FV PRs23.5

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Lalpir Power Limited

POWER GENERATION

Another Kapco

The sponsors of Lalpir Power Limited are offering 10% (37.98mn shares) of their existing stake in the company to institutional investors and general public. In the first phase, 28.49mn shares (75% of the offer size) would be offered to institutional investors and HNWIs through the Book Building process with a floor price of PRs15/share on June 18-19. The remaining 9.46mn shares (25% of the offer size) are allocated for general public which would be offered at or below the Strike Price.

Established under 1994 power policy, Lalpir Power is an oil-fired Independent Power Producer with net generation dependable capacity of 350MW. In 2010, Lalpir Power (formerly AES Lalpir) was acquired by a consortium of Nishat Group, Abu Dhabi Group and Engen. Under the 30-year Power Purchase Agreement (PPA) extending up to 2027, the company supplies power exclusively to WAPDA.

The company has guaranteed, high quality earnings, owing to the sale of 60% of its dependable capacity at a pre-fixed tariff that ensures a real US dollar based return.

As per our working, the floor price of PRs15 offers a real USD IRR of 20% over the remaining 15 years of PPA. As such, the stock particularly appeals to investors who favor inexpensive, highly yielding stocks.

Our DDM target price of the stock at 15.2% PKR discount rate is PRs23.5. At floor price, Lalpir screens extremely attractive on PE, EV/EBITDA, dividend yield and EV/MW in domestic IPP space.

Financial Statements – December Year End (PRs mn)

2012a 2013e 2014e 2015eIncome Statement Revenue 32,907 33,445 34,235 35,379 Operating Profit 2,328 2,328 2,312 2,322 EBITDA 2,811 2,836 2,928 2,950 EBIT 2,444 2,394 2,378 2,388 Earnings Before Taxes 1,446 1,136 864 1,167 Net Profit 1,446 1,136 864 1,167 Balance Sheet Total Book Value 12,205 12,777 12,864 13,156 Net Fixed Assets 8,394 8,224 10,844 10,619 Net Current Assets 3,824 4,567 4,784 3,468 Net Total Assets 12,205 12,777 12,864 13,156 Net Debt 8,752 7,572 9,199 6,931Cash Flow Statement Profit After Taxes 1,446 1,136 864 1,167 CF from Operations 1,642 1,215 1,316 3,001 CF from Investment (889) (272) (3,171) (337)CF from Financing (1,208) (564) 1,972 (2,708)Net Cash Flow (456) 380 117 (44)Closing Balance 686 1,065 1,183 1,138 Source: Lalpir, FCEL estimates

Key Data

Floor Price Offer size (mn) / Shares (mn) Mkt Cap (mn) / Shares (mn) Offer Mode Book building dates

PRs15.0 US$5.75 / 37.98 US$58 / 379.8 Price discovery 18-19 June, 2013

Major Shareholders

Nishat Mills 32% Stanhope Investments (Cayman Islands) 30% Engen (Private) Limited 20%

Valuation (based on Floor Price)

2012a 2013e 2014e 2015e

EPS 3.8 3.0 2.3 3.1

DPS 2.8 2.4 2.1 2.3

BVPS 32.1 33.6 33.9 34.6

P/E (x) 3.9 5.0 6.6 4.9

Div. Yield (%) 18.7% 16.0% 13.7% 15.3%

P/BV (x) 0.47 0.45 0.44 0.43

EV/EBITDA (x) 4.72 5.25 4.31 3.56

Ratios and Key Forecast Drivers

2012a 2013e 2014e 2015e

Revenue Growth 10.4% 1.6% 2.8% 3.8%

ROCE 20.0% 18.7% 15.2% 16.9%

ROE 11.9% 8.9% 6.7% 8.9%

ROA 6.3% 5.0% 3.6% 5.3%

EBITDA Margin 7.4% 7.2% 6.9% 6.7%

EBIT Margin 7.4% 7.2% 6.9% 6.7%

Pre tax margin 4.4% 3.4% 2.5% 3.3%

Net Debt / Equity (x) 71.7% 59.3% 71.5% 52.7%

Faraz Farooq June 17, 2013

First Capital Research

First Capital Equities Limited 4th Floor, Lakson Square Building No.1, Sarwar Shaheed Road, Karachi. Ph: (92-21) 111-226-226 Fax: (92-21) 35686682

Lalpir Power Limited June 17, 2013

About the company

Lalpir Power Limited [formerly AES Lai Pir (Private) Limited] was incorporated in Pakistan on May 8, 1994 under the Companies Ordinance, 1984 as an unlimited company by AES Corporation, USA. The principal activities of the company include ownership, operation and maintenance of the power plant. The company is managed through agreements with WAPDA, Government of Pakistan (GoP) & fuel supplier, PSO. Located in Mahmood Kot, Muzaffargarh district, Punjab, Lalpir has an installed capacity of 362MW. It is an oil-fired power plant: it uses residual furnace oil for power generation. A power purchase agreement (PPA) was executed between WAPDA and Lalpir on November 3, 1994, for a period of 30 years. In 2010, Lalpir Power (formerly AES Lalpir) was acquired by a consortium of Nishat Mills, Adamjee Insurance Company, Security General Insurance, Mian Hassan Mansha, Engen (Private) Limited and Stanhope Investments (Cayman Islands) of Abu Dhabi Investment Council.

Power Purchase Agreement (PPA) with WAPDA

In theory, the tariff structure of every IPP in Pakistan is such that its shareholders are guaranteed a fixed return, assuming they meet certain conditions set in power purchase agreement (PPA) with WAPDA. Under the PPA, WAPDA has the right to purchase electricity from Lalpir up to the Net Capacity of the Plant. WAPDA has an obligation to pay Lalpir for Net Capacity made available for electrical energy delivered in accordance with a tariff formula specified in the PPA.

The tariff has two parts a) Capacity Payments (Capacity Purchase Price - CPP) and b) Energy Payments (Energy Purchase Price - EPP).

Tariff = Capacity Payments (CPP) + Energy Payments (EPP)

Capacity Payments are the fixed component of tariff with further two components: Escalable and Non- Escalable. Escalable portion covers the fixed cost and an implicit return (shareholder’s return and fixed Operational & Maintenance costs) whereas non-escalable portion covers the principal payment and interest payment on debt.

Energy Payments are the variable tariff component, designed to cover fuel and variable O&M costs. Interestingly, if WAPDA decreases its electricity off-take from Lalpir, the company’s fixed costs, shareholder’s return and principal & interest payments would still be covered through the CPP, thereby, ensuring the stable dividend stream for the investors. That said, from a shareholder’s perspective, the most important tariff component is the escalable portion of the CPP, as it contains investors’ return.

Investment case

Guaranteed revenues & cashflows

The aspect of business risk is associated with the selling price and volume sold. The Power Purchase Agreement (PPA) covers Lalpir against both of these risks for the 30-year term of PPA. PPA guarantees a minimum off-take of 60% of the effective capacity of 350MW (dependable capacity). Although paid in rupees, the tariff is based on a calculation in US dollar. It provides full devaluation and inflation hedging, allowing for an increase in the tariff to offset the increase in variable cost, thereby, protecting against margin being squeezed as a result of cost increases. Since profit element is also index to the same the result is that the nominal profits from the company are deemed to get a kicker from these elements. This safeguards the real return for the project. Even if the plant is not dispatched, the

Lalpir Power: Key sponsors Nishat Mills Limited 32% Stanhope Investments 30% Engen (Private) Limited 20% Mian Hassan Mansha 8% Adamjee Insurance Company 8% Security General Insurance 2% Source: Lalpir Power, FCEL Research

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Important MilestonesLetter of Interest (LOI) May 19, 1994Letter of Support (LOS) Jun 22, 1994Financial Close May 16, 1995Commissioning Date Nov 6, 1997Net / Dependable Capacity 350 MWContractual Agreements Implementation Agreement Sep 24, 1994Power Purchase Agreement Nov 3, 1994Fuel Supply Agreement Nov 6, 1994GOP Guarantee May 16, 1995Source: PPIB, FCEL Research

Lalpir Power Limited June 17, 2013

capacity payments will cover the debt service and the return on equity along with other fixed costs. We have assumed 6.1% annualized growth in escalable CPP based on 2.5% US CPI and 3.5% rupee decline.

Hedged against economic turmoil

With its bond-like return characteristics and stable stream of cashflows, Lalpir provides investors a defensive investment option. That said, investors should also sought the safe heaven of IPPs earnings, which tends to be unaffected by an economic mayhem, against the stocks with more volatile earnings streams. Buying Lalpir stock will leave stockholders less vulnerable to underperformance with a plunge in the underlying indices.

The Power Purchase Agreement (PPA) signed with WAPDA and guaranteed by the government embodies a tariff structure made up of the elements subject to adjustments. That said, it has been provided a hedge against devaluation and an increase in input costs by providing indexation of revenue to the US dollar, US inflation and fuel prices. Currency fluctuations should not put additional burden on its cashflows, the rupee earnings should in fact rise.

Counter-party risk set to ease

As a result of sky-high oil prices and the government’s inability to pass on the impact domestically, the energy sector was caught in a severe inter-corporate debt crisis. Liquidity constraints – the result of a receivables build-up – had raised concerns over the certainty of IPP’s future dividends. In Budget FY14, the government has announced to settle the entire circular debt in 60 days. Though, the mechanism was not provided in the budget documents, a detailed resolution program program would be unveiled shortly after the budget session. Resolution of circular debt will significantly reduce the receivable risk for the company, which in turn will improve the certainty of dividends to shareholders. Meanwhile, the government also plans to inflate the electricity tariff to eliminate the power subsidy. This translates into improved WAPDA cashflows that would, in turn, bode well for Lalpir Power, which sells electricity to WAPDA, in terms of timely receipts of CPP. Meanwhile, overdue receivables from WAPDA bring in penalty income equivalent to the State Bank of Pakistan’s discount rate plus 2%. Interestingly, in case of Lalpir Power, the overdue receivables from Wapda is substantially less than other IPPs like Hubco, Kapco and Nishat Power as reflected from the accompanied chart.

Overdue receivables from WAPDA (Dec-2012)

Source: Companies account, FCEL Research

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30%

40%

50%

60%

70%

80%

-10

20

30 40

50 60

70

Lalpir Pakgen NCPL Kapco NPL Hubco

Overdue Receivables/MW (PRs mn)Capacity Utilization

Lalpir Power Limited June 17, 2013

BMR initiative to arrest fuel efficiency losses

Lalpir Power’s fuel efficiency currently stands at 37%. As per PPA, though fuel price is a pass-through item, the company is required to meet a fixed fuel consumption of 229.64 gm/kwh. However, actual fuel consumption varies with the capacity and load factor of the plant thus resulting in loss at lower load factor. The company’s average fuel consumption in CY11 and CY12 arrived at 241.20 gm/kwh and 240.69 gm/kwh which translates into an average fuel efficiency loss of 5.2% from the benchmark PPA efficiency. In order to arrest the fuel efficiency loss due to lower than contractual efficiency, the company has undertaken BMR initiative. In this regard, the company plans to install variable frequency drives to improve the auxiliary load and the heat rate. Furthermore, the replacement of turbine rotar is also planned. That said, the company will incur PRs3bn capex in CY13-14 under the BMR initiative which will be partly financed through the debt and partly through internal cash flow.

Extremely attractive on floor price

Despite tightening liquidity position, Lalpir has not aggressively cut its dividend payout ratio. In CY12, the DPS/EPS ratio was 74% vs. 157% in CY11. Ideally, an IPP should pay out all cash in the form of dividends after accounting for working capital and debt servicing reserves. The eventual resolution of circular debt would increase the payout capacity of the company, we believe. It is pertinent to mention that the counter has airtight agreements that would lead to sovereign default if not adhered to and as such we believe that Lalpir would be one of the last projects that WAPDA would default on.

Floor price of PRs15/share translates into an attractive CY12 dividend yield of 18.8% as against average dividend yield of 9.6% of sample IPPs. Moreover, this also compares favorably with the KSE-100 dividend yield of 5.1%.

IPO - Valuation PKGN Lalpir

No of shares (mn) 372 380

Offer size 10% 10%

Gross Capacity (MW) 365 362

EPS (PRs) - CY12 5.5 3.8

DPS (PRs) - CY12 3.0 2.8

BVPS (Dec- 2012) 37.6 32.1

Offer Px / Floor Px 19.0 15.0

Dividend yield (%) 16% 19%

PE (x) 3.5 3.9

PBv (x) 0.5 0.5

Current Mkt. Price 25.8 NA

Price gain 36% NA

Source: KSE, FCEL Research

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Relative Valuation

Sample Power Companies - CY12 NPL NCPL PKGN Kapco Hubco

No of shares (mn) 354 367 372 880 1,157

Gross Capacity (MW) 200 200 365 1,600 1,418

EPS (PRs) 5.8 5.5 5.5 6.9 7.1

DPS (PRs) 2.0 3.5 3.0 6.9 6.0

Payout ratio (%) 35% 63% 55% 100% 85%

BV (PRs/share) 20.3 16.3 37.6 26.9 26.6

Price (PRs/share) - June 17, 2013 34.0 33.5 25.8 65.0 62.1

Dividend yield (%) 6% 10% 12% 11% 10%

PE (x) 5.9 6.1 4.7 9.4 8.8

PBv (x) 1.7 2.1 0.7 2.4 2.3

EV/MW (PRs mn) 161 170 50 80 174

Sample Lalpir Spread/Discount

Avg dividend yield (%) 9.6% 18.8% 9.1%

Avg PE (x) 7.0 3.9 -44%

Avg PBv (x) 1.8 0.5 -75%

Avg EV/MW (PRs mn) 127 40 -69%

Source: Company data, KSE, FCEL Research

Kot Addu Power Limited January 04, 2013

Additionally, Lalpir power appears attractive on PE, PBv and EV/MW. Based on 2012 numbers, PE and PBV of Lalpir Power at floor price arrived at 3.9x and 0.5x, respectively. This puts the counter at a respective discount of 44% and 75% to average PE and PBv of the sector for the said year. Interestingly, based on the floor price, Lalpir’s remaining dividend stream offers a lucrative US$ IRR of 20% versus that of 11% of Hubco and 10% of Kapco.

DDM based fair value of PRs23.5/share

Keeping in view the fairly certain dividend stream and a limited project life, we believe dividend discount model (DDM) is an ideal method to value the Lalpir stock. We have used a Required Rate of Return (RRR) of 15.2% to discount future dividends. For RRR, we have applied the Capital Asset Pricing Model (CAPM) to arrive at the benchmark discount rate. RRR calculation is provided below:

Ideally, a lower risk premium should be incorporated while valuing IPPs due to the fact that these projects have been guaranteed a tariff rate which has a profit element built into it and as such there is no significant risk to earnings. However, IPPs’ underlying earnings have been disturbed by the circular debt crisis. That is why, we have used the benchmark risk premium to value Lalpir. Our target price of PRs23.5/share is aggregate PV of the following two components:

PV of dividend stream: Using 15.2% RRR on the rupee nominal dividend stream, indexed with a 2.5% US CPI and a 3.5% Pakistani rupee decline, the PV arrives at PRs20.8/share. It may be noted that Lalpir’s fair value is highly sensitive to currency fluctuations. In fact, a 1% devaluation of the Pak Pakistani rupee translates into a fair value increase of 4%.

FCEL 5

Dividend Discount Model – Year end December Forecasted year (PRs/share) CY13 CY14 CY15 CY16 CY17 CY18 Dividends 2.4 2.1 2.3 2.4 2.7 2.8 Discount Rate (%) using CAPM 15.2% Present Value of Dividend Stream 2.2 1.6 1.6 1.4 1.4 1.3 Cumulative PV of Dividend Stream 9.6 PV of Dividend Stream (CY19-27) 11.2 Cumulative PV of dividend 20.8 Add: PV of Terminal 2.7 Total PV 23.5 Source: FCEL Research

Capital Asset Pricing Model (CAPM) Ke = Rf + ß (Rm – Rf) where: Ke = Required rate of Return on the stock Rf = Risk free rate of Return Rm = Required rate of Return on the market ß = Beta, the volatility stock with respect to market Rf (%) 11% Current yield on 10-year government bond Rm (%) 6% Benchmark risk premium ß 0.7 Sector average based on Bloomberg Ke 15.2%

Lalpir Power Limited June 17, 2013

Terminal value: Applying a discount of 35% on the projected terminal value of PRs32.8/share at the end of project life (CY27), our terminal value for valuation purpose comes out at PRs21.3/share. While the IPPs are generally recognized as amortizing bond, these projects usually have significant terminal values. The PV of terminal value at 15.2% discount rate arrives at PRs2.7/share.

Concerns & Risks

Like other IPPs, Lalpirs’s underlying earnings and cashflows have been negatively affected by the presence of inert corporate debt in the energy sector. Recall that GOP guarantees the payment to Lalpir’s dues in case of WAPDA’s failures to do so. In addition, the GOP guarantees protection against specified ‘political risks’. We have assumed a gradual improvement in the circular debt situation post CY13. While the shareholders are guaranteed a fixed return insulated from currency devaluation and inflation, further deterioration in the circular debt position would cause liquidity constraints, thereby, affecting the dividend profile.

The cashflows stream of the company is highly sensitive to currency fluctuations and CPI movement. A 1% change US CPI translates into a 4% variation in the PO. Likewise, a 1% Pakistani rupee decline against the US$ causes 4% change in the PO.

Given its bond like characteristics, the rising interest rate scenario (increase in discount rate and NSS yield) reduces the attractiveness of Lalpir. A 1pps change in RRR affects the fair value by 6%.

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US CPI

1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 2.5% 19.5 20.4 21.4 22.4 23.5 24.6 25.7 27.0 3.0% 19.9 20.9 21.9 22.9 24.0 25.2 26.4 27.7 3.5% 20.3 21.3 22.4 23.5 24.6 25.9 27.2 28.5 4.0% 20.7 21.7 22.9 24.0 25.3 26.6 27.9 29.3

PR

s D

evaluation 4.5% 21.1 22.2 23.4 24.7 26.0 27.3 28.7 30.2

Lalpir Power Limited June 17, 2013

ANNEXURE - PROCEDURE FOR BIDDING

(Excerpts from the company provided information) “The Joint Lead Managers & Joint Book Runners, with the consent of Offerers, set a floor price which is the lowest price an investor can bid at. An order book of bids from investors is maintained by the Joint Book Runners, which is then used to determine the strike price through the “Dutch Auction Method”. Under the Dutch Auction Method, the strike price is determined by lowering the price to the extent that the total number of shares that the Offerer intends to offer through the Book Building process is subscribed. However, while determining the strike price the bids placed through strike order shall not be taken into consideration.” “The bidding period shall remain open for 2 working days commencing from the business hours at 09:00 a.m. on 18th June, 2013 and will close at 05:00 p.m. on 19th June, 2013 at the close of business hours.” “Bids can be placed at ‘limit price’, ‘strike order’ or ‘step bid’.” “Bid money/margin money shall be deposited through demand draft, pay order or cheque in favor of “Offer for Sale of shares of Lalpir Power Limited – Book Building Account”.” “Joint Book Runners shall collect an amount of 100% of the application money as bid money in respect of bids placed by HNWIs.” “Joint Book Runners shall collect an amount of not less than 25% of the application money as margin money in respect of bids placed by institutional investors”. “The Offerers and Joint Book Runners shall not accept bids from associated persons of the Offerers and the Company in excess of five percent (5%) of the size of the book building portion.” “Bidders can revise or withdraw their bids during the bidding period”. “At the close of the bidding period, the Joint Book Runners shall determine the strike price with the consent of the Offerer.” “Successful bidders shall be intimated, within two (2) working days of the closing of the bidding period, the strike price and the number of shares provisionally allotted to each of them.” “The successful institutional bidders shall, within seven (7) working days of the closing of the bidding period, deposit the balance amount as consideration against allotment of shares.” “Margin money of unsuccessful bidders will be refunded within three (3) working days of the close of the bidding period.” “If investors are placing their bids through “limit price” then they shall deposit the margin money based on the number of shares they are bidding for at their stated bid price.” “If investors are placing a “strike order”, then they shall deposit the margin money/bid amount equal to the product of the number of shares they are bidding for and the Floor Price which in this case is PKR 15 per share.” “If investors are placing a “step bid”, which is a series of limit bids at increasing prices, then they shall deposit the margin money/bid money based on the total number of shares they are bidding for at their stated bid prices.” “The bidders shall have the right to revise their bids any time during the bidding period up to 5.00 pm and on the last day till 07:00 pm. Online revision of the bids may be allowed to the bidders through system software. This will however be subject to the condition that the bidder shall comply with the requirements of bidding as disclosed under Appendix 4 of the Listing Regulations and any other condition or procedure disclosed in the OFSD.”

FCEL 7

Lalpir Power Limited June 17, 2013

Pakistan Contact Information

Mian Ehsan-ul-Huq (CEO) ceo@firstcapital.com.pk

Pakistan Research Team

Faraz Farooq faraz.farooq@firstcapital.com.pk Abrar Hussain abrar.hussain@firstcapital.com.pk Muhammad Rehan Khan rehan.khan@firstcapital.com.pk Hayat Khan hayatkhan@firstcapital.com.pk

Pakistan Sales Team

Farooq Habib (COO) farooq.habib@firstcapital.com.pk Muhammad Junaid (ED) muhammad.junaid@firstcapital.com.pk Hamid Siddiqui hamid.siddiqui@firstcapital.com.pk Shahood Javed shahood.javed@firstcapital.com.pk Neelam Naz neelam.naz@firstcapital.com.pk Moiz Khan moiz.khan@firstcapital.com.pk

North American Sales Partner

25 West 45th Street New York, NY 10036 USA Www.agco.com

Published by

First Capital Equities Limited

4th Floor, Lakson Square Building No.1, Sarwar Shaheed Road, Karachi Ph: (92-21) 111-226-226 Fax: (92-21) 35656710 http://www.firstcapital.com.pk

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