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

Dear investment community, this is Gozde speaking. Welcome to Enerjisa's Third Quarter 2022 Earnings Results webinar. Before starting our presentation, I would like to remind you about our disclaimer on the forward-looking statements, disclaimer is available on our presentation. Now I would like to give the floor to our CFO, Dr. Michael Moser for his remarks. Michael?

Hello, everyone. This is Michael speaking, and I hope everyone is healthy and doing well. Let me start today's earnings webcast by providing an overview of the third quarter of 2022. With the 9 months mark now behind us, I can conclude that we have had a strong operational quarter, including positive regulatory developments that have also normalized our free cash flow generation, meaning a positive cash flow generation in Q3. Our cash flow was negative for 4 consecutive quarters, mostly due to the fact that regulated retail tariff prices did not fully cover the continuing increase in electricity procurement prices. Following these 4 consecutive quarters of cash outflow, our consolidated cash flow returned positive in the third quarter of 2022, thanks to numerous regulatory mechanisms introduced to address the sustainability of the electric utility sector and also our robust risk management measures, which we were able to put in place on time and with the right balance. Regarding our grid investments, we had a low start of the year due to a number of uncertainties. While we accelerated our investments in the third quarter, supported by the positive developments on the cash flow. Please note that the financials announced yesterday and presented today are prepared in accordance with Turkish law and Turkish Financial Reporting Standards. So any explanation or statement in our meeting cannot be interpreted as an omission of or deviation from Turkish law and Turkish Accounting Standards accordingly. Predictions shared in this presentation and/or the meeting have solely been prepared in order to provide a holistic and proactive guidance on dividend expectations, only based on our dividend policy by making IAS 29 adjustments to the announced financials. As highlighted in previous calls, we are now in a hyperinflationary environment in Turkey. Therefore, our figures will be subject to accounting treatments, which appropriately and transparently represent our developments. Inflation accounting, IAS 29 is one of them and will be incorporated into our IFRS figures in the full year 2022 results, which, as you all know, is the basis of our dividend payment. Another accounting treatment triggered by the inflationary conditions is the IFRIC 12 methodology change to close an otherwise increasing gap and decoupling between the regulated asset base and our financial assets on our balance sheet. I will further elaborate on details around this change later. As another important development in October, we have issued TRY 3 billion equivalent of bonds, which includes the first green local bond issuance in Turkey, compliant with both international standards and CMB's recently issued regulations. We reiterate our guidance as well as concretizing the expected outcome with new ranges on back of strong operational developments, but at the same time, point again, to the several accounting treatments that we are incorporating this year, which, due to its nature, are subject to discussion, change and approval with our auditors at the time of adoption, which will be at our full year 2022 closing. On back of this context, we guide for an operational earnings growth of 75% to 90% year-over-year and point at an underlying net income range of TRY 2.3 billion to TRY 2.7 billion. Let us go over the financial highlights of the third quarter of 2022 on Slide 3. In the third quarter, we had a strong growth in operational earnings with a 107% year-over-year increase, thanks to strong performance in all segments with a similar performance in the first 9 months of 2022 as well. Underlying net income increased by 116% year-over-year in the third quarter to TRY 1.3 billion, while the increase in the first 9 months of 2022 was 59%. Our new IFRIC methodology had around TRY 780 million positive impact on operational earnings and around TRY 600 million impact on underlying net income in the third quarter. Please note again that the IAS 29 implementation is not yet included in our figures as it will be incorporated at the end of the year. Our free cash flow after interest and tax was positive TRY 1.9 billion in the third quarter, reducing the cumulative cash outflow within the year. The first 9 months cash outflow was TRY 2.7 billion. Despite the increase in leverage during the first 9 months, our financial net debt to operational earnings ratio declined to 1.1x in September 2022, which is the lowest level in our history, thanks to strong growth in operational earnings. Please take a look at the market environment on Slide 4. Inflation continued to increase in Q3, reaching 83% in September. In Turkey, the quarterly average day ahead power price increased by more than 450% year-over-year and more than 50% quarter-over-quarter in the third quarter of 2022. In 2022, the Turkish regulator introduced numerous measures to limit the extent of tariff increases. While at the same time, addressing the cash flow shortfall of the incumbent retail companies as a recent development as in the practices of the previous years, EUAS started to supply incumbent retail companies for the regulated sales since mid of August. The price set at [ TRY 1.100 ] per megawatt hour. Currently, EUAS covers roughly half of the procurement for the regulated segment. In the third quarter, increase in the day ahead market procurement costs compared to Q2 is counterbalanced with the start of energy procurement from EUAS at prices lower than day-ahead prices along with increasing contribution from FIT and resource-based maximum price limit applications. Thanks to these mechanisms, our tariff burden, which peaked in the second quarter declined within the third quarter. As of September 1, energy component of regulated national tariffs increased by 23% to 55% and end-user tariffs increased by 20% to 50%, with the continuation of regulatory measures and the tariff increase, we expect the blended regulated energy sourcing costs to stay under the regulated tariff with no cash burden on retail until the year-end. Now coming to a more detailed explanation on our operations on Slide 5. On the distribution side, our CapEx spend was TRY 2.3 billion in the first 9 months of 2022, with an 11% increase compared to the same period of last year. We had a low start compared to what could have been possible due to a number of uncertainties, while we accelerated our investments in the third quarter. Our RAB grew by TRY 7.7 billion compared to the year-end on the back of the revaluation of the opening balance by inflation. Efficiency and quality earnings were significantly down in the third quarter due to weak performance in CapEx and OpEx outperformance. Our retail volumes increased by 5% driven by regulated segments, thanks to the strong growth in Enerjisa's home regions, exceeding Turkish volumes. Moreover, strong growth in other regions in the corporate segment also contributed to this performance. Gross profit of our Customer Solutions business was flat year-over-year as we have a high base last year on the back of a specific project. 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. We target to grow the cumulative installed capacity of solar power plants to above 250 megawatts by 2025. We signed a contract for Fast Charging Stations Support Program for electric vehicles initiated by the Ministry of Industry and Technology during the quarter. Our e-mobility company, Esarj, is entitled to establish 495 fast-charging stations in 53 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. We will benefit from VAT and custom duty exemptions as part of our investments for these stations. Thanks to our accelerated investments, the number of our public charging stations increased to 322 as of September with a 38% year-over-year increase. We want to highlight again our strong ambitions for our Customer Solutions segment, which truly is in line with our strategy to build a cleaner, better and safer energy future in Turkey and thus, we'll continue to share insights with you on various projects, all from our solar cell installments to our energy efficiency work or our e-mobility infrastructure fleet. Coming to Slide 6, I'd like to show you on our consolidated operational earnings. Operational earnings increased by 107% year-over-year to TRY 3.8 billion. All segments contributed to that performance. We will discuss the details in the subsequent slides. Please see 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 107% year-over-year in the third quarter of 2022. The growth in financial income was 169% year-over-year. The acceleration in financial income growth is driven by the implementation of updated accounting methodology, which had TRY 780 million impact on financial income in the third quarter. The new methodology is implemented as of the third quarter and is not implemented retro prospectively. We will give more details of the new methodology in the next slide. CapEx reimbursements, excluding exceptional reimbursements, increased by TRY 0.5 billion due to the impact of inflation and the CapEx allowance increase last year. Total efficiency and quality earnings were TRY 10 million in the third quarter of 2022, significantly lower than the same period of last year. Key highlights our OpEx outperformance in the third quarter of 2022 was negative due to an increase in commodity related expenses, such as material and fleet costs exceeding inflation. We are carrying discussions with the regulator on indexation of OPEC ceiling. We have negative outperformance in CapEx as well due to higher material costs driven by supply chain issues. This is currently offset by CapEx hedges. As we had 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. theft accrual and collection earnings increased significantly mainly due to an increase in national tariff prices. Other items in the third quarter of 2022 was TRY 200 million compared to 0 last year, mainly due to CapEx, mark-to-market effects. We have an increase in free cash flow before interest and tax. Operating cash flow before interest and tax increased due to strong operational earnings. The negative cash flow impact due to the difference between EMRA's June inflation assumption, built in regulatory tariffs and the actual inflation realized is reflected to working capital. The impact is around TRY 600 million for the third quarter and close to TRY 2 billion for the first 9 months. This impact will be corrected in 2024 with financial compensation. In the third quarter of 2022, the cash effective CapEx increased by around TRY 360 million year-over-year due to acceleration of investments. And now please turn to Slide 8. As previously indicated earlier, in the third quarter results, we have a calculation methodology change to our IFRIC 12 application. The change is triggered by the high inflation environment. The effect is around TRY 700 million impact on our distribution financial income in the third quarter. The impact of this methodology change will continue due to the visible in our earnings going forward as long as inflation continues to be at the current high levels. 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, which is an IFRS standard that governs accounting for service concession arrangements. Accordingly, we account our license to operate and invest in the networks as a financial asset. In the financial model, financial income is calculated as IRR x financial asset, where IRR is a nominal value calculated over the forecast period. The IRR figure is different than WACC plus current inflation as it also considers the long-term inflation expectations. In the current environment where major deviations between short-term and long-term inflation expectations are embedded, our accounting of financial assets in the distribution business has started to decouple from our regulated asset base. In 2022, the regulated asset base started to be significantly above financial asset value as regulated asset base is adjusted with inflation, but financial asset is adjusted with IRR. Moreover, we started having a visible mismatch in timing of reflection of inflation to costs and revenues. We have reviewed our IFRIC methodology evaluating calculation alternatives as per IFRS 9. We have reviewed these alternatives with our auditors as well. As of the third quarter of 2022, we started to implement the methodology, which we believe better reflects our business model. With the new model, we started to run our financial asset model, we're forecasting CapEx only for the current year rather than over the full concession period. Accordingly, we forecast cash flow only for 10 years, which is the CapEx reimbursement period. With shorter forecasting period, short-term macro assumptions have higher weight on IRR. Our IRR was around 80% as of September compared to above 40% according to our previous model. We forecast IRR to be 60% in 2023 based on our current macro assumptions. The mismatch between regulated asset base and financial asset continues but at a lower degree compared to the previous model and is expected to be closed at a faster pace. As you see on Slide 9, our retail business showed an operational earnings growth of 113% year-over-year in the third quarter of 2022. Our gross profit in the regulated retail segment is cost plus with 2.38% gross margin. Regulated gross profit increased due to higher electricity procurement prices and higher inflation. Meanwhile, quarter-over-quarter growth was relatively muted as we started procuring from EUAS. Moreover, increasing support from feed-in-tariff mechanisms and resource-based maximum price limit application lowered the weighted average costs. Liberalized gross profit increased by 324% year-over-year due to: one, the base impact to increase in procurement prices and lastly, an effective procurement management. OpEx increased by 125% year-over-year in the third quarter, while the increase in first 9 months was 93% due to higher inflation and FX rates. Meanwhile, other expense was negative TRY 336 million as we account for installment payments due date difference invoice for day-ahead market EPIAS as an operating item. The operational cash flow was positive following 4 consecutive quarters of negative cash flow, thanks to positive price equalization impact and positive working capital, price equalization is related to start of compensation for tariffs lagging behind procurement costs in the previous quarters. The working capital was positive in the third quarter, supported by the start of procurement from EUAS, deferred payment at EPIAS and increased sourcing from other generation companies for working capital management. Our Customer Solutions operational earnings increased by 88% to TRY 32 million. Now let me elaborate on the bottom line development on Slide 10. Our underlying net income increased by 116% to TRY 1.260 million (sic) [ TRY 1.260 billion ] in the third quarter of 2022. Below the line item, operational earnings in the main effects were as follows: Net loan interest expenses increased by TRY 646 million due to an increase in both financial debt and interest rates. The average loan interest rate increased by 17.8 percentage points year-over-year to 31.8% in the third quarter of 2022. The revaluation expenses of customer deposits were significantly higher than in the last year due to both higher revaluation rate and higher deposit base. However, deposit revaluation expense eased on a quarter-over-quarter basis as we had guided. Bond interest expense increased only slightly as our CPI-linked bond of TRY 1 billion matured in July. Other item was TRY 329 million compared to TRY 6 million last year. This item includes compensation with T+2 mechanisms. There is a significant increase in that item due to accrual for financial compensation of higher working capital needs. Please turn now to Slide 11. Our economic net debt increased from TRY 11.3 billion in December to TRY 18.1 billion in September 2022, while declining from TRY 19.7 billion level in June on the back of regulatory support mechanisms. Our financial net debt operational earnings ratio is 1.1x, and the lowest level in our history, thanks to strong growth in operational earnings. Free cash flow before interest and tax was marginally positive in the first 9 months of 2022. Net interest payments were TRY 2.2 billion. This includes TRY 690 million interest payment for our CPI-linked bond at the maturity. Change in deposits was TRY 1.7 billion, mostly due to revaluation of deposits. We also have seen around TRY 900 million other items, around TRY 550 million is related to derivative financial instruments and around TRY 250 million is due to interest and FX accrual. We target to have a diverse funding base. In October, we have issued TRY 3 billion equivalent of bonds, which includes TRY 1.5 billion of green bond compliant with both international standard and CMB's recently issued regulations. We are fully funded for 2022, and we are getting prepared for further funding requirement of 2023. We also aim to conclude a green financing agreement in Turkish lira, especially for our Customer Solutions and Distribution investments within the fourth quarter. And now please turn to Slide 12. We are enhancing our guidance for 2022 with an indicative range for both the operational earnings growth as well as the expected underlying net income figure. Please be aware that the figures are IFRS figures and therefore, also includes IAS 29, which we have not seen in the current 9 months results figures, but will be visible in our full year results. Our 2022 guidance is as follows: We assess the range for our operational earnings growth guidance from previously 60% to 70% to now between 75% to 90%. The upward revision in operational earnings is mostly driven by Distribution segment. We forecast distribution operational growth to be higher driven by increase in IRR on the back implementation of updated IFRIC methodology and to some extent, higher inflation assumptions. Retail growth forecast is slightly down due to lower sourcing costs due to start of sourcing from EUAS. Our 2022 underlying net income expectation is TRY 2.3 billion to TRY 2.7 billion, with the risk of being repetitive, but due to the important and special circumstances in Turkey, I conclude that this is the IFRS figures, which also includes the effect of inflation accounting, namely IAS 29. Regarding inflation accounting, it is important to highlight some current developments and circumstances. According to the International Accounting Standard Board Communication, IAS 29, inflationary accounting should be light in 2022. For listed companies, the public oversight accounting and auditing standards authority sets accounting standards for Turkey. Until this date, the authority has not communicated about the implementation of inflation accounting for the TFRS framework. While Turkish accounting standards have been in full compliance in the past with IFRS, we might have a deviation between the standards unless TFRS recognizes IAS 29. Meanwhile, our dividend payout policy is based on IFRS standards, and we will come to distribute dividends based on IFRS financials. Given the fact that we have financial assets rather than PP&E on our balance sheet, we expect monetary expense on our IFRS income statement, while the amount is not finalized. As mentioned, our underlying net income guidance, including the IFRIC model adjustment and IAS 29 inflation accounting, will be between TRY 2.3 billion to TRY 2.7 billion. Please note that some specific accounting areas such as how to treat hedges are still being assessed by the large audit firms. Moreover, deviations in year-end inflation versus estimates will impact the size of the monetary adjustment. At this early stage of inflation accounting application and without confirmation of our auditor, we highlight that this guidance is provided at an early stage. While we are confident and have clarity in our operational performance, we respect the magnitude of the impact this year's accounting treatment and therefore provide you with the range of TRY 2.3 billion to TRY 2.7 billion with the indication of a performance in mid-range unless anything unexpected on the accounting form. We want to highlight to you that in this year, because of the circumstances of hyperinflation, a simple extrapolation of our 9 months result would not fully represent all the impacting factors that will generate our full year 2022 results. This because the IAS 29 effect has not been present in our previous 3 quarters as it will be incorporated with its full 2022 effect first in the fourth quarter results. In this context, to fully capture both the operational performance of the fourth quarter as well as the accounting impact on IAS 29, please see our full year 2022 expectation, which is taking into consideration all these aspects and guide for underlying net income of TRY 2.3 billion to TRY 2.7 billion as basis for the dividend distribution based on the dividend policy referring to IFRS. We are very confident in the operational and financial developments for 2023. We will provide you in the full year 2022 results call with the guidance for 2023 as well. Moreover, our discussions with the regulator on CapEx unit price is also continue. Our RAB growth strategy continues, and currently, we aim to spend above TRY 4.5 billion, the right balance between the current cash flow situation and our growth ambitions. We plan to compensate any gap versus the allowance during this regulatory period. We expect positive free cash flow after interest and tax in the fourth quarter of 2022 as well. However, the full year figure can be still negative as part of settlements for temporary regulatory mechanisms will defer to January. 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 are, as mentioned, very critical in supporting Turkey's transition into a low-carbon energy world. Finally, we decided to revalue our statutory fixed assets in October. According to the asset revaluation law, companies have the option to revalue their fixed asset base for a fee of 2% of the revaluation. The deferred tax calculated on the temporary differences resulting from this adjustment will be recognized in net income as of 2022 year-end. This will lead to one-off deferred tax gain and we will treat this item as extraordinary gain. Thank you very much for your attention. And now I do hand over to Gozde again.

Thank you, Michael. Now we can start our Q&A session. [Operator Instructions] Okay. We have a question from John.

Can you hear me now?

Yes, we can hear you now.

Okay. Great. I have a quick question. Can you just remind us on the terms and the average interest rates of your bond issue that you completed in October. Any comments on its maturity and the interest rate will be welcome.

Okay. One is 32%, further is tariff plus 16%. And we have bought 1-year and 2-year maturities. 32% is 1-year and 2-year is tariff plus 16%. Now we have a question from [indiscernible]

Can you hear me?

Yes, we can hear you [indiscernible]

Okay. I wanted to ask about -- you mentioned the cash flow in fourth quarter, it should be positive, but the yearly cash flow will be negative. I wanted to ask about the new supportive measures or regulations in retail and the impact of the power price levels. Does it mean that if prices stagnate or what happens if they fall looking at these mechanisms? Can there be a huge fall of free cash flow again? Or do you feel that the current mechanism is good enough to secure positive cash flow in retail?

Okay. We expect positive cash flow in the fourth quarter, but the year consolidated number might be slightly negative. That's because of the fact that some of the settlements are related to the regulatory mechanisms, they will [ fall to ] January. Therefore, you will not see -- which is relatively bulk impact. You will not see with the full year results. And we see an increasing contribution of the support mechanism. But for the full year, there might be volatilities, but all the mechanisms are set to ensure that the retail companies make proper cash flow according to the regulation. Therefore, within the year, there might be some fluctuations. But with the longer-term perspective, although the list the shift from quarter-to-quarter, this impacts -- if there's a negative impact it's compensated and consider the reverse case, if the power prices fall significantly in the hypothetic scenario. And if the tariffs start to be higher than they need to be, the positive cash flow impact is to be reversed in the subsequent quarters. Therefore, there is a working mechanism. But because of the huge increase in the power prices, the new mechanisms or support mechanisms, came with a [ less tariff ] -- with a wider horizon, these mechanisms all work.

All right. So the mechanism works that if power prices fall, you might end up being something if you earn more money if they rise, you will be compensated. But when we look at the last 12 months, you're still short some TRY 3 billion. When do you expect to recover this amount, so the terms are fair? Are we looking at 1 quarter, horizon, 2? Or will this take a year or this is too uncertain to comment on?

Of course, this depends on the power prices. But broadly, you can assume that on the retail side, excluding the impact of working capital, we will be broadly compensated within the first quarter of 2023. But of course, the power prices still have an impact on that. And you are right, that had been a cash outflow, but this is partly because of the fact that the power price continues increasing. Therefore, new mechanisms were introduced, but it was not sufficient as power prices did not stagnate. Therefore, there was a continuous gap despite new mechanisms, but we now see more of a stagnation. And for the time being, we can say that in the first quarter, we expect full compensation. But of course, we don't want to give a full guidance for that because it might be subject to change based on the timing of the support mechanisms and power prices as well.

Perhaps one more question on dividend. The guidance, you have this TRY 2.3 billion to TRY 2.7 billion. That's the guidance today and this is the amount from which dividend will be paid based on the current dividend policy. Is that right?

Yes, that's correct. This is the net income based on IFRS and our dividend policy is based on IFRS, and IFRS needs to account for inflation accounting as well. This will be the best for our dividend payment calculation.

Perhaps one more question. If we have all these regulatory mechanisms, the new schemes, have you spent some time with the regulator on also projected volumes next year? For example, in case there is recession. Is there any significant impact coming from volumes? Or are these mechanism based on flat volumes. So do you have any color on this?

Normally, we always incorporate for volume changes. Therefore, it's a normal volume adjustment. And if there's a deviation in volumes as well, there's an adjusted mechanism for that. Therefore, the adjusted mechanism works both for energy price differences and also for the volumes. And it's also corrected that for -- retail side is corrected in 2 quarters. Okay. We have two written questions, which is -- one is related to the inflation accounting in TFRS result announcement in the fourth quarter. Currently, there is no regulation for inflation accounting for TFRS. Therefore, what we report as for TFRS, if the regulation does not change, it will not include inflation accounting, but we will also have an IFRS reporting, and it will include inflation accounting, retrospectively for 2022, and we will report this at the year-end. And there is a subsequent question. It's about the impact of IFRIC 12 approve in the fourth quarter. It was close to TRY 800 million, about TRY 750 million, and we will see a broadly similar impact in the fourth quarter. If there are further questions, you can raise your hand or you can also raise your questions through the Q&A section. There is a question from [indiscernible]

It's me again, I wanted to ask now there are new rules, new mechanisms, you are turning free cash flow positive. So who is bearing the cost? Could you explain to me in more detail the power price picture, the strength of the consumer and the outlook ahead. I understand that the distribution companies need some support to be functioning. But in the end, if there is the economic downturn, what does it mean for this form of regulation and in the end, your cash flow? What I don't understand is that you have been subsidizing in the end, the consumer for the past year. So what's the fundamental change here? And how can this continue if in the end, there is no money.

Okay. Actually, a simple answer is that there are a number of support mechanisms for that, but it's not for distribution companies. You showed separate distribution companies and retail companies and retail companies work with a fixed margin, which is 2.38%. And it's on top of the procurement prices and if there's a deviation versus the forecast, they are compensated. And in the recent years, there have been a number of support mechanisms for the regulated customers. And one is, for example, related to the generation companies and for the generation companies, which have low marginal prices, there has been a maximum price floor and versus this maximum price floor, the difference with the day-ahead prices is allocated to the system in order to support the customers. Therefore, there are a number of mechanisms like that, for example. And these mechanisms are more to support the residential customers and SMEs as well. Therefore, the support for industrial customers subsidy is relatively limited. And in that, the system needs to function. Therefore, there might be differences in cash flow from quarter-to-quarter. But if there isn't a system to ensure that the cash flow is allocated to the companies, there might be -- don't think about in our result, think about overall system. There would be a risk for the system. Therefore, if there would be new mechanisms as the regulator has been quite passed -- agile actually in introducing the mechanisms, but you didn't see the impact because the power prices if quantity is going up.

All right. So you're saying that the money is now coming from the generation companies, which are making money above some price gap.

Yes. Yes. That's true. You can also see the details in our presentation as well. So where is -- the support mechanisms in our slides. And if you have further questions, we can discuss in detail in a separate session. Okay. We have a question from [indiscernible]

Can you hear me?

Yes, we can hear you now.

Can you remind me if there has been a change in the calculation of deposit valuation expense? Or is there a preparation with regards to that on the regulatory front?

Financially, in terms of accounting, there is no change for that prospect. And regarding the regulatory perspective, there are always discussions on that, but I cannot say some concrete on that road. But our accounting policy has remained the same, as we cannot change the accounting of the deposits. It seems we have no more questions for now. Thank you very much for your attendance. If you have any questions or queries, you may reach us through investor relations at enerjisa.com, email address.

Thank you very much, [Foreign Language] Good evening.

Thank you.