Electricity

The Ukrainian electricity generating company Zakhidenergo [ZAEN UZ] won access to a 100 MW power export capacity for the year 2010 through the very first auction to be held for access to electricity exports from Ukraine. As a result, now the Company will be able to sell part of its power directly to foreign clients. The auction itself signifies the liberalization of Ukrainian electricity exports and constitutes a driver for the entire power generating sector.

Finding itself in a situation characterized by a fiscal deficit and a deteriorating economic situation, both in Ukraine and worldwide, the Ukrainian Government decided to resume the privatization of large state-owned property in 2009, including the privatization of power distributing companies (oblenergos). On March 18 and April 1, 2009, Ukraine’s State Property Fund announced the auction for privatizing the blocking package of six electricity distribution companies. The auctions are scheduled on April-May 2009.

The energy sector in Ukraine is one of the country’s great assets. A country with a population of 47 mln and heavy industries generates significant demand for electricity. Currently there are 27 major electricity distribution companies (oblenergos) in Ukraine, 20 of which are public. This enables equity investors to play the Ukrainian electricity distribution sector on the stock market and gain benefits from the ongoing changes in the sector. The Ukrainian electricity distribution sector is one of the hottest on the stock market. After growing 208% YoY, on average, in 2007, the cumulative MCap of electricity distribution companies fell 90% YoY in 2008. Considerably low prices suggest that equities can be acquired for a penny; however, high spreads and low liquidity suggest that the investments should be held for a long time.

Ukrainian thermal generation companies are industrial giants traded on PFTS. Built in the late 1960s, they have supplied electricity not only in Ukraine but to bordering countries as well. Reforms of the 1990s presented new challenges while, at the same time, opening up new prospects: the announced electricity sector reform, privatization of electricity companies, and possible export liberalization raise questions that need to be answered.

The diarchy in the State Property Fund (SPF), created by the confrontation between the president and the prime minister, created grounds to question the legitimacy of the privatization that made Energy Standard group, one of the rival shareholders in 5 out of 6 oblenergos, refuse to participate until the government clears all political and judicial issues tied to privatization.

The privatization process in the electricity sector, insisted on by the current government, has revealed the existing corporate conflicts among leading Ukrainian business groups. These conflicts were mainly to blame for the failed AGMs at Centrenergo, Dniproenergo, Krymenergo, Volynoblenergo, etc. On March 28, 2008, Kyivenergo [KIEN UZ] failed to hold an AGM for the same reason.We believe these conflicts will have no substantial influence on the current operational activity of the companies and therefore reiterate our BUY recommendation for Kyivenergo, with a target price currently under review.

The Ukrainian electricity industry is going through the process of modernization and reform. Planned privatization of electricity companies and the ongoing industry reform, coupled with possible export liberalization, opens new perspectives for the companies in the sector. Once the current “cost plus” tariff calculation method is changed to a more economically sound RAB-based method, we expect the sector to be revaluated, creating new investment opportunities.

Khersonoblenergo [HOEN] is one of Ukrainian electricity distribution companies where privatization is already completed. Almost 95% of the company is owned by Czech energy company – VS Energy, affiliated to Russian businessman Alexander Babakov. As the company already shows better than average operational indicators, it is currently aimed at improving its financial transparency via restructuring its long term debt and bad debt write offs. Based on the replacement cost valuation method we value HOEN at USD 6.23 per share and recommend BUYing with current upside of 125%.

Chernivtsioblenergo, is one of the few oblenergos left with high rate of electricity losses in the grids. However, the company is successfully reducing these losses through replacement of old electricity meters and increasing modernization investments: from 34% of electricity losses in 2005 to 22% in 2007. With household consumers share strongly dominating the clientele base of the company we view the company as a better play against large industrial based oblenergos.

Khmelnitskoblenergo [HMON] is one of Ukrainian electricity distribution companies where privatization is yet to come, with the state currently holding a 70% stake. The upcoming privatization of electricity companies, announced in summer 2007, foresees reducing the state share to 60% through selling 10% of HMON through open auctions. This will positively influence the stock as privatization will increase current free float and the liquidity of the stock.