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Power Up On Electricity Generating Public Company Ltd.(EGCO:TH; EYGPF:OTC US)

By Marc Djandji, CFA

The Electricity Generating Public Company Ltd.(EGCO:TH; EYGPF:OTC US) is the first independent power producer in Thailand registered on May 12, 1992 by the Electricity Generating Authority of Thailand ("EGAT"). The incorporation was part of the Thai government's privatisation initiatives to allow private sector involvement in the development of power projects, and generating electricity power at competitive rates to households and businesses. On March 23, 1994, EGCO was transformed into a public corporation and was listed on the Stock Exchange of Thailand ("SET") on January 16, 1995.

As EGCO is structured as a holding company, its main source of revenue comes from dividend income from subsidiaries and share of profits from joint ventures (JVs). These are located in both Thailand and the Asia-Pacific region, with the majority set up across the Southeast Asia region. EGCO Group companies either operate in the power sector with long-term Power Purchase Agreements ("PPA") or conduct other related business.

We believe that the Company has tremendous potential, particularly in its gradual shift towards its overseas expansion within the Asia-Pacific region. The focus is on the upcoming Boco Rock Wind Farm in New South Wales, Australia, scheduled for completion in February 2015. Also other domestic developments, are important namely the renewable energy sectors which is poised to grow in the ASEAN region, given the amount of support provided through government subsidies, and productivity incentives.

Value proposition

1) By the end of June 30, 2013 (2Q13), net profit before foreign exchange gains, excluding the one-time gain on combination recorded during 2Q12 rose to THB2,041 million. This is approximately a 14.0% increase from THB1,760 million during the comparable quarter last year. Power generation, the mainstay of the Group's overall business, rose from THB1,714 million during 2Q12 to approximately THB1,984 million, or approximately 15.8% increase. During 2Q12, EGCO recorded gains from fair value adjustment from Quezon business acquisition worth THB4,310 million, which makes the net profits before FX approximately THB6,100 million. Earnings per share as of three months ending 2Q13 on a pro forma earnings basis came in at THB3.46 per share, versus pro forma THB4.55 per share in the last comparable year on 526.0 million diluted shares for both quarters.

Some of the key drivers for the Group during the quarter came from revenue gains from its subsidiaries including contributions from BLCP Power Limited ("BLCP") totalling approximately THB280.0 million in operating profits, the top earnings performer. As of ending FY2012, EGCO owns 50.0% of BLCP which owns an IPP coal-fired power plant located in Rayong province. It is a 1,434-MW power plant consisting of two identical 717-MW pulverised coal-fired power units using high quality bituminous imported from Australia. They acts as a primary source of fuel power and sell all electricity to EGAT (Electricity Generating Authority of Thailand) under the 25-year PPA. The long-term nature of the agreement provides a steady source of business, and income.

During 2Q13, the Company divested 40.0% of its stake in Philippines-based Conal Holding Corporation (Conal) through the sale of its share stake in Conal. As of 2Q13, Conal holds the shares in Alto Power Management Corporation, a management company with Southern Philippines Power Corporation, a 55.0 MW diesel power plant; and Western Mindanao Power Plant Corporation, a 110.0 MW diesel power plant.

2) The share price remains steady at between THB167.00 to THB123.50 per share based on the 52-week high/low quote. It has not moved significantly beyond THB127.00 per share for the past few months from August to October 2013 despite the various generally positive management outlooks and development plans. This could be seen as a relative stable stock for risk averse investors, and a dividend 'play' as well given that its historical dividend yield rate has been approximately 3.0% to 4.0% annually.

3) Gearing, measured as net debt to total equity (Total interest-bearing debt less cash divided by total equity) remains low at between 0.1 times to 0.5 times. This provides significant leg room for capital expansions through new electrical grid expansions, acquisitions, etc. without being constrained by negative debt covenants.

4) Return on equity (ROE) has increased from 9.0% during FY2011 to 17.4% as of FY2012, approximately a two-fold increase. Return on invested capital (NASDAQ:ROIC) has also increased approximately eight-folds from 1.4% during FY2011 to 8.4% as of FY2012. However, during FY2012, results were skewed by the approximately THB4.3 million of one-time accounting gain. Excluding the gain, normalised ROE is on par with FY2011 at approximately 9.0%. Normalised ROIC is approximately 2.6%.

5) On the valuation front, using information obtained from Thomson Reuters, historical P/E (ttm) is approximately 9.3 times and dividend yield is approximately 3.5%. Based on the historical P/E terms, the stock looks relatively undervalued when compared to the average market P/E of around 11.0 to 12.0 times.

6) Based on information obtained from the Company's website, management as of 2Q13 ending June 30, 2013, announced plans to expand from its current contracted capacity of 4,510.32 MWe, to 6,264.50 MWe over the next few quarters. This will be equivalent to an approximately 38.9% increase. Based on the excerpts from the 2Q13 filings, the expected increase in contracted capacity is coming from EGCO Group's current portfolio. This has 5 under construction power plants, 3 under development projects, and 1 potential project, totalling approximately 1,754.18 MWe in contracted capacity.

7) The Company currently has 3 local new power plant projects under construction, and 1 overseas plant expansion project. The domestic projects include TP Cogeneration Project (TP Cogen) and SK Cogneneration Project (SK Cogen) located in the Ratchaburi Province, TJ Cogeneration Project (TJ Cogen), and one overseas project located in Quezon, Philippines, which is a coal fire power plant.

The company is geared towards overseas expansion. There's an approximately two-fold increase in earnings derived from overseas, which was driven by its share acquisition of Quezon Power Plant in the Philippines and the investment in an operating coal mine in Indonesia. We believe that in the long-run, the gradual shift towards overseas expansion will provide additional diversification benefits to the overall Company's business.

Group structure as of 2Q13

Electricity Generating Public Company Ltd.

Source: Company data

Based on the above illustration on the group structure, the Company receives support from various local and overseas investors, including one of the most prominent ones such as Tokyo Electric Power (TEPDIA or Tepco). Although, Tepco is currently embroiled in its domestic nuclear disaster settlement with the local government authorities, an investment from a relatively well-known Japanese electric grid producer could provide some added benefits. Primarily through potential sharing of nuclear energy technology, and other knowledge transfers that could be used for the latest electric power generation technologies.

Group's largest shareholders as of FY2012

Based on the chart illustration, the Company's largest shareholder is Electrical Generating Authority of Thailand (EGAT), which was once it's parent owner before the Company had a spin off in 1992, and subsequently listed in 1994. With a substantial stake of approximately 25.4%, it provides some assurance to investors that despite the spinoff exercise, its former parent owner remains confident in the Company's overall direction and strategy through such a sizeable stake in the Company.

Valuation analysis

Based on the relatively stable record of paying out dividends at a consistent rate to shareholders, we decided to use a dividend discount model (NYSEARCA:DDM) framework to conduct a valuation analysis on EGCO Group. Using the quote details obtained from Thomson Reuters, based on a 12-month dividend per share of THB8.25 per share, and a 5-year dividend growth rate of 2.2%, we decided to use a two-step DDM model. This starts from 8.5% growth rate in 2014, peaks at 13.0% growth rate in 2016, followed by a terminal growth rate of 2.0% in 2019.

Based on historical electrical power grid expansion growth rate of 8.0-9.0% per year we derived our 12-month forward price target of THB128.17 per share. Based on the current price as of October 18, 2013 of THB124.00 per share, this represents a potential increase of approximately 3.2% in the next 12 months. This is barring any idiosyncratic or unforeseen events, including tighter price caps on utility rates charged to households and businesses, regulations, disasters both natural and man-made, etc.

The current stock price is hovering around THB124.00 since the month of September 2013. In the earnings announcement during August 2013, the price last stood at approximately THB128.00 to THB130.00. Given the low volatility of the stock price since September 2013, we believe that many potential investors are not aware of the relatively significant growth plans which management has put out during its 2Q13 earnings release and subsequent investor presentation. We believe that at the price of THB124.00 per share, the stock price has room to increase further.

A particular standout from the relative valuation analysis comes from the historical Enterprise value (NYSE:EV), measured as total market capitalisation, add total interest-bearing debt, less cash and cash equivalents. This increased by approximately 111.2% on a year-over-year (yoy) basis during FY2012 and FY2011, as compared to the historical range of approximately 0.0% to 21.0%. This is quite a significant increment based on a single year during FY2012. However, we caution investors not to be too enthusiastic in reacting to this statistic, as several factors not essentially relating to the stock's overall fundamentals could be in play. However, if the Company continues with the trend of triple digit increases in its EV growth going forward, investors might want to keep a close watch on the potential upside. However, at this time, it is advisable that investors continue to monitor the stock's fundamentals, together with other factors in determining their investment plans.

Based on the information obtained from Thomson Reuters, the Company looks relatively undervalued when comparing it with its peers using ROE (%), and price-to-book (NYSE:PB) at 17.5% and 0.97 times. The sector median average is approximately 15.48% and 1.64 times, respectively. Its fellow peer member, Rojana Industrial Park has the highest metrics based on both readings, which is approximately 21.32% for ROE and 1.77 times for price-to-book (PB). It could an indication of some potential value in EGCO based on the peer comparison on a relative basis. (All figures are highlighted in bold on the chart illustration).

Potential risks that might impact our 12-month forward price target

Natural and man-made disasters

The Company has several electric power grid, and coal mining plants located in several 'hot' spots in Indonesia and Philippines, which have been known for earthquakes, typhoons in the case of Philippines, tsunamis, etc. If such natural disasters strike on several of the Company's facilities at a given moment of time, this might result in major disruptions and damages incurred if repairs are not made in a timely fashion to restore the services. Management is aware of such issues, and have since came up with a comprehensive plan that seeks to address them, including the use of backup generators, constant training, preparedness among staff members, and other contingency plans that will hopefully mitigate the severity of the damages incurred.

Other man-made disasters could be terrorist strikes, political unrest, which in some cases, are uncontrollable. However, management has already put in place stringent surveillance systems, constantly working with the relevant government and law enforcement officials. These ensure that their facilities are not vulnerable to such man-made disasters, and management believes in protecting the social and environmental safety of its communities where most of its facilities are currently operating in.

Occupational and environmental risks

Potential occupational and environmental risks include the potential risks associated with the operations of its electric power facilities, including contamination fears, safety codes of conduct not being properly observed, etc. Management has taken steps to ensure such risks are mitigated through mandatory regular health screening requirements for its employees, and regular first-aid safety sessions to all employees to ensure they are properly equipped with the skills needed to protect themselves, and others.

Management has also taken steps to be actively engaged with the community and the public. Regular educational plant visits and allowing members of the surrounding communities in which they operate to be educated on the Company's operations have been planned. Through such constant engagement, the Company hopes to achieve public support in their business activities, and in the process help educate the community. The Company is also active in raising environmental awareness through talks, participating in environmental sustainability projects, etc.

Foreign exchange risks

The Company's main form of currency used in the conduct of their business activities is the Thai Baht (THB). The Company is also currently dealing with three main foreign currencies including the Australian Dollar (NYSEARCA:AUD), the US Dollar (NYSEARCA:USD), and the Japanese Yen (JPY). As of 2Q13, total debt outstanding stood at THB39,340.0 million, with the largest foreign currency exposure to the US Dollar at USD 750.0M, followed by Japanese Yen at JPY 314.0M, and the Aussie Dollar at AUD 44.0M.

Management is actively engaged in hedging its currency exposure by ensuring that at no one point in time, the size of its foreign currency exposure is geared towards a particular type of currency. However, due to the systematic nature and volatilities in the foreign exchange market, the Company continues to be vulnerable to swings in the forex market. Together with other potential credit events, these can be seen as disadvantageous to the overall Company's fundamentals and prospects.

Disclosure: I am long OTC:EGCO.

Additional disclosure: EGCO:TH; EYGPF:OTC US