ELECTRICITY SUPPLY: Sector Undermined by Regulatory Changes

03/22/2012
Regulatory tightening measures intensifying. Supply companies have not escaped the government’s demands for lower end-user tariffs with the next regulatory supply margin hike postponed until July 2012. In addition, practically all of their available extra income will be cut starting from 2012, resulting in a major loss of earnings.
 
Number of bad debtors a major problem. ‘Bad’ accounts receivable (cash that the supply companies will likely never receive) are a heavy burden on the companies’ balance sheets. We expect no change in the future unless the government steps in.
 
Continuation of coverage on Mosenergosbyt, cessation of coverage on the remaining supply companies. We continue our coverage of Mosenergosbyt. However, we have decided to drop coverage for all remaining companies for the following reasons: poor stock liquidity, lack of upside based on DCF models, deteriorating net margins and thus lower dividends in the future. Our DCF valuation results for Mosenergosbyt suggest a 12M target price of $0.0248 and potential upside of 37%. We believe it is now the only investable company in the supply sector.
 
Mosenergosbyt: big cash reserves, but high corporate governance risks. The company has $546mn in cash on its balance sheet (currently 6% more than its MktCap). However, we believe that InterRAO, as the controlling shareholder, poses serious corporate governance risks for Mosenergosbyt regarding the future fate of this cash.
 
Dividend opportunity still viable, but only for 2011. We estimated the potential dividends for seven selected supply companies. The companies that offer the highest dividend yields are Samaraenergo (43% for common shares and preferred), Chelyabinsk Supply Company (17% for common, 18% for prefs), and Mosenergosbyt (11%). However, due to regulatory tightening measures we expect a considerable reduction on the bottom line for all of the supply companies starting in 2012. Therefore, we believe that most suppliers will cease paying dividends until 2015.
 
M&A activity on the rise? We have analysed potential acquisition targets in the supply sector for major players in the utilities universe. The most likely buyers are RusHydro and Rosenergoatom, in our view, while the most probable sellers are Energostream and KES-Holding. We expect the deals to commence in 2012-13. If any buy-outs indeed occur, we think they would be taken marginally positive by the market.
 
InterRAO a major threat to the sector. Certain top government officials have proposed making InterRAO a federal supplier. The idea would be for the company to step into regions in which electricity suppliers had gone out of business. We believe that bankruptcy for most supply companies is just a matter of time. In fact, InterRAO has the means to push suppliers in that direction. Therefore, if the proposal is accepted by the government, we expect the supply sector to change dramatically. This further highlights persistently high corporate governance risks in the sector, the future of which hinges on government regulation and powerful, well-connected players.

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