In a significant development, HUBC has reportedly offered the federal government to buy out 100% stake in Hub Base Plant (gross capacity: 1,292MW) – for PKR65bn (or PKR50/sh). Meanwhile, the power purchase agreement (PPA) of the plant is due to expire in 2027, says a reported of Intermarket Securities Limited. The counter proposal from the government entails that the amount will be approved given the following contingencies:
HUBC has to convert two of the four units of Hub Base plant (2x330MW) from furnace oil boilers to ones based on Thar coal, and
Use the remaining funds to install a water desalination plant to provide 300mn gallons daily water to Karachi (or 50% of the city’s requirement).
From the government’s standpoint, the payment of PKR65bn would effectively eliminate the future capacity payment liability by about PKR260bn – due over the seven remaining years of the PPA.
Conversions may not be value accretive for HUBC…
The decision to offload the stake comes at a time when expensive furnace oil-based plants are substantially underutilized in Pakistan (Hub Base plant operated at 0.34% load factor in FY20). We evaluate the offer with the following metrics:
Based on future FCF or dividends, the Base plant contributes c.PKR53/sh to our SOTP based target price of PKR125/sh for HUBC; which makes the price tag of PKR50/sh (or PKR65bn) for the Base plant seem reasonable, in our view.
Alternatively, the sum of HUBC’s existing book value (PKR46bn as at Sep’20) and the present value of future dividends due from the Base plant until 2027 (discounted at 16.5% CoE) leads to a fair value of PKR61bn. This is similar to the PKR65bn proposed by the company, again suggesting that the offer is reasonable.
However, our back-of-the-envelope calculation suggests that the returns, from the conversion to coal-based plants plus a water desalination unit, will not match the potential profits from the Base plant over the next seven years. Hence, the cost of conversion is not commensurate with the PKR65bn liquidity being provided and would require additional financing for the conversion projects by HUBC, in our view.
…but the offer is a reasonable solution under the present circumstances
The immediate payment of PKR65bn would serve as an effective exit strategy for the cash-strapped IPP, bearing in mind the (i) uncertainty of its future cash-flows given ballooning circular debt (system-wide debt balance reportedly over PKR2.3tn), (ii) underutilization of FO based plants, and (iii) upcoming expiry of the Base plant’s Generation License in 2025 and PPA in 2027. The cash influx (without the contingencies) could ensure minimal cuts in future dividends from HUBC’s growth projects and ensure fulfilment of terms under existing debt covenants to lenders. However, we reiterate that deploying the money in the required conversion projects would not be value accretive, in our view.
It is pertinent to mention that HUBC has already inked an MoU with K-Electric for 600MW power supply. This would ensure more reliable and timely payments by the customer (KEL) vs. piecemeal payments from state-owned NTDC.
What about the overdue receivables?
It becomes uncertain what the government’s position would be on the outstanding overdue receivables (PKR70.7bn as at Sep’20) of the base plant, if this offer were to materialize. While HUBC has signed a MoU with the government to convert the existing plant to a take-and-pay arrangement, the settlement of overdue receivables remains unfinished business.
Further clarity is awaited, where our outlook remains intact
HUBC management team will now respond to the government on this counter-proposal on Monday (7 December 2020). At present, we have a Buy rating on HUBC with a June 2021 TP of PKR125/sh.