Culled—–Proshare

August 17, 2016/CardinalStone Research

Transnational Corporation of Nigeria Plc held a conference call on its H1’16 performance recently. Please see below the group’s H1’16 performance update and key highlights from the call.

Transcorp Hotel remained resilient through economic headwinds
The hotel subsidiary demonstrated impressive resilience and strength in what has been a turbulent six months and would likely to reach its true potential when the economy rebounds. Revenue from the hotel business grew by 4% to N7.3 billion from a year earlier, while net profit rose by 3% to N1.9 billion.

According to management, the marginal growth in turnover was on the back of improved business activities versus the same period last year which was negatively impacted by political uncertainty. Food and beverage prices were raised and consequently the unit’s contribution as a percentage of overall revenue rose to 26% from 23% in H1’15.

We laud the hotel’s cost efficiency as operating expenses remained flat, though input costs rose by 11% given rising inflation and the 40% depreciation in the Naira towards the end of H1.

Full steam on projects
Management disclosed that they will forge ahead with the upgrade of Transcorp Hilton Abuja and the construction of Transcorp Hilton Port Harcourt (PH) and Ikoyi. The upgrade of the Transcorp Hilton Abuja should be concluded by 2017. Construction work regarding Transcorp Hilton Ikoyi is expected to commence in Q1’17 whist the groundbreaking ceremony and construction of Transcorp Hilton PH will begin in 2018/2019.

According to management, these projects are key to the division’s outlook as they will provide new revenue sources and increased market coverage. However, a key concern for us regarding these projects is the increased risk of cost over-run arising from currency fluctuations. Since the initial announcement in September 2013, the NGN/USD currency pair has weakened by 105% which will have definitely pushed up initial project costs.

With no visibility regarding where the Naira will eventually settle, construction costs could even rise further over the project life cycle. Management agrees with our assessment and disclosed the possibility of raising additional capital at the appropriate time.

Power division squeezed by higher energy costs and finance charges
Transcorp Power was a beneficiary from the revised tariff regime as the surge in electricity prices (+63% YoY) compensated for the fall in output (-20% YoY). Revenue rose by 32% YoY to N17.2 billion from N13.0 billion in H1’15. Following the rise in gas prices to US$3.30 per scf in Q2 and the 41% depreciation in the currency, production costs (of which fuel expense is a major component) surged materially.

Management was able to keep a tight lead on controllable costs evidenced by the 17% YoY reduction in operating expenses. Similar to what happened in 2015, earnings was pressured by  another round of FX revaluation losses amounting to N14.5 billion and this led to a loss after tax of N12.2 billion. Following the consecutive impacts of the foreign currency borrowings on profitability, management is taking steps to pay down. Management initially wanted to covert the loan to local currency to avoid currency risk but the target was not accomplished.

We note that there’s still currency risk as Naira has plunged further by 12% at the interbank market, hence another FX loss may be inevitable if the loans are not substantially reduced by end of Q3’16. Optimal operations has been continually hampered by inadequate gas supply and management has taken a number of proactive steps in this regard. In the short term, discussions have been initiated with owners of nearby gas field for the supply of natural gas.

Longer term, management hopes to pipe gas from its prospecting lease (OPL 281) which has been proven to contain some gas reserves. We however highlight OPL 281’s close vicinity to the Tran-Forcados pipeline infrastructure, a frequent target for militant attacks.

Power subsidiary still grappling with cashflow strains
Till date, generating companies (GENCOs) are grappling with cashflow strains owing to the huge debt owed by the distribution companies (DISCOs). Transcorp Power is hampered by outstanding receivables totalling N28.8 billion and this has affected its ability to pay its obligations when due. It’s currently indebted to the gas vendors to the tune of N14.8 billion.

Alarmed by the overall debt owed to the sector, the Nigerian Bulk Electricity Trader (NBET) signed activation agreements with Gencos which was a condition precedent to the full activation of Purchasing Power Agreements (PPA). The letters of credit arrangements in the PPAs would ensure better collections for Gencos and would have been effective from July 2016.

However, Discos instituted a lawsuit against NBET and obtained a restraining injunction restricting the defendant from enforcing the payment guarantee arrangements in the PPA. This impasse is a significant threat to the already messy cash-flow situation.

Teragro undergoing business review, OPL still under exploration
Teragro is undergoing operational review given its minimal contribution to the Group’s revenue and profit. Management is looking to engage a strategic partner that will provide technical expertise and capital. Transcorp Energy has commenced an exploratory drilling program having obtained a drilling permit from the regulatory authorities. Management expects contribution from this business to kick in from 2018.

Valuation
With the exception of the hotel subsidiary, the other divisions are generating returns below par due to various factors. Given these constraints, share price performance has been weak with YTD loss of 28.3%. We retain our SELL recommendation given the 16% downside relative to our target price of N0.92.