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Utilities outlook

Energising investors in 2019

We update our DCF-derived TPs and ratings for the utility stocks under our coverage, downgrading Mosenergo to HOLD (from Buy), while upgrading RusHydro to BUY (from Hold), leaving other ratings unchanged. Although market sentiment in 2018 weakened towards the sector, we believe important milestones in 2019 could result in improved investor perception of the utility names under our coverage.

Sector fundamentals remain strong…

We believe Russia’s generation companies (Gencos) boast sustainable balance sheet strength, as we forecast solid FCF generation during the upcoming modernisation period, with high FCF yields averaging 20% in 2018-2022E. We expect the Gencos under coverage (excluding RusHydro) to enter a new modernisation capex cycle, starting from 2021, with a consolidated cash position exceeding their total required modernisation capex

…but market sentiment has been poor

However, the market continues to overlook this fundamental strength, in our view, as the government is yet to approve the final modernisation plan, the regulator has not yet carried out the first round of modernisation and capacity auctions (KOM), and conservative dividend policies are still in place at InterRAO and Gazprom Gencos. These factors weighed on the stocks in 2018, we believe, despite stronger electricity market fundamentals last year.

Important milestones in 2019 could lift sector valuation

We expect modernisation and KOM auctions to be carried out in 1H19, while InterRAO should reveal its new five-year strategy in late 2H19. FY18 figures should indicate if lower impairment charges will occur in the future. We also expect a decision on regulatory parameters for Umeme’s licence/concession, as well as possible changes in grid regulation in Russia and more details on Rosseti’s digitisation programme. We believe these developments could clarify future FCF and result in improved investor sentiment towards utility stocks under our coverage.

Reducing TPs for five companies

We update some of our DCF models based on: 1) recently published 9M18 IFRS figures; 2) electricity market dynamics in 4Q18; 3) changes to our macro assumptions for the sector, which influence DPM (capacity supply agreement) tariffs; 4) rolling forward our DCF models by one year; and 5) lowering our dividend payout ratio assumptions for some companies.

We downgrade Mosenergo to HOLD; upgrade RusHydro to BUY

As we struggle to see any short-term triggers and with a lower TP, we downgrade Mosenergo to HOLD. We upgrade RusHydro to BUY, and maintain our other ratings. We believe sector fundamentals are still strong, but do not expect this to filter through to valuations until the results of the modernisation and KOM auctions are known, which should happen in 1H19. InterRAO is still our favoured play in the Russian utility space, despite its unclear strategy regarding its significant cash pile and ‘quasi’ treasury stock.

Sector update

Equity Research 9 January 2019

Utilities

EMEA

Sergey Beiden

+7 (495) 258-7770 x4205 SBeiden@rencap.com

InterRAO

Prices in this report at close 7 January 2019.

Source: Bloomberg, Renaissance Capital estimates

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Contents

Renaissance Capital

9 January 2019

Utilities