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Daily Market Report – 24th June 2020


Faida Research - June 24, 2020 - 0 comments

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Market Commentary: 

  • The All Share Index eased by 1.4% to close the day at 138.46 as Safaricom declined for the 3rd consecutive day ( -7.3% week to date to KES 28.65). On the other hand, KenGen has gained 8.6% week to date on the back of positive investor sentiment following the President’s nomination of the next Auditor General whose vacancy had delayed the decision on the counter’s dividend payout.
  • We note that today the government extended of some of the measures to facilitate mobile money transactions until 31st December 2020. This will have a negative impact on banks’ non-interest income and Safaricom’s M-PESA revenues. We therefore expect some negative reaction on the some of the banks but more so on Safaricom.

 

News Highlights:

The MoE Set to Declare Force Majeure on Power Generation Contracts

 According to the Business Daily, the Ministry of Energy (MoE) has announced that it will invoke the force majeure clause in wholesale power generation contracts.

 The force majeure clause in contracts frees parties in a contract from liability or obligation and is generally invoked when an extraordinary event or circumstance beyond the control of the parties occurs. In this case the extraordinary event is the COVID-19 global pandemic which has resulted in reduced electricity demand especially from industrial and commercial users (who account for 70.0% of Kenya Power unit sales) due to:
i. the implementation of restrictions to curve the spread of
the virus (such as the night curfew)
ii. closure of factories and hotels

 Electricity demand fell 15.3% to 645.29 million kilowatt-hours (kWh) in April owing to the impact of the global COVID-19 pandemic.

 The invocation of the clause indicates that Kenya Power will not be obliged to fulfill the payment of existing power purchase contracts from power producers.

 Kenya Power has already indicated that it is facing challenges fulfilling the payment contracts due to reduced income (on the back of the lower demand) while also having to cover costs related to distribution and transmission.

 The nature of the contracts generally requires Kenya Power to purchase a set amount electricity while also compensating power producers for electricity availability/capacity

 The declaration of force majeure implies Kenya Power will not b obliged to pay for excess power i.e. the difference between the power consumed and the power acquired from power producers.

Commentary

 Whilst details still remain scanty on the enforcement of the force majeure, if the declaration of the force majeure holds, Kenya Power is likely to benefit from being spared from paying for excess electricity and this will most likely come into effect in FY2020/2021.

 However, this scenario is likely to significantly affect KenGen which supplies electricity to Kenya Power under the contracts in question.

 At present, it remains unclear as to whether the force majeure affects only the payment of unused electricity or also electricity capacity. KenGen generates electricity revenues from both sources – energy revenue and capacity revenue – with the latter accounting for a larger share of electricity revenues at 72.2% (as at FY2017/2018).

 If the force majeure affects electricity capacity as well this will significantly affect KenGen financial performance in FY2020/2021. However, since this is still unclear, we expect more clarifications going forward. We also note that there is a possibility of renegotiations in electricity contracts to take into account the change in electricity demand. The Energy and Petroleum Regulatory Authority (EPRA) had also earlier indicated that it is planning to shift to a “take and pay” model of power purchase agreement (PPA) between Kenya Power and investors, moving away from the current “take or pay” regime

 There has been increased activity on KenGen recently based on the President’s nomination of Nancy Janet Kabui Gathungu for the position of Auditor – General (still awaits vetting from the National Assembly Finance and National Planning Committee which will be conducted on July 3rd 2020) and we opine this has fueled investor’s optimism regarding the payment of dividends in respect to the FY2018/2019.

 KenGen’s board of directors delayed the recommendation of a final dividend for FY2018/2019 due to the absences of an Auditor – General to audit of the financial statements.

 With the nomination of Nancy Janet Kabui Gathungu for the position of Auditor – General, in our view, we believe KenGen may declare a dividend in respect to the FY2018/2019 (after tax profits remained flat in comparison to FY2017/2018 where they paid a dividend of KES 0.40). Furthermore, since the 1H2019/2020 showed a 98.1% y/y growth in after tax profits to KES 8.2 bn predominantly due to a KES 1.9 bn tax credit following the commissioning of Olkaria V 165 MW, we expect positive financial performance in FY2019/2020 due to aforementioned tax credit – despite lower electricity sales (owing to the impact of COVID-19). Notably, with the review of tax allowances from 150.0% (first year of use) to 50.0% (first year of use), going forward KenGen may not benefit (from tax credits) as much from the commissioning of new plants as it did it in the past.

However, it is important to note that a key risk to the dividend payments is the company’s need to conserve cash amidst debilitating macroeconomic conditions/reduced electricity sales and the uncertainties relating to electricity contracts. Thus, we urge investors to consider both sides of the coin and exercise caution when trading on KenGen.

 

Recommendations:

Long Term Buy- KCB, Equity, Absa, Stanbic, NCBA

Hold- Safaricom

Sell- Stanchart, Bamburi, HF

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