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

Welcome to Enerjisa's Second Quarter 2022 Results Conference Call and Webcast. I now hand over the call to CFO, Michael Moser and IR, M&A, Tax Director, Gözde Çullas. Dear speakers, please go ahead.

Thank you very much, dear operator. Hello, everyone. This is Michael speaking. I hope everyone is healthy and doing well. Let me start today's earnings telephone conference by providing an overview of the first half of 2022. We see unprecedented times for the whole energy sector across the world. Tight gas and coal markets, along with Russian invasion of Ukraine have led to all-time high coal and natural gas prices, pushing electricity procurement costs upwards. Amidst an inflationary environment, the regulators are undertaking drastic measures globally to both sustain the functioning of the electric utility sector and limit the price increases for consumers. While we are not isolated from these global developments and are also facing local ones, we managed to limit the impact with our strong balance sheet, robust risk management measures and access to liquidity. In the first half, our operational earnings doubled year-over-year, thanks to strong performance in all segments. The operational earnings growth in the second quarter was 135%. Underlying net income increased by 26% year-over-year, while the increase in the second quarter was 117%. We had highlighted in the last earnings call that the heavy decline realized in net income in the first quarter was not a proxy for the full year due to quarter-specific drivers and the recovery in the second quarter confirms that. Meanwhile, the very positive second quarter is not a proxy for the rest of the year and the average of both quarters are relatively a better indicator for the full year. The main drivers for the strong recovery in the second quarter are: first, higher inflation assumptions reflected in our financial income and other line items, which retro prospectively for the half year. Second, reflection of positive impact of regulatory financial compensation for higher working capital needs in retail. Third, some pace down in deposit revaluation expenses; and fourth, strong performance in retail operational earnings, which was driven by higher procurement costs as our gross profit and the regulated retail segment is cost plus with a 2.38% gross margin and also our effective customer and supply management in liberalized segments. Our cash flow was substantially negative in the first half of 2022, which led to an increase of debt, yet the second quarter performance, which was much better compared to the first quarter. The reason for the material negative cash flow was the fact that regulated retail tariff prices did not fully cover the increase in electricity procurement prices. This is a global phenomenon, which nearly all energy companies were facing. Moreover, tariffs are indexed at a lower indexation than current inflation, leading to a relatively weaker performance, especially in the distribution segment. The Turkish regulator temporarily introduced new mechanisms to address the sustainability of the system, which we discussed in the previous quarter. Accordingly, the outflow in the second quarter was more muted, also supported by the measures we have taken. We entered this volatile time with a strong balance sheet, where our leverage ratio in terms of net debt to operational earnings was at the lowest level in our history as of 2021 year-end. Accordingly, we have seen the benefit of our strong balance sheet, our proven business steering, along with Enerjisa's strong brands during these volatile times. We raised our guidance for operational earnings and underlying net income. Upward revision in guidance is mostly based on the impact of the increase in short and midterm inflation assumption. We now provide a specific range for operational earnings, while our underlying net income guidance sets a minimum floor. We are confident on the growth prospects for our business. Enerjisa is the best prepared Turkish energy company in the sector for generating sustainability growth and facing the current challenging times. We also believe in the energy system, the regulator, EMRA, is assuring for Turkish energy industry. And as we have just seen by the latest announcement on EÜAS, to start supplying volumes for the regulated retail segment. Accordingly, we will continue to pursue our growth strategy and our focus on increasing investments also in our adjacent businesses. We announced a strong investment program for our electric vehicle charging business named Esarj. Our Customer Solutions business, which includes many sustainable energy solutions such as solar power plant installation services, energy efficiency and electric vehicle charging station management is very critical in supporting Turkey's transition into a low-carbon energy world. Let us go over the financial highlights of the first half of 2022 on Slide 3. In the first half of 2022, we had a robust growth in operational earnings. Operational earnings growth was 100% year-over-year. Underlying net income increased by 26% year-over-year to TRY 1.276 million (sic) [ TRY 1.276 million ]. Excluding the impact of revaluation of deposits, which is mostly noncash effective, the growth was 90%. Our free cash flow after interest and tax was around negative TRY 4.5 billion compared to positive TRY 1.1 billion cash flow during the same period of last year. The negative free cash flow is driven by a combination of factors which are continuing increase in electricity prices, not supported by the national tariff levels, change in supply mix. In the first half of 2022, we had no supply from state-owned EÜAS for the regulated retail segment due to constrained capacity factors of hydro plants and market conditions. This increased both our weighted average procurement costs and reduced our payable days and thus increased the working capital requirement. Decrease in VAT rate on electricity tariffs for residential and agricultural irrigation customers grew from 18% to 8%, while the VAT rate on procurement continued to be at 18%. This impact is partly reversed in Q2 and we expect some further reversal during the rest of the year. The impact of yearly inflation assumption incorporated to national tariff calculation, the annual inflation assumption for June 2022 was set at 25.8% in the national tariff, which is far below the actual inflation, impacting especially the distribution segment. While the operational cash flow of the distribution segment was strong in the first half of this year, the inflation assumption built in tariffs still had a negative impact on the performance. The lag in reflection of positive impact of new regulatory mechanisms to the cash flow Q2 settlement period. Despite the increase in leverage during the first half of the year, we have a very healthy balance sheet. Our financial net debt to operational earnings ratio is 1.5x in June 2022. Please take a look at the market environment, which you can find on Slide 4. Inflation continued to increase in Q2, reaching 79% in June. The marginal cost of financing increased during the quarter on the back of reduced liquidity. Electricity consumption increased by around 3% year-over-year in the first half, while we see a deceleration in Q2 compared to Q1. We can explain this partly by a slowdown in economic activities and partly due to the impact of high electricity prices. 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 450% year-over-year and around 40% quarter-over-quarter in the second quarter of 2022. Our planned regulated sourcing costs increased by 284% year-over-year, which was far above the increase in regulated tariffs despite the introduction of mechanisms due to decrease in the all-in procurement costs of the incumbent retail company. There is a long list of tariff changes within the first half of the year. I will skip the details for using the time effectively. In case of any questions, please raise during our Q&A. The latest tariff change was 18% to 31% increase in energy component of the tariffs and a 15% to 25% increase in the end user tariffs as of June 1. As tariffs still lag behind the increase in procurement costs, there is the need to adjust the cash flows of the incumbent retail companies. In order to limit the extent of tariff increases, the regulator sought for alternative mechanisms to address this issue. The first mechanism is related to feed-in-tariff costs, which we discussed in the previous quarter. With feed-in-tariff costs, I refer to the difference between the guaranteed renewable prices and the day-ahead prices. Feed-in-tariff costs started to being negative due to rising day-ahead prices. With this mechanism, the funds from negative costs are provided to incumbent retail companies rather than previous practice of allocating to both liberalized and regulated tariffs. The second mechanism is a new resource-based maximum price limit application named resource-based price limits for power generation facilities. According to the mechanism, the 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 is allocated to a special fund. In this case -- in case of need, this fund is first allocated to high cost generators in order to prevent possible supply issues. The remaining funds are distributed to the incumbent retail companies. This mechanism is planned to be temporary until end of September 2022, with the possibility to extend further. As the measures were insufficient to address the cash flow issues and its continuing increase in procurement costs, another temporary mechanism has been recently introduced. Accordingly, in the day ahead market for the regulated customers, retail companies will have the option to defer payments until the last payment day of the invoice, post monthly settlement rather than the regular regulatory practice of advanced payment. This mechanism will be effective until end of August with the possibility of an extension. The interest rate is 1.6% per month until July 2022 and 2.5% per month from the 21st of July 2022. We receive the financial compensation for the delayed cash flow in the retail business regardless whether we use this option or not. If these measures turn out to be insufficient, we believe other options will be sought such as the relaunch of EÜAS as the supplier for incumbent retail companies or a tariff price increase. Regarding EÜAS, we informed you that this happened already. In relation to that, as a very recent development, EÜAS has announced the prices for incumbent retail companies at around TRY 1.100 per megawatt hour for the regulated sales and we are carrying discussions on volume allocation. Historically, we procured around 30% to 40% of regulated volumes from EÜAS. While the net impact will depend on many factors, including volume allocation, day-ahead prices and whether current temporary mechanisms continue, the working capital burden will substantially ease if we start receiving volumes from EÜAS. Meanwhile, we have been doing our part to address these issues by a number of measures such as by supplying regulated volumes with bilateral contracts at longer payment terms and compensation of VAT related working capital impact with accelerated VAT returns and cash. Now coming to a more detailed explanation on our operations on Slide 5. On the distribution side, our CapEx spend was TRY 934 million in the first half of 2022, with a 16% decrease compared to the same period of last year. We have seen a relatively low start compared to what could have been possible due to a number of uncertainties, in particular, the high negative cash flow and cost spikes, while we are ensuring our flexibility to accelerate our investments again once these challenges are mitigated. New investments in the first half of 2022 were below the CapEx reimbursement level. Nevertheless, our [ Rep ] grew by TRY 7.4 billion compared to the year-end on the back of the revaluation of the opening balance by inflation. Efficiency and quality earnings increased by 10%. Theft and loss and the quality-related performances were higher than last year, mostly due to the electricity price increases, while we had a weak performance in CapEx and OpEx outperformance. Our retail volumes increased by 16%, driven by both regulated and liberalized segments, thanks to the strong growth in energy [indiscernible] regions exceeding Turkish volumes. Moreover, strong growth in other regions in the corporate segment also contributed to this performance. In the liberalized retail business, corporate volumes continued to increase, while SME volumes declined as we shifted SME customers to the regulated segment in the last quarter of last year. The liberalized gross margin declined in the first half due to the impact of a sharp increase in procurement costs and the impact of a change in the feed-in-tariff costs allocation mechanism, while improving considerably in the second quarter. Gross profit of our Customer Solutions business more than tripled in the first half of 2022, mostly due to solar projects. Meanwhile, Esarj was granted a charging network operator license, which will be valid for 49 years. The e-mobility market continues to grow rapidly in Turkey. Turkey ratified the Paris agreement and also pledged to replace all new automobile and van sales by 0 emission vehicles by 2040. The Turkish Ministry of Industry and Technology expects between 1 million and 2.5 million electric vehicles in Turkey in 2030. The significant increase should be supported by an increase in electric vehicle offerings and by the launch of electric vehicles by the Turkish car manufacturer TOGG, which is expected to start next year. Needless to say that a rapid development of the charging station infrastructure is a prerequisite for an increase in the numbers of electric vehicles. Esarj established many collaborations with local and international brands, including OEMs, [indiscernible], in order to broaden its footprint. Esarj operates an electric vehicle station network with 520 charging sockets at 275 public locations and 35 cities as of June 2022. Esarj is the market leader in the DC market with around 75% share and aims to accelerate its growth in this market. As another important development, it is worth mentioning that Esarj participated in the tender for the fast-charging station support program for electric vehicles initiated by the Ministry of Industry & Technology. The outcome of this tender is that Esarj will be entitled to establish 495 fast charging stations with a minimum of 2 charging sockets in 43 cities, which covers the cities with the highest potential for electric vehicles. We plan an approximately TRY 300 million investment within the scope of the program until April 2023 and cover all cities with at least 1 fast charging station by the end of next year. Coming to Slide 6, I'd like to show you our consolidated operational earnings. Our operational earnings increased by 100% year-over-year to TRY 6.7 billion. The retail segment with 186% growth was the main contributor to this performance, while the distribution segment also delivered a strong growth of 84%. We will discuss the details in the subsequent slides. Please see the details of the operational earnings and cash development of our distribution business on Slide 7. In the distribution segment, the growth in operational earnings was 84% year-over-year in the first half of 2022. The growth in financial income was 87%, mainly due to the impact of higher short and midterm inflation assumptions, leading to a higher IRR. Please note that the increase in IRR was reflected retro prospectively for the full 6 months. The incremental financial income related to the first quarter was around TRY 200 million. Our IRR was close to 39% as of June. The value of the financial assets as of June 2022 was TRY 11.7 billion. The IRR will be effective for the long term even when we see a decline in inflation. Therefore, the positive impact of higher midterm inflation will reflect to our financial income over the concession period rather than only over the midterm period. CapEx reimbursements, excluding exceptional reimbursements, increased by TRY 1 billion due to the impact of inflation and the CapEx allowance increase last year. Total efficiency and quality earnings increased by 10% in the first half of 2022 compared to the same period of last year. Theft accrual and collection earnings increased significantly due to an increase in national tariff prices. Theft and loss outperformance was lower than last year due to a decrease in net procurement prices. OpEx outperformance in the first half of 2022 was negative due to an increase in commodity related expenses such as material and fleet costs exceeding inflation, while we see a slightly positive performance in the second quarter on the back of the reflection of the actual inflation, which was higher than our previous estimates. CapEx outperformance was 0. As we discussed, the effectiveness of CapEx unit price escalation mechanism decreased due to supply bottlenecks and local factors. Therefore, EMRA has introduced a new mechanism. Accordingly, it will reassess the price escalation if the loss of the sector exceeds 10% of the CapEx spending. Meanwhile, the current decline trend in commodity costs might reduce the longer-term risks on CapEx outperformance if sustained, dependent on our procurement performance. Quality bonus increased due to the increase in revenue ceiling. We expect a significant growth in year-end due to an increase in allowed ceiling for quality items from 6% in 2021 to 7% this year and due to a better field performance. Other item in the first half of 2022 was TRY 320 million compared to TRY 66 million last year, mainly due to CapEx [indiscernible]. Tax correction increased by 65% due to higher June inflation realization. We have strong increase in free cash flow before interest and tax. Operating cash flow before interest and tax increased due to strong operational earnings. The cash flow gap due to the difference between EMRA's June inflation assumption built in regulatory tariffs and the actual inflation realized is reflected to working capital. Despite that, we have a working capital inflow supported by our mitigation measures and compensation for overspent CapEx of the third regulatory period, which amounts to TRY 273 million. The cash effective CapEx increased by around TRY 900 million. We continued to offer flexible payment terms to our contractors for securing our supply chain. We carry inventories above normalized level in an effort to ensure supply security in 2022 and accelerate our investments in the second half of the year. As you see on Slide 8, our retail business showed an operational earnings growth of 186% year-over-year in the first half of 2022. The growth of the half of 2022 was mainly a result of an increase in gross profit of the regulated market segment. Our gross profit in the regulated retail segment is, [ cost plus ], was a 2.38% gross margin. Therefore, higher costs mean higher absolute gross profit. 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. Liberalized gross profit also increased due to an increase in sourcing costs. However, the increase was more muted, as around 40% of our business is on fixed prices backed by fixed price supply contracts. The year-over-year increase in liberalized gross profit in the second quarter was 262% due to the base impact and effective procurement management and the compensation of the negative impact of allocation of negative feed-in-tariff costs of the regulated segment, mostly in the second quarter. OpEx increased by 77%, tracking the inflation. The bad debt-related income decreased slightly from TRY 77 million in the first half of 2021 to TRY 70 million in the first half of this year, as doubtful provision expenses increased mainly due to an increase in the electricity tariffs, while this is only gradually reflected to late payment income due to the timing of the accrual of late payment income. Please note that the interest rate on late payments have increased from 1.6% to 2.5% within July. The operational cash flow decreased from around TRY 660 million in the first half of 2021 to around negative TRY 6 billion in the first half of 2022. The price equalization impact was TRY 5 billion, as the regulated tariff price increases were not sufficient to cover procurement price increases. Additionally, the working capital was negative for higher trade receivables due to a higher national tariff deferred VAT due to a decrease from 18% to 8% for the residential and agricultural customers and the time lag in compensation via the new regulatory mechanisms due to settlement periods. Our Customer Solutions operational earnings increased by 600% to TRY 35 million, mainly due to new solar projects. Now let me discuss the bottom line development on Slide 9. Our underlying net income increased by 26% to TRY 1.276 billion in the first half of 2022. Below the line item, operational earnings, the main effects were as follows, net loan interest expenses increased by TRY 856 million due to an increase in both financial debt and interest rates. The average loan interest rate increased by 12.9 percentage points year-over-year to 25.1% in the first half of 2022. Net loan interest expense includes TRY 162 million, FX losses on operational items, which is more than compensated by TRY 340 million hedging gains and other item of the distribution segment. Excluding the FX impact, the increase in financing costs is 10.8 percentage points year-over-year. The revaluation expenses of both our bonds and our customer deposits were significantly higher than in the last year. The revaluation rate in Q1 was 31% and 90% for -- 19% for Q2. It is important to highlight that most of the deposit revaluation expenses are noncash in nature. Tax expenses increased with an increase in pretax earnings. Other item was TRY 360 million compared to TRY 10 million last year. This item includes compensation with T+2 mechanism. There is a significant increase in that item due to accrual for financial compensation of higher working capital needs. Turning to Slide 10. Our economic net debt increased from TRY 11.3 billion in December to TRY 19.7 billion in June 2022. Meanwhile, our financial net debt to operational earnings ratio is 1.5x, still at a healthy level. Free cash flow before interest and tax was negative TRY 3.2 billion in the first half of 2022. The negative free cash flow is driven by temporary tariff-related impacts, which will be financially compensated as discussed in detail. Net interest payments were around TRY 920 million in the first half of the year. We have seen TRY 385 million of tax paid. Change in deposits was TRY 1.4 billion, mostly due to revaluation of deposits. We have seen around TRY 1.5 billion of dividend payment and we have seen around TRY 1 billion other item, which includes interest accrual of around TRY 750 million and the remaining amount is related to derivative financial instruments. 67% of our gross debt has fixed rate. 25% is linked to TLREF and 8% is CPI linked. Please also note that we redeemed our inflation index bond of around TRY 1 billion in July. We target to have a diverse funding base. In this sense, we aim to conclude a green financing agreement in Turkish lira, especially for our Customer Solutions investments within the fourth quarter. Additionally, in June, we applied to Capital Markets Board on issuance of green bonds and green [ builds ] for a total amount of up to TRY 1.5 billion. Please go to Slide 11. Our guidance 2022 is as follows. We increased our operational earnings growth guidance from above 40% to between 60% to 70%. 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 IRR with higher short and midterm inflation assumption. Retail growth forecast increased due to higher sourcing costs. We raised our underlying net income guidance to above TRY 2.3 billion. Operational earnings does not fully reflect to the bottom line as the increase is driven partially by CapEx reimbursement, which is not a component of net income. More importantly, our depository valuation and financing cost expectations are higher compared to the previous guidance due to an increase in inflation assumptions and the cost of financing. However, it is important to stress that while now sharing a specific range in operational earnings, we provide a minimum for underlying net income with a prudent approach, reflecting uncertainties in cash flow and volatility in new financing costs. Based on the market developments, including EÜAS volume support prospects for retail, we see prospects for an upside compared to the minimum floor. Our discussions with the regulator on CapEx unit prices also continue. Until further progress with the discussions on an umbrella of items, including EÜAS volume, we do not provide a guidance on CapEx and [ Rep ] at this stage. Meanwhile, we continue our confidence on the growth prospects in distribution. Our regulated asset base growth strategy continues and we have ensured the flexibility to manage potential changes in CapEx volumes. We are required to spend a minimum of 65% of the regulatory CapEx allowance according to the regulation and we aim higher volumes, ideally full CapEx allowance, which is above TRY 5 billion. Any gap versus the allowance will be compensated during this regulatory period. Given the higher volatility in procurement prices and also the upside risk related to the possibility for EÜAS to start supplying volumes for regulated retail segment, we do not provide a cash flow guidance. However, now the risks are skewed on the upside, which means a significant recovery compared to our first half performance and cash flow. Specifically, positive cash flow in the second half of the year. We acknowledge that the high -- that the current high inflation environment has made following our performance, I would say, more complex. Despite the fact that accounting methodology change is not a preferred option for us during these extraordinary times, we are evaluating such an option, especially for the IFRIC model, if we come together with our auditor to the conclusion that such a change provides better transparency for our shareholders and our stakeholders. We will finalize our decision in this respect latest by the end of the year. Regarding inflation accounting, according to the International Accounting Standards Board's communication, IAS 29 inflationary accounting should be applied as of 30 of June, 2022 and thereafter for Turkey according to IFRS. However, for listed companies, the Public Oversight, Accounting and Auditing Standards Authority sets accounting standards for Turkey. The Turkish financial reporting standards, so-called TFRS, are in full compliance with IFRS. Until this date, the authority has not communicated about the implementation of inflation accounting for the TFRS framework. We started our preparations for IAS 29. However, there are a number of regulated utility sector issues to be considered, such as indexation of industry-specific data, whether we can continue with our regular indexation in June or need to switch to December indexation. Therefore, we currently do not share a color on the net impact. Nevertheless, we plan to complete our preparation latest by year-end. Thank you very much for your intention. And dear operator, we can now take questions.

[Operator Instructions]. There are no audio questions at the moment. Dear speakers back to you.

So thank you very much for listening. So that there are no questions, then we can close the call. Or are there any written questions as well?

We can't see any questions in the system. But if you have any follow-up questions, you can contact IR any time.

Ladies and gentlemen, this concludes today's webcast call.

Okay. Just a second. Just a second.

Okay. Go ahead, please.

Okay. Can I please go over again on [indiscernible] mentioned, okay? In our accounting, we used an IFRIC model and in the IFRIC model, you take into account the full cash flow until the end of the [ consolidation ] period and to use the regulated [indiscernible] as well. And as you take the long-term assumptions into account, the IRR, we mentioned that our IRR was 39%. It's lower than what we would calculate for 2022, for example, which will be 12% plus inflation because we used the weighted average of the cash flow because of the calculation methodology. This methodology works well. In the previous period it was, in the times of such high inflation, we started to restore the [ fixture ] because you see high increases, deposit costs items ,[indiscernible] inflation but you only see the positive impact over the longer term. The positive thing is that the higher IRR, even if you do not change the methodology, with respect to our financial income over the longer term. And we said that we are looking to various methods to see whether we can better represent the current high inflationary environment. And we are looking to a number of models for this, which can be more into your calculation of [indiscernible] financial income, as we target to finalize the studies by the year-end. Perhaps earlier as well and we will come to a decision and inform the stakeholders and investors on that. Again, if you have any full questions, you can type. Okay. It looks like there are no further questions. Thank you for participating. And as I mentioned, if you have any follow-up questions, you can contact IR anytime. Thank you.

Thank you very much and have a good day and see you soon in the next meetings. Thank you. Bye-bye.

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