AK ENERJI Turkey - Equity - Utilities

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1 AK ENERJI Turkey - Equity - Utilities Outperform AK ENERJI Current Price / Mcap: TL January / US$881mn January end TP / Mcap: TL4.60 / US$1,235mn Initiation of Coverage Price Performance (TL) Stock Market Data Bloomberg/Reuters: Relative Performance: 52 Week Range (TL): Market Cap (TLmn): AKENR Average Daily Vol (TLmn) 3 mth: 1 mth 3 mth 12mth -7% -9% -29% 1,278 Beta: 0.8 YTD TL Return: -6% Shares Outstanding (mn): AKENR.TI/AKENR.IS Free Float (%): 25.0 Foreign Ownership in Free Float (%): Shareholders: Akkok Group 37.5%, CEZ 37.5% The Company in Brief: Ak Enerji is the longest standing and the leading private electricity generation company in the Turkish electricity market with a total installed capacity of 659MW and a 1.2% market share in total production. CEZ, the Czech electricity giant, has held a 37.5% stake in the Company since Ak Enerji has a competitive advantage with its distribution arm, SEDAS, in which it has a 45% stake since February Financials and Ratios E 2011E 2012E Net Sales (TLmn) EBITDA (TLmn) Net Profit (TLmn) EBITDA Margin (%) 13.3% 6.6% 20.8% 25.1% P/E (x) 52.7 n.m EV/EBITDA (x) EV/Sales (x) EPS (TL) DPS (TL) Source: Garanti Securities estimates, Company data ISE A vertically integrated IPP... We initiate coverage of Ak Enerji with an Outperform recommendation and a 2011-end target share price of TL4.60, implying 35% upside, well above our estimate for the ISE100 index. We believe Ak Enerji s integrated structure and improving financials will capture investors attention in One of the leading IPPs with a distribution arm... Ak Enerji is one of the largest independent power producers (IPP) in the Turkish electricity market with an installed production capacity of 659MW, implying 5.6% of total IPP market and 1.3% of the whole market. In July 2008, Ak Enerji entered the distribution business in a consortium with CEZ through the acquisition of a 45% stake in SEDAS, the electricity distribution grid for the Sakarya region, for US$600mn. Ak Enerji thus also enjoys a competitive advantage with its distribution arm, SEDAS, which commands 6.8% of the total electricity distribution market in Turkey. Current shareholder structure creates synergies... Ak Enerji s parent, Akkok Group, creates synergies with its strategic partner CEZ, the largest corporation both in the Czech Republic and the 10 new EU member states. CEZ acquired a 37.5% stake in Ak Enerji for US$302mn in May 2009, implying total value of US$810mn before the US$210mn rights issue in April CEZ is vertically integrated in the Czech Republic from mining through generation to distribution and supply. Capacity expansion plans with high demand growth in the market... Ak Enerji aims to increase its current installed capacity of 659MW to 1,646MW by The management s ultimate target is to reach an installed capacity of 3,000MW by 2015 with a total investment budget of US$3bn. Meanwhile, upcoming privatization tenders for state owned power plants offer inorganic growth opportunities for the company. New hydropower generation plants to enhance profitability... In the second half of 2010, Ak Enerji added five HPPs to its portfolios with a total installed capacity of 286MW, extending its renewable portfolio to 301MW. Three other HPP plants, with a combined capacity of 87MW will be added in due course. We expect Ak Enerji s EBITDA margin to improve to 21% in 2011 and 25% in 2012 with a higher CUR and the inclusion of renewable energy plants. Research Contact: +90 (212) research@garanti.com.tr Sales Contact: +90 (212) icm@garanti.com.tr Please see the last page of this report for important disclosures. 1

2 INVESTMENT THEME Valuation We reinitiate coverage of Ak Enerji with an Outperform recommendation and a 2011-end target share price of TL4.60, implying 35% upside potential, well above our forecast for the ISE100 index. We believe Ak Enerji s integrated structure and improving financials will capture investor attention in Among the leading IPPs with a distribution arm Ak Enerji is one of the largest independent power producers (IPP) in the Turkish electricity market with an installed production capacity of 659MW, implying 5.6% of total IPP market and 1.3% of the whole market. In July 2008, Ak Enerji entered the distribution business in a consortium with CEZ through the acquisition of a 45% stake in SEDAS, the electricity distribution grid for the Sakarya region, for US$600mn. Ak Enerji thus also enjoys a competitive advantage with its distribution arm, SEDAS, which commands 6.8% of the total electricity distribution market in Turkey. Current shareholder structure creates synergies... Ak Enerji s parent Akkok Group benefits from synergies with its strategic partner, CEZ, the largest Czech corporation and the largest corporation among the 10 new EU member states. CEZ acquired a 37.5% stake in Ak Enerji for US$302mn (implying total value of US$810mn for Ak Enerji before the US$210mn rights issue in April 2010). CEZ is vertically integrated in the Czech Republic, with an array of operations ranging from mining to generation and distribution and supply. CEZ also has expertise in distribution and supply in Romania and Bulgaria, with know-how in lignite, coal and nuclear energy. Capacity expansion plans to meet expected high demand growth in the market... The company aims to increase its current installed capacity of 659MW to 1,646MW by The management s ultimate target is to reach an installed capacity of 3,000MW by 2015 with a total investment budget of US$3bn. Meanwhile, upcoming privatization tenders for state owned power plants offer inorganic growth opportunities for the company. New hydropower generation plants to enhance profitability. In the second half of 2010, Ak Enerji added five HPPs to its portfolio with a total installed capacity of 286MW, extending its renewable portfolio to 301MW. Three other HPP plants, with a combined capacity of 87MW will be added in due course. We expect Ak Enerji s EBITDA margin to improve to 20% in 2011 and 25% in 2012 with a higher CUR and the inclusion of renewable energy plants. Three other HPP plants with a combined capacity of 87MW will be injected in due course. We expect Ak Enerji s EBITDA margin to improve to 21% in 2011 and 25% in 2012 once the renewable energy plants come on stream. Risks... Political and economic instability, rapid changes in the exchange rates, regulatory changes, lower than expected electricity prices and delays in investments could all pose a risk to our valuation. 2

3 VALUATION We valued Ak Enerji using a sum of the parts methodology in which we analyse the generation and distribution businesses separately. We value Ak Enerji s electricity generation business through DCF analysis and the distribution business (AkCEZ) at the average multiples in the privatization tenders of distribution companies in Turkey. We arrived at a 2011-end fair value of US$1,235mn for Ak Enerji which implies 35% upside potential in TL terms. Ak Enerji Valuation Summary (US$mn) Target Value Stake Contribution Valuation Method Generation % 978 DCF Distribution- AkCEZ % 257 Avg. multiples in DisCo privatizations 2011-end Target 1,235 Target share price (TL) 4.60 Current share price (TL) 3.42 Upside (Downside) Potential 35% Source: Garanti Securities estimates Electricity Generation Business - DCF Analysis In our DCF analysis, we assumed a risk-free rate taking the 10-year Eurobond as a reference, while assuming a market risk premium of 5.5%. We also assumed a terminal growth rate of 0% while employing a Beta of 0.8. We assumed a 6% cost of debt after tax while the corporate tax rate over our forecast period remains constant at 20%. Accordingly, we assume a WACC around 7% in Note that we assumed a total net debt of TL641mn (US$470mn) which includes TL103mn that the company borrowed from Akkok Group as short term debt. 3

4 Main Assumptions 2010E 2011E 2012E 2013E 2014E 2015E Installed Capacity (MW) ,646 1,646 Electricity Sales (GWh) 2,520 3,084 3,283 3,514 9,065 9,065 Blended Electricity price TL/MWh Revenues (TLmn) ,630 1,711 Revenue Growth 24% 13% 13% 170% 5% EBITDA (TLmn) EBITDA Margin 6.4% 20.8% 25.1% 27.9% 25.6% 25.4% EBITDA growth 305% 36% 26% 147% 4% EBIT (TLmn) US$ based DCF Analysis EBITDA Taxes Capex Free Cash Flow WACC 7% 8% 8% 7% 7% PV of Cash Flows Terminal Growth 0% Total Present Value of Cash Flows -557 Present Value of Terminal Value 2,005 Net cash Position (3Q10) -470 Net Value 978 Source: Garanti Securities Estimates Electricity Distribution Business (SEDAS) SEDAS is owned by AkCEZ, in which Ak Enerji has a 45% stake. AkCEZ acquired SEDAS for US$600mn in February The multiples of the latest DisCo privatizations suggest a much higher valuation for the region. The average deal in all regions implied a valuation of US$128/MWh of consumption, versus the figure of US$71/MWh of consumption implied in the SEDAS privatization. Also, the average acquisition price of US$536 per subscriber for all regions exceeded the price of US$448 per subscriber for the privatization of the Sakarya region (SEDAS). Ak Enerji uses equity pick-up method for the consolidation of SEDAS in its financial statements. We therefore preferred to determine the fair value for SEDAS on an individual basis and add it to our valuation for Ak Enerji s generation business. We used the average deal multiples to value SEDAS, calculating a value of US$896mn. We included the US$325mn net debt of AkCEZ incurred by the SEDAS acquisition in our net value calculation for AkCEZ. We arrived at a net value of US$571mn for AkCEZ, and therefore a valuation of US$257mn for the 45% stake held by Ak Enerji in AkCEZ. Fair Value for AkCEZ Multiple Weight Value 128 US$/MWh 50% 1, x US$/subscriber 50% 718 SEDAS Value 896 Debt due to SEDAS acquisition (-) 325 Net Value of AkCEZ (US$mn) 571 Source: Garanti Securities estimates 4

5 FINANCIAL ANALYSIS AND ESTIMATES Ak Enerji currently has an operational capacity of 659MW in Turkey, which is projected to rise to 1,646MW by Management s ultimate target is to reach an installed capacity of 3,000MW by 2015 with a total investment budget of US$3bn. However, we only took account of the capacity increase to 1,646MW in our valuation. In May 2010, Ak Enerji acquired Ickale Enerji with a 160MW dammed hydro project license in Kemah. However, the project is at the beginning of the development stage, thus is not included in 2013 capacity target of 1,646MW. Ak Enerji Electricity Capacity and Sales Volume 9,600 9,065 9,065 8,000 6,400 4,800 3,200 1,600 2,520 3,084 3,283 3, ,646 1, E 2011E 2012E 2013E 2014E 2015E Capacity (MW) Production (GWh) Source: Ak Enerji, Garanti Securities estimates In 2009, Ak Enerji directed 78% of its electricity sales to the DUY market while the rest was sold to direct and indirect customers. In 2010, approximately 70% of sales were to indirect customers while DUY constituted 22% of total sales. We project slight changes between these segments in our projection period, where indirect sales constitute the majority of sales in the future. In 2010, DUY prices declined by 20% in 1H10 due to a wet season and recovered in summer with hot weather, positively impacting 3Q margins. However, prices declined again in 4Q with higher than average temperatures in winter. In 2011, we project a 10% YoY increase in DUY prices. In period, our electricity price increase assumption is 1pp above inflation, at around 5-6%. We applied 5-8% discount to prices for direct and indirect customers when compared to average DUY pricing of the Company as bilateral agreements will provide a discount to the customer in exchange for higher CUR. In addition, as set by the Regulator, sales prices to distribution companies cannot exceed the price established in the day ahead planning system. With the change in customer mix, our assumptions lead to an average 5% annual increase in blended prices for Ak Enerji in period. Electricity Generation Breakdown (%) DUY 22% 30% 30% 25% 25% 25% Direct customers 8% 10% 10% 15% 15% 15% Indirect customers 70% 60% 60% 60% 60% 60% Total 100% 100% 100% 100% 100% 100% AKENR Blended Electricity price TL/MWh Source: Garanti Securities Estimates 5

6 The Company guidance on the average CUR for HPP plants is 30-40%, and 30-35% for its wind farms. Meanwhile, the base load factor for NG fired power plants is 70-80%. Ak Enerji s main cost item is production costs, mostly natural gas, compromising around 85% of COGS. In our assumptions, we applied an average 3.5% rise in fuel cost assumptions period, slightly below inflation. While we expect share of fuel expenses to drop in the coming years with HPPs starting operations; in the meantime, with 900MW natural gas power plant coming into stream in period, we expect fuel costs stake in COGS to increase to around 85% of COGS in We believe opex/ sales ratio will decline from an expected 10% in 2010 to 5% in 2015, thanks to higher revenues. Accordingly, we project Ak Enerji s EBITDA margin to improve from an expected 6% in 2010 to 21% in 2011, and a gradual improvement in the margin will continue to 28% until With the natural gas plant with 900MW installed capacity becoming operational in , we project a decline in the EBITDA margin to 25% in Financial Debt In 2Q10, Ak Enerji increased its capital by 475% via rights issue for deleveraging. At the end of 3Q10, Ak Enerji reported a financial debt figure of TL861mn, of which TL382mn comprised from short term loans. Currency and Maturity Breakdown of Financial Debt Loans 19% $ Loans 55% Due to related parties 12% TL loans 14% (mn TL) Due until year years years years years over 5 years Total Source: Garanti Securities Estimates Meanwhile, at the end of 3Q10, Ak Enerji had a short FX position of TL577mn, comprised of US$332mn and 50mn. As the TL depreciated against the US$ (6%) and (4%) in 4Q10, we expect around TL30mn FX losses in 4Q, negatively impacting the bottom line. Yet in 2011, we project TL to appreciate and thus we project FX gains in We project TL37mn net financial income in 2011 vs. net financial expenses of TL19mn in

7 Capex To finance its projects, Ak Enerji uses a debt to equity ratio about 70/30%. We project a US1.2bn capex scheduled for period. Following 2013, we expect Ak Enerji s annual capex to decline to a stable US$40mn, which comprise only maintenance expenditures. Investments Project Developed Under Capacity MW Expected Date Feke 1 HPP Akkur* Himmetli HPP MEM* Gokkaya HPP MEM* Hatay NG PP Egemer* Kemah HPP Ickale 160 Development stage Total 1,147 Source: Ak Enerji, *SPV 4Q10 Expectations In 4Q10, we project Ak Enerji to report revenues, EBITDA and net loss of TL105mn, TL9mn and TL17mn, respectively. Reveneus will come down on a QoQ basis due to the decline in DUY prices while the bottom line will be on the red mostly due to FX losses with the depreciation of TL in 4Q. We expect a slight improvement in the EBITDA margin on a QoQ basis with renewables added to the portfolio. (mn TL) 1Q10 2Q10 3Q10 4Q10E 2010E Net Sales EBITDA Net Income/Loss

8 THE COMPANY Ak Enerji, the first autoproducer group in Turkey, was founded in 1989 to provide electricity and steam to Akkok Group companies. Akkok Group is a conglomerate operating in the textile, chemicals, real estate and energy sectors. The Group s total revenues reached US$2.2bn in The energy segment accounted for 22% of total Group revenues in 2009 while the chemicals and textile segments took 42% and 5% shares of total revenues, respectively. Besides Ak Enerji, other Akkok Group Companies trading on the ISE are: Aksa Akrilik (AKSA.IS, N/R), the world s largest producer of acrylic fibre. Ak-Al (AKAL.IS, N/R), a leading and long established manufacturing of textiles (fabric and yarn). Akmerkez (AKMGY), REIC, a globally acclaimed shopping centre. In 2008, Ak Enerji bid with the Czech energy giant, CEZ, in the tender for Sakarya Electricity Distribution (SEDAS) and won the tender with a winning bid of US$600mn. The acquisition of SEDAS, which commands 6.8% of the Turkish electricity distribution, provided a competitive advantage for Ak Enerji. In May 2009, CEZ acquired a 37.5% stake in Ak Enerji for US$302mn and became a controlling shareholder. The sale implies a total valuation of US$810mn for Ak Enerji. However, note that the Company increased its capital by US$210mn through a rigts issue in April CEZ Group is the largest corporation in the Czech Republic, and the largest corporation among 10 new EU member states. The Czech Ministry of Finance holds 63% of CEZ, a vertically integrated company in the Czech Republic with an array of operations ranging from mining to generation and from distribution and supply. CEZ has boasts experience of distribution and supply in Bulgaria and Romania. During its transformation into a larger energy conglomerate, Ak Enerji will benefit from the partnership with CEZ with its know-now in distribution, coal, lignite and nuclear power plants. Ak Enerji - Shareholder Structure (3Q10) Free Float, 25.3% CEZ, 37.5% Source: The Company Akkok Group, 37.5% 8

9 Ak Enerji - Operations and Investments Source: Ak Enerji Ak Enerji is one of the largest independent power producers (IPP) in the Turkish electricity market with an installed production capacity of 659MW, representing 5% of the total IPP market and 1% of the whole market. Ak Enerji aims to increase its capacity from the current 659MW installed capacity to 1,646MW by 2013, under its ongoing capacity expansion plans. The management s ultimate target is to reach an installed capacity of 3,000MW by Accordingly, Ak Enerji has announced its long term plan to invest US$3bn in Turkey to achieve this target by Upcoming privatization tenders for state owned power plants offer inorganic growth opportunities for the company. The company has excluded six power plants in its portfolio in an effort to establish higher efficiency and cost control in The natural gas powered plants in Yalova, with a total capacity of 69.9MW, were transferred to Aksa Akrilik Kimya Sanayi for TL12.6mn in April The company recently started operating three different hydropower plants with a combined installed capacity of 198MW in 4Q10, giving Ak Enerji a more balanced and diversified portfolio. The new hydropower power plants are expected to enhance the company s profitability in Current Power Plants Capacity (MW) Generation Type Expected Date Cerkezkoy 98 natural gas Bozuyuk 132 natural gas Kemalpasa 128 natural gas Ayyildiz 15 wind Akocak 81 hydro 3Q 2010 Bulam 7 hydro 3Q 2010 Uluabat 100 hydro 4Q 2010 Burc 28 hydro 4Q 2010 Feke II 70 hydro 4Q 2010 Current Capacity 659 Source: Ak Enerji 9

10 In March 2009, the Company took control of the Egemer Enerji Production Company, which is an SPV holding a license to develop a 900MW natural gas power plant in Hatay. Ak Enerji has secured financing for all projects except the NGPP project of Egemer. Financing for current projects has been secured with loans which has a maturity over 7 years terms. Ak Enerji s current installed operational electricity capacity of 659MW consists of natural gas, hydro and wind power plants. According to current investment plan, the company targets to have a capacity breakdown of 76% by natural gas, 23% by hydro and 1% by wind capacity by the year Breakdown of Ak Enerji s Generation Capacity Wind 2% Hydro 23% Wind 1% Hydro 43% Natural gas 55% Natural gas 76% E Source: Ak Enerji, Garanti Securities estimates All of Ak Enerji s renewable projects are eligible to benefit from the recently accepted Renewable Energy Law. The law sets guaranteed prices of 7.3 US$cents/kWh for wind and hydroelectric energy from licensed plants, while additional incentives for using local equipment may add 0.4US$cents/kWh to 2.4US$cents/kWh to the price for five years. We project Ak Enerji as well as other renewable electricity producers to prefer the DUY market and bilateral agreements where the pricing is more favourable. 10

11 Electricity Distribution Business: SEDAS In July 2008, AkCEZ, the SPV formed by Akkok (27.5%), Ak Enerji (45%) and CEZ (27.5%) won the Sakarya Electricity Distribution (SEDAS) tender with a US$600mn bid. The transaction price implies a valuation of US$448 per subscriber and US$71/MWh. Since the share transfer in February 2009, Ak Enerji has consolidated SEDAS through the equity-pick up method. AkCEZ paid US$300mn during the share transfer while the remaining US$300mn was paid in two equal US$150mn payments, one in January 2010 and the other in January AkCEZ has SEDAS transfer of operating rights for 30-years. AkCEZ Shareholder Structure Ak Enerji, 45.0% CEZ, 27.5% Akkok Group, 27.5% Source: The Company SEDAS serves the industrial heartlands of Bolu, Kocaeli, Sakarya and Düzce, reaching 1.3mn customers. SEDAS revenues reached approximately US$1bn in 2009, while distributing 8.4 billion kwh of electricity. SEDAS distribution margin is set as 2.23% for under the operating rights agreement by EMRA. Industrial sales accounted for 60% of SEDAS sales during The fact that industrial customers account for the majority of SEDAS sales is a disadvantage as these customers have the clout to negotiate for deeper discounts. We think that the industrial sales margin will remain at these levels going forward, while the margin on residential sales increases. SEDAS theft/lost ratio is less below 7%, one of the lowest in Turkey. At the end of 2010, EMRA announced the theft/loss Tatgets for the next 5 years. As the difference between the actual level and the target is recorded as profit, the higher the target the better for the distribution company. SEDAS theft/loss ratio for 2011 has been set at 7.66%. 11

12 Summary Financials Balance Sheet 2008/ / / E 2011E 2012E ASSETS CURRENT ASSETS Cash and Cash Equivalents Short-Term Trade Receivables Short-Term Other Receivables Inventories Other Current Assets LONG TERM ASSETS 623 1,158 1,513 1,480 1,984 2,362 TOTAL ASSETS 861 1,505 1,861 1,762 2,286 2,702 LIABILITIES SHORT TERM LIABILITIES Short-Term Financial Loans Short-Term Trade Payables Other Short-Term Loans Short-Term Provisions Other Short-Term Liabilities LONG TERM LIABILITIES ,255 Long-Term Financial Loans ,253 Other Long-Term Loans Provisions for Retirment Pay Deferred Tax Liabilities SHAREHOLDERS EQUITY TOTAL LIABILITIES & S.HOLDERS EQUITY 861 1,505 1,861 1,762 2,286 2,702 Net Debt ,170 1,505 Income Stat. 2008/ / / E 2011E 2012E Net Sales Cost Of Sales Gross Profit (Loss) Operating Expenses EBIT EBITDA Other Income/Exp. (net) Net Financial Exp./Inc Profit Before Tax Taxation on Continuing Operations Minority Interests Net Income (Loss) Gross Margin 16.4% 14.5% 10.4% 9.7% 21.8% 24.5% EBIT Margin 10.6% 7.2% n.m. n.m. 12.8% 16.1% EBITDA Margin 15.8% 13.3% 5.9% 6.6% 20.8% 25.1% Net Margin 14.7% 5.2% n.m. n.m. 19.1% 7.3% Source: Ak Enerji, Garanti Securities Estimates 12