20171012-三星证券-Share_prices_not_matching_up_with_profits_10页_610kb

Sector Update Summary: Utilities (OVERWEIGHT)

Core Content

This report provides an analysis of the utilities sector in South Korea, focusing on four key companies: Kepco, Kogas, Kepco KPS, and Kepco E&C. The report highlights the performance of each company in the third quarter of 2017 and provides forward-looking forecasts and valuation insights.

Key Companies and Their Performance

Kepco (015760 KS)

• Current Price: KRW37,350
• Rating: BUY
• Target Price: KRW50,000
• Upside: 33.9%

3Q17 Performance

• Operating Profit: KRW3.3t (vs. consensus of KRW3.1t)
• Sales: Flat year-over-year at KRW15.9t
• Earnings Outlook: Profitability is expected to improve in 2H17 due to:
  • Improved power-generation mix with new coal plants
  • Increased nuclear plant utilization rates
• Valuation Concerns: Despite strong fundamentals, shares trade at an undervalued 0.34x P/B due to regulatory risks associated with the government's shift away from nuclear energy
• Valuation Methodology: Target price is based on expected ASP increases in early 2018 and improved production mix with two new nuclear plants online in 2018

Kogas (038460 KS)

• Current Price: KRW41,400
• Rating: BUY
• Target Price: KRW57,000
• Upside: 37.7%

3Q17 Performance

• Operating Loss: KRW149.6b
• Sales: KRW4.08t (up 12.4% y-y)
• Performance Breakdown:
  • Domestic operations: Seasonal loss of KRW166.4b
  • Overseas operations: Profitable y-y due to narrowing losses at the GLNG project and rising margins in Iraq
• Impairment Losses: Expected to recognize KRW300b-400b in impairment losses on its 15% stake in the GLNG project
• Government Policy: Designation of Dangjin as a preferred site for the fifth LNG storage base increases the likelihood of rate base and guaranteed return growth
• Valuation Methodology: Changed from P/E to residual income model due to policy uncertainties; target price lowered to KRW57,000

Kepco KPS (051600 KS)

• Current Price: KRW42,750
• Rating: BUY
• Target Price: KRW57,000
• Upside: 33.3%

3Q17 Performance

• Operating Profit: KRW41.1b (up 37% y-y, surpassing consensus of KRW37.6b)
• Sales: KRW328.1b (up 18% y-y)
• Performance Drivers:
  • Domestic nuclear plant maintenance sales increased 23% y-y
  • Jordan's al Manakher project saw increased routine maintenance revenues
  • Combined cycle project in Uruguay is expected to start generating full sales in 2018
• Valuation Methodology: Changed from P/E to residual income model; target price lowered to KRW57,000
• Earnings Growth: Expected to grow 66% in 2017, significantly higher than the 8% average for peers
• Policy Outlook: Policy uncertainties are expected to dissipate by year-end, and the market is anticipated to recognize the company's undervaluation

Kepco E&C (052690 KS)

• Current Price: KRW19,800
• Rating: HOLD
• Target Price: KRW18,000
• Upside: -9.1%

3Q17 Performance

• Operating Profit: KRW12b (vs. loss of KRW1.6b in 3Q16)
• Sales: KRW89.8b (down 12.1% y-y)
• Performance Drivers:
  • Profitability is driven by long-standing projects rather than new ones
  • Expected to benefit from potential overseas nuclear orders, particularly the UK's Moorside project
• Valuation Concerns: Shares have not sustained rallies despite news of overseas orders due to the long lag between order receipt and revenue realization
• Order Outlook: No significant orders since 2H16, and backlog may start to dwindle, reducing long-term earnings visibility

Key Points

• Sector Outlook: Overall sector operating profit is expected to be in line with consensus
• Regulatory Impact: Concerns about government policy on nuclear energy affect valuations
• Valuation Models: Some companies have shifted from relative valuation (P/E) to absolute valuation (residual income)
• Market Expectations: There is an expectation that policy uncertainties will decrease by year-end, improving market perception of undervaluation
• Target Price Rationale: Based on improved fundamentals, potential earnings growth, and long-term project developments

Summary of Valuation Metrics

• Kepco: Forward P/B = KRW109,327, Target P/B = 0.5x
• Kogas: Forward P/B = KRW109,327, Target P/B = 0.5x
• Kepco KPS: Forward P/E = 13x, Target P/E = 14x (vs. peers)
• Kepco E&C: Forward P/E = 10.2x, Target P/E = 11.2x

Key Charts

• Crude and Coal Prices: Source: Bloomberg
• Power-use LNG Price vs. SMP: Source: Company data, EPSIS
• Kepco Forward P/B: Source: Company data, Samsung Securities estimates
• Kogas Forward P/B: Source: Company data, Samsung Securities estimates
• Kepco KPS Forward P/E: Source: Company data, Samsung Securities estimates
• Kepco E&C Forward P/E: Source: Company data, Samsung Securities estimates

Compliance Notice

• Analysts did not own any shares or convertible debt instruments in the covered companies as of Oct 11, 2017
• Samsung Securities' holdings would not exceed 1% of each company's outstanding shares if convertible debt was exercised
• The report reflects the analyst's views and is based on publicly available information
• No guarantees of accuracy or completeness are made
• The report is not an offer to buy or sell securities