- Korea Electric Power is raising its tariffs by +5.6% this year, which could potentially increase fiscal 2022 operating income by as much as KRW3 trillion.
- South Korea wants hydrogen to be the main energy source for the country by 2050, and Korea Electric Power could potentially be involved in hydrogen production in the future.
- Korea Electric Power remains a Buy, with its shares trading at a fifth of book value.
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I maintain my Buy investment rating for Korea Electric Power Corporation (NYSE:KEP) [015760:KS]. My previous article for the company was published on October 18, 2021, where I discussed the potential for future tariff hikes.
I still view Korea Electric Power's shares as a Buy. The company's tariffs will be hiked by +5.6% this year, which will help the company to partially offset rising energy costs. Furthermore, Korea Electric Power could possibly be involved in hydrogen production in a big way going forward, and this might help in a positive re-rating of its valuations.
In my prior October 18, 2021 update on Korea Electric Power, I had noted that "tariff hikes under the new cost pass-through tariff system should continue after the March 2022 presidential elections", which I deemed as one of the "key re-rating catalysts" for the stock. I turned out to be right on the timing of the next tariff rate increase.
Local media Korea JoongAng Daily mentioned in a December 27, 2021 news article that South Korea's "utility bills are going up after the presidential election in March" and they "will be 5.6 percent higher" in 2022 versus 2021. Specifically, the +5.6% increase in Korea Electric Power's tariff rate is comprised of an increase in the Environmental Charge from KRW5.3 per kWh in 2021 to KRW7.3 per kWh starting in April 2022, and two hikes in the Base Fuel Cost (each amounting to KRW4.9 per kWh) in April 2022 and October 2022, respectively.
Key Components Of Korea Electric Power's New Cost Pass-through Tariff System
Source: Korea Electric Power's December 2021 Investor Presentation Slides Published On December 13, 2021
In terms of the potential financial impact of the upcoming tariff hike, sell-side analysts from Korean broker NH Investment & Securities are expecting a +KRW3 trillion increase in the company's FY 2022 operating income, according to a December 28, 2021 Seeking Alpha News article. This is significant, as the additional operating income contribution of approximately KRW3 trillion represents 73% of Korea Electric Power's FY 2020 operating profit which amounted to KRW4,086 billion, while the company suffered from an operating loss of -KRW1,130 billion in the first nine months of FY 2021.
I had highlighted in my previous article that "investors have been skeptical about the actual implementation of Korea Electric Power's new cost pass-through tariff system", considering that it "was not allowed to raise tariffs in Q3 2021 despite higher-than-expected fuel costs." As such, this tariff hike will help to ease investors' concerns that Korea Electric Power's cost pass-through tariff system will not be allowed to function properly as a result of populist pressures to keep utility costs low.
Hydrogen Economy Plans
South Korea has set a goal of becoming a "first mover in the hydrogen economy", according to a S&P Global article published on November 26, 2021, and Korea Electric Power could be one of the key beneficiaries of the country's "green ambitions." In the S&P Global article, it is specifically mentioned that South Korea aims to make hydrogen "the country's number one energy source by 2050", and this is aligned with its target of achieving "carbon neutrality" in the same year.
It is very likely that state-owned utility companies will be the ones which will get support from the Korean government to be involved in hydrogen production. On December 8, 2021, Argus Media reported that "state-controlled Kogas" is planning to "build a hydrogen production base in the country's southwest city of Gwangju." On its LinkedIn page, Kogas or Korea Gas Corporation describes itself as the "sole LNG (Liquefied Natural Gas) provider" in South Korea, which "was incorporated by the Korean government in 1983." There is a good chance that Korea Electric Power could follow in Kogas' footsteps.
According to the company's December 2021 investor presentation slides, Korea Electric Power is 51%-owned by the Korean government, and boasts a 64.9% share of the power generation market in the country. The company also has a monopoly over the power transmission and distribution market in South Korea. Earlier in October 2021, Korean media Business Korea noted in a news article that Korea Electric Power "was considering setting up a hydrogen production complex at the Bylong Valley in New South Wales, Australia."
An October 7, 2021 article published in The Korea Economic Daily mentioned that South Korea targets to "create 30 South Korea-based global hydrogen companies by 2030" and will offer support to these corporates in the form of "tax deductions" and "debt payment guarantees." There is a high probability that Korea Electric Power or its subsidiaries will be one of these 30 companies, given its status as a state-owned company and its market leadership in specific power segments in the country.
Being heavily involved in hydrogen production going forward will definitely be a key valuation re-rating catalyst of Korea Electric Power, as the market tends to assign a valuation premium to companies leveraged to the green energy theme.
Korea Electric Power trades at 0.21 times historical trailing P/B now, based on S&P Capital IQ's financial data. There are two key factors that have depressed Korea Electric Power's valuations.
Firstly, Korea Electric Power has been suffering from losses in 2021 as evidenced by its 9M 2021 operating loss of -KRW1,130 billion highlighted earlier, as it has not been able to pass on the increase in energy costs to consumers as a result of political pressures to keep utility costs low before the March 2022 South Korean presidential election. With recent news that Korea Electric Power will be able to implement tariff hikes after March 2022, the company's FY 2022 financial performance should turn out to be better than what sell-side analysts had been expecting previously.
Secondly, Korea Electric Power has been slow in pivoting towards renewables or green energy businesses, which caused it to lose favor with investors. With South Korea pushing hard to achieve carbon neutrality and make hydrogen a key energy source by 2050, there are new growth opportunities that could emerge for Korea Electric Power, such as hydrogen production.
In my opinion, an improvement in the company's profitability in FY 2022 as a result of the recently announced tariff hike and venturing into new business areas like hydrogen production could be the catalysts that will re-rate Korea Electric Power's shares. In consideration of these factors, I still rate Korea Electric Power as a Buy.
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This article was written by
The Value Pendulum is an Asian equity market specialist with over a decade of experience on both the buy and sell sides.
He is the author of the investing group Asia Value & Moat Stocks, providing ideas for value investors seeking investment opportunities listed in Asia, with a particular focus on the Hong Kong market. He hunts for deep value balance sheet bargains and wide moat stocks and provides a range of watch lists with monthly updates within his investing group.
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