Russian Utilities - Lower Rates Lead to Lower Required Dividend Yields
With interest rates in the economy continuing to fall, we believe that investors will look to stable businesses with robust dividends secured by cash generation ability. The utilities sector has a number of such stories. We think the lockdown has actually affected the sector less severely than this year's high water flows, which have driven spot electricity prices lower. And though a deterioration in the orderliness of payments could take a toll on the sector as well - which can only be properly gauged after the 1H20 results - we believe it will be much less dire than the Energy Ministry's initial estimates. Meanwhile, retail money has continued to flow into the stock market, providing another tailwind for the sector. We prefer InterRAO, OGK-2 and RusHydro, as they offer the highest potential for further dividend growth among Russian gencos. > Virus-driven selloff affected utilities stocks. Since our last update in late February, the sector has posted a -8.9% total return in dollars and -4.7% in rubles. The initial market reaction played out as one might expect: less liquid names with ruble-denominated businesses fell victim to the global risk-off move. However, since the market hit bottom, utilities have failed to outperform, which could suggest that additional risks are priced in to sector valuations.> High water flows a bigger factor for sector than virus. The impact of the virus and lockdown on the utilities sector has been quite limited. More important has been the high water flows, and therefore increased share of HPPs in production (meaning pressure on thermal gencos). This has driven a drop in spot electricity prices, with those in the European price zone down 10% y-o-y in 5m20. Following a conservative approach, we do not model a full recovery in spot prices to the trajectory we had expected them to follow before the spike in water flows, and we now assume lower long-term spot prices. Lower payment discipline could come into play, but the impact has so far been limited and the outlook should be clearer in 3Q20.> New normal for dividend yields. The risk-free rate in the Russian economy has declined since the onset of the virus. Yields on 10y local government bonds have fallen to 5.7% from above 6.0% in early March. Moreover, our economists expect interest rates to continue to fall and the key rate to reach 4% by the year-end. This should support the equity market in general and dividend stories in particular. The lower risk-free rate should lead to a revision in the "normal" level of dividend yields for Russian companies, and we believe that for a non-cyclical sector with robust FCF, such as utilities, this new normal dividend yield should be close to 6-7%. This is a tide that should lift all boats.> Names with dividend growth potential the most attractive. We prefer companies from which we expect to see substantial dividend increases or those that have the greatest ability to increase shareholder distributions - among gencos, these are InterRAO, OGK-2 and RusHydro.PJSC Enel Russia is a wholesale generation company in Russia. Co.'s main areas of operation are production of power and heat, supply (sale) of power and heat, receipt (purchase) of power and heat from the wholesale power (capacity) market. Co. is active in four production branches around Russia: in the Ural region - Reftinskaya GRES, Sredneuralskaya GRES, in the northern Caucasus - Nevinnomysskaya GRES, and in Central Russia - Konakovskaya GRES. Co.'s aggregate installed capacity is 9,677 MW for power and 2,382 GCal/h for heat. Co. provides power and heat to both industrial enterprises and household consumers via local power distribution networks.
PJSC RusHydro is a hydro-generating company based in Russia. Co. is engaged in the generation and sale of electricity and capacity on the Russian wholesale and retail markets, as well as generation and sale of heat energy. The main activity of Co. is production of power from renewable energy sources, developing power generation using water flows, tidal, wind and geothermal energy. It has an installed electricity generation capacity of 38.5 GW; and heat capacity of 16.2 GCal/h.
Inter RAO UES PJSC is a functioning operator of electricity exports and imports in the territory of Russia. Co. represents the interests of two Russian power sector participants: RAO UES of Russia and Rosenergoatom concern, which possess 60 and 40% of the shares respectively. Co. is engaged in arranging transboundary electricity supplies, to provide both domestic and foreign consumers with electric power. Co. is also engaged in pursuing effective investment activities. Co. is developing several areas of activity, including: electric power export and import supplies; electricity sales in home and foreign markets; investment activities; and foreign asset management.
Mosenergo is a regional energy company primarily involved in generation of heat and electric power and heat distribution services in the Moscow city and Moscow region. Co.'s portfolio includes 15 power plants with the electric installed capacity of 11.9 thousand MW and heat installed capacity of 40.5 thousand MW (34.9 thousand Gcal/hour). Co. produces 6% of the electricity generated in the Russian Federation (exclusive of nuclear power plants) and is a main supplier of electricity and heat for the Moscow region. Co. supplies 67% of the total electricity consumption of Moscow region.
OGK-2 JSC is primarily engaged in the generation and sale of electric and heat power. Co. consists of the following power stations (plants): Troitskaya GRES, Stavropolskaya GRES, Pskovskaya GRES, Serovskaya GRES, Surgutskaya GRES-1, Kirishkaya GRES, Ryazanskaya GRES, Novochercasskaya GRES, Krasnoyarskaya GRES-2, and Cherepovetskaya GRES.
Territorial Generating Company - 1 is a producer of electricity and heat energy in the North-West region of Russia. Co. incorporates generating enterprises from the Baltic Sea to the Barents Sea. Generated electricity is delivered to the domestic wholesale market of electricity and capacity as well as exported to Finland and Norway. Co. is a strategic supplier of heat energy in Saint Petersburg, Petrozavodsk, Murmansk, Kirovsk in the Leningrad Oblast, and Apatity in the Murmansk Oblast.
E.ON Russia is engaged in the wholesale electricity market, it produces and sells electric and heat power. As of Dec. 31, 2012, the structure of Co. includes five heat power plants with the total installed capacity of 10,345 MW/2,125.9 Gcal/h: Surgutskaya GRES-2 (Khanty-Mansi Autonomous Area, Tyumen Region), Berezovskaya GRES (Krasnoyarsk Territory), Shaturskaya GRES (Moscow Region), Smolenskaya GRES (Smolensk Region) and Yaivinskaya GRES (Perm Territory).
Sberbank CIB Investment Research is a research firm offering equity, fixed income, economics, and strategy research. It covers analysis on all aspects of Russia’s capital markets, issues and industries. The firm analyzes trends in Russia and combines local knowledge with a global perspective. It processes macroeconomic data, market and company-specific news, stock quotes and other information for providing research reports. The firm provides details and latest prices on the most traded names and most traded paper on all segments Russian market. In strategy research, it provides thematic research, tips and descriptions of the methodology used to evaluate companies.
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