Morning Call about – Improved targets amid monetary easing – Arif Habib Limited

Karachi, June 27, 2013 (PPI-OT): Upgrading NCPL’s target price by 14% to PKR 32.3/share, why? Upon revisiting Arif Habib Limited Nishat Chunian Power Limited’s (NCPL) financial model and incorporating recent 50 bps cut in SBP discount rate, Arif Habib Limited upgrades NCPL’s Dec- 13 target price to PKR 32.3/share.

According to Arif Habib Limited has also revised Arif Habib Limited dividends assumptions but Arif Habib Limited are still to join enthusiastic wing of market participants hoping for breather (circular debt resolution in near future) leading to improved payouts from IPPs.

Arif Habib Limited payouts assumption for FY13 and FY14 averages around 60%, slightly below 63% distribution in FY12. However, Arif Habib Limited await details about structure of PKR 326bn transaction to conclude whether it can impact payouts or it’s just a book cleaning.

Targeting PKR 31.1/share for NPL seems realistic!
Arif Habib Limited dividends Discount Model (DDM) based financial model values Nishat Power Limited (NPL) at PKR 31.1/share for Dec-13. Apart from the macro indicators stated above, Arif Habib Limited has assumed the payout for NPL to gradually increase and join its peer NCPL from FY15 onwards.

Why just DDM? What do free cash flows suggest?
Dividend Discount Model (DDM) is supposed to be the prime choice for valuing Pakistan Power companies. Using FCFE (free cash flow to equity) methodology, Arif Habib Limited estimates NCPL and NPL to have a fair value of PKR 42.3/share and PKR 41.4/share respectively.

Though both plants are generally termed as identical twins, the slight difference in FCFE based target values arises from relatively lower net borrowings by NPL (NCPL short term borrowings PKR 6,103mn versus NPL’s PKR 5,595mn).

The key hindrance to 100% free cash flow payout is working capital requirement of these companies, as they have a power purchase agreement under which they have to procure fuel from their own sources. Thus Arif Habib Limited currents payout assumption for both NCPL and NPL is 50% of free cash flow to be distributed as dividends.

Recommendation
NCPL and NPL are trading at a premium of 4% and 9% to Arif Habib Limited Dec-13 target prices. Though the scrips do not offer any upside to Arif Habib Limited convictions target values but the dividend yields are not to be missed. NCPL’s dividend yield of 13.3% stands 245 bps higher than the 10 year PIB yield of 10.87%.

Moreover, the dividends are expected to grow and the average dividend yield of 17% stands way higher than the risk free benchmark. Therefore, Arif Habib Limited recommends a HOLD on total return basis!

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