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Has EM power lost its spark?

Despite operating in a market with compelling structural factors, some emerging market energy providers have endured torrid trading conditions over the past 12 months
November 27, 2015

It's well known that many emerging market economies are held back by perpetual energy deficits. So it's little wonder that western companies have been rushing in to fill the gap. Whether it is conventional electricity generation in India, or the provision of temporary power sources in parts of the Middle East and Africa, there are UK-listed companies with an interest. With intertwined structural levers linked to population growth and rapid industrialisation, it's easy to appreciate the investment case - but it is far from clear whether selling power in these markets is a sure-fire way to generate regular returns.

The performance of UK power providers has been hit by geopolitical volatility, in addition to a marked contraction in economic growth in several emerging market countries. So it would be justifiable to ask whether the opportunities on offer still outweigh the potential pitfalls.

 

Black is the new black

India seems the obvious place to start. Prime Minister Narendra Modi has targeted uninterrupted power supply to all of India's 1.3bn population by 2019. Coal will play a big part in achieving this. What's more, Mr Modi is looking to increase private participation in the sector. Coal India currently accounts for around 80 per cent of coal production in the country and is 80 per cent owned by the government. However, authorities in Delhi recently approved the sale of a 10 per cent stake in the state-controlled entity, potentially generating $3.2bn (£2.1bn) for government coffers. Things have not been running smoothly at Coal India, with bulk production of the black stuff failing to keep pace with nationwide demand. The country's industries are reliant on imports, which now account for 18 per cent of total electricity generation - hardly an ideal scenario for a nascent economic superpower.

Operating against this backdrop is electricity generator OPG Power Ventures (OPG). OPG operates coal-fired plants in Chennai and Gujarat, which currently have a combined capacity of 600 megawatts (MW). By January 2016, management expects this to increase to 750MW. The UK group's capacity expansion has been impressive; increasing year-on-year generation by more than 50 per cent at its half-year mark. Industrial customers now make up 62 per cent of its total sales, but what makes OPG different to many other coal-fired power generators in India is that its fuel mix is split around 70/30 between Indonesian and Indian coal. This means it has been less affected by domestic coal shortages in India.

 

Mytrah's leveraged play on a green India

Although carbon predominates, renewable energy still has an important part to play in India's growth story. In its union budget for 2015-16 the Indian government set a target to install 60 gigawatts (GW) of wind power capacity and 100GW of solar power capacity by 2022 - more than six times the current installed capacities of around 22GW and 3GW, respectively.

Following the sale of Greenko (GKO) to the Singapore government earlier this month, the remaining UK-listed company in the Indian green energy space is Mytrah Energy (MYT). The wind power provider has been steadily building up its capacity, which now stands at 578MW, with plans to reach 743MW of capacity by the time the 2016 windy season comes around. But this rapid expansion has come at a price. Net debt stands at an unwieldy $519m. It was up a fifth during the first half of Mytrah's financial year, effectively tipping the company into negative earnings. Although Mytrah's high degree of leverage is hardly helping the shares re-rate, it could eventually translate into strong earnings growth, assuming capital has been allocated wisely.

 

Rapid capital expansion and risk profiles

"There is an element of risk with all these companies because they're developing quite quickly," says Cantor Fitzgerald analyst Adam Forsyth. "That sometimes holds back profitability because a lot of the time cash is being put into new products." However, this is absolutely what renewable energy companies should be doing, he adds. Of course, it is also important to note that both OPG and Mytrah should reap the rewards of this investment and throw off a lot of cash once their assets are fully operational - but investors may require patience.

Shares in both OPG and Mytrah have suffered, with the latter falling by 40 per cent over the past six months. This may have something to do with investor sentiment towards emerging markets, which has soured on continued US dollar strength. Yet it is worth remembering that India's GDP is forecast to grow 7.7 per cent in 2015, compared with Chinese forecast growth of 6.9 per cent.

 

Plugging the gap

With the intensified strain on power transmission in some emerging economies, a number of temporary power providers are now selling energy straight into national grids. Aggreko (AGK) is the most prominent UK-listed company in this field. Recent contract wins included the provision of 95MW of natural gas generation to Myanmar during the drier summer months, since around 70 per cent of the country's energy supply comes via hydropower. Contracts can also last several years, providing enhanced revenue visibility. For example, Aggreko first set up its gas-fired generation plant in the Ivory Coast in 2010, initially producing around 70MW. That has subsequently been stepped up to 200MW and Aggreko recently had its contract extended by another three years.

 

Geopolitics and other power plays

Geopolitical turmoil in Libya and Yemen has derailed operations for many western companies, including Aggreko and APR Energy (APR). The disruption was particularly acute for APR Energy. After failing to ratify its contracts with the Libyan government, APR was forced to withdraw its assets from the country. Management followed a similar course of action in Yemen earlier this year, due to ongoing security concerns.

While events have been out of the company's hands, the financial consequences have been dire. The company has so far booked a combined total of almost $775m in non-cash impairments and asset writedowns. In June, management announced that long contract lead times and delays to contract negotiations would also dampen profits for the current year. However, there may be light at the end of the tunnel for investors. APR is currently in discussions with a consortium, which includes Albright Capital Management - a private equity group led by former US Secretary of State Madeleine Albright - over a possible takeover. This has triggered a slight resurgence in the shares.

 

 

IC VIEW: As GDP growth depends on securing enough energy to power the industrialisation taking place within many emerging markets, the demand for services offered by Mytrah, OPG et al is undoubtedly there. So while the jury is still out as to when the temporary power providers will be able to overcome their current end-market troubles, investments within this sector, certainly for OPG and Mytrah, should be seen as long-term - there's no quick power fix.