Business Finance

K Electric
Submitted to: Danish Ahmed
Submit by:
Hassan Ahmed
Labeeb Ahmed
Musaddeq Ahmed Khan
Osama Farooqui
 - Risk and Return
Q1. What is the risk profile of your company? (How much overall risk is there in this
firm? Where is this risk coming from (market, firm, industry or currency)? How is the
risk profile changing?)
K-Electric is facing risk on the following fronts:
- Furnace oil prices
- Electricity theft and line losses
- Tariff negotiations with NEPRA
- Devaluation of the Pakistani currency
At the end of FY16, the company’s debt-to-capital stood at roughly 20%, which makes
the power generation company a safe bet in terms of risk arising from debt.
Q2. What is the performance profile of an investment in this company? What return
would you have earned investing in this company's stock? Would you have under or out
performed the market? How much of the performance can be attributed to management?
The stock price of K-Electric increased by only 2.2% in the past five years. Meanwhile,
during the same period, KSE-100 Index experienced an increase of over 66%. The low
rate of return against the market can be attributed to the negotiation with the Shanghai
Electric breaking down recently, which has wiped out significant gains. Furthermore, the
recent scandal involving Abraaj Capital has deepen the optimism in the stock also.
Q3. How risky is this company's equity? Why? What is its cost of equity?
K-Electric’s equity is very low risk. This is because the beta of K-Electric’s stock against
the KSE-100 Index is 0.128.
Q4. How risky is this company's debt? What is its cost of debt?
K-Electric’s debt to capital ratio stands at only 20%. This means that the company has
four times more equity than debt. However, the present rate of debt is 18%, which is
resulting in high finance costs. The company should have considered debt restructuring
when the discount rates were low.
Q5. What is this company's current cost of capital?
K-Electric’s current cost of capital is 16.3%. The calculation is shown in the Excel sheet
attached.
 - Measuring Investment Returns
Q1. Is there a typical project for this firm? If yes, what would it look like in terms of life
(long term or short term), investment needs and cash flow patterns?
K electric entered into the shareholder agreement dated May 20, 2016, for incorporation
of company “Datang Pakistan Karachi Power Generation Ltd. with China Datang
Overseas Investment Company Limited having 51% Share, 25% by China Machinery
Engineering Corporation (CMEC) having 25% shareholding and the company having
24% shareholding. The principal operations of DPKPG will be to carry out the business
of power generation, distribution, transmission and sales of Electricity by development of
a 700MW (2x350MW) coal-based power plant at Port Qasim, Karachi. Total cost of the
project is estimated at USD 1070 million, which would be financed through equity
junction of USD 321million and debt portion of USD 749 Million. Debt Portion would be
a mix of local and foreign financing.
Q2. How good are the projects that the company has on its books currently?
The information regarding this project has been accumulated through the website and is
not available in the annual report as the most recent annual report available to us is of the
FY16. Therefore, assumptions regarding the status of this project cannot be made with
high certainties.
 - Capital Structure Choices:
Q1. What are the different kinds or types of financing that this company has used to raise
funds? Where do they fall in the continuum between debt and equity?
K-Electric has opted for different types of financing. The company issued its AZM Sukuk
in mid-2014. It was an Islamic debt instrument where the company placed its grid station
as collateral against the funds raised. There were three issuances of 13 months for an
amount of 750 million, 36 months for an amount of Rs. 3.5 billion and 60 months for an
amount of 1,250 million.
Q2. How large, in qualitative or quantitative terms, are the disadvantages to this company
from using debt?
As the cost of debt is high, K-Electric is at a big disadvantage by using more debt.
Furthermore, following the most recent increase of 150 basis points (bps) in the monetary
policy, it would advisable for the company to avoid debt instruments at all cost.
Q3. From the qualitative trade off, does this firm look like it has too much or too little
debt?
We personally believe that the company has the right balance of 80% equity and 20%
debt currently. However, in the future, if the discount rates decline, K-Electric should
seize the opportunity and restructure its debt at a lower cost of debt and get more debt for
expansionary projects, which would have a positive impact on the top line and bottom
line of the company.
 - Valuation
Q1. What type of cash flow (dividends, FCF) would you choose to discount for this firm?
We have used discounted cash flow (DCF) method to find the equity value of the firm.
We forecasted the future revenues and profits of the company based upon various
assumptions and then found the free cash flow (FCF) and discounted them to find the net
present value (NPV). Following that, we added the cash balance and subtracted the long-
term debt to reach at the equity value and divided it by total shares outstanding.
Q2. What growth pattern would you pick for this firm? How long will high growth last?
As K-Electric is a mature company, there is no phase of high growth. We have used
Pakistan’s long-term GDP growth of 3% as the continuous growth rate to find the
terminal value of the firm.
Q3. What is your estimate of value of equity in this firm? How does this compare to the
market value?
Following our forecast and the use of DCF technique, we arrived at an estimated value of
Rs. 6.73 per share. This reflects an upside of 22% from Friday, December 7 closing price
of Rs. 5.53.