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External broker reports(aggregated public sources)

Equity Bottom-Up

We update our stance on <a href="https://www.smartkarma.com/entities/25981" target="_blank" data-smartkarma-citation="entities:25981:1">K-Electric Ltd (KEL PA)</a> from “Under Review” to “Sell” post National Electric Power Regulatory Authority (NEPRA) tariff determination. We attribute our negative stance to lower then expected base tariff announcement by NEPRA, which is expected to hamper both profitability and cash flows of the company significantly. Weak profitability outlook could also impede prospects for future capital expenditures (capex).NEPRA increased base tariff marginally by 6% to Rs12.8/kWh, from previous Multi Year Tariff  (MYT) determination of Rs12.15/kWh announced in Mar’17. This tariff is 18% lower than the FY09-FY16 MYT of Rs15.6/kWh. Further, KEL had requested base tariff of Rs15.9/kWh.In addition, NEPRA has disallowed cost of recovery to be passed on to the consumer as had been the case in previous MYT (FY09-FY16), while allowing annual write-off cost of 1.69% of assessed sales revenue , which is on the lower side and is negative for KEL.Moreover, certain tariff adjustments can substantially erode KEL’s sizable “other income” which would also hamper earnings. KEL may not record Late Payment Surcharge (LPS) from defaulters as “other income” as it may need to do provisioning against these defaulters in its accounts. The company has to make large mandatory reduction in it’s service charge rate as per the new MYT. In addition, the authority has disallowed KEL to charge meter rent, further reducing other income. Given its strained cash flows, KEL is also less likely to earn interest income on financial assets.As per new MYT, KEL is required to carry out mandatory capex of Rs300bn during next 7 years (FY17-FY23). NEPRA has asked KEL to carry out this capex in generation, distribution and transmission infrastructure. We believe that lower than expected tariff could restrict KEL’s ability to carry out such significant capex and may further affect base tariff  and profitability in the mid term review.NEPRA has imposed a cost-plus-return tariff in the new MYT disallowing the company to benefit from efficiency gains achieved over the years, as was the case during the last MYT (FY09-FY06) which was performance based tariff structure. This will further restrict the bottom line of the company.Possible recourse measures are: 1) KEL requests federal govt. to make reconsideration request to NEPRA, 2) KEL goes to courts to readdress its concerns and 3) the federal govt. amends NEPRA Act where an appellate board reviews.<div class="content-highlight">We are re-instating the stock as “Sell” as the company will be hardly profitable with annual 3 year average earnings per share (EPS) coming to only Rs0.15 as per estimate. Given these expectations, KEL’s borrowing ability will be affected, making it more difficult for KEL to execute its capex plan.Key Risks; 1) large receivables at Rs93bn (making up ~27% of total balance sheet), 2) sizable legal liabilities to Sui Southern Gas Company (SSGC) and National Transmission and Distribution Company (NTDC), 3) KEL’s inability to meet efficiency, transmission &amp; distribution benchmarks set by NEPRA, 4) failure to improve recovery ratio, 5) shortfall in meeting the required mandatory capex, 6) regulatory risk and 7) legal risk in case KEL goes to courts.</div>

We update our stance on K-Electric Ltd (KEL PA) from “Under Review” to “Sell” post National Electric Power Regulatory Authority (NEPRA) tariff determination. We attribute our negative stance to lower then expected base tariff announcement by NEPRA, which is expected to hamper both profitability and cash flows of the company significantly. Weak profitability outlook could also impede prospects for future capital expenditures (capex).NEPRA increased base tariff marginally by 6% to Rs12.8/kWh, from previous Multi Year Tariff  (MYT) determination of Rs12.15/kWh announced in Mar’17. This tariff is 18% lower than the FY09-FY16 MYT of Rs15.6/kWh. Further, KEL had requested base tariff of Rs15.9/kWh.In addition, NEPRA has disallowed cost of recovery to be passed on to the consumer as had been the case in previous MYT (FY09-FY16), while allowing annual write-off cost of 1.69% of assessed sales revenue , which is on the lower side and is negative for KEL.Moreover, certain tariff adjustments can substantially erode KEL’s sizable “other income” which would also hamper earnings. KEL may not record Late Payment Surcharge (LPS) from defaulters as “other income” as it may need to do provisioning against these defaulters in its accounts. The company has to make large mandatory reduction in it’s service charge rate as per the new MYT. In addition, the authority has disallowed KEL to charge meter rent, further reducing other income. Given its strained cash flows, KEL is also less likely to earn interest income on financial assets.As per new MYT, KEL is required to carry out mandatory capex of Rs300bn during next 7 years (FY17-FY23). NEPRA has asked KEL to carry out this capex in generation, distribution and transmission infrastructure. We believe that lower than expected tariff could restrict KEL’s ability to carry out such significant capex and may further affect base tariff  and profitability in the mid term review.NEPRA has imposed a cost-plus-return tariff in the new MYT disallowing the company to benefit from efficiency gains achieved over the years, as was the case during the last MYT (FY09-FY06) which was performance based tariff structure. This will further restrict the bottom line of the company.Possible recourse measures are: 1) KEL requests federal govt. to make reconsideration request to NEPRA, 2) KEL goes to courts to readdress its concerns and 3) the federal govt. amends NEPRA Act where an appellate board reviews.We are re-instating the stock as “Sell” as the company will be hardly profitable with annual 3 year average earnings per share (EPS) coming to only Rs0.15 as per estimate. Given these expectations, KEL’s borrowing ability will be affected, making it more difficult for KEL to execute its capex plan.Key Risks; 1) large receivables at Rs93bn (making up ~27% of total balance sheet), 2) sizable legal liabilities to Sui Southern Gas Company (SSGC) and National Transmission and Distribution Company (NTDC), 3) KEL’s inability to meet efficiency, transmission &amp; distribution benchmarks set by NEPRA, 4) failure to improve recovery ratio, 5) shortfall in meeting the required mandatory capex, 6) regulatory risk and 7) legal risk in case KEL goes to courts.

K-Electric Ltd (KEL): Re-Instate with "Sell"