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

Welcome to Enerjisa Second Quarter 2021 Results Conference Call and Webcast. I now hand over the call to CFO, Mike Moser, and IR, M&A, and Director, Gozde Cullas. Dear speakers. Please go ahead.

Thank you very much, moderator, and hello, everyone. This is Michael speaking. First of all, I hope that everyone is healthy and doing well. So let me start today's earnings telephone conference by a quick overview of the first half of 2021. And by this, turning to Slide 2. In the first half, we had a strong performance, thanks to our sound risk management processes, our robust balance sheet and accelerated investments. Underlying net income grew by 34% year-over-year compared to the same period of last year. Coming to COVID-19. COVID-19 continues to affect Turkey in the second quarter of the year. In order to address the peaking number of cases in April, lockdowns were implemented during the quarter, while normalization started in July. Despite the lockdown, electricity consumption demonstrated strong growth in Q2 and increased by around 20% year-over-year, albeit on a weak base. We have taken all the measures to mitigate any potential impact and the results continue to demonstrate the resilience of our business. Meanwhile, the pace of COVID vaccinations in Turkey has accelerated during the second quarter. Currently, 68% of the population over 18 years old received the first dose of vaccine and 48% received the second one. Reflecting the strong performance in the first half and the impact of inflation, we have revised our 2021 guidance upwards. We will discuss, of course, the details in the subsequent slides and in the course of this call. Meanwhile, collective bargaining agreement negotiations with our union and our electricity distribution companies were concluded with an agreement for a period of 3 years, effective as of the 1st of March 2021. Let us go over through the financial highlights of first half of 2021 on Slide 3. In the first half, we had a strong earnings growth and strong cash flow despite some impact of COVID-19, thanks to lower financing costs, strong operational performance and prudent balance sheet management. Operational earnings growth was 30% year-over-year, exceeding the inflation including for exceptional CapEx reimbursements, the growth was 39%. Meanwhile, underlying net income increased by 34% year-over-year. Our free cash flow after interest and tax was around TRY1.070 billion compared to around negative TRY 1.080 billion in the first half of last year. Our balance sheet is very healthy with no unhedged FX exposure. We have no funding need until 2022, and therefore, have low exposure to unfavorable interest rate developments. Our financial net debt to last 12 months operational earnings ratio is down from 2.1x in June 2020 to 1.4x in June 2021. Please take a look at the market environment on Slide 4. Inflation continued to increase in Q2, reaching 17.5% in June and 19% in July. Interest rates peaked with 6 months [ TR ] labor increasing to 20% in March and was stable during the quarter. Our balance sheet had low exposure to the reason interest rate increase with 73% of our borrowings, either fixed loans or linked to CPI. We have financed most of our funding requirements for 2021 prior to the rate hikes during the low interest rate environment of 2020, while also extending majorities. Revenue items such as CapEx reimbursements and some other operational allowances and RAB are linked to June inflation, while financial income is more dependent on long-term inflation assumptions. Meanwhile, higher inflation leads to higher deposit valuation and increase in CPI-linked bond expenses. Therefore, an increase in short-term and long-term inflation assumptions combined leads to higher operational earnings and underlying net income. An increase only in short-term assumptions leads to higher operational earnings along with a negligible negative impact on underlying net income. With respect to energy procurement costs, excluding the impact of monthly fluctuations due to sourcing mix, we see an increase in the sourcing costs quarter-over-quarter due to increasing [indiscernible] higher natural gas and coal prices and to some extent, the impact of drought and we expect the cost increase to continue in Q3. The increase in [indiscernible] was mitigated by lower U.S. costs for the regulated segment during the quarter. Therefore, the increase in liberalized costs was higher than in the regulated segment in the second quarter. Meanwhile, end-user tariffs for Q3 2021 have been announced. Broadly, the end-user tariffs increased by 15% quarter-over-quarter. Specifically, distribution tariffs increased by around 7% and active energy prices increased by 17% to 20%. Regulated U.S. tariffs also increased from TRY 169 per megawatt hour to TRY 238. The increase in electricity tariffs was cost reflective and was the right move for the health of the liberalized market and the power generation. Meanwhile, the current day-ahead prices are running above TRY 600 per megawatt hour, both due to the factors I've discussed and also the extremely hot weather conditions. However, we believe the factors leading to peak in prices in August are partly temporary and heavily linked to weather conditions. Coming now to a more detailed explanation on our operations. Please turn to Slide 5. On the distribution side, our CapEx was TRY 1.110 billion in the first half of this year, almost doubling compared to the same period of last year, reflecting the increase in CapEx allowance in the fourth regulatory period. Meanwhile, the first half is seasonally low in terms of investments. Accordingly, the first half realization is lower than the average planned CapEx for the rest of the year, which is in line with our plans. Although CapEx reimbursements in the first half of the year exceeded new investments, our RAB grew by TRY 1.5 billion compared to the year-end as the opening balance has been revalued with inflation. Please note that RAB revaluation increased from TRY 1.2 billion reported in the first quarter to TRY 1.6 billion as we reflected actual June inflation of 17.5% compared to the previous assumption of 12.4%. We had highlighted this upside risk in our previous call. Efficiency and quality earnings increased by 40% in the first half, while the increase was 79% in Q2. I will discuss the underlying factors on the next slide. In our liberalized retail business, volumes continued to increase while liberalized corporate margins continued to normalize from the high base of last year, partly due to competition and partly due to increasing procurement costs. Our gross profit from the free market accounted for 33% of our retail gross profit in the first half of 2021 compared to 29% in the same period of last year. Coming to Slide 6. Operational earnings increased by 30% year-over-year compared to the first half of 2021, exceeding TRY 3.3 billion. Both Distribution and Retail segments contributed positively to that performance. This figure does not include TRY 227 million exceptional reimbursements. We will discuss the details in the subsequent slides. So please therefore, turn to Slide 7. In the Distribution segment, operational earnings growth was 28% year-over-year in the first half. The financial income growth was soft given the declining WACC. Please note that the impact of decline in WACC and RAB adjustments on 2020 was reflected in the last quarter of last year in lump sum and is not included in the first half of 2021 financials. Adjusting for the impact of WACC decrease and RAB adjustments, which are not included in first half 2020 financials, the growth in financial income was around 14%. Please note that the impact of inflation increase is not visible in first half due to our CapEx spending pattern and the accounting impact. While this impact will be more visible in the second half as our investments accelerate, please also note that the financial income estimate for 2021 might be subject to change based on long-term inflation assumptions. CapEx reimbursements excluding exceptional reimbursements, increased by TRY 380 million due to higher CapEx ceiling. And as the regular compensation for overspend CapEx of the third regulatory period started as of January 2021. CapEx reimbursements reported in operational earnings does not include the exceptional reimbursement, meaning overspend CapEx not reimbursed in the third regulatory period due to the regulatory mechanism for the overspend CapEx. We will receive this amount over 2 years. The amount reimbursed through distribution tariff was TRY 227 million in the first half. Total efficiency and quality earnings increased by TRY 126 million in the first half of this year compared to the same period of last year. Theft and loss performance was higher in the first half of this year compared to the same period of last year. Despite the ongoing COVID impact, our field activities in total increased compared to last year. Similarly, theft accrual earnings increased despite the fact that we now retain [ 50% ] of theft usage accruals at collection compared to 75% in the previous year. CapEx outperformance improved with increase in CapEx investment. As you know, we completed our tenders in the beginning of the year. One item to watch out is that the commodity markets are tight and with some disruptions in global supply chain as supply chains were slow to catch up with the demand post vaccinations. While the price risk for us is limited due to escalation of unit prices, there might be some risks that our contractors cannot fulfill their commitments. We are, of course, closely monitoring our subcontractors and suppliers and taking prompt mitigation actions when necessary. Regarding quality bonus. Since Q1, we are recognizing in-house sourcing incentive and incentives for publicly listed companies on our income statement. For these items, we do not need to wait for year-end for the eligibility assessment. I would remind that the quality income recognition in Q4 will be lower than historic levels as the remaining scope in Q4 will be more limited and the criteria for eligibility for remaining items became stricter together with decreasing calculation base as per defined for the fourth regulatory period. Our revenue requirement for FX-based CapEx purchases are linked to FX-based commodity indices. And for those without the perfect match, we carry out hedges. The gains for these hedges are classified in other items. We had a very strong performance in that item in the first half of this year as well. Please note that the counterbalancing impact, which is operational FX gains/losses are reported on financial expenses. We had a significant improvement in free cash flow before interest and tax. Operating cash flow before interest and tax increased significantly by strong operational earnings. The base impact due to COVID-19 and pro rata reimbursements related to previous regulatory periods. This reimbursement includes financial income related to the third regulatory period, which is accounted in financial income, not yet cash effective. Meanwhile, exceptional CapEx reimbursement is reported under net working capital. The strong performance in net working capital is supported by the new maintenance, OpEx maintenance. OpEx is reimbursed equally through the distribution tariffs, while our spending in the first half was lower than the allocated budget as tender process continues as this is a new item not included in the previous regulatory period. The impact of this item on cash flow, which is around TRY 150 million will be reversed in the second half, while the impact on the operational earnings was negligible in the first half. Cash effective CapEx increased by around TRY 100 million despite the significant increase in CapEx as we had lower carryovers from the previous year compared to the first half of last year. As you see on Slide 8, our retail business showed a strong operational earnings growth of 41% year-over-year in the first half of this year. The growth in this half was mainly a result of increase in gross profit of regulated market segments. Prudent contract management with hedging of FX-based costs and improvement in the collections related income. Regulated gross profit increased due to higher retail service revenue, meaning due to increase in OpEx allowance and inflation effect. Liberalized gross profit increased due to higher volumes, while we started to see a normalization in margins, especially in corporate segments where we have a higher competitive activity and increase in sourcing costs. This trend is in line with our expectations, which we shared during the Q4 results release. In the third quarter, the electricity tariffs has increased by [ 15% ], while due to the jump in day-ahead prices prospects for an immediate margin recovery might be limited. Customer Solutions gross profit doubled to TRY 19 million mainly due to new solar projects. We target to leapfrog in our Customer Solutions business, especially focusing on e-mobility, but also on e-mobility but also on PV and CHP. We believe that Customer Solutions and e-mobility combined have the potential to deliver around TRY 1 billion annual revenues by 2025. The share of liberalized corporate volumes within total corporates reached 72% in Q2 due to the tariff structure, incentivizing liberalization and last resort tariff mechanism. Due to unchanged national tariff prices in Q2 and increasing sourcing costs, the switch of mid-corporate and SME customers from the regulated market to the liberalized market was limited. OpEx growth was slightly higher than inflation due to increase in volumes. The bad debt related income increased from TRY 25 million in the first half 2021 to TRY 76 million as doubtful provision expenses decreased due to improvement in payment behavior. The operational cash flow increased from around negative [ TRY 250 million ] to [ TRY 640 million ] with increase in operational earnings. Other important factors are price equalization impact in the first half is limited. While there was a substantial negative impact last year due to COVID-19 and temporary impact of higher-than-expected sourcing costs. There were increases in net deposit additions with the slowdown of shifts of customers to the liberalized segment. Higher net working capital inflow was mainly driven by positive effect of U.S.-related payables. Now let me come to the bottom line, development on Slide 9. Our net income grew by 34% to TRY 1.013 billion in the first half, exceeding operational earnings growth. Below the line item operational earnings, the main effects were as follows: with the decrease in average loan volume and lower interest rates, net loan interest expense decreased by TRY 83 million. Our average loan interest rate was down by 1.2 percentage points year-over-year to 12.2% in the first half 2021. The revaluation expense of both our bonds and our customer deposits was higher due to higher inflation compared to last year. Tax expenses increased with growth in pretax earnings. In Q1 2021, effective tax rate booked was 20%, while corporate tax rate increased to 25% for this year and 23% for next year. The increase was announced in the official gazette in April, and the increase was booked retrospectively in Q2 as we had highlighted. As the increase to 25% is a temporary application, we treated this as a one-off, and we have booked for the increase in tax expenses and extraordinary items. Please note that the tax correction of distribution business unit might increase due to tax rate increase. We continue our discussions with EMRA on that. Once it is finalized, we plan to book this as an extraordinary operating item. As a new development with changes in tax law in June 2021, of which the details are explained by the [indiscernible] July, companies will have the option to revalue the distribution assets and other property, plant and equipment by inflation at the statutory books, which are currently included with their historical costs. The value increase due to revaluation with inflation will be accounted only on the statutory books given the opportunity to expand incremental depreciation and amortization arising from the revaluation difference. Meanwhile, companies using this option have to pay 2% over the revaluation differences and one-off tax expense. The revaluation mechanism is not an obligation but optional. We are in the process of assessing the potential implications both for the statutory and IFRS financial statement, in particular, for the financial asset model within the scope of IFRIC 12 and EMRA tariff application. Turning to Slide 10. Our economic net debt remained stable compared to year-end at TRY 11.3 billion despite the dividend payment, thanks to our strong free cash flow. Meanwhile, our financial net debt to operational earnings ratio is 1.4x. Free cash flow before interest and tax was about TRY 2.3 billion in the first half, while net interest payments were around TRY 800 million. Net interest payments were higher than interest payments due to payment schedule and the payment of CPI reevaluation of our bond, which was redeemed in the first quarter. We have TRY 491 million of tax payment in the first half. We had a dividend payment of TRY 1.1 billion in the second quarter. Our balance sheet is very healthy with no unhedged FX exposure, 62% of our gross debt has fixed interest rate, 27% has variable interest rate and around 11% is CPI linked. So proxy to our inflation index revenues. The share of variable interest loans has slightly increased compared to 2020 year-end as we had utilized our floating rate committed lines. For the rest of 2021, we do not have any additional financing needs as we are able to fund new investments and scheduled loan repayments by our operational cash flow. Now let me come to the last slide, which is Slide 11. Regarding the 2021 guidance, we had highlighted that we were not expecting a major impact on guidance due to the lockdowns of Q2. Based on the strong performance in Q2 and reflecting higher inflation rates, we have revised our guidance upwards. So our 2021 guidance is as follows: first 15% to 20% growth in operational earnings. Our previous guidance was double-digit growth. Second, around TRY 2 billion underlying net income. Third, year-end RAB of at least TRY 11.2 billion, reflecting higher inflation. And fourth, at least TRY 1.8 billion free cash flow after interest and tax. On operational earnings, we expect an upward momentum in financial income as we accelerate our investments. Our RAB guidance reflects higher inflation and also some caution due to tight commodity markets and potential supply risks as we have already discussed. Based on Q3 performance, we will consider revising it. So thank you very much for your attention. And moderator, we can now take all the questions the participants might have.

Thank you. Ladies and gentlemen, we will now start our question-and-answer session. [Operator Instructions] The first question comes from Ekaterina Smyk from Bank of America.

I have a couple of questions. The first one is on the lump-sum amount that you expect to receive over 2 years, this year and next year. I think you provided the number of TRY 200-something median Turkish lira for the first half. What is the total amount you expect to receive for the year and that is included in your free cash flow guidance of at least TRY 1.8 billion? The second question is on the difference between sort of the short-term CPI assumptions and the long-term, the one that is included in your financial income. Do you expect any changes to the long-term assumption on the inflation? And when do you expect these 2 metrics to converge, if so? And the third question is on the interest rates on your loan portfolio. Where do you see -- how do you see your interest average realized interest rate changing in the second half versus first half? And with respect to the next year, we appreciate you covered your funding needs for this year before the interest rate spike. What about next year? And I think that at some point, you mentioned that for the time being, you will be covering your needs with your free cash flow generation. Is that correct?

Okay. Thanks Ekaterina. Let me start with the first question on CapEx reimbursement. Of the reimbursememt, we had received TRY 227 million, and is the extra CapEx reinvestment part while there is also the financial income concentration and other items. And the total amount we provided the guidance it was TRY 3 billion. As there is no change in this TRY 3 billion, it will be received over 2 years. And for 2021 from TRY 227 million to around TRY 250 million would be related to extraordinary CapEx reimbursement. And the other part, you will see in working capital and financial income less cash effective. So received quick calculation, of course, with the inflation. The share might be slightly different between 2021 and 2022, but you can roughly assume same share between the years. And coming to your second question regarding the long-term inflation expectations, we believe that there is some [indiscernible] to our inflation assumptions, especially for 2022. Given the wholesale price index and in terms of division, we'll move to that again by the year-end. Therefore, directly some upside just related to that. And the first question is on the loan portfolio as not much interest expense, we expect in the second half of the year. Compared to the first half of the year, we expect the full year results to be [ individual events ] like we saw an increase in the second half compared to the first half, but we do not expect a major difference. 2022 is a difficult question because we had not refinanced debt [indiscernible] interest rates have gone up and this will also need to be considered in relation to the inflation because for instance -- for example, the inflation is going above our expectations and also is lower to 2022. Therefore, the net impact will come from the differentials [indiscernible]. I hope this answers the questions.

Can I just follow up on the first one? Sorry, I didn't get it entirely. So you said TRY 3 billion, which is in line with the previous guidance, that's a cash impact, right? And out of this cash impact half, it can be -- you said it can be evenly distributed between 2 years or I misheard you?

Yes, so this will be clear model that it's evenly split, of course, there will be inflation adjustment, but for simplicity, let's assume it to be [indiscernible] split.

Okay. So for the third -- sorry, for the second half, the amount can be -- roughly TRY 750 million?

The second half the amount would be like...

Sorry, sorry, TRY 250 -- sorry, TRY 1:5 billion less TRY 250 million, right? TRY 1.25 billion.

This TRY 227 million is the only CapEx reimbursement plus it also includes financial income compensation, and it also includes some loss capital or other impacts as well. We provide TRY 227 million because we did not include this to our operating earnings and is not part of our guidance. Our operating earnings guidance does not incorporate for this exception item. Therefore, for that purpose it provides TRY 227 million because the CapEx reimbursement you would see is not in line with [indiscernible] table so we showed the split. You see the rest in other items. So growth, you can assume that we -- this is something close to TRY 750 million in the first half, but is in the other cash flow items.

Okay. Understood. That was the number I was looking for. And with respect to the funding for next year, at what stage do you normally start covering your funding needs? Is that Q3 -- end of Q3 or more of the end of Q4 or it's flexible depending on the macro environment?

We start the discussions earlier, of course, because it's also the kind of -- what kind of financing you would like, but the finalization [indiscernible] as well. So it's truly more likely need to be in the fourth quarter.

Okay. Understood.

We had a question from [indiscernible] and the question is, do you expect continued reaching from regulated to the realized segment in retail, given the market [indiscernible] in the first quarter. Actually, this call, we tried to explain in the second quarter, the switch has been more limited compared to the first quarter of last year because of the sourcing cost increases. And the reprice has increased in the first quarter by 15%, but sourcing cost continued to increase. Therefore, we do not expect a major switch from the regulators to liberalized segment, unless there are rate increases -- project rate increases or the cost come down together with the normalization of the other conditions. And we can take -- if there are further questions, we can them down from the audience.

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

So then thank you very much for your patience and for your attention and keep safe and healthy, and we are looking forward to see you soon in person in one of our roadshows and investor calls. Thank you. Bye-bye.

Thank you for participating.

Ladies and gentlemen, this concludes today's webcast call. Thank you for your participation. You may now disconnect.