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

Welcome to Enerjisa Third Quarter 2021 Results Conference Call and Webcast. I now hand over the call to CFO, Michael Moser and IR, M&A Tax Director, Gözde Çullas. Please go ahead.

Thank you very much, and hello, everyone. This is Michael speaking. I first of all, I hope that everyone is healthy and doing well. And then please let me start today's earnings telecall by an overview of the first 9 months of this year. So please turn to Slide 2. In the first 9 months, we had a robust performance, thanks to our sound risk management processes, our robust balance sheet and accelerated investments. Underlying net income grew by 13% year-over-year compared to the same period of last year, while CapEx increased by 60% during the same period. Electricity consumption demonstrated strong growth in Q3 and increased by around 7% year-over-year. The increase was driven by economic recovery as well as hot weather conditions in the quarter. COVID vaccination rate continued to increase during the quarter. So 89% of the population over the age of 18 years received the first dose of Covaxin and 79% received the second dose as of November 2. In October, we issued an TRY 800 million bonds with two-year maturity at the rate of TLREF+1.4% interest rate. And this is the third largest TL dominated bond issuance of the real sector and the largest bond issuance of the electric energy sector in Turkey. So we are glad in the high investor interest in our bond. We have adjusted our guidance, reflecting our 9 months performance and expectations for the fourth quarter. Our new guidance for operational earnings is getting more specific to the higher end, reflecting the impact of higher inflation. Our cash flow expectation has now a wider range with a lower end, reflecting the impact of higher electricity procurement prices and its impact on price equalization mechanism. It is important to note that this guidance adjustment is simply a time shift. This means that any impact of electricity prices on cash flow will be reversed in 2 quarters with price equalization mechanisms without any loss of time value of money, thus would not have any impact on valuation. I will discuss the details in the subsequent slides, so please turn to Slide 3. Sound risk management is, in our view, essential to address the inherent price fluctuation in the commodity markets. In 2020, commodity markets was impacted by a merge of COVD-19, while this reversed in 2021 and the recovery has led to tightened commodity markets and price increases. Crude oil price increased from USD 20 per barrel levels during mid-2020 to around USD 70 per barrel in mid-2021. Spot natural gas prices increased as well due to demand recovery, tight supply and some extent, weather-related factors. Q2 increase in natural gas prices, there was also a switch to coal, high natural gas and coal prices have led to higher power prices in many markets. Turkey's natural gas supply mix is skewed towards long-term contract index to Brent prices. Therefore, the impact of spot price increases on weighted Turkish supply costs was more limited compared to other markets so far. However, Turkey has not been fully immune to the impact of -- Sorry, my connection is falling away. However, Turkey has not been fully immune to the impacts of natural gas and coal price increases. Quarterly average day-ahead power prices increased by 76% year-over-year and 49% quarter-over-quarter increase in Q3. Additionally, in mid-October, EMRA has changed the formulation for price ceiling in the day-ahead market. The previous formulation was 2x the 12-month average prices. The new formulation is 3x the 12-month average prices. Accordingly, the price ceiling set for October increased from TRY 718 per megawatt hour to TRY 1.078 billion per megawatt hour. We believe the change is undertaken in order to ensure uninterrupted supply ahead of winter to enable coal and natural gas-driven generation. What means the outlook for the Turkish power market for Enerjisa. Given the mix of our business and predominantly regulated nature of the retail business, we are relatively protected, and we are taking all the measures to mitigate any potential negative impact of electricity price increases. Distribution accounts for around 85% of our operational earnings. The change in electricity prices have very limited impact on our distribution earnings and our consolidated earnings as well. On the retail side, our regulated retail segment accounts for around 2/3 of our retail gross profit. Our gross profit in regulated retail segment is cost plus with a 2.38% gross margin. Therefore, the electricity costs do not have any impact on our percentage margin, while higher costs mean higher absolute gross profit. Meanwhile, if the increase in electricity cost is not reflected in the regulated national tariffs within the quarter, this impacts our cash flow, which is compensated with 2 quarters lag as per the regulatory price equalization mechanism without any loss of time value of money. In Liberalized segment, we have 2 type of contracts, as you know, fixed and variable. Both type of contracts have around 50% share in sales. For fixed contracts, we generally carry out hedges or have bilateral supply contracts matching the sales contracts. During times of high volatility in electricity costs, some negative impact on liberalized segment profit is possible, which is partly compensated by a higher gross profit in the Regulated segment. In net, the impact of electricity costs in our consolidated earnings is limited. While there might be a temporary impact on cash flow, which is compensated, as I stated in 2 quarters, including interest. Now let us please go over the financial highlights of the first 9 months of 2021, which you can find on Slide 4. In the first 9 months, we had robust earnings. Our cash flow was positive in these 9 months, while increase in electricity procurement costs had an impact on our cash flow in the third quarter. Operational earnings growth was 23% year-over-year, exceeding the inflation, including for exceptional CapEx reimbursements, the growth was 31%. Meanwhile, underlying net income increased by 13% year-over-year. Our free cash flow after interest and tax was around TRY 540 million compared to around negative TRY 470 million in the same period of last year. The negative free cash flow after interest and tax in the third quarter is driven by price equalization impact in regulated retail segment due to higher increase in electricity procurement costs than tariff prices. Our balance sheet is very healthy with no unhedged FX exposure. Our financial net debt to last 12 months operational earnings ratio is down from 1.9x in September last year to 1.5x in September this year, while there is a slight increase if you look quarter-over-quarter. Please now take a look at the market environment, which you can find on Slide 5. Inflation continued to increase in Q3, reaching 17.5% in June and 19.6% in September, while interest rates peaked with 6 months TR labor increasing to 20% in March and was mostly stable during the quarter, while declined by around 3% to 16.7% since the start of easing cycle by CBRT in September. We financed most of our funding requirement for 2021 prior to the rate hikes during the low interest rate environment of 2020, while also extending majorities. As a principle, we start the preparation for subsequent years financing in the second half or last quarter of the year. We have been opportunistically unhedged for 2022 as we were expecting a window of easing cycle, and we started the process following the rate cut by CBRT in September. As mentioned, in October, we issued TRY 800 million bond with 2 years majority at TLREF+1.4%. We are glad in the high investor interest in our bond. I will now go over the electricity prices as we discuss them in detail in the previous slides. In this slide, we see the planned regulated sourcing costs for which the increase is lower than they had prices as the increase in regulated U.S. prices was more muted than spot prices. As another note, end-user tariffs has been unchanged since July 1, which has led us to take a cautious stance on the cash flow for 2021. Now coming to a more detailed explanation on our operations on Slide 6. On the distribution side, CapEx was around TRY 2.1 billion in first 9 months of 2021, with a 60% increase compared to the same period of last year, reflecting the increase in CapEx allowance in the fourth regulatory period. Our investments accelerated in the third quarter as per our guidance. New investments in the first 9 months slightly exceeded CapEx reimbursement, including exceptional items. Our RAB grew by TRY 1.8 billion compared to the year-end, also reflecting revaluation of opening balance with inflation. Efficiency and quality earnings increased by 16% in the 9 months of 2021. In Q3, there was a slight decline of 8% on a year-over-year basis due to a high base reflecting the shift of field activities to Q3 last year due to covered and lower theft accrual collection income driven by a decrease in retention rate as per the new tariff. In our liberalized retail business, volumes continue to increase, while margins declined from a high base of last year due to bold competition in early 2021 and more importantly, the impact of increase in procurement costs. Our profit from the free market accounted for 24% of our retail gross profit in the 9 months of 2021 compared to 35% in the same period of last year. As a significant change, our Customer Solutions business accounted for 7% of retail gross profit again in 9 months of 2021 compared to 2% for the same period of last year. Now let me please come to Slide 7. Operational earnings has increased by 23% year-over-year to TRY 5.2 billion. Both distribution and retail segments contributed to that performance. This figure does not include TRY 339 million exceptional CapEx reimbursements. We will discuss the details in the subsequent slides. So please see the detail of our distribution business on Slide 8. In the Distribution segment, operational earnings growth was 24% year-over-year in the first 9 months. The financial income growth accelerated in the third quarter with the impact of higher inflation despite the declining WACC. There are 2 impacts in the first 9 months. First, the impact of decline in WACC and rapid adjustment on 2020 was reflected in Q4 2020 in lump sum and is not included in the 9 months 2020 financials. The base impact in the 9 months is around TRY 130 million. And two, we reflected the changes in our inflation assumptions, which has around TRY 80 million impact in 9 months financials. CapEx reimbursements, excluding exceptional reimbursements, increased by TRY 570 million due to higher CapEx ceiling. And as the regular compensation for overspend, CapEx on the third regulatory period started as of January 2021. CapEx reimbursement 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 tariffs was TRY 339 million in the first 9 months. Total efficiency and quality earnings increased by TRY 101 million in the first 9 months compared to the same period of last year. Theft and loss outperformance was higher than the first 9 months 2021 compared to the same period of last year despite the decline, the lower TL threshold levels, thanks to increase in field activities and to some extent, due to the impact of higher electricity prices. Theft accrual earnings decreased as we now retain 50% of theft usage accruals at collection compared to 75% from the previous year. OpEx outperformance in the first 9 months of 2021 was TRY 122 million, slightly lower than in the first 9 months of last year, mainly due to the shift in spending between quarters and to some extent, the impact of increase in commodity costs. CapEx outperformance improved with increase in CapEx investments. Since Q1, we are recognizing in outsourcing centers and incentives for publicly listed companies on our income statement. I would again kindly remind you that the quality income recognition in Q4 will be lower than historic levels as the remaining scope in Q4 will be more limited than the criteria for the eligibility for the remaining items became stricter together with decreasing calculation base as per defined for the fourth regulatory period. Other items was TRY 65 million lower than last year due to change in hedge gains, losses, which is partially compensated by a legal case income of TRY 48 million. We had a significant improvement in free cash flow before interest and tax. Operational cash flow before interest and tax increased significantly by strong operational earnings. The base impact due to covered '19 and pro rata reimbursements related to previous regulatory periods. This reimbursement includes financial income related to the third regulatory period, which was accounted in financial income, not yet cash effective at previous years. 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 and equally through the distribution tariffs. While our spending in the first 9 months was lower than the allocated budget, a standard process has been completed at the end of the second quarter as this is a new item, which was not included in the previous regulatory periods. The impact of this item on cash flow, which is around TRY 150 million, is expected to be reversed in the fourth quarter. While the impact on operational earnings was injectable in the reported earnings. Cash effective CapEx increased by only around TRY 570 million despite the significant increase in CapEx as we have lower carryforward from the previous year compared to the first 9 months of 2020. As you see on Slide 9, our retail business showed a strong operational earnings growth of 20% year-over-year in the first 9 months of this year. This year, we have completely different dynamics compared to last year. The growth in the first 9 months was mainly a result of increase in gross profit of regulated market segments and improvement in the collections related income. Regulated gross profit increased due to higher electricity prices and higher retail service revenue, meaning due to increase in OpEx allowance mainly driven by higher inflation. Despite higher volumes, liberalized gross profit declined due to competitive activity early in the year and more importantly, increase in sourcing costs. While we were stressing a potential decline in margins compared to last year due to high base, the decline was higher than our expectations due to the pace of increase in sourcing costs. Nevertheless, the increase in regulated gross profit was more than compensated for the decline in liberalized gross profit. Customer Solutions profit [ quad dropped ] to TRY 66 million mainly due to new solar projects. Given the project-based nature of the segment, we can have volatility in our quarterly earnings, while it is very clear that we have strong growth potential in that segment. OpEx growth was in line with inflation, and this increase was compensated by retail service revenue. The bad debt related income increased from TRY 28 million in the first 9 months of 2020 to TRY 102 million as doubtful provision expenses decreased due to improvement in payment behavior. The operational cash flow increased from around TRY 250 million to TRY 320 million with increase in operational earnings and improved payment behavior partially set off by price equalization impact. Meanwhile, we have a negative operational cash flow in the third quarter due to price equalization impact as the tariff price increases were lower than procurement price increases. This impact will be corrected, as I stated in the beginning, with 2 quarters lag. There were increases in net deposit additions with the slowdown of shift of customers to the liberalized segment. Now let me come to the bottom line development, which you can find on Slide 10. Our underlying net income grew by 13% to TRY 1.597 billion in the first 9 months, below the line item, operational earnings, the main effects were as follows: With the decrease in average loan volume, net loan interest expense decreased by TRY 41 million. Our average loan interest rate increased by 0.3 percentage points year-over-year to 12.8% in the first 9 months of 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. Corporate tax rate increased to 25% for this year and 23% for next year as the increase to 25% as a temporary application, we treated this as a one-off, and we have booked for the increase in tax expenses and extraordinary items. EMRA confirmed reflection of this corporate tax increase to tax correction component of revenue ceiling in October. As it was confirmed in October, this development was not reflected in Q3 financial statements. This income will be treated as exceptional items when reflected. As we discussed before, with changes in tax law, companies now 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. This was initially planned to be a temporary change. But now with the new draft law, the mechanisms might be provided as a permanent option. The value increase due to revaluation with inflation will be accounted only on the statutory books, giving the opportunity to extend incremental depreciation and amortization arising from the revaluation difference. Meanwhile, companies using this option have to pay 2% over the revaluation difference as one-off tax expense. The revaluation mechanism is, as I stated, not obligatory but optional. So we continue assessing the potential impact implications both for the statutory and IFRS financial statements, in particular for financial asset models within the scope of IFRIC-12 and EMRA tariff application. Turning to Slide 11. Our economic net debt increased to TRY 12.1 billion in September this year from TRY 11.3 billion in December last year. Meanwhile, our financial net debt operational earnings ratio is 1.5%. Free cash flow before interest and tax was around TRY 2.6 billion in the first 9 months, while net interest payments were around TRY 1.1 billion. Net interest payments were higher than interest expenses due to payment schedule and the payment of CPI revaluation of our bond, which was redeemed in the first quarter. We have TRY 900 million of tax payments in the first 9 months. The tax payment is higher than tax expense as the one-off financial income reimbursement just started to be booked in statutory accounts in 2021 while they were being accrued in IFRS accounts in the previous years. We had a dividend payment of TRY 1.1 billion in the second quarter. Our balance sheet is, as stated is very helpful with no unhedged FX exposure. 64% of our gross debt has fixed interest rates, 25% has variable interest rates and around 11% of CPI linked. So proxy to our inflation index revenues. The share of variable interest loans has slightly increased compared to last year as we had utilized our floating rate committed line. In October, we have issued an TRY 800 million bond as per preparation for next year. The interest rate is TLREF +1.4% and majority is 2 years. Now let me please come to the guidance, which you find on Slide 12. We have adjusted our guidance, reflecting our 9 months performance and expectations for the fourth quarter. Our revised 2021 guidance is as follows: 18% to 20% growth in operational earnings. Our previous guidance was 15% to 20% growth. We narrowed the range to the higher end reflecting the impact of higher inflation. Around TRY 2 billion underlying net income. There is no change against the previous guidance. While we are now on the higher end of our previous operational earnings guidance due to increase in inflation, the impact is counterbalanced by short-term inflation, also impacting deposit valuation and CPI-linked bond expenses. Our year-end RAB guidance is unchanged and is at least TRY 11.2 billion. Our RAB guidance reflects some caution due to tight commodity markets and potential supply risks as we have already discussed. We provide a wider range for free cash flow after interest and tax, between TRY 1.5 billion and TRY 1.8 billion. Our previous guidance was at least TRY 1.8 billion. Now we are more cautious on the back of electricity markets and risks continue. Nevertheless, any impact on free cash flow would be reversed in 2022 without any loss of time value of money. Thank you very much for your attention. And operator, please, we can now take your questions.

Ladies and gentlemen [Operator Instructions]

Operator, there is a question online, and it's discussed about the way. And it basically asked the difference in distributed energy growth and retail volume growth in the third quarter. The retail volume growth was higher than distributed energy growth. And [indiscernible] retail volume includes customers connected to transmission lines, while distributed energy does not. And because of the difference [indiscernible] especially strong growth in industrial electricity consumption, retail volume growth is higher than distribution energy growth. And we can take other questions.

[Operator Instructions] Thank you you. There are no other questions. Dear speakers, back to you.

So thank you very much for your time and for your interest in Enerjisa, and I wish you [indiscernible] ongoing health for you and your families and see you soon on the road shows or in the investor calls. Thank you very much.

Thank you all for participating.

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