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

Ladies and gentlemen, welcome to Enerjisa Q3 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. Good afternoon, everyone. This is Michael speaking. And I hope that everyone is healthy and doing well. And I also hope that everyone had sufficient sleep despite of the election in the United States. So I would like to start today by giving you an update on how we navigate through COVID-19 pandemic. For this, I kindly ask you to turn to Slide 3. The pandemic continues to be the main topic of the year. While we had seen a normalization in Q3, the current trends in the number of positive COVID-19 cases requires high awareness also for Q4. Nevertheless, our strong performance, also during COVID-19 times has demonstrated the management's agility for early precautions and the resilience of our business model. Let me deep dive on certain effects to highlight our resilience. At first, let me elaborate on the volume impact. In April and May, we saw a maximum contraction of 10% in our regions compared to last year. Following significant normalization measures undertaken, the consumption level started to recover in June and increased further in Q3. With volumes even exceeding last year's level by around 5% with the impact of high-weather temperature. In net, our distributed energy volume in the first 9 months has been flat, if I compare it to first 9 months of last year, the period without COVID-19. Let's have a closer look to the electricity prices. Because of the overall decline in electricity demand and the significantly lower oil and gas prices, the monthly Turkish electricity spot price in April was roughly 2/3 of the February level. Spot prices then rebounded in June, reaching February levels again in August and further increased by around 5% month-over-month in September. Meanwhile, spot prices are only one component of the regulated retail profit. Total sourcing costs are a weighted average of regulated U.S. electricity costs, feed-in tariff prices and spot prices and total sourcing costs form the base for our retail regulated profit, which is a pass-through with a 2.38% gross profit margin. Even in April, when the spot price reaches its lowest level, the decline in spot price did not reflect negatively to total sourcing costs due to increase in feed-in-tariff prices, therefore, did not have a negative impact on our regulated gross profit. It is also important, in my view, to look at the payment behavior of our customers. We have seen only a very moderate impact on our on-time collection rates. Starting with May, there was some decline compared to previous months with a small COVID-related impact on our cash flow. While there is currently no indication of further deterioration, we see ourselves well prepared even in case of further payment behavior changes. First, on regulated retail side, we have a compensation mechanism for doubtful provisions. Covering around 50% of these provisions and on the distribution side, we are fully covered. Second, increases in doubtful provision expenses are generally offset by higher late payment penalty income. Thirdly, electricity prices in Turkey are relatively cheap and the right to disconnect regulated customers and the option to shift the liberalized customers to regulated segments, in case of nonpayment work as deterrents against major shifts in payment behavior. Finally, deposits and other collaterals covering around 2 months of invoices work as mitigation tools for the risk. As a last item at our field operations, our meter reading and connection and disconnecting activities are back to normal, which allows again for timely invoicing and cash collection. This also have reflected positively to our performance in the third quarter. In this sense, CapEx execution activities have accelerated in Q3. However, considering the recent trend in COVID cases, we adopt a cautious approach regarding further investments into our grids for the rest of 2020, in order to ensure health and safety for our employees and contractors. What this means, I will discuss in detail in our outlook 2020. To conclude, COVID-19 has operationally only a limited impact on our financials. Let me now show you this conclusion by taking a closer look to our 9 months financials, which you can find on Slide 4. We had an outstanding earnings growth in the first 9 months and the strong recovery in cash flow in Q3. And this, despite the COVID-related challenges, is underpinned by our proactive and prudent debt management and robust operational performance. Operational earnings growth in the first 9 months was 20% year-over-year, marking an acceleration compared to 13% growth in the first half. Overall, our 9 months results show a significant acceleration in our bottom line earnings growth as we benefited from lower financing costs, robust operational earnings growth and lower effective tax rate. We had around TRY 660 million, underlying net income solely in the third quarter, which is almost double of last year's level. Our free cash flow after interest and tax was negative in the first 9 months of 2020. However, if you compare it to the same period of last year, it is higher and this despite the COVID-related challenges in 2020 and the positive one-off impact in 2019. Moreover, we expect further recovery during fourth quarter to offset lower volume and price-related negative impact through price equalization at our retail business. On the retail side, there is a cash flow impact related to volatility in procurement costs, which is expected to be recovered within the current year. While on the distribution side, we have a minor impact due to increase in pass-through transmission expenses, which, again, will be reversed by the regulatory correction mechanism. The yearly comparison is also impacted by the absence of last year's high positive one-off working capital reversals of around TRY 800 million in the retail business. In line with the last outlook we provided, we started seeing a positive cash flow in Q3 as the price correction mechanism started to materialize and electricity volumes started to recover. Our free cash flow after interest and tax in the third quarter was around TRY 600 million. Our economic net debt increased from TRY 10.6 billion in December 2019 to TRY 11.7 billion in September 2020, driven by both negative free cash flow after interest and tax as well as the dividend payment in April. Meanwhile, economic net debt declined by around TRY 600 million quarter-over-quarter with the recovery in cash flow. From a resilience perspective, our balance sheet is very healthy. We have a financial net debt to LTM operational earnings ratio of just 1.86x and no unhedged FX exposure on the balance sheet. Please take a look at the market environment on Slide 5. Inflation remained stable at a level of around 12% since the beginning of the year. Meanwhile, interest rates have sharply declined until August and since then, bounced back with 6 months [ TR ] labor reaching to 13.4% in September and currently at levels higher than 15%. Using the low interest window, we proactively repriced our loan portfolio at lower rates. This, along with extension of majorities of our fixed rate loans even to 2023, would enable us to be less sensitive to the reason increase in interest rates. We are fully funded for 2020 and we also have further liquidity reserve options through committed lines. With respect to energy procurement costs, we have seen a continued increase until May due to higher feed-in-tariff costs as well as TL depreciation, especially with lower hydro energy costs in June, the cost level has broadly returned to their levels at the beginning of the year. Meanwhile, end-user tariff for Q4 have been announced. Regulated retail tariff component increased by around 7% to 8% and distribution tariff component increased by around 1% quarter-over-quarter, leading to a 5% to 6% change in end-user prices, which is overall positive for the liberal retail market profitability. Meanwhile, in Q4, regulated U.S. costs for Regulated segment increased from TRY 132 per megawatt hour to TRY 155 per megawatt hour, which is also a small but positive step for liberalization of the market. Commercial and industrial tariffs set above residential tariffs and last resort tariff mechanism allow for the continuation of the liberalization process for these segments. On the other hand, residential customers are to remain regulated unless regulated residential tariffs increase above procurement costs. Now coming to a more detailed explanation on our operations, which you can find on Slide 6. On the distribution side, investment activities have accelerated adding around TRY 700 million in the third quarter due to both normalization measures and the start of construction season. With new investments exceeding CapEx reimbursement in the first 9 months and revaluation of opening balance, our RAB grew by TRY 1.3 billion compared to last year-end. Efficiency and quality earnings have slightly contracted in the first 9 months as theft accrual income was hit by lower level of field operations in the first half. On the other hand, with the normalization measures, we started seeing a recovery in the third quarter. In the third quarter, our efficiency and quality earnings increased by around 100% compared to average of first 2 quarters. In our regulated retail business, volumes continued to decline compared to last year as corporate customers with consumption above the last resort tariff, limits switch to the liberalized market in the beginning of this year. We also proactively switched mid-corporate and SME customers from the regulated market into the liberalized-sized market as profitability levels are again attractive. As such, our gross profit from the free market accounted for around 43% of our gross retail profit in Q3. And this performance is supported by our prudent contract and FX management and favorable market dynamics. Coming to Slide 7. Operational earnings have increased by 20% year-over-year compared to the first 9 months of 2019, reaching TRY 4.2 billion. We have a very strong performance in retail. The contribution of retail to operational earnings increased to 15% in the first 9 months of 2020 and 17% in the third quarter of this year, up from 12% in full year 2019 with a very strong performance in the liberalized segment. Meanwhile, the operational earnings growth of Distribution segment accelerated compared to the first half of this year, thanks to recovery in the efficiency earnings. We will discuss the details in the subsequent slides. So please turn to Slide 8. In the Distribution segment, operational earnings growth accelerated to 17% year-over-year in the first 9 months with the positive momentum and efficiency earnings in the third quarter. The financial income growth was only moderate as financial income recognition this year is at a lower nominal return rate compared to last year, given decreasing inflation expectations. Efficiency and quality earnings started to recover in the third quarter as our field operations normalized reversing the hits in our T&L related performance, we had in the first half. Moreover, CapEx outperformance improved with increased volumes and lower procurement costs. As in last year, we expect to have a quality bonus income to be recognized for the full year in December. Our revenue requirement for FX-based purchases are linked to FX-based commodity indices. And for those without the perfect match for 2020, we carry out hedges. The gains for these hedges are classified in other items, including for that impact, our actual efficiency earnings is higher than reported. The cash conversion in distribution improved significantly for several reasons. First, negative working capital increased and price equalization impacts were lower compared to last year as a higher portion of our outperformances was included in the tariff calculation, and therefore, previous earnings accrual started to become cash effective in line with the regulatory correction mechanism on top of lower carryforward balances from 2019 compared to the year before to 2018. We see a negative cash impact of around TRY 100 million to increase in TEIAS transmission costs compared to the same period last year. Transmission costs are a pass-through, but the actual cost was higher than what was included in our tariffs impacting the cash flow. This impact will reverse with the regular correction mechanism. Also growth in not yet cash effective financial income was muted at last year's and this year's CapEx was more or less close to our initial CapEx loans, in line with our front-loaded CapEx spending strategy in a tariff period. Cash effective CapEx increased due to an increase in investment volume, partly offset by a lower spillover from prior year purchases. In net, our free cash flow of the distribution business significantly improved in the first 9 months of 2020 compared to the same period of last year. As you see on Slide 9, our retail business showed a very strong operational earnings growth of 41% in the first 9 months of this year. Looking only at the third quarter, we see an annual growth rate of 69%. The growth in the first 9 months was mainly a result of a significant increase in the earnings contribution of the liberalized market segment from around TRY 40 million last year to around TRY 300 million this year. Along with the favorable market dynamics and our customer-focused approach, our prudent contract management with hedging of FX-based cost has played a critical role in that performance. OpEx growth was above inflation as the switching of customers from the regulated to the liberalized segment requires efforts from various marketing channels. Nevertheless, OpEx growth was significantly less than the increase in total gross profit of the Retail segment. The bad debt-related income was lower than last year as doubtful provision expenses increased due to higher electricity prices and some impact of slight deterioration and payment behavior. At the same time, the late payment income was flat compared to last year as late payment interest rate was reduced to lower interest rate environment. Late payment penalty rate peaked at 2.5% in the third quarter of last year, then it declined to 2% in the last quarter of 2019 and to 1.6% in the beginning of 2020. So therefore, we have a high base impact, especially in the third quarter. Despite that, late payment interest income is almost unchanged in the first 9 months compared to same period last year due to higher electricity prices. The retail cash conversion is lower compared to last year. On top of the base impact due to one-off gains of last year of around TRY 800 million, we have a negative price equalization effect of around TRY 400 million due to under-collection of our regulated revenue requirement because of volume and price effects to be mostly corrected at Q4 via the price equalization mechanism. This effect is mostly related to a sudden increase in procurement costs in the second quarter of this year with the impact of higher feed-in-tariff costs and to some extent, a volume impact. The negative price equalization started to reverse in the third quarter, and we expect an accelerated reversal in the fourth quarter as the majority of the negative price equalization was in the second quarter and the correction led time is 2 quarters. There is also some decline in net deposit additions with the shift of customers to the liberalized segment. Now let me come to the bottom line development, which you'll find on Slide 10. Our underlying net income grew by 77% to TRY 1.416 billion in the first 9 months of this year, significantly exceeding operational earnings growth. Specifically, the underlying net income growth in the third quarter was around 100%. Below the line item operational earnings, the main effects were as follows: despite the increase in average loan volume, net loan interest expense significantly decreased by around TRY 270 million, mainly due to our actions to reprice our existing loan portfolio at lower rates since the beginning of the year. This is visible through an average loan interest rate reduction of 6 percentage point year-over-year to 12.5% in the first 9 months of this year. This average loan interest rate is calculated over full loan portfolio, excluding bonds. The revaluation expense of both our bonds and 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. Our tax expense growth was lower compared to the growth in pretax earnings as the effective tax rate is now in line with the marginal tax rate of 22% in Turkey compared to 29% last year as we started to recognize the deferred tax asset for our holding company since Q4 of last year. Turning to Slide 11. Our economic net debt has increased from TRY 10.6 billion in December 2019 to TRY 11.7 billion in September, driven by both a negative free cash flow after interest and tax as well as significant dividend payment in April, as I stated in the beginning. On the other hand, we have an improvement in Q3 with economic net debt declining by around TRY 600 million quarter-over-quarter. Meanwhile, our financial net debt per LTM operational earning ratio is slightly below the level in 2019 year-end, thanks to strong growth in operational earnings. Free cash flow before interest and tax was around TRY 0.9 billion from TRY 900 million in the first 9 months of 2020. While the majority of the realization was in the third quarter, specifically, free cash flow before interest and tax was around TRY 1 billion in the third quarter of this year. In interest payments, we have one-off prepayment fees of TRY 85 million pretax to complete our refinancing transactions. Other item is negative mainly due to increase in fair value of derivative instruments on the balance sheet, which is partly netted off with net interest and deposit valuation accruals. Our balance sheet is very healthy with no unhedged FX exposure. Around 73% of our gross profit debt has fixed interest rates, around 13% has variable interest rates and around 14% is CPI-linked. We do not have any refinancing needs for the rest of the year. Moreover, we have committed lines of USD 125 million equivalent in Turkish lira. Outlook 2020. Now let me finally give you our outlook before we take questions. For this, please turn to Slide 12. With the Q3 results, we are updating our 2020 outlook. Most importantly, we revised our underlying net income upwards to around 40% year-over-year growth from previously communicated above 30% as we are more confident based on the performance in the first 9 months of this year, again demonstrating the resilience of our business model and also because of the recent increase in electricity tariffs. For operational earnings, we keep our outlook of above inflation rate. Our new year-end RAB guidance is around TRY 9.7 billion. As with the increasing number of COVID cases, we decided to be more conservative in our remaining CapEx program in the last quarter of this year to ensure health and safety of our employees and as mentioned, of our contractors in line with our sustainability approach. In this respect, we plan to compensate for this difference in the coming years. We continue to expect our free cash flow after interest and tax for 2020 to be positive and specifically, at least at low 3-digit million TL level. Meanwhile, we also want to mention the environment in which we give you our outlook. As you all know, we reassess our IRR assumptions for distribution financial assets periodically. Also, we do not expect major changes in our estimates regarding ongoing operations. The regulated asset-based financial income from distribution, of course, depends on the new tariff and this will be announced by year-end. With respect to our discussion with EMRA, I'm sure you would like to hear more details. However, we know that you would acknowledge our approach to do so after the announcement of the new tariff period parameters. Nevertheless, I want to mention that we are in good exchanges. I could even say in very good exchanges and in a very open discussion with all relevant authorities. This, and the urgent need for further investments into the energy infrastructure and in particular, into the networks as the backbone of the Turkish industry, make me very confident of a prosperous new energy world in Turkey also in the years to come. Thank you very much for your attention and we can now take your questions.

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

Thank you very much for the presentation and congratulations on the strong results you achieved. I have 2 questions. The first one is about the guidance. The -- around 40% growth that you guide for the full year in underlying net income, that implies a weak fourth quarter profit, nearly 40% below the fourth quarter last year and almost 1/3 of the third quarter profit, if I'm calculating correctly. Why is that? Are you being overly cautious and conservative or is there something that you expect will suppress the fourth quarter profit that much? My second question is about the big jump in the liberalized gross margin of retail operations in the third quarter. I'm wondering how sustainable that is? What does it depend on mostly? What are the risks for a sharp downturn in that profitability? And what should we expect in general for the fourth quarter in terms of deadline?

Thanks for the question. Regarding the guidance question, our guidance has some conservatism regarding the fourth quarter, given the increasing trend in the COVID cases, therefore, compared to third quarter, we've built a significantly more conservative estimate. And the second driver is actually looking to the fourth quarter numbers in our business can be a bit misleading, causing our distribution business, we work with long-term assumptions on WACC and inflation. And we reflect these assumption changing for our financial in the year-end. And in our outlook, we had incorporated a declining trust in interest rates which would impact the full year result retrospectively. Therefore, it will impact the fourth quarter numbers. But we actually see an increasing trend in the inflation rate. Therefore, there is not such -- to that. But considering the theft negotiations and also the macro volatility, we prefer to do so after the trades are announced. Therefore, it's better to look to the full year later than [indiscernible]. Is it clear or would you like me to... So, we have an assumption in Estimating the financial income. And at the year-end, we look to that assumption and if there is a change, we reflect it to the full year. But when you had the deducted fourth quarter number, there might be deviations on that. And we currently see an upside risk with the transient inflation but we had taken a cautious approach and we prefer to face for the new tariff parameters in order to change that. Regarding resales, the third quarter was exceptionally strong. We overall expect the retail business to be strong, better than the previous years, but the third quarter can be misleading, [indiscernible] that would be, if that has continued, the competition might increase. Therefore, I would expect the numbers to be better than 2019, close to the first half numbers rather than the third quarter.

Okay. Thank you, Gözde. Just to expand a bit on the guidance, I am understanding that you have adopted a cautious approach, especially around, call it, for the fourth quarter. Is that the same factor in your RAB guidance or are you actually slowing down CapEx to a level that additions will be wiped out by the CapEx reimbursements in the fourth quarter so that your RAB stays flat during the quarter? Or is that also a conservative assumption?

For RAB, I wouldn't say that we incorporated a very conservative assumption. So I would call it realistic. But regarding the outlook, given the assumptions regarding the parameters, there is some conservatism. And this assumption changes, actually, it should be reflecting to the full year financial income. But even the changes carried out by the year-end, you have a deductive number, which might seem to be low. Therefore, the conservatism is more with us to form underlying net income [indiscernible].

Our next question comes from [indiscernible].

Firstly, congratulations on the very strong results. I'm a bit confused as a follow-up to Cenk's question, I'm a bit confused here. Normally, if you are incorporating higher inflation into your assumptions, I would normally expect your financial income to go up or, let's say, your fourth quarter earnings to be positively affected. I mean, I couldn't understand that part, firstly. Maybe you can give us some more color on that. And secondly, as interest rates go up, you said that you're fully funded for this year. Is 12.5% average cost of funding is the lowest level that we can see for this year? Or I mean, would you expect your average cost of funding to increase starting from fourth quarter?

Okay. Regarding the financial income, in our outlook, which we provided before, we have seen a declining trend in inflation, which impacts the outlook and it also impacted the previous outlook we have provided. And in the actual numbers, you do not see that because we have been reflecting the initial inflation assumptions, which we had done after the announcement of 2019 numbers. This is what we do always. And currently, therefore, the change in inflation assumptions, the declining trend expectations would impact the fourth quarter. If it continues to be with the new budget assumptions. But currently, after the cut of state of the budget, we started seeing an increasing trend in inflation. Therefore, if we had reflected this trend, the outlook would have been better, but we prefer to be more cautious on that. This is the first question's answer. The second part regarding the cost of financing, as we do not have a financing required in the fourth quarter, I wouldn't see an increase compared to the third quarter. And remember that our financing costs started from a very high base in the first quarter and it gradually declines. Therefore, although it's very difficult to give a guidance for 2021, compared to average of 2020, the increase might not be significant. And regarding the total financing cost as we would expect a continued deleveraging, I wouldn't see a major increase in the financing costs in [indiscernible] terms.

[Operator Instructions] Our next question comes from [indiscernible], GMB Finance Invest.

I just missed your statement on loan commitment from the banks. If I'm not wrong, you said the amount of USD 125 million [indiscernible]. Is that correct?

[indiscernible] million dollar account to be converted in Turkish lira.

Okay. Great. And there is no average interest rate on that, right?

There is a reference to [ tariff ] on that. [ Tariff ] plus FX margin.

Thank you. We have no further audio questions. Dear speaker, back to you for the [indiscernible] question. We have another question from Mr. [indiscernible].

Can I ask what portion of your bank loans is referenced to tariff?

Referenced to... It's [ 14% ].

14%, right?

14% -- 13%.

Thank you. We have no further audio questions. Dear speaker, back to you for the [indiscernible] questions.

Okay. Then we can conclude the call. Thanks for attending and hope to see you with the fourth quarter results, after we see the new tariffs, so we can start discussing the long-term expectations as well.

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