Pearl Securities Limited – Power in Focus

Karachi, January 08, 2015 (PPI-OT): Sitara Energy Limited – Tend to benefit from lower cost!

Synopsis

Thermal power companies, particularly oil based, stand to benefit from significant decline in international oil rates and consequent reduction in Furnace Oil prices. In this report Pearl Securities Limited would likes to highlight Sitara Energy Limited (SEL) which primarily consumes RFO for generation purposes, making up 82% of generation mix (FY14).

Past performances have been pressured by lower RFO based power demand and rising raw material costs. The firm posted bottom line decline of 18% YoY and 44% YoY in FY14 and 1Q FY15 respectively.

With macro movement in favour of thermal power generation, Sitara Energy has strong potential for recovery. 32% reduction in HSFO rates (same as RFO price) and 21% reduction in HSD prices during YTD FY15 stand to upgrade SEL’s margins and improve profitability. Additionally, power tariff reduction of PKR 2.97/unit will improve thermal based demand and improve Top-Line.

Stressed past performance

Due to generally expensive raw materials, the company’s Top-Line was negatively affected as thermal power was substituted for other sources with lower tariffs. OPEC basket average during FY14 stood at US$106/bbl. HSFO average for the same period is recorded at PKR 83,943/Ton while HSD stands at 113/liter.

Due to lower RFO power demand, the firm’s Top-Line declined by 3% YoY in FY14 and by 8% YoY during 1Q FY15 while gross margins were negatively impacted, declining by 242bps YoY in FY14 and by 201bps YoY in 1Q FY15. OPEX charges increases in both periods are in line with indexation and other macro effects. End result of stressed performance during these terms was NPAT decline of 18% YoY in FY14 and 44% YoY decline in 1Q FY15.

To be revitalized on macro positives

Moving forward, the power company has a solid chance to recover from past performances as raw material prices have declined significantly during YTD FY15. Overall macro impact of international oil price drop will have a positive effect on the company. OPEC oil prices have declined significantly by 52% in YTD FY15 to lowest point of US$47/bbl by the end of Jan’15, showing an average of US$87.2/bbl (down by 16% YoY against average of US$104.2/bbl in the same period).

Due to drastic reduction in global oil rates, PSO has reduced HSFO and HSD prices by 40% and 20%, respectively, since the start of 2Q FY15. Ex-Habibabad HSFO price now stands at PKR 47,797/Ton (against Oct’14 rate of PKR 79,780/Ton) while HSD stands at PKR 86.23/liter (against Oct’14 rate of PKR 107.39/ton). Pearl Securities Limited expects drastic reduction in raw materials to positively impact operations in 2Q FY15 and the rest of FY15 as well.

NEPRA has also reduced power tariffs by PKR 2.97/unit on low input prices, however, Pearl Securities Limited expects effects of such strong input reduction to still pass over to generation companies. Additionally, power tariff reduction will improve demand of RFO based electricity and improve SEL’s sales.

Tariff petition pending with NEPRA

SEL has filed a tariff petition with NEPRA to revaluate some clauses of the tariff agreement, including revision of the O and M component of the RFO generation tariff for sale of power to FESCO, segregation of tariffs in components and allowing a long-term PPA with FESCO. IT is important to note that this petition was filed in May’14, much before expectations of international oil price decline where price of FO was still high. In any case, revaluation of the O and M component and segregation of tariffs in components will ultimately be beneficial to SEL.

Capacity expansion

Management has announced plans to expand generation capacity of the plant by 21MW. This will take total capacity to 70MW, up by 43% YoY against current ability. At this stage no additional information has been provided, however, it is a commendable move by the management which is more feasible as oil prices are expected to remain suppressed in the near future.

1Q FY15 Summary – Poor core operations, PAT down 44%

During the first quarter of FY15, Top-Line decline was pressured by rising expenses. Stressed core operations were further burdened by lower other income, while OPEX remained stagnant to derive some stability. PAT is recorded at PKR 33mn (EPS: PKR 1.74), a notable decline of 44% YoY against net income of PKR 60mn (EPS: PKR 3.13) in the same term last year.

Net sales declined by 8% YoY to reach PKR 1.2bn.

Cost of fuel, oil and lubricants increased to 72% of sales against 69% (YoY).

Gross margins declined by 201bps YoY, at 8.2%.

Other income declined by 66% YoY to reach PKR 333mn.

Finance costs declined by 16% YoY, at PKR 40mn.

Operation details

Sitara Energy Limited is primarily engaged in managing a 49MW thermal based power plant. The company’s most significant clients are FESCO, M/S Sitara Chemicals Limited and M/S Sitara Spinning Mills Limited. The plant is located in Faisalabad, Punjab. Notable associate companies out of total 8 include, SITC, Sitara spinning and Sitara Fabrics among others. Sitara International (Pvt) Limited is a subsidiary of the SEL.

Company Outlook

Significant raw material price reduction will substantially help the company’s operations and better 2Q results are expected to stabilize half year results. Moving forward, additional cut in power tariffs can be expected, however, Pearl Securities Limited still expects positive impact of low HSFO price to pass on to thermal IPPs. Pearl Securities Limited recommends buy at this stage as it has 25% upside potential to pursue its Target Value of PKR52 with the historic record of lower P/E(x) at 3x. Buy!

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