Disclaimer: The article below is the work of a participant of Fundamentals of Capital Market training. Sarmaaya.pk holds no liability for the recommendation mentioned.

The energy and power distribution sector is one of the most important sectors in the Pakistan Stock Exchange (PSX), accounting for a significant share of the market capitalization and trading volume. The sector is dominated by K-Electric Limited (KEL), which is the only vertically integrated power utility in Pakistan with exclusive licensing rights for Karachi. In this detailed report we will look at the various aspects of the KEL stock on Pakistan Stock Exchange and determine whether its suitable for investment in short and long term.

In a Nutshell

• Analyst Background
• Macroeconomic Profile
• Company Profile
• Financial Analysis
• Business and Management Analysis
• Strength and Weakness
• Summary

Analyst Background:

Asim Mehmood has an MS. in Finance and he owns a coaching centre. He has no prior investing experience but after taking the Fundamentals of Capital Markets course by Ammar Yaseen, Asim is now confident about investing in the right companies backed by the knowledge and data analysis skills he gained through the course.

Macroeconomic Profile:

There are six main macroeconomic factors which effect on Pakistan’s economy. Out of six four factors (oil, interest rate, currency and inflation in Pakistan) are negative for Pakistan’s economy. This means that Pakistan is going through difficult situations. But 2024 will be the green year for Pakistan with better business confidence, and a better outlook for manufacturing, construction, and all allied services.

Following Six factors are described briefly:

OIL: Petrol prices in Pakistan are increasing because of increase in international oil prices such as 6.72% per barrel monthly increase in Arab Light price (source: oilprice.com) and also due to IMF policies for Pakistan. This will cause higher inflation specially hit Food sector and electricity charges. So, oil factor is NEGATIVE for Pakistan.

Interest Rates: The Central Bank of Pakistan has decided to keep its interest rate unchanged at 22% in July. This is due to nine-month Stand-By Arrangement (SBA) with the IMF. Due to SBA program we see a very strong performance of KSE-100 Index in July surging by 15.9%. But interest rate is still high and it is NEGATIVE for Pakistan.

Currency Valuation: According to State Bank of Pakistan report REER is at 91.58 (Jul-23), and currently USD/PKR currency conversion rate is 296.22 which means PKR depreciates very badly. This is NEGATIVE for Pakistan. It may be appreciate in near future if some good news arrive from IMF.

Current Account: Cumulatively, the current account deficit for FY23 clocked in at USD 2.6bn as compared to USD 17.5bn during FY22, reflecting a sharp reduction of 85% owing to imposition of import restrictions and economic slowdown during FY23. On monthly basis, current account surplus (CAS) was recorded in Jun-23 at USD 334mn as compared to USD220mn in May-23 (source: UBL FMR Jul-23). This is POSITIVE for Pakistan.

Fiscal Account: On the fiscal front, Federal Board of Revenue (FBR) provisionally collected PKR 538 billion during Jul-23 against the assigned monthly target of PKR 534 billion, while PKR 458 billion were collected in Jul-22, reflecting growth of 16.6% Y/Y. So, this is a positive start for financial year 2023-24. However, amid continuing economic slowdown and import compression, we think it will be very difficult to achieve full year tax collection target of PKR 9,400 billion (source: UBL FMR Jul-23). So, currently this is POSITIVE for Pakistan.

Inflation: In July, headline inflation in Pakistan rose by 28.3% Y/Y and 3.5% M/M and it will rise further in next coming months. The monthly inflation was mainly driven by higher oil prices, higher food prices, quarterly revision in house rent and higher electricity charges. This is NEGATIVE for Pakistan.

Company Profile:

K-Electric (KE) energizing Karachi for over one hundred years. Through a network spanning across 6,500 square kilometres, KE supplies power to all residential, commercial, industrial and agricultural areas that fall under the city’s ambit and beyond, serving over 3.4 million customers across Karachi, Dhabeji and Gharo in Sindh, and Uthal, Vinder and Bela in Balochistan. KE is the only vertically-integrated power utility in Pakistan, which means the organisation manages all three key areas – Generation, Transmission and Distribution – of producing and delivering energy to consumers.

KES Power Limited is the majority shareholder of KE. It is a consortium of investors including Al-Jomaih Power Limited of Saudi Arabia, National Industries Group of Kuwait and Infrastructure & Growth Capital Fund (IGCF).

The share price of the Company is PKR 2.18 as of 18th August 2023.

Financial Analysis

Growth Factors:

All growth factors except revenue CAGR portray a bad image of a company. Although sales are increasing about 18% from last five years but operating profit and net income CAGR are constantly decreasing. EPS is also decreasing (0.31 in FY22 against 0.43 in FY21). This is due to massive increase in electricity cost, fuel and oil cost and operating expenses.

Stability Factors:

Out of 12, only 1 factor (Net Fixed Assets Turnover) is in the GOOD category. The company's operating profit and net profit margin is declining for the last five years due to low operating and net income. Due to these low margins company is suffering to cover its operating expenses so the interest coverage ratio is also in a BAD category. To cover these expenses and liabilities, the company goes for debt financing and the company's debts (186.51 B in 2017 and 772.97 B in 2022) are increasing every year. The company cannot be able to maintain its cash because its cumulative cash flow from operations is less than cumulative profit after taxes.

Overall management is unable to control its expenses and cash flows. So, margins are very low and it's a Red Flag for investors.

Financial Analysis

Valuation Factors:

PE Ratio: Price to Earning ratio was 9.81% in 2022. Company is undervalue and at a good price. It is in the GOOD category.

Earning Yield: company’s earning yield was 10% in 2022. Spread is -4% so it is considered BAD.

PEG ratio: PEG ratio in 2022 was 0.91. So it is in GOOD category.

PB Ratio: Price to book value was 0.33. So it is in GOOD category.

PS Ratio: Price to Sale ratio was 0.16 in 2022. So it is in GOOD category.

Graham Value: 3.28 in 2022. It is also in GOOD category.

Dividend Yield %: The Company has not paid a dividend since 2017.

EV-to-EBITDA EV/EBITDA: EV/EBITDA was 20.63 in 2022. So, it is in BAD category.

GOOD = 5 BAD = 3

OVERALL THE COMPANY IS UNDERVALUED AND AVAILABLE AT GOOD PRICE.

Business and Management Analysis

Business Factors:

During the year, despite various challenges including macro-economic environment, the Company invested around PKR 62.8 billion across the power value chain and continued to show positive growth in key operational indicators with reduction of T&D losses from 17.5% to 15.3% and increase in unit sent out by 1.6%. This improved performance was partly set-off due to negative impact of additional PKR 9.5 billion recorded this year on account of Mid Term Review (MTR) decision. Driven by these operational improvements, the Company’s gross profit increased by 22% as compared to last year.

Further, profit before tax of the Company witnessed a decline of around 63% as compared to last year mainly due to increase in finance cost by 36%. This was mainly on account of increase in effective rate of borrowing and higher levels of borrowing as compared to last year. Decrease in profit before tax was partially off-setted by recognition of deferred tax income on unrealised tax losses, resultantly the Company’s net profit decreased by 29% as compared to last year.

Cash conversion cycle is in GOOD category because it is a Power generation and Distribution company, so it collect cash in the form of bills on timely basis from its consumers.

PRODUCTION AND SALES:

Production of electricity decreased and sales increased. This means sales are increasing due to an increase in electricity prices. The main reason for this increase is

• Purchase of electricity and consumption of fuel and oil
• Operating & Maintenance expenses
• Financial charges

CASH FLOW STATEMENT:

Decline in profit before tax to PKR 5.6 billion along with increase in working capital owing to accumulation of fuel cost adjustment translated into negative cashflows from operating activities of PKR 26.9 billion for FY22 with cashflows from operating activities to revenue of negative 5% as compared to positive 13% last year. These negative operating cashflows coupled with investments across the value chain were managed through cash inflows from financing activities which are on the increasing trend over the years due to additional/increased utilisation of various long-term and short-term borrowing facilities to fund the investments and growing working capital requirements of the Company; owing to accumulation of receivables from Federal and Provincial government entities.

Management Factors:

The Company has not paid a dividend since 2017.

Strength and Weakness

Strengths:

• Entrenched service provision to 3.4 million customers.
• Operational Transformation and strategic expertise
• Adequate network capacity to serve future growth in power demand
• Agile and competitive workforce as a result of continuous in-house learning and development opportunities.
• Economies of scale

Weaknesses:

• High cost of power due to non-provision of gas by SSGC.
• Interdependence on external stakeholders for execution of planned initiatives and operational performance.
• Illegal encroachments / hook connections impede maintenance and cause safety hazards.
• Low renewable footprint.
• Uncertain landscape leads to difficulty in securing financing.

Summary

Pakistan is in the RED zone, and the power sector performs well in this zone. But K-electric is going through tough times. Although sales are increasing, the following are reasons due to which K-Electric cannot perform:

• Circular debt in Pakistan and non-paying consumers causing cash flows constraints
• Volatile gas markets leading towards expensive fuel mix given KE’s heavy reliance on RLNG due to non-provision of indigenous gas by SSGC
• Market share capture with the advent of open market regime
• Uncertainty in supply from National Grid due to dependence on approvals from external stakeholders consequentially impacting demand-supply gap
• Unplanned development in the city and lack of urban development protocols

RECOMMENDATION:

DON’T BUY.