InterRAO - New Contracts Support Distant Cash Flows, but no Short-Term Triggers

InterRAO released its 1Q21 results on Friday. The figures did not present major surprises and were in line with our and consensus estimates. We summarize the main comments by the management below:> Recent acquisitions. The company presented its estimates for the financial indicators of the companies purchased in 1Q21. It expects the engineering companies to generate an annual contribution to revenues reaching R57 bln and the IT company to add roughly R8 bln per year in 2021-23. Roughly two-thirds of these expected revenues have already been contracted. The combined annual EBITDA contribution in 2021-23 is expected at R10.2 bln (R8.5 bln from engineering and R1.7 bln to IT). Given that the engineering companies have roughly R10 bln of debt (and the IT company none), InterRAO purchased these assets at 5.5 and 5.8 times forward EBITDA. As we understand, the logic behind the purchase is to have full control over the engineering processes, especially those related to the Vostok Oil project. The share of InterRAO in the revenues of the contractors it purchased currently does not exceed 25-30%. The main customers of those contractors are electricity and heating grids, as well as water channels.> Modernization and new contract for CCGT construction. InterRAO recently obtained a contract to construct two CCGT units at Kashirskaya TPP to be commissioned in January 2028. These units would require four large gas turbines to be built (which were contracted to the company Power Machines). Total installed capacity of the two units combined is to reach 896 MW. As part of the modernization project, the company will decommission 747 MW of coal-fired capacity at the Yuzhnouralskaya TPP. Total capex related to the project is estimated at R80 bln (R63.1 bln in 2021 prices) and the unit is expected to generate roughly R15.6 bln of EBITDA per year, which should allow an IRR of 11.3% on the project. This is comparable to the R72 bln of capex, 11-13% IRR and the roughly R12.5 bln of average annual EBITDA contribution related to all of the other modernization projects and once again underlines the future importance for the company of new larger-scale projects with localized gas turbines.> Localization project with GE. It is worth noting separately that InterRAO had previously expressed ambitions in the field of gas turbine localization in cooperation with GE. However, the first gas turbine tender took place but the gas turbine that InterRAO and GE are seeking to localize was not offered to the market. The management commented that it continues to seek localization opportunities and that the company believes that out of 30 units - this is the minimum number of turbines required to justify localization efforts - 15 could be used to create the energy infrastructure of the Vostok Oil project and several more units could be purchased by RusHydro for its modernization projects.> Vostok Oil. InterRAO is currently finalizing the conception for the energy infrastructure of the project and is proceeding with work related to the design of the first stage. The company currently sees its role as a contractor, but the management mentioned that this could eventually change. But at least at the first stage InterRAO will act as a contractor, which does not require investments from its own balance sheet. Later the company could become an investor in the project as well.> Still plenty of locked-up value, but few short-term triggers. We see the contract for the CCGT units allocated to the company as a positive factor, yet the impact of the new contracts on free cash flow will be negative until 2028, so the positive impact is quite distant in time. The M&As do not look expensive (though in terms of EV/EBITDA almost any acquisition would be more expensive than InterRAO itself) and for us look more like a purchase aimed at establishing full control over the priority projects (both in terms of timing and spending). However, this is not the type of M&As investors had in mind for unlocking value. Meanwhile, the visibility of the EBITDA of the acquisitions is lower than the visibility of the EBITDA of any public company that InterRAO could potentially purchase. With the company having stated that it is comfortable with the current setup regarding the Kaliningrad region-based assets that it built for Rosneftegaz but is currently leasing, and given the reiterated 25% payout (which the company commented as being "a balance between growth and shareholder remuneration"), comments that the option program for the management "could only be considered at a more appropriate moment" and few details on Vostok Oil, we see little short-term triggers for InterRAO. We still see the stock having plenty of locked-up value but not many triggers for this value to be unlocked in the near term.