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

Welcome to Enerjisa First Quarter 202 Results Conference Call and Webcast. I now hand over the call to CFO, Michael Moser; and IR, M&A, Tax Director, Gozde Cullas. Dear speakers, please go ahead.

Thank you very much, and hello, everyone. This is Michael speaking. And I hope everyone is healthy and doing well. Let me start today's earnings telephone conference by providing an overview of the first quarter of 2022. In this respect, please go to Slide 2. We are going through unprecedented times for the whole energy sector across the world. Strong economic growth and weather conditions resulted in a more than 6% growth in the global electricity demand in 2021. The strong growth in energy demand has put pressure on coal and natural gas supply chains, leading to spikes in electricity procurement costs. These trends continued at full force in the first quarter of this year. Amidst an inflationary environment, the need to ensure both the functioning of the electric utility sector and affordable prices, especially for vulnerable customers, urged the regulators to undertake drastic measures globally. While we were not insulated from these developments, we managed to limit the impact to some extent with our strong balance sheet and robust risk management measures. In that environment, our operational earnings increased by 64% year-over-year on the back of strong performance, especially in Retail and Customer Solutions segments. Underlying net income declined by 59% year-over-year. The main drivers for the decline in underlying net income were inflation index bonds and deposits, which was reevaluated with a quarterly inflation rate of 31%, an increase in our financing rates due to a low base and an increase in our net debt at higher marginal interest costs. In retail, regulatory retail tariffs, not reflecting actual electricity procurement costs and the temporary impact of VAT rate decreased in some tariff segments have also led to substantial negative cash flows. Nevertheless, please note that this heavy decline in net income in the first quarter is not a proxy for the full year due to quarter-specific drivers. On the contrary, we expect a substantial recovery throughout the year compared to the first quarter for the following reasons. First, the peak in inflation took a toll on our financing expenses in the first quarter of 2022, while the impact of inflation on our costs will be lower in the subsequent quarters. Second, the positive impact of inflation on revenues will continue to be reflected throughout the year, notably for distribution segment even when the inflation starts to ease. Our cash flow was substantially negative in the first quarter. The increase in regulated tariff prices was not sufficient due to continuing increase in electricity procurement prices and cash flow situation worsened further with the Russian invasion into Ukraine. Moreover, tariffs are indexed at a lower indexation than current inflation, leading to a relatively weaker performance, especially in the distribution segment. In relation to the aforementioned retail cash flow issue, the Turkish regulator temporarily introduced new mechanisms to address the sustainability of the system, which I will discuss in detail in the subsequent slides. However, please note that access to funding and balancing the cash requirements were never an issue for us. Here, we see once again the benefit of our strong balance sheet, our prudent business steering, along with Energisa's strong brand. Despite the weak performance in net income and cash flow in the first quarter, we raised our guidance for operational earnings and underlying net income. Upward revision and guidance is mostly based on the impact of the increase in short and midterm inflation assumptions, given the positive impact of inflation on performance will continue in the subsequent quarters, while the cost impact will be more muted. Despite the challenges in our sector, we are confident on the growth prospects, and we view the current issues as temporary. We even see in these challenges for the whole energy sector further upside potential for Enerjisa as Enerjisa is the best prepared energy company in the sector, and it might not be unlikely that we benefit from improved regulatory adjustments. Accordingly, we will continue to pursue our growth strategies and our investments will continue. Please turn over to Slide 3. Higher natural gas and coal prices continued to result in higher power prices across markets globally. In Turkey, the quarterly average day-ahead power prices increased by around 370% year-over-year and around 70% quarter-over-quarter in the first quarter of 2022. Given the mix of our business and predominantly regulated nature of the retail business, our P&L has been protected against these fluctuations. The change in electricity prices has limited impact on our distribution earnings, except for stronger theft and loss related performance driven by higher prices. Our gross profit in the regulated retail segment is cost plus with a 2.38% gross margin. Therefore, higher costs mean higher absolute gross profit. 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' time lag with financial compensation as per the regulatory price equalization mechanism. During times of high volatility in electricity sourcing costs, some negative profit impact on the liberalized segment is possible. When the regulatory tariffs are cost reflective and there is stability in the market, the impact of higher electricity sourcing cost is positive for the liberalized segment as well. In that, the impact of higher procurement costs on our consolidated operational earnings was positive in the first quarter of 2022, while there was a substantial negative impact on cash flow due to regulated tariffs lagging behind procurement costs. Let us go over the financial highlights of the quarter of 2022 on Slide 4. In the first quarter of 2022, we had a robust growth in operational earnings. Operational earnings growth was 64% year-over-year. Underlying net income decreased by 59% year-over-year to TRY 2,013 million. Excluding the impact of revaluation of deposits, which is mostly noncash effective, the growth was 16%. Our free cash flow after interest and tax was around negative TRY 3.8 billion compared to around positive TRY 300 million during the same period of last year. The negative free cash is driven by a combination of factors, which are continuing increase in electricity prices, not supported by current national tariff levels, change in supply mix. In the first quarter, there was no supply from state-owned EUAS for regulated retail segment due to constrained capacity factors of hydro plants and market conditions. This increased both our weighted average costs and reduced our payable days. Decrease in VAT rate of electricity tariffs for residential and agricultural irrigation segments from 18% to 8%, while the VAT rate on procurement continued to be at 18%. This impact will be mostly reversed through the year. The impact of yearly inflation assumption incorporated to national tariff calculations. The annual inflation assumption for June 2022 is set at 25.8% in the national tariffs impacting especially the distribution segment. While operational cash flow of Distribution segment was strong in the first quarter 2022, the inflation assumption built in tariffs still had a negative impact on performance. And lastly, the impact of higher receivables due to increase in national tariff levels. Despite the increase in leverage on a quarterly basis, we have a healthy balance sheet. Our financial net debt to operational earnings ratio is 1.5x in March 2022. Please take a look at the market environment on Slide 5. Inflation continued to increase in the first quarter, reaching 61% in January. 2-year government bond yields reached 25% in March. Electricity consumption continued to be robust in the first quarter of 2022 and increased by around 5% year-over-year. The increase was driven by economic growth, low base due to lockdowns last year and, to some extent, bad weather conditions. I will not go over the electricity prices as we discussed them in detail in the previous slide. In this slide, we see that the planned regulated sourcing costs increased by 239% year-over-year, which was far above the increase in regulated tariffs. There is a long list of tariff changes within Q1. I will skip the details for using the time effectively. In case you might have any questions, please raise during our Q&A. The highlights of the quarter are high increases in national tariff prices in January, introduction of 2 peer price structure for both commercial and residential tariffs and some dilution of the electricity price increases implemented in January with the changes carried in the first quarter. Meanwhile, as of April 1, the energy component of industrial tariffs increased by 22.7%. As we discussed, the national tariff changes were not sufficient to pass through all procurement cost increases. Accordingly, the need to adjust the cash flow of the incumbent retail companies has arisen. However, consumers are already suffering from high inflation. For this reason, the regulator sought for alternative mechanisms to address the issue. The first mechanism is related to feed and tariff costs. With feed in tariff costs, I refer to the difference between the guaranteed renewable prices and the day-ahead prices. Feed and tariff costs started to be negative due to rising day-ahead prices. With the new mechanism, the funds from negative costs will be provided to incumbent retail companies rather than previous practice of allocating to both, liberalized and regulated tariffs. This mechanism aims to subsidize regulated residential and SME customers and is planned to be temporary for 6 months with the possibility to extend for further 6 months. The second mechanism is a new resource-based maximum price limit application, which is resource-based price limits for power generation facilities. According to the mechanism, maximum settlement price for each electricity generator type has been defined, reflecting differences in marginal costs. For low-cost generators, the difference between the market price and the resource-based maximum settlement price will be allocated to a special fund. In case of need, the collections of this fund will be first allocated to a high-cost generator in order to prevent possible supply issues. The remaining funds will be distributed to the incumbent retail companies. This mechanism is also planned to be temporary. If these measures turn out to be insufficient, we believe that new measures will be introduced or tariff prices increases will be considered. Meanwhile, we are doing our part to address these issues by a number of measures, such as by supplying related volumes with bilateral contracts at longer payment terms and compensation of VAT related working capital impact with accelerated VAT returns in cash. Now coming to a more detailed explanation on our operations on Slide 6. On the distribution side, our CapEx spend was TRY 380 million in the first quarter of 2022 with a 24% increase compared to the same period of last year. We had a relatively low start due to the early issues regarding the CapEx unit prices and also due to seasonality. New investments in the first quarter of 2022 were below CapEx reimbursements due to seasonality. Nevertheless, our RAB grew by TRY 5.1 billion compared to the year-end reflecting revaluation of opening balance with inflation. Efficiency and quality earnings was flat with a weak performance in CapEx and OpEx outperformance, while theft and loss and quality-related performance was higher than last year, mostly due to electricity price increases. Our retail volumes increased by 22%, driven both by regulated and liberalized segments, thanks to strong growth in Energisa's home regions, exceeding Turkish volumes, especially in commercial and industrial segments with increasing economic activity post-COVID and increasing exports. Moreover, strong growth in other regions, thanks to attractive offers also contributed to that performance. In Liberalized retail business, corporate volumes continued to increase, while SME volumes declined as we shifted SME customers to regulated segment in the fourth quarter. Liberalized gross margin declined due to the impact of sharp increase in procurement costs and the impact of change in FAT cost allocation mechanisms. Gross profit of our Customer Solutions business more than tripled in the first quarter of 2022, mostly due to solar projects. Coming to Slide 7. Operational earnings increased by 64% year-over-year to TRY 2.7 billion. Retail and Customer Solutions segment with 97% growth was the main contributor to this performance, while distribution was also strong with 57% growth. We will discuss the details in the subsequent slides. So therefore, please turn to Slide 8. In the Distribution segment, operational earnings growth was 57% year-over-year in the first quarter of 2022. The growth in financial income was 57%, mainly due to the impact of higher, short and midterm inflation assumptions. CapEx reimbursement, excluding exceptional reimbursements increased by TRY 371 million due to the impact of inflation and the CapEx allowance increase last year. Total efficiency and quality earnings were flat in the first quarter of 2022 compared to the same period of last year. Theft and loss outperformance was higher than last year due to an increase in theft and loss, specific U.S. prices and better performance in our [indiscernible] region. Theft accrual and collection earnings increased significantly due to increase in national tariff prices. OpEx outperformance in the first quarter of 2022 was negative due to increase in commodity related expenses, such as material and fleet costs exceeding inflation. CapEx outperformance was 0 as we had discussed the effectiveness of CapEx/unit price escalation mechanism decreased due to supply bottlenecks and local factors. Accordingly, EMRA, the regulator, has introduced a new mechanism, which limits the loss to 10% of CapEx spending for the sector and if we outperform the sector, there is a possibility for some positive CapEx outperformance. However, we do not incorporate for that as the performance will be assessed in the year-end. Quality bonus increased due to the increase in revenue ceiling. We expect significant growth in the year-end due to increase in allowed ceiling for quality items from 6% in 2021 to 7% this year and better field performance. Other items in the first quarter of 2022 was TRY 111 million, higher than TRY 51 million last year, mainly due to CapEx [indiscernible]. Tax correction increased by 54% due to higher June inflation assumptions. We have a slight decline in free cash flow before interest and tax. Operating cash flow before interest and tax increased due to strong operational earnings despite the net working capital outflow. Working capital outflow was mostly due to the difference between EMRA's June inflation assumption built in regulatory tariffs versus what we incorporate in our forecast for June. Cash effective CapEx increased by around TRY 500 million. We continue to offer flexible payment terms to our contractors for securing our supply chain. Finally, we also further increased our inventories beyond normalized levels in an effort to ensure supply security in 2022. As you see on Slide 9, our retail business showed an operational earnings growth of 94% year-over-year in the first quarter of 2022 despite many challenges during the quarter. The growth of the first quarter of 2022 was mainly a result of increase in gross profit of regulated market segment. Regulated gross profit increased due to higher electricity procurement prices and higher retail service revenues, meaning due to increase in OpEx allowance, mainly driven by higher inflation. Despite higher volumes, liberalized gross profit declined due to increase in sourcing costs. The increase of FAT costs from negative to 0 also impacted gross profit of the Liberalized segment. However, most of this negative impact will be compensated in the upcoming months. The increase in regulated gross profit more than compensated for the decline in Liberalized gross profit. The bad debt related income declined from TRY 32 million in the first quarter of 2021 to TRY 4 million in the fourth quarter of this year as doubtful provision expenses increased mainly due to increase in electricity tariffs while this has not reflected to late payment income in the same magnitude yet due to timing of accrual of late payment income. The operational cash flow decreased from around TRY 500 million in the first quarter of 2021 to around negative TRY 3.6 billion in the first quarter of 2022. The price equalization impact was TRY 2.8 billion as the regulated tariff price increases were not sufficient to cover procurement price increases. Additionally, the working capital was negative with higher trade receivables due to higher national tariff and deferred VAT due to decrease from 18% to 8% for the residential and agricultural customers. Customer Solutions gross profit increased by 260% to TRY 36 million, so TRY 36 million, mainly due to new solar projects. Now let me discuss the bottom line development on Slide 10. Our underlying net income declined by 59% to TRY 213 million in the first quarter of 2022. Below the line item, operational earnings, the main effects were as follows: net loan interest expense increased by TRY 334 million due to an increase in both financial debt and interest rates. The average loan interest rate increased by 13 percentage points year-over-year to 23.4% in the first quarter of 2022. Net loan interest expense includes TRY 49 million FX losses on operational items, which is more than compensated by TRY 115 million hedging gains in other items of the distribution segment. Excluding the FX impact, the increase in financing costs is 12.2 percentage points year-over-year. The revaluation expenses of both our bonds and our customer deposits were significantly higher than in last year. We revalue the inflation index bonds and deposits with the inflation between October and January, which was 31%. It is important to highlight that most of the deposit revaluation expenses are of noncash nature. Tax expenses declined with decline in pretax earnings. Other item was TRY 51 million compared to TRY 6 million last year. This item includes compensation with T+2 mechanism. We expect a significant increase in this item in the subsequent quarters as we will be booking the financial compensation for the tariff gap. Turning to Slide 11. Our economic net debt increased from TRY 11.3 billion in December to TRY 16.3 billion in March 2022. Meanwhile, our financial net debt operational earnings ratio is 1.5x, still at a very healthy level. Free cash flow before interest and tax was negative TRY 3.2 billion in the first quarter of this year, while net interest payments were around TRY 440 million. Change in deposits was TRY 822 million, mostly due to revaluation of deposits. We also have around TRY 400 million other item, mainly due to revaluation of bonds. 57% of our gross debt has fixed interest rates, 31% is linked to TLREF and 8% is CPI-linked. Slide 12 is a repetition, but we believe it is important to understand how the IFRIC model works to better understand our financials in Turkey. Distribution companies are not the legal owners of the networks and receive guaranteed investment return components. As a result, our distribution companies are subject to the application of IFRIC 12. The calculation of IFRS financial income using nominal RAP, VAC and inflation is an illustration to explain to basics of our business model. However, this model is not representative when there is high volatility in the market. In the financial asset model, financial income is calculated basically as IRR time financial assets, where IRR is a nominal value calculated over the lifetime of our concession assets. The IRR figure is different than WACC plus current inflation, and it also takes into account the long-term inflation expectations. Our IRR was close to 30% as of March. And we start with our guidance on Slide 13, and I want to elaborate our new guidance. So we increased our operational earnings growth guidance from above 30% to above 40%. The upward revision in operational earnings is driven both by distribution and retail segments. We forecast distribution operational growth to be higher driven by increase in short and midterm inflation assumptions. Retail growth forecast increased due to higher sourcing costs. Given the high volatility in new financing costs, we continue a relatively cautious stance in underlying net income guidance. Our underlying net income guidance is raised to above TRY 2.2 billion. The impact of guidance revision in operational earnings does not fully reflect to the bottom line as the increase is driven partly by CapEx reimbursement, which is not a component of net income. Moreover, our deposit revaluation and bond expense expectations are higher compared to the previous guidance due to increase in inflation assumptions. While the issue in distribution CapEx unit prices is mostly resolved, we still continue our discussions with the regulator on the subject. Until further progress with these discussions, we decided not to provide a guidance on CapEx and [indiscernible] REP. Meanwhile, we continue -- are confident on the growth prospects in distribution. Our REP growth strategy continues, and we have ensured the flexibility to manage potential changes in CapEx volumes. The regulator has set the expected yearly inflation for June 2022 at 25.8%, which impacts our cash flow. In Distribution segment, the impact of deviation in actual and forecasted inflation on cash flow will be corrected in 2 years with financial compensation as per T+2 correction mechanism. We are carrying discussions also on inflation item with regulators or looking for other early compensation mechanism. More importantly, high volatility in energy-related costs can lead to deviations in our cash flow estimates for retail, which will be corrected in 2 quarters. Until visibility on these items including the impacts of new mechanism introduced for retail, we will not provide a cash flow guidance. We acknowledge that the current high inflation environment has made following our performance more complex. While accounting changes is not a preferred option for us, during these extraordinary times, we might evaluate such an option, especially for the IFRIC model if we assess such a change provides better transparency for our stakeholders. So thank you very much for your attention, and we can now take your questions. Please, operator, go ahead.

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

I have a question on your mention of EMRA assumption and June inflation of 25.8% that is quite detached from the real inflation that we are going through in Turkey at the moment. That's for regulatory tariffs. Can you tell us what happens when we get to end of June and if the inflation is much higher than this assumption, let's say, 50% or 60%, what happens?

We have already mentioned, for distribution, normal correction mechanism is 2 years. And for that, we would be accruing financial income. For retail, it's 2 quarters. Therefore, the impact is now higher for distribution, and we're also looking for alternative mechanisms. This would be win-win for us in order to address this issue.

So 2-year lag for distribution means you will not be correcting anything arising from the big difference between end of June real inflation and the EMRA assumption, does that mean?

Financial reporting is different. So in the financial reporting, we would be putting whatever June inflation is. So you will see the impact, but the cash flow impact will be corrected in 2 years. It's stays the same. But of course, we are trying to address the issue in a way that [indiscernible] for the customers and for us as well.

Okay. And for the P&L, you will be retrospectively reflecting the differential -- inflation differential for second quarter, right? The financial income.

In last years, it will be reflecting retrospectively. And if there is a change in our inflation assumption for the midterm for 2 to 3 years, it will be reflected as well. You are right. So it doesn't impact the operational earnings part, and you will see whatever inflation is in the financials.

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

So thank you very much for your time and your attention and for all the ones who are celebrating [Foreign Language] and have a good remaining week. Thank you very much.

[Foreign Language].

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