We update our estimates for HUBC and maintain our Buy rating with a revised TP of PKR140/sh. Our liking is based on coal capacity addition and increasing dividend payouts. Potential reduction in circular debt buildup, on the IMF’s push, can be an added trigger. HUBC paid out PKR30/sh in FY23 due to one-offs (83% payout). We expect DPS of PKR18 in FY24f and a gradual improvement towards 50% payout as newly incorporated coal plants achieve the Project Completion Date. The settlement of HUBC’s base plant upon its PPA expiry in Mar’27 can also generate high one-off cash flows.
HUBC offers a 1yr dividend yield of c 20% which does not stack up very well against the current 22% policy rate. That said, domestic interest rates are already at all-time highs and expected to come off in 2024. As interest rates normalize and HUBC looks to maximize payouts, the recurring dividend yield appears quite lucrative.
Capacity additions bearing fruit
With the base plant’s PPA expiring in 2027, HUBC initiated several coal power plant projects under the CPEC umbrella with ROE up to c 30% over the investment coupled with exchange rate indexation. All these projects are now commercially operational and contributing to HUBC’s earnings (net generation capacity is about 3,300MW i.e. 8%+ of Pakistan’s dependable generation). Dividend from these high earning projects should start soon, subject to achieving PCD. In addition, HUBC has also diversified its portfolio by entering into mining and oil & gas businesses. We expect HUBC to deliver a consolidated 3yr EPS CAGR of 7% (FY23-FY26f), despite a high base as earnings more than doubled in FY23.
Payout to gradually increase
HUBC paid out more than 90% of its earnings (2015-2018) before it embarked on an expansion phase which, together with circular debt buildup, resulted in payouts being missed in 2019 and 2020. With the government releasing payments to IPPs following tariff negotiation, HUBC was able to lift its payout to 83% in FY23. We expect HUBC to sustain a 35-40% payout over the medium-term, especially after its Thar coal plants declare PCD. There is potential for positive surprises in the middle, especially when the base plant’s PPA expires. As a result, while the 1yr forward dividend yield of 20% does not look particularly attractive when compared to the current policy rate, it will start to look good again as domestic interest rates normalize and as management maximizes payouts.
Energy reforms will come
Rising capacity payments amid lower generation, lack of investment in transmission lines, elevated losses of distribution companies and higher non-recoveries have lifted circular debt to PKR2,310bn (2.7% of GDP). The ongoing IMF SBA programme is understandably short on structural reforms given it is a stop-gap arrangement until Pakistan enters into a new longer EFF programme. However, even the SBA pushes energy reforms and this is likely to be a priority area for Pakistan going forward. We believe some steps that may come through to address this issue include privatization of distribution companies to control power theft, timely tariff revision, and discontinuation of unbudgeted subsidies.
HUBC is Pakistan’s best all-round energy sector exposure
HUBC has strategically diversified its operations into multiple sectors within the energy industry, notably in mining through its JV in Sindh Engro Coal Mining Company (SECMC) and in the oil & gas sector with Prime Oil and Gas (ex-Eni assets). This diversification is expected to significantly expand HUBC’s presence in the energy sector, and enable it to stand out against peers.
Courtesy – IMS Research