Enerjisa Enerji A.S. (ENJSA) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to Enerjisa Second Quarter 2020 Results Conference Call and Webcast. I now hand over the call to Mr. Michael Moser, CFO of the company. Sir, please go ahead.

Thank you very much, and hello, everyone. This is Michael speaking. I hope everyone is healthy and doing well in these crazy times. As you all are aware, the COVID-19 crisis, continues to be the main topic of the year, even for us. Although many countries, including Turkey, have taken significant steps towards normalization, the situation continues to be extraordinary. Turning to Page 3. Let me give you an update on how we experience the second quarter dealing with the challenges coming from COVID-19 and where we stand today. As we indicated during our Q1 earnings call, one of the biggest COVID-19 related challenge with the direct impact is the contraction of electricity consumption. During the second quarter, we've now seen for our regions for the months of April and May, a maximum contraction of round about 10% compared to last year. In June, after significant normalization measures have been taken, the consumption level already rebounded to levels that were close to last year's. Let me reiterate my explanation from Q1. Electricity consumption has, and this is different to the upstream business, only a very limited impact on our business. On the distribution side, earning recognition is not linked to consumption volume. Nevertheless, there will be a temporary hit to the distribution cash flow as invoicing volume will not be sufficient to cover our revenue requirement. The resulting under collection will be corrected via the regular correction mechanism for such misestimations with a 2-year time lag, including a compensation for the time delay. On the retail side, such under collection is corrected with a time lag of only 1 quarter and should, therefore, fully reverse within this year already. From an earnings perspective, the retail business is only moderately affected as we have seen stable volumes in our mass segments compared to last year. With the volume contraction being limited to large and midsized corporate customers with thin margin anyway. With the reduction of electricity demand as well as significantly lower oil and gas prices, the Turkish electricity spot price in April was roughly half of the February level. For our regulated business, the electricity price is regarded as uncontrollable and hence the pass-through cost for our business. Although a very moderate negative base effect can be expected on the retail side at the regulated profit margin of 2.38% is applied to the procurement cost, we have already seen June prices to rebound towards precrisis level with consumption increasing again. Although general payment behavior in Turkey was expected to deteriorate across all sectors, we have seen only a very moderate impact to our on-time collection rate so far. In May, they were down by around 1% compared to March levels and also remained stable in June. Nevertheless, we remain cautious as payment behavior usually develops with a certain time lag. But even with a further deterioration, we expect only a moderate earnings impact at year-end as potential increases in doubtful provision expenses are generally offset by higher late payment penalty income. Our field operations, which have been affected during the lockdown period, are back to on track. Especially CapEx execution activities have been accelerated in order to compensate for the delays we experienced, but also meter reading activities are back to normal, which allows again for timely invoicing and cash collection. Let me now come to our first half financials, which you find on Page 4. Overall, our half year results show an acceleration of our bottom line earnings growth as we increasingly benefit from lower financing costs, adding around TRY 400 million net income, purely for the second quarter. At the same time, the second quarter last year was burdened by one-off phasing effects that reversed in the second half of last year. The operational earnings growth remained stable compared to the first quarter. Our free cash flow for the second quarter improved compared to the first quarter but remains and this is as expected, negative for the first half of 2020. The comparison to last year is skewed by a large positive one-off working capital reversal, which came from our retail business last year and which is also as expected, absent in this year. As a result of the negative free cash flow as well as our dividend payment in April, net debt has increased to TRY 12.3 billion. Please take a look on Page 5 at the market environment. Inflation has remained stable at a level of around 12% since the beginning of the year, while interest rates have further declined on lower inflation expectations going forward. This further decline in interest rates has allowed us to continue the repricing of our existing loan portfolio at lower rates also in the second quarter of this year. To remind you, we are fully funded for 2020 and therefore, we've only screened the market for opportunities to optimize our loan portfolio. With respect to energy procurement costs, we've seen a continued increase until May as a result of significantly higher feed-in-tariff costs, both due to high renewable energy volumes as well as further TL depreciation, especially because of lower hydro energy costs in June, the cost levels have returned to their levels at the beginning of the year. Commercial and industrial tariffs therefore remain well above procurement cost level and allow for a continuation of the liberalization process for these segments. Residential customers, on the other hand, will remain regulated as long as tariffs are not increased above procurement costs. Now coming to a more detailed explanation on our operation, and I kindly ask you to turn to Page 6. On the distribution side, investment activities have accelerated adding around TRY 400 million in the second quarter alone both due to normalization measures being taken, but also because of construction season starting. Most of the CapEx execution for this year is still outstanding and will become visible in the second half of the year as always. Although CapEx reimbursements in the first half have exceeded new investments, our RAB grew by TRY 1 billion as the opening balance has been revalued by June end inflation of 12.6%. Efficiency and quality earnings have slightly contracted as theft accrual income has been hit by the lower meter reading activities during the lockdown period. We expect this hit to be recovered in the second half of the year. For our retail business, regulated volumes continued to decline compared to last year as corporate customers with consumption above the last resort tariff limit have switched to the liberalized market in the beginning of this year. More importantly, we have actively switched mid-corporate and SME customers with a volume of around 2 terawatt hours from the regulated market into the liberalized market as profitability levels are, again, highly attractive. Coming now to Page 7 and talking about operational earnings. Operational earnings have increased by 13% to TRY 2.6 billion. Similar to the first quarter, growth was coming in more equal shares from our distribution and retail business with significantly higher liberalized retail market profits. Nevertheless, additions to liberalized retail market profits in the isolated second quarter were reduced compared to the first quarter due to the above mentioned moderate volume and price impacts of the current COVID-19 crisis. Let us now dive into our distribution business, which you find on Slide 8. Operational earnings increased by 12%, while cash conversion significantly improved. Earnings growth was only moderate as financial income recognition this year is at a significantly lower nominal return rate compared to last year, given the decreasing inflation expectations. However, as our RAB has significantly grown since the beginning of last year, year-over-year growth is still positive. As indicated before, efficiency and quality earnings were slightly hit by lower theft accrual income as a result of delayed meter reading activities during the lockdown months. Cash conversion is significantly improving for several reasons. First, financial income, not yet cash effective, did not grow further as last year's CapEx was more or less in line with our initial CapEx allowance and therefore, no further overspending was added. Second, although working capital increases are lower compared to last year as a higher portion of our out-performance was considered in the tariff calculation and therefore, previous earnings accrual started to become cash effective in line with the regulatory correction mechanisms. Cash-effective CapEx only increased slightly between the years despite the increase in investment volume. The reason is that fewer payments built over from last year and consequently, the increase in investment volume has been offset by a lower portion of prior year payments. As a result of both, the free cash flow of the distribution business turned positive already for the first half of this year. Our retail business on Page 9 showed a very strong earnings growth of 25% in the first half of this year. As indicated before, this earnings growth was mainly a result of a significant increase in the earnings contribution of the liberalized market segment from just short of TRY 20 million last year to just short of TRY 150 million this year. As the switching of customers from the regulated to the liberalized segment requires efforts from various marketing channels, OpEx increased as well. Finally, doubtful provision expenses slightly increased as a result of moderately deteriorated payment behavior. At the same time, late payment penalty income did not grow further compared to last year as the late payment penalty rate was substantially decreased as a consequence of the lower interest rate environment. Cash conversion is significantly lower compared to last year for 2 key reasons. First, last year's cash conversion in the first half was particularly high due to the reversal of significant one-off working capital effects summing up to more than TRY 700 million that were stemming from the year 2018. And these positive reversals are absent this year. Second, this year's first half is burdened by negative price equalization effects of around TRY 500 million that are a result of the above-mentioned undercollection of our regulated revenue requirement. This effect will reverse in the second half of this year with a correction and the regulated tariff levels. Now let me come to the bottom line development and the outlook, which you find on Page 10. As I indicated earlier, our underlying net income grew by 62% to TRY 754 million in the first half of this year, and therefore, significantly exceeded operational earnings growth. The low operational earnings, the main effects were as follows: Net loan interest expense significantly decreased by around TRY 160 million. Please note that this has several reasons. First, this decrease is, of course, a result of our continued efforts to reprice our existing loan portfolio at lower rates also since the beginning of this year. This is visible through an average loan interest rate reduction of 4.6 percentage points. Second, the reduction in our average loan interest rate was partially offset by an increase in the average loan volume as maturing bonds are replaced by loans. Finally, last year's interest expense in Q2 was burdened by a temporary net interest expense of TRY 63 million, stemming from an exceptional one-off financial transaction. This amount was overcompensated with the majority of this transaction in Q3 of last year. Accordingly, the year-over-year comparison is skewed by this phasing effect. The revaluation expense of both our bonds as well as our customer deposits was higher as inflation since Q4 of last year, remained relatively stable, while it was decreasing over the same period last year. And finally, our tax expense remained almost flat despite higher pretax earnings as the effective tax rate is now in line with the marginal tax rate of 22% in Turkey since we started to recognize the deferred tax asset for our holding company since Q4 of last year. Turning to Page 11. Our economic net debt has increased to TRY 12.3 billion in the first half of this year, driven by both a negative free cash flow after interest and tax as well as the significant dividend payment in April. While free cash flow before interest and tax was roughly breakeven, especially interest payments were high in the first half. This is a direct consequence of our refinancing actions to utilize the opportunity of repricing our existing loan books at lower rates. First and foremost, such refinancing transaction led to interest accruals of prior periods becoming immediately cash effective. Accordingly, we see a shift from other, which largely comprises FX and interest accruals to interest payments. Second, one-off prepayment fees of TRY 85 million pretax has been paid to complete these transactions. Since these costs are nonrecurring in nature and economically amortized over the majority of the new loan, we have classified these costs as exceptional items in our P&L. Now let me turn to our outlook, which you find on Page 12. As we promised during our Q1 earnings release, we will further specify our outlook for the year-end 2020 as soon as further reliable visibility is available. On the back of the strong bottom line development of the first half as well as first tangible evidence of a very moderate impact of the COVID-19 crisis on our financials, we now feel comfortable to do so. Most importantly, we revised our guidance for underlying net income upwards to above 30% year-over-year growth. We also further specify our year-end RAB guidance to around TRY 10 billion as we have seen higher-than-expected June end inflation, as well as sooner than expected normalization of our CapEx execution. For operational earnings, we reiterate our expectation of at least above inflation growth. Similarly, we also reiterate our expectation of an at least positive year-end free cash flow after interest and tax. Thank you very much for your attention. And dear operator, we can now take questions from the participants.

[Operator Instructions] Our first question comes from Cenk Orcan, HSBC.

I have 2 questions. First one is on -- given the current level of market interest rates, do you see any further opportunity to reprice your loan portfolio in the second half of the year? Is there further room to improve your average cost of debt? That's the first question. Second question is, can you expand a little bit about the 2-year lag in recovering the free cash flow for distribution. Is that irrespective of the 5-year regulatory periods and works every time with a 2-year lag. I'll be glad to hear some more details. Yes, these are the 2 questions I have in mind at the moment.

Cenk, this is Chris. Thanks for your questions. I'll start with your second one, asking for the 2-year time lag, which is also caused -- just technically caused T+2 correction mechanism. And as the name suggests, this is not something specific, specifically designed for what we are describing here, but it is really something that is being utilized as a general rule in the regulatory framework in Turkey, especially on the distribution business side. So for all of the out-performances, for example, that are unforeseeable by the regulator. And we first of all, start accruing earnings for this out-performance. All of these items are cash-wise collected with a 2-year time lag. So all of these items eventually fall under the T+2 correction mechanism. So to make a concrete example, take our theft accrual income, which is basically, our performance of detecting theft usage in the grid and invoicing it and legally executing those invoices. For all of these incomes that we accrue, we only start collecting the cash 2 years later because only then the regulator starts to consider this performance in this calculation of the tariff. And exactly, this is also at work in what we are describing regarding the export correction of the consumption levels that were assumed by EMRA in their calculation of the tariff unit price, i.e., the TL per kilowatt hour price that we are invoicing at the moment, which is simply not enough to fully collect the entire, let's say, revenue requirements for the Turkish distribution system. But fall short because actual consumption, especially for the month of April and May was surprisingly low compared to the previous assumptions. And this is fully independent of the 5-year regulatory review period. Now for the second question, I'll hand over to Michael.

Yes. And very valid question, room for lowering average cost borrowings. First of all, technically, we have the room. And technically, we also have the possibility. So according to the contract, we are quite flexible. But looking at the macroeconomic development, especially looking at when have we signed and funded. We clearly see that we found the optimal point in time, which means that I do not assume that this optimal point in time with this favorable interest rates, which we signed will be in future better. Most likely, and you see this already interest rates will increase or at least be above what we have reached so far. So therefore, I don't see really a realistic room for further improvements to what we have done in this year.

Okay. And may I add a third question. Given the recent lira weakness, if that is persistent, how does that impact your electricity purchases through Yekdem feed-in-tariffs. And does that pose any downside risk to your expectation of recovery in free cash flow in the second half of the year?

Yes. That's a fair question to ask. I think it's a little bit isolated, so the question is what will be the bigger picture from a macro perspective, but let's stick to the specific question you asked. You're right, with lower FX, the TL equivalent feed-in-tariff costs, of course, increases. Nevertheless, in general, the feed-in-tariff costs will decrease in -- seasonally right now, we already see this simply because the highest feed-in-tariff cost is incurred when you have the highest hydro volumes in Turkey, and this is generally in the spring time. And since this is behind us, the topic of feed-in-tariff costs significantly impacting the overall procurement costs in any case is largely over for this year. Maybe we see again a spike towards the end of the year. But for now, this is not much of a topic. Regarding recovery of -- recovery -- this in connection to our recovery of the free cash flow. This depends on how much the development surprises the regulator. And the regulator has just announced the tariff for Q3 and has another chance to announce the tariff for Q4. So there is one more shot at getting the tariff level right in the fourth quarter of this year in order to cover costs fully. If FX doesn't just surprise this quarter, but then again, next quarter, then similar to the year 2018, we may indeed see again a consecutive buildup of a receivable in our price equalization accounts. But if this is a development that we only see this quarter, then it may just be that this is already fully reversing in the fourth quarter of this year. So as always, it depends on how things continue to develop. At least the good thing is, on a quarterly basis, EMRA has always the chance to correct what they got wrong the quarter before. So you have a difference to the T+2 correction mechanism. You have a very quick reversal of whatever mistake has been made.

We have no further audio questions. Dear speaker, back to you for the written questions.

Okay, then I would like to continue with the question from Ekaterina simply because they are partially connected to what Cenk has just asked. The first question of Ekaterina is what is our estimated amount of undercollected revenues on the distribution side that will have to be compensated for over the next 2 years. So this is, again, linking to this T+2 correction mechanism that Cenk already asked for. To answer that question on a relatively high level, think about our total revenues that we need to collect for our revenue ceiling on average to be around TRY 2 billion every month. Most of those revenues are related to the retail business. Only a smaller part of that is related to the distribution business. If -- as we have now seen consumption surprises to the downside and let's say, it now surprised by exactly the 10% downside that we observed for our regions. That means we are collecting TRY 200 million too little of what we should collect for every month. Since this has happened largely for the 2 months of April and May, and consumption has now returned to more or less precrisis levels. That means we are talking about an overall receivable of around TRY 400 million to TRY 500 million, let's be a little bit conservative. If -- Ekaterina, if that's enough, then I would keep the answer at this level if you want me to be even more specific, then let's take this off-line. For the second question of Ekaterina, the question is, where do you stand in the discussions with the regulator over the next regulatory period parameters appreciated regulated WACC is too early to discuss. But in terms of allowed CapEx, what is the outlook? Can it stay flat in real terms almost likely be decreased? Same question with respect to allowed OpEx. So basically, the question is, do we have any news regarding the ongoing regulatory negotiations at this moment? First of all, the answer is, no, we don't. There is nothing that we know today that we wouldn't have known 2 months ago, which doesn't mean that the negotiation is not ongoing, but there is at least no clarity on these parameters so far. With regards to the concrete parameters you are asking for, the only, let's say, expectation that we can provide you at this moment is that regarding our CapEx allowance, so the amount of CapEx that we are expected initially to spend every year for the next 5 years. Our expectation is that this will increase in real terms versus what it has been in the prior period. Simply due to the fact that we have significantly overspent on our initial allowance this period and that the regulator will take this into consideration in order to set the allowance for the next period. Regarding the OpEx allowance, it is a little bit too early to answer this tangibly because it depends also on the scope of the regulation and the mechanisms of the regulation for the next period. Since especially on the quality side, we do not fully know yet how this will play out. It is hard to say whether or not further OpEx allowance is given for additional activities that so far are not part of the regulation. But Ceteris paribus, so if all of the activities stay unchanged, then the OpEx allowance in real terms should theoretically be slightly lower, simply due to the fact that there is an efficiency factor being applied every year. So that it becomes harder to outperform your OpEx targets year-by-year. And lastly, on WACC. Again, no news on that side. Nevertheless, one important comment. We do see now in the macro environment next to a depreciating era that also interest rates are coming under pressure. Also with CDS levels for Turkey now on the rise. This, of course, may be a factor that eases our negotiation with the regulator, simply because we may now come again into a macro environment where interest rates then need to be raised in order to protect the currency. Okay. Then I'll continue with the question that Fabian asked, which is, can you comment on the outcome of the WACC review, both in terms of time line, when will we find out as well as the regulated return levels, yes. So just reiterating again what I already said answering Ekaterina's question. There's no news at the moment, expectation of the timing of that news is still Q4, most likely with the uncertainty that we currently see in the market, especially regarding WACC, most likely towards really the end of the year. And regarding the WACC level, basically the same answer that I just gave to Ekaterina. The second question that Fabian asked is you have previously talked about M&A opportunities in Turkey. How has the crisis impacted this. I'll give this answer to Michael.

Yes, Fabian. I mean, generally, saying it always in M&A, don't talk about M&A unless you have signed the contract. So therefore, I specifically answer your question, whether the crisis has changed anything in the M&A market. One observation is clearly that a big auction tracks, so big sales processes have been postponed because most of the people looking at the cash side are reluctant to join big auction tracks right now. So this is one observation. The second observation and now looking closer at assets, that the crisis, of course, creates additional new opportunities. And this inside our core because some of our peers might face the situation more challenging than we. And secondly, also outside, meaning really adjacent businesses in the noncore area. So therefore, and I always see this like this, every crisis creates new chances, and especially talking about M&A, this clearly is a situation which changes the game. And please don't forget, if we talk about core, then this also means that, of course, the discussion of the fourth tariff has a huge impact, which has not, if you talk about outside core, but this is also something regarding timing and when would be the ideal point in time to take into consideration. I mean, there are 2 ways, either you take a certain portion of risk by knowing most likely the outcome of such a tariff and then having a, let's say, more favorable terms in the M&A contract or you just make it, let's say, safe, knowing the fourth tariff and then doing M&A transaction where usually that the [indiscernible] fees is a bit less. And as I stated, outside of the core, it's always beneficial, I would say, because we are, as you know, in a very strong shape funded for this year. So yes, always positive and challenges or opportunities, let's say, and not only challenges in the COVID-19.

All right. And I'll continue with the question asked by Koray, which is whether we can please reiterate our outlook about free cash flow in the second half of 2020. And whether we have any other plans for investments. Now just -- first of all, reiterating what we already said in the presentation, our expectation for the full year free cash flow after interest and tax remains to be above 0, so to remain positive. And obviously, positive doesn't mean just TRY 1 billion, but positive enough that we feel comfortable to make the statements to you. Right now, at half year stage, we stand at around negative, negative, how much, at negative TRY 1.1 billion. Just wanted to make sure that I give you the right number. So basically, for the second half, we are telling you that you should expect our free cash flow in the third and fourth quarter accumulated to be significantly above TRY 1 billion in order to turn this cash flow positive again. And that, of course, also includes our base case investments. And as we indicated in our specified RAB guidance, since we are seeing a sooner-than-expected normalization of CapEx execution activities, we rather see our CapEx being higher than what we anticipated or what used to be our base case maybe towards the first quarter stage, Overall, it still means that our CapEx for this year is expected to be significantly higher than what we have spent last year. So that remains unchanged.

We don't have any more questions online.

Now taking the last written question that we currently see. There's one question being asked by Andre, who is asking whether there is a possibility that the current regulatory period will be extended by 1 year as the regulator is busy with the current COVID situation. And whether this could mean that any retrospective payments that we should receive may be delayed. Now my answer to that would be that, yes, indeed, there was a time in the early days of corona where a rumor along these lines indeed was in the market. And we indeed have seen in the first weeks of the corona crisis, so back in March, that the negotiations at least were paused for the regulator to take or to concentrate and focus on the urgent matters around the corona crisis. However, this has now long resumed already in April, and the negotiation is now fully back on track. And therefore, our expectation is that it will conclude within this year. And accordingly, you will also hear a new regulatory announcement being made later than towards the year-end, yes. Operator, at the moment, we are not seeing any further questions, neither written nor verbal. Can you ask 1 final time if there's any further questions in the audience?

[Operator Instructions] We have no further questions. Dear speakers, back to you for the conclusion.

So thank you, everybody, for attending our call, during these extraordinary times. And let me reiterate what we have also said in Q1 call, I and the whole team really look forward to seeing you and hopefully in person, healthy and hopefully very soon. So stay healthy and take care. Have a good remaining and successful week. Bye-bye.

Thank you. Ladies and gentlemen, this concludes today's webcast. Thank you all for attending. You may now disconnect.