The principal activities of the company are to develop, own and maintain power stations. The company owns an oil-fired power station with an installed net capacity of 1,200 MW at Hub, and a 214 MW net capacity oil-fired power station in Narowal, Punjab. The company also has a 75 percent controlling interest in Laraib Energy Ltd, a subsidiary that is developing an 84 MW hydro-electric (hydel) power plant near Mangla Dam in Azad Kashmir. The project is required to achieve commercial operations by the middle of CY13. This will be Pakistan's first private sector hydropower project.
The company recently lost its largest international sponsor, International Power. The divestment by the foreign company negatively affected the share price performance of Hubco in early 2012. The company has paid dividends to shareholders twice a year for at least the past decade.
INDUSTRY OVERVIEW The electric power sector in Pakistan is primarily state-owned. It is governed under a regulatory regime which requires IPPs to sell electricity under long-term agreements to Wapda and NTDC. The tariff agreement is the key financial instrument determining IPPs income and profitability, and this tariff is determined by the regulatory authority Nepra. The combination of these two factors implies that the IPPs ability to convert fuel to energy at an efficiency level equal to or below the stipulated level is the sole controllable determinant of profitability for a company.
Since 1997, Pakistan's generation capacity has exceeded demand. However, the achievement of equilibrium in demand and supply has come due to production deficits. In this regard, the issues of circular debt (which amounts to Rs 400 billion in the energy industry, according to Foundation Securities Limited) and shortages in the gas supply have curtailed IPPs abilities to produce sufficiently. Simultaneously, demand has grown at faster rates than was anticipated in 1997, thus antagonising the existing shortage. Expansion into alternate energy sources has presented itself as a key opportunity for IPPs.
Performance Snapshot FY12 The two key highlights for Hubco in this fiscal year were the implementation of cost less transfer of risk of non-payment by power purchasers (Wapda and NTDC) to the fuel supplier, PSO, which has given the IPP the lowest risk profile in the industry; and the 51 percent increase in bottom-line, emanating primarily from a 42 percent increase in turnover - this was fuelled by-and-large by Narowal Plant seeing its first full year of production. Profitability was further augmented by gains in efficiency, higher generation bonuses, and the devaluation of the currency. The operational and maintenance regime of Hubco conforms to best international standards, and the company benefited greatly from the modernisation and maintenance of its plants along with the close supervision of operational risks.
Cost of sales increased by approximately 39 percent primarily due to the higher oil prices. It is important to note that augmented short-term borrowing requirements - financed through two issues of Sukuks during the year - as a result of delayed payments from Wapda and NTDC led to an increase of financing costs by 109.42 percent which constrained the aforementioned growth in net profits.
With a dividend yield of 14.32 percent and an increase in the return on equity from 18.38 percent in FY11 to 26.62 percent in FY12, shareholders were more than pleased. However, it is important to note that from a DuPont analysis perspective, the increase in operating margin only increased the return on assets by 23 basis points; the crucial driver of the increase in ROE was the increase in financial leverage from 4.95 to 6.75, an increase that poses a question to the financial risk profile of the company. With an interest coverage ratio of 2.16, though, the question is not an imminent challenge.
In terms of liquidity, the company saw a deterioration of ratios. Days in receivables increased from 226 to 248. The combined receivables from Wapda and NTDC totalled Rs 151 billion at 30 June, 2012 out of which Rs 130 billion were considered overdue. However, the current ratio remained at 1.04 while the acid test ratio improved from 0.99 to 1.02 primarily due to the increase in payables days from 214 to 232 which was possible through the transfer of risk to PSO.
Market Performance The divestment by foreign shareholders had a negative impact on Hubco's share price performance earlier this year. However, this is not expected to be sustained, and a six percent correction has already taken place. The company's growth in EPS has averaged 29.37 percent on annual basis since FY09, far exceeding that of peers. The price-to-book ratio has increased steadily from Rs 1.061 in FY09 to Rs 1.575 in FY12, thus showing a consistent net contribution to shareholder value, and this has been coupled with an average 14.25 percent dividend yield over the last four years.
In terms of price performance, the KSE-100 Index far outperformed Hubco, however with predictions by brokerage houses such as Elixir Securities that the fair value of the company is Rs 65/share (as compared to the year-end price of Rs 41.89), the full breadth of correction is likely to occur soon.
Performance over the Years Since FY09, sales have grown on an average annual rate of 28.27 percent, gross profits have increased by 36.92 percent, and net profits by 29.39 percent. Over the same time period, dividends have grown by 21.4 percent from Rs 3.35 in FY09 to Rs 6.00 in FY12. Market share, due to expanding capacities and watertight agreements with the Government of Pakistan, has grown from 8.72 percent in FY09 to 9.09 percent in FY12.
In terms of profitability, the high-water marks of FY10 have yet to be realised again. Return on Assets in FY10 were 4.53 percent compared to 3.94 percent in FY12. Net profit margin was 5.57 percent compared to 4.69 percent today. Most starkly, the working capital turnover was 196.07 times compared to 29.94 times in FY12. This largely explains the significant role of circular debt for the overall profitability and risk profile of any IPP in Pakistan.
In terms of leverage, the company's risk profile has increased from a leverage position of 3.05 in FY09 to 6.75 in FY12. The interest cover ratio has, correspondingly, reduced from 2.81 to 2.16 between FY09 and FY12. Over the four-year period, Hubco has increased its desirability to shareholders favouring inexpensive, high-yielding stocks. The Price-to-Earnings Ratio has decreased from Rs 8.28 to Rs 5.92 over the period where return on equity increased from 12.80 percent to 26.62 percent.
Future Outlook The key challenges to the sector remain the same - circular debt and gas shortages. The persistence of these issues will cause the current energy crisis to continue indefinitely thus harming economic development of the nation as a whole, and causing massive inconvenience to households that often face 8-10 hours' worth of loadshedding or more. If the current rate of expansion of IPPs does not continue, then the gap between demand and supply will likely widen.
For Hubco, the divestment by foreign investors may magnify the extent to which the company has faced the issue of circular debt hitherto. Since foreign players have been replaced by local ones, the government is under less stress regarding the debt to the company, and this may lead to more working capital issues despite the risk-transfer agreement with regards to PSO. On the whole, though, Elixir estimates Hubco's IRR to be 16 percent as compared to 11 percent for peers, and has therefore upgraded HUBC as the top pick in the IPP space.
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DuPont Analysis - 2012
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Return on Equity
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26.62%
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Return on Assets Financial Leverage Return on Equity
3.94% 6.75 26.62%
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Net Profit Margin Asset Turnover Financial Leverage Return on Equity
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4.69% 0.84 6.75 26.62%
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Tax Burden Interest Burden Operating Margin Asset Turnover Financial Leverage Return on Equity
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100.00% 53.62% 8.74% 0.84 6.75 26.62%
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