1. KENYA POWER
powering people for better lives
Intiation of coverage and valuationreport.
I initiate coverage of Kenya Power midway on its plans to increase electricity inclusion from the current
30% to 70% by 2017.This effort will be boosted by the expected increase of additional power from
1700MW in 2013 to 6700MW in 2017.The aim of the powerincrease is to change the energy mix in
power away from relying on weather prone hydro plants andexpensive emergency power to renewable
and reliable sources of energy (geothermal) and cheap fossil powered plants(coal and gas).To date,
geothermal powerinstalled power capacity has increased by 406MW against a set target of 506MW by
September 2015.Legal complications delayed the Lamu coal plant, but they are now in the clear.
Multiple power generation projects have runintolegal headwinds but the general expectation is that
theywill clear through active community participation with the power investors.
Kenya power and the Rural ElectrificationAuthority(REA) have renewed vigor toincrease electricity
inclusion with some 435,558 customers connected to the grid between the financial years 2013-
2014.Though the agencies hope to connect an additional one million between 2014-2015, my belief is
that they will connect about 700,000 additional customers and hitting the one million mark as from
financial year 2015.If they race to connect 70% by 2017, the company risks to accumulate excessive debt
that will choke the company. Spacing it by anextra two years allows for proper and sustainable growth
in tandem with the increase in installed cheaper capacity who are already behind schedule.
Kenya power is a buy with a fair value of 24.9 against a trading price 16.45 with a 51% upside. Over the
last three years Kenya power has been experiencing a trading price discovery towards its cashflow
generated from operations per share.
2012 2013 2014 2015E
Cash flow generated from operations
per share 7.38 9.46 11.89 15.10
Trading price at 30th
June 15.10 14.50 13.30 16.45
The main reason is that the FCFE and FCFF (Free Cash Flow to Equity and Free Cash Flow to Firm) has
been negative for several years given the heavy fixed capital investments and debt payments.

2. Below is a snapshot of a few historical metrics.
Note:
My definition (and the right definition for that matter) of EV is.
Enterprise value=Market value of equity at 30th
June+ market value of preferred stock at 30th
June+ book
value of debt as at 30th
June-Cash and cash equivalents as at 30th
June.
Kenya Power intends toincrease electricityinclusion from the current 30% to over 70% by 2017, a very
ambitious move.I opine that the most sustainable growth rate would be to achieve this target by 2019
Year Ending (June) 09A 10A 11A 12A 13A 14A
Ksh billion
Revenue 65.2 73.2 73.2 95.7 88.9 105.4
EBITDA 7.8 8.8 10.9 12.4 14.6 21.8
Operating Profit 5.7 5.9 7.1 7.8 8.9 15.0
Pre-Tax Profit 4.8 5.6 6.3 8.5 6.6 10.2
EPS (Ksh) 40.76 46.97 2.43 2.37 1.77 3.31
DPS (Ksh) 8.00 8.00 0.45 0.50 0.00 0.50
Revenue Growth % 59.82% 12.20% -0.02% 30.77% -7.06% 18.54%
EBITDA Growth % 48.5% 11.8% 24.8% 13.2% 17.8% 49.5%
Earnings Growth % 82.74% 15.23% 13.54% 6.40% 4.96% 58.01%
Operating Margin % 8.7% 8.1% 9.7% 8.2% 10.1% 14.2%
Net profit margin 4.9% 5.1% 5.8% 4.7% 5.3% 7.1%
Dividend Payout % 19.6 17.0 18.5 21.1 0.0 15.1
Return on Equity % 12.7% 13.4% 12.3% 11.2% 7.6% 12.7%
Return on Assets % 4.91% 4.75% 4.09% 3.49% 2.94% 3.68%
Gearing Ratio % 28.58% 29.88% 27.20% 38.53% 53.00% 53.95%
Capex Coverage 95.67% 92.44% 66.12% 49.69% 37.31% 72.56%
EBIT Coverage 6.44 9.37 18.43 6.82 6.46 6.41
P/CF 0.75 0.98 2.55 2.24 1.78 1.34
Price/Sales 0.18 0.22 0.51 0.31 0.32 0.25
EV/ EBITDA 4.88 5.02 4.77 4.56 5.59 4.11
P&L items as percentage of total assets
Revenue 91% 86% 60% 70% 48% 48%
EBITDA 11% 10% 9% 9% 8% 10%
Depreciation 3.0% 3.3% 3.2% 3.3% 3.0% 3.0%
Finance Costs 1.25% 0.37% 0.68% -0.51% 1.29% 2.18%
Pre-Tax Profit 6.68% 6.62% 5.16% 6.25% 3.57% 4.63%
Net Income 4.51% 4.37% 3.48% 3.30% 2.56% 3.38%
Source: Paul Maina

3. without compromising the financial health of the company. The company intends to invest an extra USD
1.3Bn to support the distribution of the extra capacity to the grid of which 70% will constitute debt.
70% electricity inclusionwould see the company have 6,812,989 customers.
2014 2019F
Kenya's Population 45,010,056 49,963,279
Number of house
holds 8,767,954 9,732,841
Number of domestic customers 2,481,450 6,812,989
Electricityinclusion 28.30% 70%
People per
household 5.13 5.13
KeyAssumptions.
a) Kenya’s population growth rate continues at the current 2.11%.
b) Population per household remains constant.
A key metric to forecast both FCFF and FCFE is the fixed capital investments (FCinv).To forecast capital
expenditures, I noticed a strong correlation between the amount of money invested in time T and the
growth of customer numbers in time T+1.Typically this is how Kenya Power works.After numerous
applications for connectivityin a given area, Kenya power extends the distribution to that area. The
numbers have to be sufficient to justify the extension. That is why there are cases of people who paid
for connectivity and remain pending for months. The plan to connect all schools hasled to heavy
investments and significant increase in customer numbers. Building and extending the network takes a
long time such that its effects are felt one year period later.

4. The FCinv at financial year T versus increase in customer numbers at T+1 is as follows.
Year 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
FCinv/Customer
inc t+1 60 78 91 98 99 94 86 76 65 56
Fcinv (Mn) 26,511 26,949 30,742 33,550 35,453 36,713 37,706
In 2014, they spent Ksh 26,650Mn.My forecast stands at 26,949Mn, a margin of error of less than
1.2%.The expenditure per additional increase in customeris decreasing due toeconomies of scale,
transformer maximization and leverage of newer electricity distribution strategies. Convexity analysis of
FCinv and targetincrease in customer numbers is used to create the FCinv model.
2015E 2016E 2017E 2018E 2019E
CFO 23,431,150 28,389,021 34,395,945 38,685,948 42,941,402
Borrowings 12,928,233 15,312,199 18,135,768 21,480,004 25,440,916
Debt Repayments (8,303,795) (9,835,015) (11,648,592) (13,796,592) (16,340,684)
Fixed Capital Inv (30,741,823) (33,550,183) (35,452,856) (36,712,784) (37,706,122)
interest expense 2,462,640 2,916,751 3,454,600 4,091,628 4,846,124
- - - - -
FCFE (2,686,236) 316,022 5,430,264 9,656,575 14,335,513
- - - - -
(4,551,222) (4,995,622) (3,119,436) 1,361,308 4,837,303 8,627,567
Valuation as at 30 Sept 2015 (5,090,394) (2,948,429) 1,193,503 3,933,899 6,508,201
Discount Factor 1.0190 0.9452 0.8767 0.8132 0.7543
Terminal Value - - - - 96,565,298
FCFF 100,162,078

5. COST OF EQUITY NSE 20 Market Return WACC 7.81%
Equity Level 30.00% 30 June 2002 1,077.96
Risk free rate
(FXD1/2012/20YR) 12.92% 30 June 2015 4,906.07
Historical equity risk premium 2.86% Annual Return 12.36%
Beta 0.79
Bond
YTM2004 9.50%
CAPM E(R) 15.17%
CURRENT CAPITAL MIX
cost of equity 4.55% EQUITY 54,205,569 0.5050
COST OF DEBT DEBT 53,141,442 0.4950
Debt level 70.00%
Cost of Debt 6.64% TOTAL 107,347,011
After tax cost of Debt 3.25%
FCFF Value 100,162,078.18
Less Debt 53,141,442.00
Equity Value 47,020,636.18
Equity Value per share 24.10
Current Price 15.8
Upside 52.50%
FCFF forecast assumptions:
a) CFO will increase by 21% per annum over the next five years.
b) Debt will grow by USD 0.91Bn to support evacuation and distribution of additional electricity.
c) Electricityinclusionin the country will increase from 28% to 70% by 2019.
d) Annual debt repayments average 10% p.a
e) 1% terminal growth rate.

6. Alternatively,
Should investors continue to price the stock at CFO generated from operations per share then the five
year forecast would be
2012 2013 2014 2015E 2016E 2017E 2018E 2019E
CFO_gen 14,405 8,454 23,208 29,474 37,432 47,539 60,375 76,676
Operation costs 19,680 20,984 22,683 26,629 30,369 34,548 39,193 44,325
Bank overdraft est 4,628 6,580 4,229
Bank overdraft interest exp 1,110 1,669
Borrowings 27,762 51,079 70,110 83,037 116,485 137,965 157,106 163,406
interest expense 1,144 1,383 2,338 2,856 3,495 4,276 5,232 6,401
Cash flow generated per
share 7.38 9.46 11.89 15.10 19.18 24.36 30.94 39.29
Trading price at 30th June 15.1 14.5 13.3 18.35
2019 30th
June expected trading price range: Kshs 42.86-ksh 46
Conclusion
The next few years will be veryinteresting for Kenya Power. It has a lot of value lockedin it. From an
entrepreneurial stand point, KenyaPower meets the threshold of a good and potentially great company;
Home grown management, big hairy audacious goals, the power of alignment, a clear vision,
increasingly strong customerfocus among others.
RECOMMENDATION: BUY
Paul Maina: Head of research, Relic Capital.