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Inter RAO - why is the equity cheap with high forecasts from analysts?

May 21, 2020, 03:55 PM • ☕️ 5 min read

Tags:IRAOElectrisityGenerationDividendsStrategy

Translations: EnglishРусский

Recently, shares of PJSC Inter RAO have been trading sideways 4.5-5.0 rubles per share with a median fair value (market analysts’ forecasts) of 8.15 rubles per share, which 64.5% higher than the current market price of shares - 4.95 rubles.

What is the reason for the high underestimation of the shares of PJSC Inter RAO by the market and why has it persisted for more than two years?

In the article the consensus forecasts of market analysts and the potential upsdie on Russian stocks on May 20, 2020 were updated. One of the leaders on the upside is PJSC Inter RAO …

PJSC Inter RAO is one of the main representatives of the generation sector in Russia, which owns 18 assets in electricity generation, 6 assets in heat generation, 6 foreign assets in generation, as well as companies in the transmission (network) of electricity and distribution.

Almost 70% of EBITDA of the company is generation in the Russian Federation, 18% are sales companies and the remaining 12% are trading and foreign assets. PJSC Inter RAO accounts for approximately 16% of the wholesale electricity sales market. Among the main competitors are Enel Russia, Unipro, SUEK, T plus, Eurosibenergo, RusHydro. The company’s strategy and its main strategic priorities until 2020 are presented on the official site.

The company’s business is stable and has reached a plateau at which historical growth is no more than 5% y / y, therefore, in the past few years, the company has shown stable performance in terms of revenue, operating and net profit.

Projects in the field of DPM-2 (agreement on the provision of capacity) are of interest, according to which the generating company carries out modernization (reconstruction) of capacities (various thermal power plants, hydroelectric power stations) at its own expense (capital costs), and then receives a refund through increased tariffs for consumers. At the same time, the initial return of funds was forecasted at 12% as the yield on OFZs in the region of 7.5% + spread of 4-4.5%. According to article of Vedomosti of September 2019, Inter RAO won the competition for most of the projects for PDM-2, which was generally positively received by the market, as this means an increase in cash flows in the long run. However, there are risks.

It can be seen from the graph that the stocks were in a long sideways until April 2019, when they reached 3.6 rubles / share. After that, information about holding contests for DPM-2 began to appear in the media and markets it was forecasted to receive most of the projects of PJSC Inter RAO. Then the shares for 2-3 months before the end of June rose by 40%, reaching a price of 5.05 rubles. This was also accompanied by the expectation of dividend payments.

Share dynamics of PJSC Inter RAO

Share dynamics of PJSC Inter RAO

After the dividend cutoff, the shares started to roll back down to 4.0 rubles, however, after the approval of projects and companies at DPM-2, the shares made a breakthrough again within a month - the price of shares rose 25%. The phenomenal growth continued shares along with the Moscow Stock Exchange Index until the end of February - up to 6.5 rubles per share (another + 32%). Now the stock has returned almost to the summer level of 2019 and costs less than 5.0 rubles.

Is this an interesting moment to enter a stock?

On the one hand, up to February highs - 30% (6.5 rubles per share) and there is a possibility of growth, since the paper has not won back the fall. However, the main fundamental factor of growth in 2019-2020. the new Strategy of the company and the expectation of a change in the dividend policy of the company were to become. But these factors are unlikely to be realized before the fall-winter of 2020, since PJSC Inter RAO has already postponed the consideration of the Strategy by the Board of Directors for the 3rd quarter of 2020. At the same time, a dividend policy is usually adopted after the approval of the Strategy, and therefore rather no earlier than the winter of 2020-2021.

Now the company pays very few dividends - 25% of IFRS net profit. In 2018, the company paid 0.1304 rubles per share (3.6% dividend yield), in 2019 - 0.1716 rubles per share (4.4% dividend yield), in 2020 a recommendation of 0.1962 rubles per share (3.7% dividend yield). These returns are not only 2-3 times lower than their peers (Unipro, Enel Russia, Rosseti), but also lower than OFZs, which is of no interest in terms of dividends. Switching to payments of 50% of net profit under IFRS could greatly strengthen the company’s position - dividend yield of 7.5% -8.0% at the level of the best market practices in the electric power industry. But while the company does not announce a change in dividend policy, it prefers to circumvent this issue in quarterly conference calls until the Strategy is approved.

PJSC Inter RAO strictly adheres to its dividend policy. Therefore, if it is simplified to calculate the fair value of a share from the current level of payments of 0.1962 rubles per share, return on equity of 12% in rubles and average business growth of 5-6%, then the fair value of the share will be 2.95-3.45 rubles per share, which is 30-50% lower than current levels. That is, there is no growth potential.

Additionally, you can evaluate the company using the DCF method, taking as a basis the IFRS results for 2019 and excluding the coronovirus factor. Then it turns out that the fair value of the shares, taking into account the growth of the entire business, will be about 5.5-5.8 rubles per share, which gives a growth potential of a maximum of 10-15% from the current level.

Why, in the end, analysts predict a fair share price of 8-10 rubles in recent years and why is it not achieved, as for other companies?

  1. The lack of a new Strategy, which could become a trigger for growth.
  2. Weak dividend policy, which lags behind other companies. With payouts up to 50% of the base, the fair value of a share can increase to 6-7 rubles per share.
  3. A company with state participation and the presence of foreign assets is undoubtedly a risk for foreign investors.
  4. The decrease in OFZ yield by 1.5-2.0 percentage points, which leads to a decrease in profitability from the implementation of DPM-2.

The article is not an individual investment recommendation: everyone makes a decision based on their own risk level and forecasts regarding the future potential of the company.