KEP - Korea Electric Power: Good Recovery Prospects Justify A Positive Re-Rating

2023-03-09 07:40:08 ET

Summary

• Korea Electric Power is expected to witness a narrowing of losses in 2023, prior to turning profitable in 2024.
• Actions taken by the Korean government like tariff hikes and the SMP cap should enable KEP to achieve a better set of results in the near future.
• I keep my Buy rating for Korea Electric Power, as I expect a positive re-rating of KEP's valuations and share price driven by the company's good recovery prospects.

Elevator Pitch

My investment rating for Korea Electric Power Corporation's ( KEP ) [015760:KS] stock stays as a Buy. I previously touched on KEP's recent developments and potential catalysts with my earlier December 26, 2022 update .

In this latest write-up, my attention turns to Korea Electric Power's recovery prospects. I believe that KEP can return to profitability by 2024 with the support of electricity tariff hikes, and this should eventually drive up the company's share price. This is why I continue to assign a Buy rating to KEP.

Consensus Numbers Point To A Turnaround For KEP In 2023 And Beyond

The sell-side analysts covering Korea Electric Power's shares have become increasingly bullish about the company's financial outlook. Based on data sourced from S&P Capital IQ , KEP's consensus fiscal 2023 net loss per share has been reduced by -13% between December 1, 2022 and March 8, 2023. During this same period, the analysts' consensus prediction of Korea Electric Power's FY 2024 bottom line was changed from a net loss to positive earnings.

Specifically, the sell-side sees KEP's net loss attributable to shareholders narrowing from -KRW24,471 billion in FY 2022 to -KRW8,564 billion for FY 2023, before turning around to generate a net profit attributable to shareholders of +KRW2,378 billion in FY 2024.

In my view, the market's expectations of Korea Electric Power delivering a substantial turnaround in 2023 and beyond are realistic, as explained in greater detail in the next section.

Two Major Factors Support An Improvement In Korea Electric Power's Financial Performance

There are two key tailwinds for Korea Electric Power in the current fiscal year.

Firstly, the System Marginal Price or SMP cap should help to limit the increase in purchased power costs for KEP.

A November 16, 2022 Pulse News Korea article highlighted that Korea's "Ministry of Trade, Industry and Energy will introduce a monthly cap" for "the rate Korea Electric Power Corp. pays to power generators (SMP cap) from Dec. 1" 2022 for three months.

Power purchased costs for Korea Electric Power rose by a significant +94% from KRW21.6 trillion in FY 2022 to KRW41.9 trillion for FY 2023 and accounted for approximately 40% of KEP's total operating expenses last year as indicated in its investor presentation . KEP's power purchased costs for Q1 2023 should be lowered thanks to the SMP cap. Also it is likely that the SMP cap for the company will be extended to subsequent quarters considering its poor FY 2022 performance (-KRW24.5 trillion net losses).

Secondly, KEP is expected to benefit from higher electricity tariffs in 2023.

As per the company's prior December 2022 announcement , Korea Electric Power will raise its overall electricity tariff rate by +KRW13.1 per kWh or +9.5% for the first quarter of the current year.

Earlier, the electricity tariff rates for KEP were increased by between +KRW7.4 per kWh and +16.6 per kWh in the final quarter of the previous year.

It is highly probable that there will be further electricity tariff hikes for Korea Electric Power in the subsequent quarter of 2023.

A March 2023 opinion piece published in The Korea Times cited "officials" mentioning that "the (Korean) government can no longer check the increase of the utility charges" to prevent KEP from running into "a snowballing deficit." Separately, KEP noted at the company's most recent Q4 2022 results briefing (transcript and audio recording not publicly available) in late-February 2023 that it is "going to make efforts to rationalize the electricity tariff system in a phased manner."

KEP's Shares Have Meaningful Capital Appreciation Upside Potential

According to the consensus sell-side price target data taken from S&P Capital IQ , the South Korean analysts think that Korea Electric Power's stock price should be +27.5% higher compared to where it is currently trading at. This level of upside warrants a Buy rating for KEP.

I think that the +27.5% capital appreciation upside potential for Korea Electric Power's shares as estimated by analysts is pretty reasonable. The current consensus sell-side target price for KEP translates into a trailing price-to-book valuation multiple of 0.30 times and a normalized P/E ratio of 7.3 times (assume that it returns to its prior level of profitability in FY 2020).

Korea Electric Power's share price has dropped by -30% in the past one year on fears of dilutive fund raising or even bankruptcy. Recent developments such as the SMP cap and electricity tariff hikes suggesting that the Korean government won't allow KEP's losses to widen further and get into serious financial trouble. Korea Electric Power is 51% (source: investor presentation) owned by the Korean government, and it is the "largest electricity utility" in the country as indicated on the company's profile on social media platforms. It won't be an exaggeration to say that KEP is "too big to fail."

As KEP's losses narrow in the quarters ahead, I expect Korea Electric Power's stock price to rise going forward.

Closing Thoughts

Korea Electric Power's valuations and business outlook justify a Buy rating for the stock. I expect the announcement of further electricity tariff hikes and narrowing losses in the quarters ahead to be the major re-rating catalysts for KEP.

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