In this note we initiate coverage of Federal Grid Company (FSK) with a 12M TP of $0.0145 (47% potential upside, WACC of 13.4%), and a BUY rating. We believe the company demonstrated satisfactory performance under RAB in 2010, earning an effective rate of return on RAB of 3% (vs the regulatory rate of 4%). We have not identified any significant problems in regulation of FSK so far, but we see federal government intervention as a key risk. In this regard, to stay on the conservative side, we incorporated government tightening plans by explicitly capping transmission tariff growth at 10% in the longer term. Since the state does not intend to give up control of FSK anytime soon, corporate governance will remain an issue and the planned privatisation of a minority stake is not a driver, but rather poses stock overhang risk. Overall we believe FSK is generally lower risk than MRSKs, but lacks strong triggers.
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