EDC, FPH, AP, FGEN Stock Update from COL

We are lowering our earnings forecast and FV estimates for all power generation companies, including FPH which owns FGEN, to factor in lower ancillary service revenues for hydroelectric plants beginning this year as the NGCP changed the pricing structure for ancillary services. We maintain our HOLD rating on EDC, FGEN and AP, as the drop in ancillary service revenues led to a further reduction in their earnings and fair value. However, we maintain our BUY rating on FPH. Even with the downward revision, FPH’s valuation remains attractive, with the stock trading at a 15% discount to our FV estimate and a steep 29.5% discount to its market based NAV of Php145.6/sh.

• Ancillary revenues from hydroelectric plants to drop. Earnings of hydro plants are expected to decline this year after the NGCP and ERC revised its rules on the pricing of ancillary service revenue. Power plants can now choose between 1.) Selling ancillary services to the national grid on a firm basis, with a pre-agreed upon capacity fee; or 2.) Selling ancillary services on a non-firm basis with flexible pricing, but taking the risk that the capacity offered will not be sold. Regardless of the method chosen, power generation companies are anticipating a drop in ancillary service revenue this year.

• The change in the pricing structure for ancillary services will negatively affect the earnings of the listed power generation companies given their significant exposure to hydroelectric plants. Ancillary service revenues of the 130MW Pantabangan-Masiway hydroelectric plant account for around 15.7% of EDC’s and 21.4% of FGEN’s total earnings, while ancillary service revenues from the 360MW Magat and the 215MW Ambuklao-Binga hydro plants together account for 26.1% of AP’s earnings. Although FPH doesn’t own any hydro plants, it will also be negatively affected given that it owns 32% of EDC indirectly and 66% of FGEN.

• In our revised forecast, we assumed that ancillary revenue/kwh would drop to around Php2.50. As a result, our FY13E earnings forecast would drop by 4.0% for EDC, 6.7% for FGEN, 4.2% for FPH and 10.1% for AP. Meanwhile, our revised FV estimate fell by 3.1% for AP, 5.0% for FGEN, 3.5% for FPH and 7.4% for AP (see exhibits 2and 3 for details). Since there is still no certainty as to how much ancillary revenue/kwh would be, we provided a sensitivity analysis of earnings and FV estimates based on the assumption that actual revenue/kwh would be higher than expected at Php4.00 or lower than expected at Php1.50.

After reducing our earnings and FV estimates for EDC, FGEN, FPH and AP, we maintain our HOLD rating on EDC, FGEN and AP, and our BUY rating on FPH.

Due to the downgrade in our FV estimates coupled with the recent increase in share prices, capital appreciation potential is limited at only 6.8% for EDC. In fact, FGEN and AP’s share price is already trading at a premium to our revised FV estimate. Moreover, although the actual ancillary service price could exceed our base case forecast of Php2.5/kwh, our sensitivity analysis shows that valuations of EDC, FGEN and AP remain unattractive, with capital appreciation potential still limited at less than 15%.

Nevertheless, we are maintaining our BUY rating on FPH. Despite rising by 14% for the year to date period, FPH still trades at a 15% discount to our reduced FV estimate. The stock is also trading at a steep 29.5% discount to its market based NAV of Php145.6/sh. Fundamentally, we like FPH because it is a cheaper way to gain exposure to the country’s power industry given the Company’s 66% stake in FGEN and its 3.9% stake in Meralco, the country’s largest power distributor.