/19

COD 10/7/19

Under Construction

In Operation

Corporate Structure

Source: Company Presentation & AKD Research


Timely expansion into coal power plants

New Projects China Hub Power Thar Energy Ltd ThalNova Power

Fuel Category Imported coal Local coal Local coal

Location Balochistan Sindh Sindh

Capacity (MW) 1320 330 330

Commercial Operations 2019 2021 2021

PPA duration 30 years 30 years 30 years

Project Cost (US$mn) 1,900 520 527

Stake (%) 47.5 60 38.3

ROE (%) 27 30 30

Existing Portfolio Hub Power Plant Narowal Laraib

Fuel Category Furnace Oil Furnace Oil Hydro

Location Balochistan Punjab Jammu and Kashmir

Capacity (MW) 1292 213 84


PPA duration 30 years (FY27) 25 years (FY35) 25 years (FY37)

Power Policy 1994 2002 2002



Furnace Oil plants make up majority of HUBC’s portfolio

04

AKD RESEARCH

About the sponsors—Mega Conglomerate: Mega Conglomerate (Private) Limited (MCPL)

operates under a holding company structure. The company was setup as a wholly owned

investment arm of Mega & Forbes Group of Companies (MFG). Largest investment on bal-

ance sheet is in the Hub Power Company Limited (Hubco). The company has two other

investments, 100% stakes in VMFG (Private) Limited (VMFG) and G4 Mega Pakistan

(Private) Limited (G4), through which MPCL has exposure in the consumer goods (Haleeb

Foods Limited - HFL) and real estate development (Imperial Developers and Builders Pri-

vate Limited - IDBL) sectors. The group led by Habibullah Khan owns 47% shares of Pioneer

Cement through Vision Holding Middle East Limited.

Events timeline since Jan’18

Source: Company Report & AKD Research

50

60

70

80

90

100

110

Jan-1

8

Feb-1

8

Mar-

18

Apr-

18

May-1

8

Jun-1

8

Jul-18

Aug-1

8

Sep-1

8

Oct-

18

Nov-1

8

Dec-1

8

Jan-1

9

Feb-1

9

Mar-

19

Apr-

19

May-1

9

Jun-1

9

Jul-19

Aug-1

9

Sep-1

9

HUBC decides to issue 12.1%

right

Financial close of 330MW

Thar Energy

Skipped quarterly payout

Due diligence of 37% stake in ThalNova

Energization of 1st unit of 2x660MW

plant

MoU with FWO Enjazat

(UAE)

Sponsor sells 17% stake at PKR106/sh

Financial close of 2x660MW

CPHGCL

CoD of 2x660MW

CPHGCL

Complete right sub-scription

Financial report reveal

D/A exceeding the Shariah compliance

criteria

1M 6M 12M CYTD

Absolute (%) 7.1 -3.7 -20.2 -14.7

Rel. Index (%) 5.9 13.9 3.0 -0.3

Absolute (PkR) 4.9 -2.9 -18.5 -12.6

Source: PSX & AKD Research

Price performance chart

05

Committee of Amin - Fauji

Foundation, 9%

Islamic Mutual Funds, 3%

Others, 58%

HUBC: Share Holding Pattern HUBC: Price vs. Volume

Source: CDC, PSX & AKD Research

FY18

55

60

65

70

75

80

85

90

95

100

0

2000

4000

6000

8000

10000

Se

p-1

8

Oct-

18

No

v-1

8

Dec-1

8

Jan

-19

Fe

b-1

9

Ma

r-1

9

Ap

r-19

Ma

y-1

9

Jun

-19

Jul-

19

Au

g-1

9

Se

p-1

9

Volume (In Thousand) HUBC (RHS)

Source: AKD Research

FY20 EPS Contribution by project

AKD RESEARCH

Dominating Pakistan’s Power space Amid a stream of new power plants, HUBC is expected to continue to dominate Pakistan’s power space, with 1,980+ MW of generation capacity addition to its portfolio over FY19-21F. HUBC’s 47.5% owned 2x660MW imported coal based power project (China Power Hub Generation Co. – CPHGC) has already commenced operations in Aug’19 (Jun’19 load factor of ~40%), while 60% owned 330MW Thar Energy Ltd (TEL) will commence opera-tions in FY21F. HUBC’s successful foray in coal power projects (CPHGC, TEL and SECMC - c. EPS contribution: PKR14.07/sh, 50% of FY22F EPS) is expected to translate into 3 year earnings CAGR of 42%. HUBC has also bought 38.3% stake in ThalNova power project in Mar’19, which is expected to achieve financial close by 1HFY20 (CoD: FY22). The project will add PkR1.2/sh to HUBC’s bottomline, assuming 100% debt financed equity invest-ment in the project. However, we await financial close of the project before incorporating the same in our estimates.

Riding the wave: With the demise of Furnace Oil based generation (down 60% YoY), coal and LNG based generation have come to the forefront, with coal power capacity additions to date making up 43% of total new capacities (8,600MW). Unlike other listed FO based power plants (NPL, NCPL and KAPCO), HUBC jumped on the bandwagon of cheaper fuel based power generation era, by entering into a joint venture agreement with China Power International Holding Ltd (CPIHL) in FY16 for constructing a 2x660MW imported coal fired power plant and an ancillary jetty (4.2MTPA coal handling capacity). The first 660MW unit of China Power Hub was synchronized with the National Grid in Dec’18 (load factor: 43% in Jun’19). Meanwhile, the second 660MW unit was synchronized with National Grid in May’19, with commercial operations in Aug’19. We have conservatively assumed 50% dis-patch and availability levels for 1,320MW in FY20. HUBC will start receiving dividends from its 47.5% owned venture from FY21 onwards, easing liquidity situation for the Power giant. CPHGC’s payouts (ROE) to HUBC is expected to contribute PKR3.91/7.15 per sh in FY20/21F. As per the JV agreement, the company had an option to increase its stake in the project to up to 47.5% 180 days before commercial operations. The company exercised the aforemen-tioned call option through 12.1% right issue at PKR50/sh (PKR7bn raised) in May’19.

Lion’s share of the pie: HUBC also holds 60/38% stakes in Thar Energy Ltd (TEL - 330MW) and ThalNova Power Ltd (TNPL - 330MW), respectively – both coal mine-mouth power plants, which are slated to commence operations in 2021. With power surplus situation on the horizon in FY16, the GoP decided not to approve tariffs for any more power plants based on imported fuel (NPL and KAPCO’s application for generation license for 330/660 MW coal based power plants were rejected). Furthermore, the GoP is also considering to reduce IRRs for any fresh applications for generation license by 1-4.5 ppt. Through buying a non-controlling stake in the mine-mouth ThalNova power plant in Mar’19, HUBC was able to avoid GoP restictions in further strengthening its standing in high yielding coal power projects in Pakistan (IRRs of 17/20% for imported/local coal power projects). While T&D losses will continue to choke the energy chain’s liquidity situation in absence of long-term solution, we find HUBC’s 26% share in the new wave of coal based plant expansions hard to ignore, more so since the local/imported coal power projects offer one of the most lucrative US$ hedged RoEs in the entire power space.


Timely expansion into coal power plants

New Projects China Hub Power Thar Energy Ltd ThalNova Power

Fuel Category Imported coal Local coal Local coal

Location Balochistan Sindh Sindh

Capacity (MW) 1320 330 330


PPA duration 30 years (FY49) 30 years (FY51) 30 years (FY51)


Stake (%) 47.5 60 38.3

ROE (%) 27 30 30

06

We have conservatively assumed 50%

dispatch and availability levels for

1,320MW in FY20. HUBC will start receiv-

ing dividends from its 47.5% owned ven-

ture from FY21 onwards, easing liquidity

situation for the Power giant. CPHGC’s

payouts (ROE) to HUBC is expected to con-

tribute PKR3.91/7.15 per sh in FY20/21F.

Source: NEPRA & AKD Research

Highest IRRs for coal power projects

CPHGC, 6.30

SECMC, 0.71

Hub, Narowal and Laraib, 8.97

20%

17% 17%

15% 15% 15%

14%

12%

13%

14%

15%

16%

17%

18%

19%

20%

Th

ar/

Local C

oa

l

Imp

ort

ed

Co

al

Hyd

ro

RL

NG

Lo

ca

l g

as

Baga

sse

So

lar/

Win

d

Fuel Current Proposed Change

Thar/Local Coal 20% 14.0% 6.0%

Imported Coal 17% 12.5% 4.5%

Hydro 17% 14.25-16% -

RLNG 15% 13.3% 1.8%

Local gas 15% 14.0% 1.0%

Bagasse 15% 14.0% 1.0%

Solar/Wind 14% 14.0% 0.0%


Proposed reduction in IRRs

Earnings to grow at a 3yr CAGR of 42%: The coal power projects with total net capacity of 1,980 MW will thus not only extend HUBC’s payout lifeline beyond PPA expiry of 1292MW Hub Base plant (FY27), but will also offer better returns than the existing FO based projects. The three coal power projects (CPHGC, TEL and SECMC) are expected to cumulatively con-tribute PKR14.07/sh to HUBC’s bottomline in FY22F. HUBC’s acquisition of 38.3% stake in the project will add PkR1.2/sh (12.5% of FY19 EPS) to HUBC’s bottomline, assuming 100% debt financed equity investment in the project. We await financial close of the ThalNova power project (expected in 1HFY20) before incorporating it in our estimates, while the con-struction on the project has already initiated in Mar’19. The hefty debt-financed equity con-tribution in coal power projects may however, limit dividends in the medium term. To note, HUBC missed payouts in FY19, in contrast to an average payout ratio of 70% over last 10 years (post CoDs of Narowal and 75% owned Laraib power plants).

AKD RESEARCH

China Power Hub Generation Company

Total capacity: 1,320 MW

Laraib Energy Ltd. Total Capacity: 84MW

Narowal Energy Ltd. Total capacity: 225 MW

Hub Power Plant Total capacity: 1292 MW

Geographical Locations

Thar Energy Ltd. Total capacity:

330 MW

New power projects to result in a 3 yr earnings CAGR of 42%


-10,000

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

FY18A FY19A FY20F FY21F FY22F FY23F FY24F FY25F FY26F FY27F

Base Plant, Narowal and Laraib China Hub Power Generation Co.

Thar Energy Ltd Sindh Engro Coal Mining Co.

(PkRmn)

07

AKD RESEARCH

Payouts to improve over medium term HUBC’s CAPEX requirements imply a financing gap of PKR7-8bn, post 12.1% right issue in Apr’19 and after taking complete drawdown of long term finance facility into account. We expect payouts to resume in 2HFY20, in the best case scenario, where elevated leverage levels - D/A at ~40% on average over FY19-21F - shall constrain payouts in the medium term. The payouts are however, expected to steadily increase as power plants move past their gestation stage. We foresee FY20/21/22F DPS of PKR2.0/8.0/11.0, based on improv-ing consolidated FCFE, implying D/Y of 2.7/11.1/15.3%, at last close vs. 10yr PIB rate of 12.1%.

CAPEX requirement indicates further debt financing: The total CAPEX requirement for the three coal power projects and SECMC amounts to ~PKR50bn - HUBC has financed the CAPEX through (i) entering into financing agreements of PkR26.5bn with a consortium of banks in Jun’17, (ii) withholding payouts of PKR10.8bn (assuming 100% payout) in FY19 and (iii) right issue. HUBC issued a 12.1% right (~140mn shares at a price of PkR50/sh), raising PKR7bn to meet 42% financing requirement for increasing its stake in China Hub Power Generation Company Ltd (CPHGC) in Apr’19. The company has also significantly increased its leverage over last two years (D/A: 40% in 9MFY19 vs. 30% on average in last 3 years), where HUBC also relies on working capital financing for its fuel needs due to liquidity issues. As of Mar’19, the company has cumulatively invested PKR27bn (approximately 55% of the total equity investment requirement). Incorporating complete debt drawdown of the fi-nancing facility (PKR6.5bn of financing facility remains un-utilized) and the recent right issue of PKR7bn in our estimates will still leave a gap of PKR7-8bn, as per our calculations.

Energy Sukuk II may be routed towards retiring payables: Reportedly, Energy Sukuk II (another PkR200bn) is expected in 2QFY20– however, the IMF’s restriction on issuing fresh sovereign guarantees may cause a delay. To recall, HUBC received PKR17.5bn, 8.75% of the total settlement amount from Energy Sukuk I in Mar’19, which was entirely used to retire payables towards PSO. While Sukuk II was initially planned to be launched in May’19, IMF restriction on fresh guarantees to remain within 2% of the national GDP in any fiscal year (0.4% of GDP required for Energy Sukuk II), GoP has been looking to retire sovereign guar-antees, which has caused a delay in the whole exercise. HUBC may likely get a sizeable por-tion of the upcoming settlement as compared to other IPPs. As opposed to the first tranche of clearance, we expect a higher amount i.e. ~15% of the upcoming cash injection, or PkR25-30bn to be routed towards the IPP, implying 50% of receivables settlement, as opposed to Dec’18 level. Materialization of cash injection would still be mostly prioritized towards retir-ing payables to PSO which stand at PKR65bn as of Mar’19, highest in the listed IPP space. Therefore, while cash injection may relief immediate liquidity pressure for the IPP, the ex-pected amount will not be sufficient to cushion payouts, in our view.


D/A may peak in FY19-20F

20%

25%

30%

35%

40%

45%

20,000

25,000

30,000

35,000

40,000

45,000

FY

17A

FY

18A

FY

19F

FY

20F

FY

21F

FY

22F

Short Term Debt D/A

08


CAPEX financing requirement imply further leverage

Project Details CPHGC TEL TNPL SECMC Total

Project Cost - (USD mn) 1,900 520 527 1,259 -

Project Cost - (PKR mn) 228,000 75,400 84,320 151,080 -

Equity Financing (PKR mn) 25% 25% 25% 25% -

HUBCO's stake 47.50% 60.00% 38.30% 8.00% -

Equity Contribution HUBCO (PKRmn) 27,075 11,310 8,074 3,022 49,480

Investments as per latest financials (PKR mn) 19,639 3,969 2,775 1,236 27,619

Investment as % of required CAPEX 73% 35% 34% 41% 56%

Equity Investment Remaining - A (PKR mn) - - - - 21,861

Financing facility available - B (PKR mn) - - - - 6,500

Right Issue (PKR mn) - - - - 7,000

Financing Gap - A-B-C (PKR mn) - - - - 8,361

PKR bn

Trade debt outstanding (Mar'19) 86

Total payable 65

Short term borrowing 40

Settlement amount - A 30

Payables retired - B* 30 Reduction in borrowing - C= A-B 0

As per March’19 accounts


AKD RESEARCH

Slow and steady wins the race: As per the management, HUBC may raise US$110mn through Commercial paper and Non-bank TFCs. HUBC’s CAPEX requirements thus imply: (i) further short term borrowings in 1HFY20, while (ii) payouts to resume only in 2HFY20, in the best case scenario. While earnings are expected to grow at a 3 year CAGR of 42%, the payout ratio is expected to remain at an average of 30% over FY20-22F, albeit increasing steadily, as the new coal power capacities progress beyond their gestation phase. To em-phasize, we foresee FY20/21/22F DPS of PKR2.0/8.0/11.0, based on improving consolidated FCFE, which imply D/Y of .2.7/11.1/15.3% at last close, as opposed to 10yr PIB rate of 12.01%.

Payout ratio to improve steadily... ...implying D/Y to surpass 10 year PIB rates

Source: Company Reports, SBP & AKD Research

0%

3%

6%

9%

12%

15%

18%

21%

24%

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

FY

19

FY

20F

FY

21F

FY

22F

FY

23F

FY

24F

FY

25F

10 yr PIB

rate 12.01%

09

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

0%

20%

40%

60%

80%

100%

120%

140%

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

FY

18

FY

19

FY

20F

FY

21F

FY

22F

FY

23F

Payout Ratio DPS (PkR/sh)

AKD RESEARCH

FO based generation demise


RLNG, 10%

FY18

RLNG, 23%

FY19

From IPP to IPWP? The company’s management is considering to convert its 1,292MW Hub Base plant into a non-recycled waste based desalination plant. Karachi’s non-recycled waste (13,240 TPD) could generate around 200 MW electricity which could be used to run desalination plants to produce 175-190 million gallons per day (MGD) of potable water (550 MGD of water shortage in Karachi). While non-recycled waste may utilize only one out of four 300MW units of the Base plant, a new water desalination plant of 200 MGD capacity would cost US$400mn (PKR62bn), where project financing appears to be a herculean task for HUBC at the moment, given its cash-stressed B/S. Assuming HUBC’s 50% stake in the US$400mn water desalination plant, with 25% RoE, it would translate into a positive EPS impact of PKR0.81/sh on its bottomline, assuming 100% debt-financed equity.

HUBC Base plant’s operations come to a halt: Pakistan’s power sector has witnessed ca-pacity additions of 8,600MW (60% of pre-expansion capacity) over FY17-19, leading to inev-itable replacement of the more expensive power generation source, Furnace oil. To empha-size, while power generation in FY19 increased 2% YoY to 140,708GWh, the share of FO based generation sliced to 8% vs. 19% in the same period last year. HUBC base plant (operating under 1994 power policy) amongst GENCOs and inefficient power plants have borne the major brunt of the FO based power generation demise. To note, HUBC base plant’s load factors declined by 42 ppt YoY in FY19 to 8% vs. peak levels of 72% in FY16. While less severely affected, Narowal has also operated at 34% utilization level in FY19, 30 ppt YoY lower as compared to same period last year. A delay in the financial close (Feb’19) and expected commissioning (Mar’21) of the Lahore to Matiari transmission line with a transmission capacity of 2,000MW has further kept the load factor from Hub Base plant below optimal level, since 1,980MW coal power plants have been added in last six months in South.

The inevitable capacity trap: Going forward, with Lahore-Matiari transmission line opera-tional, we expect HUBC’s base plant load factors to improve from current levels. However, the Base plant will still not operate at optimal levels. Notwithstanding low utilization levels, HUBC Base plant should continue to receive USD hedged capacity payments as guaranteed by its PPAs, on the back of plant availability. The long brewing capacity trap however, has surfaced as a potential risk to FO based IPP’s guaranteed returns. With PKR having shed 33% of its value since the long stable USD/PKR 105 levels in CY17, amid capacity additions, the capacity payments are likely to increase 57% YoY to PKR1,000bn (2% of GDP) in FY20F, a hefty but inevitable price for improved power availability. Amid this background, we can rule out coal conversion of existing Base plant, as it will just add to the power project cost and further inflate capacity payments while creating excess electricity, making the proposal economically infeasible. To note, HUBC submitted a plan to convert its Furnace Oil (FO) based power plant into coal powered plant in May’19. Converting the Base plant into water desalination plant appears to be a more viable option, in our view. Meanwhile, HUBC Base plant will continue to receive capacity payments.

10

FY19 FY18 YoY Change

HUBC base 8% 50% -42%

HUBC Narowal 34% 64% -30%

HUBC Laraib 47% 54% -8%

KAPCO 42% 63% -21%

NPL 39% 70% -31%

NCPL 35% 64% -30%

Decline in dispatch factors


AKD RESEARCH

Desalination plants – an opportunity under study: HUBC signed a Memorandum of Under-standing (MoU) with UAE based FWO Enjazat in May’18, to explore opportunities in water, energy and mining sectors. The company’s management is considering to convert its 1,292MW Hub Base plant into a non-recycled waste based desalination plant. Karachi’s non-recycled waste (13,240 TPD) could generate around 200 MW electricity which could be used to run desalination plants to produce 175-190 million gallons per day (MGD) of pota-ble water (550 MGD of water shortage in Karachi).

Given the available details, we expect only one of the four 300MW units of HUBC to be con-verted into non-recycled waste based desalination plant, while the remaining three are expected to continue FO based power generation. Firm details on the project could be ex-pected by FY20F end. In line with its long term goals, HUBC may also consider 200 MGD of new water desalination plant capacity from scratch, which would cost US$400mn (PKR62bn), reportedly, with a construction period of two years. Note that co-locating a de-salination plant with a power plant reduces project cost by 5-20%, as building a separate water intake and discharge structure can be avoided.

This aligns with the company’s long term goal of transforming into an Independent Power and Water Producer (IPWP). The project will likely be undertaken as a public private part-nership, with FWO Enjazat as a foreign partner. Assuming HUBC’s 50% stake in the US$400mn water desalination plant, with 25% RoE, it would translate into a positive EPS impact of PKR0.81/sh on its bottomline, assuming 100% debt-financed equity.

HUBC Base plant’s load factors may remain low Capacity trap to worsen liquidity woes

Source: NEPRA , PPIB & AKD Research

416

652

1,0091,085 1,073

1,286

0

200

400

600

800

1,000

1,200

1,400

FY

18

A

FY

19F

FY

20F

FY

21F

FY

22F

FY

23F

Capacity pmt (bn)

72%

65%

50%

8% 8% 8% 8%

62%

71%

65%

34% 35% 35% 35%

FY

16

FY

17

FY

18

FY

19

FY

20F

FY

21F

FY

22F

Hub Base Plant Narowal Plant

11

Valuation We have valued HUBC by discounting dividends over HUBC’s project life to arrive at Jun’20 TP of PKR140/sh, which implies an upside of 91% at last close (Buy). We have forecasted payouts on the basis of minimum of (i) HUBC’s consolidated free cash flow to equity and (ii) applying a 40% haircut to consolidated attributable NPAT, less profits from associates, plus dividends from associates (70/100% RoEs of China Power Hub Generation Company –CPHGC and Sindh Engro Coal Mining Company – SECMC, respectively). While we have re-mained conservative in our dividend forecasts, higher than assumed payout ratio from CPHGC, and a lower Rfr can be upsides to our valuation estimate.

Non-compliant – not for long: HUBC’s D/A surpassed Shariah compliance threshold of 37% as per 9MFY19 financial statements. Islamic funds hold 6% of the free-float of HUBC’s shares as of Jun’19 and an anticipated sell-off after a Shariah Compliance Review in Nov’19 has kept a cap on HUBC’s price performance in last 3M (10.08% correction), despite CoD of HUBC’s largest ever power plant – CPHGC -2x660MW in Aug’19. Meeting further CAPEX financing through shariah compliant methods (similar to PKR8.5bn raised in 3QFY19), and partial conversion of existing debt in Sukuks may potentially keep HUBC’s leverage levels compliant in upcoming review (Nov’19), catalyzing price performance. While project debt (75/25% debt/equity) may keep leverage levels elevated, simultaneous additions to fixed asset will stabilize D/A ratio.

Price performance post CoDs: Recall HUBC had previously outperformed KSE-100 by 15%on average in 12M post the expected CoD of its Narowal and Laraib power plants. It is also pertinent to note that, CPHGC is expected to add PKR6.16/sh to the bottomline in FY20F, 65% of FY19 EPS as opposed to PKR0.72/0.42sh impact, or 15/5% of previous year EPS con-tributed by Narowal/Laraib to HUBC’s bottomline in the financial years following their CoD.

Investment Perspective: We highlight HUBC’s unique exposure in Pakistan’s IPP space, which will not only survive the FO based generation phase-out, but its timely investments will add to the stream of US$ hedged returns. HUBC is trading at FY20F P/E of 4.5x and P/B of 1.1x, which are expected to compress to undemanding 2.7x and 0.7x in FY22F respective-ly, post CoD of all power projects. Meanwhile, steadily improving dividends will translate into D/Y of 2.8/11.1/15.3% in FY20-22F.

AKD RESEARCH

FY20F FY21F FY22F FY23F FY24F FY25F FY26F FY27F …. FY49F

NPAT attributable to owners - A (PKR mn) 16,331 26,310 34,456 45,436 51,234 54,754 60,752 67,567 39,666

EPS 12.59 20.28 26.56 35.03 39.50 42.21 46.83 52.09 30.58

Adjustments

Share of profits from associates- B (PKR mn) 9,101 14,083 15,277 16,517 17,923 19,438 21,072 22,836 22,467

Dividends from associaties- C (PKR mn) 43 8,626 8,862 9,110 9,432 9,764 10,108 10,463 17,676

Total income = A-B+C (PKR mn) 7,273 20,853 28,041 38,029 42,743 45,080 49,788 55,194 34,876

Payout Ratio 60% 60% 60% 60% 60% 60% 60% 60% 100%

Payout (PKR mn) 4,364 12,512 16,825 22,818 25,646 27,048 29,873 33,116 34,876

DPS (PKR) 3.36 9.65 12.97 17.59 19.77 20.85 23.03 25.53 26.89

FCFE/sh (PKR) 1.71 13.55 28.32 30.06 13.82 21.45 34.57 38.77 38.51

Dividends per Share 2.00 8.00 11.00 15.00 13.00 19.00 21.00 23.00 26.00

Source: AKD Research

Conservative approach for DDM based valuation

Valuation Model DDM

Risk Free Rate 12%

Market Risk Premium 6%

beta 0.85

Discount Factor 19%

TP 140

LDCP 73.21

Upside 91%

Rfr TP (PkR/sh)

14% 119

13% 129

12% 140

11% 152

10% 166

Valuation Assumptions Risk free rate Sensitivity

Absolute

After 3M 6M 12M

Narowal’s CoD 3.4% -9.6% -14.2%

Laraib’s CoD -15.8% -2.9% -3.1%

Price Performance

Relative

After 3M 6M 12M

Narowal’s CoD 1.2% -7.2% 3.9%

Laraib’s CoD -1.5% 10.1% 25.6% Source: PSX & AKD Research

Source: SBP & AKD Research

12

Risks to valuation 1. Sell-off by Islamic funds: HUBC’s D/A surpassed Shariah compliance level of 37% as per

9MFY19 financial statements, while we expect D/A to remain at elevated levels in FY20. We however highlight that if further debt issuance is through shariah compliant methods (similar to PKR8.5bn sukuk issuance in Apr’19), HUBC may soon come within the radar of Shariah compliant investors again.

2. IFRS 9 implementation: The SECP has delayed the implementation of IFRS 9 for pow-er supply chain companies till Jun’21. While Energy Sukuk II is expected to bring down the level of receivables for HUBC, provisioning for a one-off charge would still result in a negative impact on the IPP’s FY21F EPS, which we have not incorporated in our esti-mates.

3. Budgetary changes: To meet stringent fiscal deficit targets by IMF, Budget FY20 in-troduced an increase in withholding tax on dividends from IPPs double to 15%, which was later restored to previous rate of 7.5%. Given tax collection scenario in 2MFY19 and backlash from traders, any further increase in WHT on D/Y in FY21 budgets can shave off effective dividend yields for HUBC.

4. Circular debt build-up: While liquidity injections, subject to sovereign guarantees available, may keep the circular debt accretion at manageable levels in medium term, lack of long term solution could translate into cashflow constraints for the expanding IPP and hinder HUBC’s payout capability.

5. Delay in Lahore – Matiari transmission network: With 1,980MW of coal power plants added in last six months in South, a lack of transmission capacity in case of delay in Lahore to Matiari transmission line may pose challenges to offtake from Base plant, which in turn may keep HUBC’s capacity payments on a low priority for the GoP.

AKD RESEARCH

13

AKD RESEARCH

HUBC – Annual Financial Databank

Source: Company reports & AKD Research

+70.7% +29.7% EPS

Growth FY21F

+29.4%

14

(Year end Jun-30) FY18 FY19 FY20F FY21F FY22F

EPS 9.6 9.4 16.0 20.7 26.8

EPS Growth 3.45% -1.97% 70.67% 29.74% 29.42%

PER (x) 7.5 7.7 4.5 3.5 2.7

ROE 29.88% 19.27% 25.88% 26.89% 29.53%

ROA 6.27% 5.68% 7.28% 7.91% 10.06%

BVPS 30.09 47.72 64.32 79.79 98.48

P/B (x) 2.4 1.5 1.1 0.9 0.7

DPS 7.4 - 2.0 8.0 11.0

Dividend Yield 10.3% 0.0% 2.8% 11.1% 15.3%

Payout Ratio 77.4% 0.0% 12.5% 38.6% 41.0%

Sales Growth -1.2% -41.9% 90.5% 5.1% 15.9%

Net Margin 11.7% 20.5% 19.5% 23.9% 28.0%

NPAT Growth 3.4% -2.0% 70.7% 29.7% 29.4%

EBITDA Margin 23.5% 37.6% 36.3% 43.4% 35.5%

EBITDA Growth 51.3% 17.7% 3.0% 23.9% -1.0%

Current Ratio (x) 102.0% 109.4% 110.3% 108.1% 116.5%

Effective Tax Rate 4.0% 4.2% 0.8% 1.0% 1.0%

Income Statement

(PkR mn) FY18 FY19 FY20F FY21F FY22F

Total income 18,279 21,489 24,464 24,167 33,559

Admin expenses 1,525 1,606 1,596 1,725 1,732

Other operating income 219 527 510 1,345 2,975

Other operating expenses 110 128 0 0 0

Operating Profit/(Loss) 16,863 20,282 23,377 23,786 34,801

Finance cost 4,432 7,401 10,706 9,761 11,958

PBT 12,150 12,447 21,772 28,109 38,121

Taxation 486 517 181 279 392

PAT 11,665 11,930 21,591 27,830 37,729

NPAT 11,665 11,930 21,591 27,830 37,729

Balance Sheet (PkR mn) FY18 FY19F FY20F FY21F FY22F

Non Current Assets 64,156 107,450 148,036 188,391 192,466

Current Assets 121,849 102,580 148,612 163,455 182,471

Total Assets 186,006 210,031 296,649 351,846 374,937

Non Current Liabilities 27,522 54,401 78,520 97,132 90,607

Current Liabilities 119,449 93,725 134,695 151,209 156,587

Shareholders' Equity 39,034 61,905 83,434 103,505 127,743

Total Equity and Liabilities 186,006 210,031 296,649 351,846 374,937

Cash Flow Statement (PkR mn) FY18 FY19F FY20F FY21F FY22F

Cashflow from Oper. Activities 10,053 9,636 16,779 34,926 42,468

Cashflow from Inv. Activities -11,709 -53,865 -37,014 -43,650 -10,533

Cashflow from Fin. Activities -5,521 450 43,567 21,966 16,368

Net change in cash -1,206 -662 1,731 7,644 18,893

Beginning cash balance 3,860 2,654 1,992 3,723 11,367

Ending cash balance 2,654 1,992 3,723 11,367 30,260

EPS Growth FY20F

EPS Growth FY22F

AKD RESEARCH

HUBC – Quarterly Financial Databank

Source: Company reports & AKD Research 15

Valuation Multiples

(Year End Jun-30) 3QFY2018 4QFY2018 1QFY2019 2QFY2019 3QFY2019

EPS (PkR) 1.5 1.9 1.2 1.2 2.17

EPS growth 2.7% 21.8% -38.7% 2.9% 83.0%

PER (x) 11.9 9.7 15.9 15.4 8.4

ROE 41.6% 49.2% 28.0% 31.3% 50.2%

ROA 6.1% 7.1% 4.6% 4.8% 8.5%

BVS (PkR) 14.8 15.3 16.4 15.1 17.3

P/BVS (x) 4.9 4.8 4.5 4.8 4.2

Sales Growth -36.2% 39.8% -45.0% -22.5% 6.2%

NPAT Growth 2.7% 21.8% -38.7% 2.9% 83.0%

Gross Margin 18.3% 11.9% 22.5% 30.8% 39.6%

Operating Margin 17.0% 10.6% 20.8% 28.4% 37.6%

Net Margin 14.4% 12.5% 14.0% 18.6% 32.0%

Income Statement

(In PkRmn) 3QFY2018 4QFY2018 1QFY2019 2QFY2019 3QFY2019

Net Sales 13,891 19,422 10,690 8,282 8,799

COGS 11,343 17,102 8,282 5,734 5,318

Gross Profit 2,548 2,321 2,408 2,548 3,481

Operating Exp 186 256 179 194 174

Operating Profit 2,363 2,065 2,229 2,354 3,308

Other Income 208 1,200 11 155 924

Financial Charges 555 639 739 954 1,300

NPAT 2,000 2,436 1,493 1,537 2,812

Balance Sheet


Long Term Assets 30,916 36,156 36,662 39,174 50,387

Current Assets 100,066 100,462 93,639 89,503 82,022

Total Assets 130,981 136,617 130,301 128,677 132,409

Long Term Liabilities 7,334 12,662 13,225 15,239 20,924

Current Liabilities 104,403 104,128 95,758 93,825 89,062

Total Liabilities 111,737 116,790 108,983 109,063 109,986

Share Holders' Equity 19,244 19,827 21,318 19,613 22,423

Total Liabilities & Equity 130,981 136,617 130,301 128,677 132,409

Cash flow Statement


CF from operations 2,534 6,939 731 869 (647)

CF from investing activities (2,768) (7,305) (994) (3,854) (14,647)

CF from financing activities (4,874) (2,116) 479 (1,174) 4,367

Net chg. In cash & equiv. (5,108) (2,482) 216 (4,159) (10,927)

Cash & Equiv. At beg. of the year 3,961.8 4,102.0 2654.0 3,580.0 3,962.0

Cash & Equiv. At end of the period 4,102.0 2654.0 3580.0 3962.0 5,847.0

AKD RESEARCH

AKD Securities Limited 602, Continental Trade Centre, Clifton Block 8, Karachi, Pakistan. UAN: +92 111-253-111 FAX: +92(21) 3586-7992

Securities and Exchange Commission of Pakistan National Insurance Corporation Building,

Jinnah Avenue, Islamabad-44000, Pakistan.

[email protected]

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Investors should carefully read the definitions of all ratings used in each research report. In addition, research reports contain information carrying the analyst's view and investors should carefully read the entire research report and not infer its contents from the rating ascribed by the analyst. In any case, ratings or research should not be used or relied upon as investment advice. An investor's decision to buy, sell or hold a stock should depend on individual circumstances and other considerations. AKDS uses a three tier rating system: i) Buy, ii) Neutral and iii) Sell (new rating system effective Sep 10’18) with total returns (capital upside + dividend yield) benchmarked against the expected one year forward floating (variable) risk free rate (10yr PIB) plus risk premium. Valuation Methodology

To arrive at our period end target prices, AKDS uses different valuation techniques including:

Discounted Cash Flow (DCF, DDM)

Relative Valuation (P/E, P/B, P/S etc.)

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New Rating Definitions

Buy > 18% expected total return (Rf: 12% + Rp: 6%)

Neutral > 12% to < 19% expected total return

Sell < 12% expected total return (Rf: 12%)

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