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This month share price of KTO rallied by 20% following the release of a much stronger than expected consolidated financial results for 9M2013. The improvement in operating costs and lower capex spending translated into a net cash position of T100.7bn, which means that the company is capable of paying out a much larger dividend for 2013 than previously expected. We updated our forecasts to reflect the consolidated financial results for 9M2013 and production results for FY2013, lower operating costs, lower capex in 2013 and slower tariff growth beyond 2016. These changes lifted our 12-month target price by 19.6% to T1283 per share.
Despite the recent run up in the share price, we believe the shares remain undervalued. The company’s cash generating ability has improved markedly because of recently revealed improvements in the operating cost. However, the regulatory risk remains the biggest risk. It is mitigated by the government’s demonstrable commitment to People’s IPO program, but that may wane over the next few years.
9M2013 financials marked by significant cost improvement
9M2013 financial results were much stronger than we and the market had expected due to a sharp deceleration of operating costs. Cost of sales grew by just 4% YoY to T53.4bn, at a much slower rate than in the past (average growth rate over 2009-2012 was 9.0%). The cost improvement was primarily due to reduction in maintenance and other expenses. We attribute the improvement primarily to better cost management, but also note that inflation declined from 7.0% over 2009-2012 to 4.8% in 2013.
Spread between export and domestic tariffs is narrowing
In November 2013, the regulator unexpectedly raised KazTransOil’s tariffs by 3.1% on export routes and by 50.9% on domestic transportation. We believe the tariff raise was made possible partly thanks to a revaluation of assets in July 2013, whereby the company’s regulated asset base was marked up by 21.7%. Going forward, we expect that the ratio of domestic to external tariffs to remain at the current level of 60%.
In our baseline scenario used in the model we peg the tariff hikes in 2016, 2019 and 2022 to the average return on equity of 13.5% over the forecast period. This reflects our understanding that the use of monopoly tariffs for suppressing consumer inflation and as a tool of social policy has long become institutionalized in Kazakhstan, and would continue to depress the returns on regulated monopolies.
Valuation updated, dividend estimates raised
As a result of changes to our model, estimates for revenue in 2013 and 2014 are higher by 3.0% and 9.8%, respectively, primarily due to effect of higher oil turnover base in 2013. Our EBITDA forecasts in 2013 and 2014 increased sharply by 14.3% and 33.7%, respectively, reflecting lower unit cost base in 2013 and our expectation of a moderate costs growth rate going forward compared to the pre-IPO period. Therefore, we now estimate that EPS for 2013 will amount to T173 per share, which at a 60% payout ratio translates into a T104 per share dividend, implying a 9.7% dividend yield at the current stock price.