KEP - Korea Electric Power: Still Bullish Considering Improved Outlook

2023-08-03 10:39:09 ET

Summary

• Korea Electric Power's Q2 2023 performance is expected to be better as compared to the first quarter, considering an electricity tariff hike and lower purchased power costs.
• KEP's high financial leverage isn't a major concern, taking into account Fitch's credit rating, its debt maturity profile, and asset monetization plans.
• I leave my Buy rating for Korea Electric Power unchanged, after assessing KEP's financial outlook and its credit risks.

Elevator Pitch

I still rate Korea Electric Power Corporation ( KEP ) [015760:KS] stock as a Buy. My earlier May 23, 2023 article was focused on the review of KEP's Q1 2023 key metrics and the company's new restructuring proposal.

In this latest write-up, I come to the conclusion that Korea Electric Power's near-term prospects are becoming better, and I also highlight why I think that KEP's high headline financial leverage is not a substantial concern. As such, I keep my Buy rating for Korea Electric Power intact.

Korea Electric Power's Outlook Has Turned More Favorable

There are various indicators which suggests that Korea Electric Power's prospects have improved significantly.

A June 27, 2023 Seeking Alpha News article mentioned that the "May (2023) wholesale power price, at which Kepco (Korea Electric Power) purchases electricity from private power suppliers, fell below the retail price for the first time in 19 months."

Purchased power costs accounted for 56% of Korea Electric Power's top line in the first quarter of 2023, making this the largest expense line item for KEP, as indicated in the company's Q1 2023 results presentation . As such, it is realistic to expect that Korea Electric Power's purchased power costs in Q2 2023 might turn out to be lower as compared to Q1 2023. As a reference, KEP's purchased power costs grew by +15.0% YoY in the first quarter of this year.

Separately, KEP's revenue for the second quarter of the current year is expected to be boosted by higher electricity prices.

An earlier mid-May news report published by The Korea Herald indicated that South Korea will "jack up the electricity rates for consumer and industrial use by 8 won ($0.01) per kilowatt hour" in Q2 2023. In comparison, a relatively smaller electricity tariff hike of +KRW4.9 per kWh was imposed for the second quarter of 2022. This implies that Korea Electric Power's actual Q2 2023 top line expansion might be on par with or even stronger than the +15.6% YoY revenue growth (in local currency or Korean won terms) that KEP registered in Q2 2022.

Another indicator that is worth watching is the change in the sell-side analysts' consensus financial projections for Korea Electric Power. Based on data sourced from S&P Capital IQ , KEP's consensus fiscal 2023 top line was raised from KRW81.2 trillion at the end of last year to KRW86.4 trillion now. During the same time period, the company's consensus FY 2023 operating loss estimate was lowered significantly from -KRW12.8 trillion to -KRW7.1 trillion now.

KEP's High Financial Leverage Isn't As Bad As What It Seems

KEP's gross debt-to-equity ratio was pretty high at 3.42 times as of March 31, 2023 as disclosed in its first quarter results presentation. However, I think that Korea Electric Power's credit risk profile isn't as poor as what the headline financial leverage ratio suggests.

Firstly, a key credit ratings agency is sticking with its investment grade credit rating for Korea Electric Power. In its most recent June 19, 2023 report , Fitch Ratings noted that it "has affirmed the 'AA-' Long-Term Issuer Default Ratings (IDRs) and senior unsecured ratings of Korea Electric Power Corporation" on the basis that it expects KEP's "operating performance to gradually improve as energy prices stabilize."

Secondly, Korea Electric Power has limited refinancing risks, and it is less susceptible to further interest rate hikes or fluctuations in foreign exchange rates than most other highly leveraged companies. Based on the company's debt maturity schedule outlined in its Q1 earnings presentation, only about 11% of KEP's total debt is due for repayment this year. Approximately 97% of Korea Electric Power's debt is on fixed rate terms, so that means that future rate hikes won't depress its earnings in a significant manner. Also, 99% of the company's debt is denominated in Korean won, so KEP doesn't have to worry about its (foreign) debt burden growing significantly if the Korean won depreciates against other currencies.

Thirdly, KEP isn't just relying on operating cash flow to pay down its debt. The company continues to explore various avenues to monetize its assets. Local Korean media publication Pulse News previously reported on June 22, 2023 that Korea Electric Power plans to "sell its assets in the Jordanian gas complex and wind power generation projects worth 1.9 trillion won." It is likely that Korea Electric Power will consider divesting more foreign assets, as the company places a greater emphasis on its home market, South Korea, in challenging times.

In a nutshell, things aren't as bad as what they seem on paper, when it comes to Korea Electric Power's financial position. KEP's ability to service its interest payments and repay its debt could improve going forward, as the company's loss narrows and its cash flow improves. Also, it isn't just the absolute amount of debt that matters, as Korea Electric Power's refinancing and interest rate risks are not significant. Lastly, Korea Electric Power has the ability to generate cash flow from asset divestments that can be allocated to debt repayment.

Closing Thoughts

Korea Electric Power's shares are still rated as a Buy. Concerns over KEP's financial leverage are overblown, as I have explained earlier in this article. Also, Korea Electric Power's short-term outlook has turned more favorable. These factors provide support for my Buy investment rating assigned to KEP.

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