Company Update
Colbun: increasing forecasts
HOLD
Colbun
28 January 2009 Tomas Gonzalez tgb@celfin.com +562 490 5034
Utilities | Chile
Higher earnings, on lower operating costs
We are changing our forecasts for the Chile-based generation company Colbun: maintaining our HOLD recommendation, but raising the 12-month DCF-based target price from ChP110/share to ChP120/share – indicating upside of 10% from current levels. We expect EPS to increase by 239% in 2009 and 49% in 2010. We expect a significant fall in operating costs, led by a fall in international oil prices, to improve Colbun’s earnings in the coming years. We expect revenue from regulated sales (40% of Colbun’s total sales) to decline, based on lower node prices – our forecasts for average regulated sale prices are: US$94.2/MWh in 2009, US$82.7/MWh in 2010, and US$75/MWh as a long-term forecast. At the same time we expect lower variable costs, from cheaper diesel-fired generation, and lower spot market prices (reducing costs of bought energy), to more than compensate for the fall in revenues, producing Ebitda growth of 83% in 2009, and an additional 20% in 2010. We expect the better water levels at the Chapo and Colbun reservoirs, where accumulated energy levels at the end of 2008 were (respectively) 128.5% and 1,005.6% higher YoY, to result in an improved generation mix for Colbun during 1H09. On the other hand, lower regulation capability could mean these reservoirs might even be emptied if intensively used. We expect Colbun’s combined cycle plants to continue to run, burning diesel (potentially buying LNG in 2H09), as a backup, in the context of a continuing tight supply/demand balance. We expect lower capital expenditures, post 2010, of around US$100mn, reflecting lower prices of plant equipment (due to lower demand for it), and lower construction costs (this applies also to the Aysen Project, though that project is not included here), as Colbun’s plan to expand generation by about 809MW through 2012 continues unchanged. We believe that lower investment costs could even lead Colbun to announce new investments for the next decade, such as the expansion of the Santa Maria coal plant (350MW). Colbun announced its intentions to change the accounting currency to US$-dollars from pesos once IFRS accounting rules take effect.
Valuation improved – main reason being reduced costs
We are raising our target price for Colbun, from ChP110 to ChP120 per share –– based on an improved valuation, resulting from reduced variable costs. The resulting current P/Es, of 19.5x for 2009 and 13.1x for 2010, are a premium to Colbun’s own historical 14-year average of 15.4x, a premium to the P/Es of BUY-rated Endesa Chile (to which Colbun has historically traded at a discount), and a premium to Brazilian peers. EV/Ebitda multiples – 8.5x for 2009 and 6.4x for 2010 – are a premium and a discount to those of Endesa Chile in 2009 and 2010, respectively, though a premium to Brazilian peers. If hydrological conditions improve in 2009, we would expect to see these multiples expand.
Colbun | Electric Utilities
1
Colbun | Company Update
28 January 2009
In the last two months Colbun’s stock rose 11.8%, on market expectations of improved earnings in 4Q08 and lower generation costs in 2009. These were in line with our thinking, but we still see continuing structural concerns – which include: (a) uncertain hydrology of the coming rainy season; (b) Colbun still being over-contracted; and (c) the possibility of increased operational costs due to intensive use of diesel instead of natural gas or hydro.
Q4 earnings beat our expectations of ChP1.4/share
Colbun’s 4Q08 earnings improved significantly to ChP35.3bn (ChP2.01/share) compared with a ChP8.0bn (ChP0.5/share) loss of in the same period of 2007. Earnings estimations were well-above our and market projections (refer to our 4Q08 preview released on 26 January). Operating revenues were 14.7% higher YoY to ChP198.4bn mainly due to higher average generation prices, despite a 10.3% YoY decline in physical sales as a consequence of the termination of some regulated contracts during the end of 2007. Operating costs were 21.0% lower YoY as a result of lower thermal generation (using diesel) and energy purchases. EBITDA rose significantly to ChP69.1bn versus last year’s ChP5.2bn. Improvement vs. last year reflects (1) a 25.5% YoY jump in hydro generation due to better hydrology and reservoir levels and (2) a 34.4% YoY drop in thermal output. Both factors reduced the amount of energy the company had to purchase in the spot market to meet contract commitments. Earnings were helped by 59.9% YoY decline in non-operating charges. Other non operating income of ChP45.9bn resulted mostly from FX forward contracts in order to hedge financial investments in US-dollars, which partially compensated monetary correction/exchange differences expenses of ChP54.0bn.
Main concerns
The fall in international oil prices has significantly diminished – though not eliminated – concerns on Colbun’s variable costs. In our view, today’s main concerns associated with investment in Colbun (as, indeed, for most generation Chilean generation companies) are: (1) water availability (periods of drought, which reduce physical sales and increase energy costs – especially for Colbun, which is still over-contracted); (2) a rise in variable costs due to poor hydrology or a renewed rise in oil prices; (3) mechanical failure at thermal plants due to intensive use of diesel instead of natural gas; (4) FX risk – the possibility of adding volatility to reported earnings; and (5) environmental pressures resulting in cost over-runs.
Colbun | Electric Utilities
2
Colbun | Company Update
28 January 2009
DCF-based target price: ChP120/share
We believe that earnings and cash flows indicate DCF as the primary source for valuation. Our 12-month target price for end-2009, based on DCF, is ChP120 per share. We assume cost of equity of 11.45%, made up of: risk-free rate of 6.43%, equity risk premium of 5.7%, 1year beta of 0.88, and perpetuity growth of 3%. Assumed cost of debt is 6.48% (pre-tax). Discounted cash flow calculation (ChPmn)
NPV (2009 - 2018) Terminal value (+2018) Total NPV (operating value) Net debt Equity value Growth rate in perpetuity (%) WACC (%) Shares outstanding (mn) 12-month target price (ChP/share) Current price Expected return (%) Source: Celfin Capital. 939,700 1,403,337 2,343,037 238,638 2,104,399 3.0 9.02 17,536 120 109 10.1
Construction of cost of capital
Risk-free rate (%) Equity risk premium (%) Beta Cost of equity (%) Marginal tax rate (%) Post-tax cost of debt (%) Target debt/equity (%) WACC (%) Source: Celfin Capital. 6.43 5.70 0.88 11.45 17.0 5.38 40.00 9.02
Sensitivity of NPV per share
WACC (%) 8.02% 8.52% 9.02% 9.52% 10.02% Source: Celfin Capital. 1.0 117 107 99 91 85 2.0 130 118 108 99 91 Terminal growth rate (%) 3.0 148 133 120 109 100 4.0 176 154 137 123 111 5.0 222 188 162 142 126
Colbun | Electric Utilities
3
Colbun | Company Update
28 January 2009
Financial forecasts
Income statements (millions of nominal Chilean pesos)
Period ended Revenues from generation Other revenues Operating revenues Variable operating expenses Fixed operating expenses SG&A Operating expenses Operating profit (loss) Depreciation & amortization Ebitda Net financial revenues (expenses) Equity gain – related companies Positive amortization of goodwill Monetary adjustment Other non-operating revenues (expenses) Pre-tax profit Income tax Minority interests Negative amortization of goodwill Net profit EPS Shares outstanding Sources: SVS, Colbun, Celfin Capital. 2006A 387,155 12,057 399,212 (155,319) (56,229) (7,835) (219,384) 179,829 56,509 236,338 (9,563) 2,149 (8,689) 578 164,304 (16,681) (1,253) 1 146,370 9.83 14,884 2007A 593,869 11,306 605,175 (586,455) (62,148) (9,265) (657,867) (52,693) 62,543 9,851 (7,166) 1,675 22,734 (8,677) (44,126) (445) (2,191) 1 (46,762) (3.14) 14,884 2008A 703,256 20,532 723,788 (572,778) (70,828) (12,658) (656,264) 67,524 71,280 138,804 (16,741) 1,214 (72,223) 63,692 43,466 (11,899) (2,735) 0 28,831 1.64 17,536 2009E 595,245 9,033 604,278 (339,727) (77,239) (10,719) (427,685) 176,592 77,827 254,420 (33,555) 1,013 (14,060) (9,416) 120,575 (20,498) (2,229) 0 97,848 5.58 17,536 2010E 523,775 7,948 531,723 (216,972) (79,744) (9,571) (306,287) 225,436 80,259 305,695 (30,045) 895 (11,024) (7,460) 177,802 (30,226) (1,953) 0 145,623 8.30 17,536
Colbun | Electric Utilities
4
Colbun | Company Update
28 January 2009
Balance sheets (millions of nominal Chilean pesos)
Period ended Cash and cash equivalents Accounts receivable Inventory Other current assets Current assets Net property, plant & equipment Positive goodwill Negative goodwill Net intangibles Other assets Total assets Accounts payable Short-term debt Other current liabilities Current liabilities Other liabilities Deferred tax Long-term debt Long-term debt – related companies Bonds payable Notes payable Total liabilities Minority interest Common equity Total liabilities & equity Sources: SVS, Colbun, Celfin Capital. 2006A 101,620 36,111 798 22,730 161,259 1,402,414 14,506 27,419 1,605,599 49,110 74,406 28,917 152,433 2,362 64,574 190,337 42,260 14,219 466,184 5,339 1,134,076 1,605,599 2007A 39,923 138,296 4,145 155,464 337,828 1,537,516 16,665 59,236 1,951,244 47,289 27,779 84,404 159,472 7,450 84,008 197,265 217,515 6,751 672,461 6,413 1,272,370 1,951,244 2008A 332,433 154,711 2,783 173,264 663,192 1,724,441 17,869 158,074 2,563,576 57,934 17,990 61,871 137,796 8,076 99,740 299,580 393,972 4,324 943,487 6,464 1,613,624 2,563,576 2009E 485,922 114,196 2,106 127,891 730,115 1,713,108 17,281 158,074 2,618,578 43,831 17,990 45,669 107,490 8,076 93,620 299,580 393,972 4,324 907,062 8,694 1,702,822 2,618,578 2010E 680,750 95,329 1,329 106,761 884,170 1,679,095 16,766 158,074 2,738,105 27,668 17,990 68,184 113,842 8,076 88,573 299,580 393,972 4,324 908,368 10,647 1,819,091 2,738,105
Cash flow statements (millions of nominal Chilean pesos)
Period ended Net profit Depreciation Monetary correction Goodwill amortization Change in working capital Cash flow Capex Free cash flow before dividends Dividends Free cash flow Sources: SVS, Colbun, Celfin Capital. 2006A 139,889 56,509 8,689 (1) 378 205,464 (127,720) 77,744 (82,094) (4,350) 2007A (46,762) 62,543 (22,734) (1) (184,600) (191,554) (111,939) (303,492) (392,546) (696,038) 2008A 28,831 71,280 72,223 0 (44,741) 127,593 (222,276) (94,683) (2,202) (96,885) 2009E 97,848 77,827 14,060 0 56,261 245,995 (65,906) 180,089 (8,649) 171,440 2010E 145,623 80,259 11,024 0 47,124 284,030 (45,731) 238,299 (29,354) 208,945
Colbun | Electric Utilities
5
Colbun | Company Update
28 January 2009
Investment drivers
Colbun, Chilean-based and controlled, is Chile’s third largest power generator, with a portfolio of high quality generation plants, 46% hydro and 54% thermal, by generating capacity. We expect it to return improving earnings for the foreseeable future. The following factors are main assumptions behind this conclusion.
Any rise in Colbun’s generation in 2009 will depend on hydrology
In 2008 Colbun generated 7.8% less than in 2007, due to a failure of its 370-MW Nehuenco I combined cycle plant, which was out of service from end-December 2007 to September 2008. We are currently expecting Colbun’s generation to be a further ~2% lower in 2009 – any rise in its generation output in the year would come only if hydrology is stronger than expected. Its first new capacity is expected only after 2010 (Santa Maria, 350MW, coal – 1Q11; San Pedro, 144MW – 4Q11; and Angostura, 309MW – 4Q12). Hence we believe Colbun will continue to be a net spot market buyer, to meet contractual obligations. We see the following as leading factors in Colbun’s generation output: (1) full availability of Nehuenco I; (2) the regulator’s decisions in dispatching its own generating units; and (3) absence of government energy-saving measures.
Lower regulated prices, reducing revenue only after 2009
Our forecast is that node prices will fall faster than expected, to average US$94.2/MWh in 2009, mainly due to a significant fall in costs in the SIC grid, on lower fuel prices, though we expect SIC node prices to remain high through 2009 (based on our high assumption for the FX rate), due to a continuing tight supply-demand balance, which we expect to soften by the end of 2010. There are more details on our forecasts for node prices in Power play, our Jan. 22 report on Endesa Chile. We expect Colbun’s regulated physical sales to be relatively unchanged during 2009, with revenues 6% higher YoY on higher average regulated prices than in 2008; but in 2010 we expect revenues to be ~44% lower YoY, on lower regulated prices and contractual commitments falling 38% YoY. Colbun’s regulated physical sales (~4,800GWh per year) are some 40% of its total sales, and we expect them to decline to ~3,000GWh per year in 2010, as a consequence of Colbun’s commercial policy of not renewing this type of contract. For more detail please see Future growth, present HOLD, our report on Colbun of November 27, 2008. We expect the ending of contracts to enable Colbun to move from being a net buyer to a seller in the spot market during 2H10 – though confirmation of this will again depend on hydrology. After the termination of several contracts by the end of 2009, new volume of 2,200GWh/year will be added in new contracts won in the first energy auction. The average energy price of these new contracts is specified as US$54.3/MWh, with indexation formulas, which on current forecasts are likely to increase this price by 16%, to US$62.9/MWh, by 2010. At the forthcoming energy auction, with energy requirements of 8,575GWh per year – postponed to January 30, 2009 – long-term prices are expected to be around US$68/MWh. We believe Colbun is in a position to take on additional energy contracts for supply starting in 2010, to be supplied by its Santa Maria coal-fired plant as from 2011.
Lower oil prices => lower spot prices => lower variable costs
International oil prices fell by ~50% during the last quarter of 2008. We expect oil prices to average US$52/bbl in 2009 and US$63/bbl in 2010 – still high, but much lower than the 2008 average of US$103/bbl. For more detail please refer to Stirred but not shaken, our Economic
Colbun | Electric Utilities 6
Colbun | Company Update
28 January 2009
Outlook report of January 15, 2009. With lower oil prices, we expect average spot prices in the SIC grid to decline significantly in 2009 – helped also by better reservoir levels (up 17.7% at the end of 2008). We expect Colbun to benefit from lower variable costs, resulting from two main factors: (1) Lower oil prices should reduce operational costs – Colbun has been operating its combined cycle plants on diesel instead of natural gas (33% of its total generation, and 54% of its total variable costs, in 2008). (2) Lower average spot prices should reduce the total cost of energy purchases that the company needs to make to comply with contractual obligations (29% of total variable costs, in 2008). We expect Colbun to continue to be a net buyer in the spot market in 2009. For more detail on forecasts for average spot prices please see Power Play, our January 22, 2009 report on Endesa Chile. With the fall in oil prices, and due to indexation mechanisms, we expect prices of LNG to be lower than oil prices in relative terms, so that Colbun could be a buyer of LNG.
Better reservoir levels=> low-cost generation in 1Q09
At the end of 2008 the total level of energy accumulated in Chile’s reservoirs was 17.7% higher than at the end of 2007. Energy levels in Colbun’s own reservoirs were also significantly up year-on-year at the end of 2008: 128.5% higher at the Chapo reservoir, and 1,005.6% higher at the Colbun reservoir – due to a better rainy season, and faster snowmelt than expected. We believe this should be enough to secure Colbun’s supply for 1Q09, provided it also operates significant diesel-fired output as backup. Higher water resources would enable Colbun to generate at a much lower cost, though we expect it would still run its combined cycle plants, on diesel, as a backup, due to the continuing tight supply/demand balance in the system. The following charts show altitudes above sea level for the Colbun and Chapo reservoirs of the SIC grid, since 1994: Colbun reservoir: level (meters above sea level)
440 430 420 410 400 390 Jan-94
Chapo reservoir: level (meters above sea level)
250 245 240 235 230 225 220 215 Jan-94
Jan-97
Jan-00
Jan-03
Jan-06
Jan-09
Jan-97
Jan-00
Jan-03
Jan-06
Jan-09
Sources: CNE, Celfin Capital.
Sources: CNE, Celfin Capital.
Hydro conditions in Chile are expected to be in the normal-dry range, though according to the National Oceanic and Atmospheric Administration (NOAA), trends in the observations of SSTs (Surface Sea Temperatures), and model forecasts, show “La Niña” conditions are likely through early 2009 – the phenomenon usually means a delay of the rainy season until June. This would not favor Colbun, given its reservoirs’ low regulation capability, and expected high hydro output could empty its reservoirs. A decline in hydro output would naturally increase diesel generation substantially, to meet contractual obligations. We would also expect it to increase spot market prices, which would likely make Colbun a net buyer in the year – unless hydrological conditions improve.
Colbun | Electric Utilities 7
Colbun | Company Update
28 January 2009
Q4 review
Earnings review (millions of nominal Chilean pesos)
Revenue Operating expenses Gross profit Gross margin (%) SG&A Operational profit (loss) Operational margin (%) Depreciation & amortization Ebitda Ebitda margin (%) Net financial revenue (expenses) Equity gain (loss) from related companies Positive amortization of goodwill Negative amortization of goodwill Monetary adjustment Other non-operational revenue (expenses) Net profit before taxes Minority interests Other / extraordinary Provision for taxes Net profit Preferred dividends Net earnings to common stock Shares outstanding EPS
Figures in nominal terms
4Q08 4Q07 3Q08 198,351.5 173,005.1 165,391.9 (144,072.2) (182,459.5) (129,882.6) 54,279.3 (9,454.3) 35,509.3 27 (5) 21 (3,764.8) 50,514.5 25 18,573.5 69,088.1 35 (3,262.0) 322.8 0.0 0.0 (53,961.6) 45,874.8 39,488.6 (1,141.7) (3,091.8) 35,255.1 35,255.1 17,536.2 2.0 (2,528.6) (11,982.9) (7) 17,229.1 5,246.2 3 (667.3) 324.7 0.0 0.3 9,315.8 (4,437.9) (7,447.2) (874.4) 336.0 (7,985.6) (7,985.6) 14,884.0 (0.5) (3,242.8) 32,266.5 20 18,848.3 51,114.8 31 (871.0) 215.1 0.0 0.0 (17,550.0) 12,215.3 26,275.9 (317.9) (8,738.9) 17,219.2 17,219.2 17,536.2 1.0
YoY 14.7 (21.0) -
QoQ 19.9 10.9 52.9
48.9 -
16.1 56.6
7.8 1,216.9
(1.5) 35.2
388.9 (0.6) (100.0) 30.6 17.8 -
274.5 50.1 207.5 275.6 50.3 259.2 (64.6) 104.7 104.7 104.7
Sources: SVS, Colbun, Celfin Capital.
Colbun | Electric Utilities
8
Disclaimer
This document and its contents do not constitute an offer, invitation or solicitation to purchase or subscribe to any securities or other instruments, or to undertake or divest investments. Neither shall this document or its contents form the basis of any contract, commitment or decision of any kind. This material has no regard to the specific investment objectives, financial situation or particular needs of any recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Before undertaking any transaction with these instruments, investors should be aware of their operation, as well as the rights, liabilities and risks implied by the same and the underlying stocks. Investors should note that income from such securities or other investments, if any, may fluctuate and that price or value of such securities and investments may rise or fall. Any information relating to the tax status of financial instruments discussed herein is not intended to provide tax advice or to be used by anyone to provide tax advice. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report, thus investors effectively assume currency risk. References to third parties are based on information obtained from sources believed to be reliable but are not guaranteed as being accurate. Celfin Capital has not independently verified such information and therefore no warranty, either express or implicit, is given regarding its accuracy, integrity or correctness. Recipients should not regard it as a substitute for the exercise of their own judgment. Any opinions expressed in this material are subject to change without notice and Celfin Capital is not under any obligation to update or keep current the information contained herein. Celfin Capital may make purchases and/or sales as principal or agent of this security or provide corporate finance or other services to the issuer. However, Celfin Capital does not trade for its own account. Celfin Capital or any of its salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to its clients that reflect opinions that are contrary to the opinions expressed herein. Furthermore, Celfin Capital or any of its affiliates' investing businesses may make investment decisions that are inconsistent with the recommendations expressed herein. Celfin Capital accepts no liability of any type for any direct or indirect losses arising from the use of this document or its contents. All information is correct at the time of publication; additional information may be made available upon request. Rating System: Ratings refer to a period of 12 months. Our ratings are classified in three categories: Buy = an absolute return of at least 15%; Hold = an absolute return between 15% and 5%; Sell = a return of 5% or lower in relation to its absolute valuation. Under exceptional circumstances and for specific reasons, we may use UR – Rating under review.
Colbun | Electric Utilities 9