Government support drives valuation

Mariyam Zhumadil, CFAApril 08, 2014

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Last month KazTransOil published financial results for 12M2013 and announced a 20% hike in export tariffs following tenge devaluation in February. We note that both the magnitude of the tariff increase and the timing were a positive surprise to us, reflecting a much stronger government commitment to People’s IPO program. We updated our model to reflect the consolidated financial results, tenge devaluation and the subsequent increase in export tariffs, the shift in our tariff forecast methodology from every-third-year to annual increases, the revised capex assumptions for 2014-2015 and the delayed execution of Yeskene-Kuryk project. The end result was a lift in our 12-month target price by 12% to T1442 per share.

KTO shares remain our top pick among Kazakh stocks in the infrastructure sector. The company generates stable and predictable cash flows, and is capable of paying out large dividends. The main risks to our valuation are the weakening of government support for People’s IPO program, regulatory and corporate governance risks.

Government raised export tariffs by 20% to offset the effect of the devaluation

KazTransOil’s oil transportation tariffs on export routes were raised by 20% to T5,817 per 1000tkm, effective April 1, while the tariffs on domestic routes remained unchanged. We learned from the company that the new export tariffs include not only the impact of devaluation, but the 2013 revaluation of fixed assets. This explains why the magnitude of export tariff increase was larger than necessitated by the devaluation. We estimate that about 20% of company’s operating costs are denominated in dollars, while tenge inflation would accelerate to only low double-digits in the next couple of years. Another positive surprise was the approval of the new export tariff under an expedited 'extraordinary regulatory measures' category. This allowed increasing tariffs much sooner than we have anticipated. The expedited approval of the new tariffs effectively allows KTO to match revenue and costs growth timing, allowing the company to avert the slump in 2014 earnings and sends a strong signal to the market that the government is committed to support the People’s IPO program.

Cash flow to decline over 2014-2015, but dividend capacity remains high

Based on our operations and financial forecasts we estimate that KTO’s free cash flows will decline over 2014-2015 due to step up in capex spending. However, the company’s tariffs are still more than sufficient to both fund capex of T133bn over 2014-2015 and to maintain our base case dividend payout assumption (60% of earnings). Furthermore, we argue that KazTransOil is capable of paying out even larger dividends on 2013-2015 earnings, in the magnitude of 90% of earnings. In our base case scenario KTO would accumulate net cash of T186bn by 2015, or approximately 25.4% of total assets. Some would argue that KTO needs to accumulate cash to fund construction of Yeskene-Kuryk pipeline (cost at IPO announced at T387bn) sometime after 2016. But we believe given the uncertainty over the start of this project due to production halt at Kashagan, KTO’s large debt capacity and that the project is likely to be executed in a JV with other investors, KazTransOil does not need to accumulate such large cash pile. Excess cash is needed to weather the storms for companies in the cyclical or high risk operating environments, but the regulated monopolies are not the case, we believe. If the company pays out about 90% of  2013-2015 earnings, this would allow to reduce net cash to 16.8% of total assets by 2015 and after the start of the project further reduce it to just 6% of total assets by 2017, or T52bn. Such rich dividend distribution could translate into an average dividend yield of 13.2% on KTO shares over 2013-2015, we calculate.

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