TUE 09 JAN 2018

New capacity to drive power

companies’ earnings growth
amidst oversupply concerns

Ample supply in Luzon and Visayas, oversupply in Mindanao ABOITIZ POWER CORPORATION
BUY
PHP52.00
After experiencing years of tightness, the country’s power capacity is currently a state of
oversupply and this condition will likely persist in 2018. Amongst the three grids (Luzon, Visayas ENERGY DEVELOPMENT CORPORATION
and Mindanao), the Mindanao grid has the greatest oversupply as a result of the influx of N/A
numerous coal plants from 2017 to 2021. Luzon is expected to have excess power supply until N/A

2025. Meanwhile, the Visayas grid is expected to hover at a state of equilibrium.

FIRST GEN CORPORATION
BUY
Going forward, the state of oversupply will limit power generation firms’ ability to aggressively PHP27.60
expand their capacity as it becomes increasingly difficult to obtain long term power supply
contracts from power distribution utilities. The oversupply situation will also keep spot prices SEMIRARA MINING CORPORATION
in the Wholesale Electricity Spot Market (WESM) subdued, unless the supply is temporarily BUY
PHP47.25
disrupted by power plant outages. As such, companies that are vertically integrated (those
which own both power generation and power distribution) and those that can produce power
MANILA ELECTRIC COMPANY
cheaply are in a better position to grow profits. BUY
PHP372.00
Exhibit 1: Luzon supply and demand forecast

GEORGE CHING
SENIOR RESEARCH MANAGER
george.ching@colfinancial.com

Source: AP

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 POWER SECTOR OUTLOOK I NEW CAPACITY TO DRIVE POWER COMPANIES’ EARNINGS GROWTH
AMIDST OVERSUPPLY CONCERS

TUE 09 JAN 2018

Exhibit 2: Visayas supply and demand forecast

Source: AP

Exhibit 3: Mindanao supply and demand forecast

Source: AP

New capacity to drive 2018 earnings growth

While the opportunity to grow profits in the medium term is limited given the oversupply
situation, net income of most power firms is still expected to grow in 2018 due to the first
full year earnings contribution of new power plants. AP’s earnings are expected to grow by
60.6% this year due to the first time earnings contribution of three projects, namely the 68MW
Manolo-Fortich hydroelectric plant, the 400MW Pagbilao expansion project and the 300MW
Cebu coal project. Meanwhile, FGEN’s net income is projected to grow by 10.1% as we expect
a gradual improvement in the capacity factor of the San Gabriel owing to higher revenues
generated through bilateral contracts and WESM sales. Finally, SCC’s earnings are expected to
increase by 3.7%, mainly due to the improvement in coal prices and volume of coal production.

COL Financial Group, Inc. 2

 POWER SECTOR OUTLOOK I NEW CAPACITY TO DRIVE POWER COMPANIES’ EARNINGS GROWTH
AMIDST OVERSUPPLY CONCERS

TUE 09 JAN 2018

Exhibit 4: Power companies 2018E EPS growth

Company EPS growth (%)
Aboitiz Power 60.6
FGEN 10.1
Meralco 1.1
SCC 3.7
source: COL estimates

Exhibit 5: Valuation of peers

2018 P/E ratio
Aboitiz Power 11.2
FGEN 9.1
Meralco 17.8
SCC 9.9
Average 12.0

source: COL estimates

Meralco earnings to improve slightly due to sales volume

growth

We forecast Meralco’s earnings to improve slightly, by 1.1% in 2018 to Php20.9Bil, on the

assumption that MER’s new tariff (~20% lower than current tariff ) under the 4th regulatory
period will be not be implemented unitl mid-2019. In terms of its core operation, we assumed
that sales volume would grow by 3.5% in 2017.

Top picks - AP and SCC

While all power companies are expected to book higher earnings in 2018, our top picks are AP
and SCC.

We like AP given its vertically integrated structure which will allow it to expand its power
generation portfolio despite concerns of oversupply in the market. Furthermore, valuations
have become increasingly attractive. Note that shares of AP were recently sold-off after its
weighting in the MSCI was reduced to make way for MER and after the company disclosed
that it could potentially write-off its assets related to Aseagas. Nevertheless, the reduction
of its weighting in the MSCI has nothing to do with the company’s fundamentals while the
Aseagas asset write-off will only have a minimal impact on profits and valuations. At Php41.45,
AP is trading at only 11.2X 2018E P/E, a discount relative to the 12X average P/E of industry
peers. While AP’s dividend yield is expected to dip to 3% in 2018 (as a result of the lower 2017E
earnings), we expect this to improve to 4.8% in 2019 due to the improvement in earnings next
year. Capital appreciation potential based on our FV estimate of Php52/sh is also significant
at 25.4%.

COL Financial Group, Inc. 3

 POWER SECTOR OUTLOOK I NEW CAPACITY TO DRIVE POWER COMPANIES’ EARNINGS GROWTH
AMIDST OVERSUPPLY CONCERS

TUE 09 JAN 2018

We like SCC since we expect it to be a major beneficiary of the country’s rising power demand
given its vertically integrated operations which makes it a low cost power producer. Plans
to boost power generation capacity from 550MW in 2012 to 1,200MW in 2021E should also
drive earnings growth. Furthermore, the outlook for its coal mining business has improved
due to its higher production level and the recent recovery of regional coal prices. Similar to
AP, valuations are also attractive. Recall that shares of SCC were sold off due to the removal
of SCC’s coal excise tax exemption in the recently passed tax reform program. However, the
impact of excise tax on SCC’s valuation is only minimal. At Php36.1/sh, SCC is trading at only
9.9X 2018E P/E, which already factors in the negative impact of the higher excise taxes on coal.
This is a steep discount relative to the 12X average 2018E P/E of its domestic peers. Capital
appreciation potential based on our reduced FV estimate which already includes the impact
of the higher excise taxes on coal is also significant at 30.9%.

Fundamentally, we also like MER since it is a power distribution company which makes it less
vulnerable to the impact of the oversupply situation. However, the stock is already fairly valued
as it is trading at 17.8X 2018E P/E. Capital appreciation potential based on our FV estimate is
at Php12.5%.

We also like FGEN fundamentally as bulk of its plants’ capacity is contracted providing it with
stable cash flow. Valuations are also attractive, with the stock trading at only 9.1X 2018E P/E,
the lowest among its domestic peers, while capital appreciation potential is the highest at
63%. However, sentiment for the stock could remain poor as the prevailing power shortage
could continue to make it difficult for the company to secure contracts for its newly completed
San Gabriel plant. Aside from the fact that FGEN does not own any distribution utility, its new
power plant is fueled by natural gas, which makes its power cost more expensive compared to
the output of coal-fired plants. It also remains uncertain whether FGEN will succeed in finding
a partner for its regasification project.

Major risk: Unplanned outages

The major risk for the power sector in 2018 comes from unplanned outages of large baseload
plants, given that 50% of the country’s power generation capacity is 16 years or older.
Unplanned outages could result to higher WESM prices and benefit companies with capacities
that are not contracted. However, this will be detrimental to companies that have to purchase
replacement power from the spot market. Among the companies that we cover, FGEN has the
largest capacity that is not contracted, accounting for 18% of its total attributable capacity.
AP should also benefit from any increase in WESM prices resulting from unplanned outages of
large baseload plants given its large hydroelectric plants that make up 10.2% of its attributable
capacity.

COL Financial Group, Inc. 4

 POWER SECTOR OUTLOOK I NEW CAPACITY TO DRIVE POWER COMPANIES’ EARNINGS GROWTH
AMIDST OVERSUPPLY CONCERS

TUE 09 JAN 2018

IMPORTANT RATING DEFINITIONS

BUY
Stocks that have a BUY rating have attractive fundamentals and valuations based on our analysis. We expect the share price to outperform the market in the next six to
12 months.

HOLD
Stocks that have a HOLD rating have either 1) attractive fundamentals but expensive valuations 2) attractive valuations but near-term earnings outlook might be poor
or vulnerable to numerous risks. Given the said factors, the share price of the stock may perform merely in line or underperform in the market in the next six to twelve
months.

SELL
We dislike both the valuations and fundamentals of stocks with a SELL rating. We expect the share price to underperform in the next six to12 months.

IMPORTANT DISCLAIMER
Securities recommended, offered or sold by COL Financial Group, Inc. are subject to investment risks, including the possible loss of the principal amount invested.
Although information has been obtained from and is based upon sources we believe to be reliable, we do not guarantee its accuracy and said information may be
incomplete or condensed. All opinions and estimates constitute the judgment of COL’s Equity Research Department as of the date of the report and are subject to change
without prior notice. This report is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security. COL Financial and/
or its employees not involved in the preparation of this report may have investments in securities of derivatives of the companies mentioned in this report and may trade
them in ways different from those discussed in this report.

COL RESEARCH TEAM

APRIL LYNN TAN, CFA

VP & HEAD OF RESEARCH
april.tan@colfinancial.com

CHARLES WILLIAM ANG, CFA GEORGE CHING RICHARD LAÑEDA, CFA

DEPUTY HEAD OF RESEARCH SENIOR RESEARCH MANAGER SENIOR RESEARCH MANAGER
charles.ang@colfinancial.com george.ching@colfinancial.com richard.laneda@colfinancial.com

FRANCES ROLFA NICOLAS ANDY DELA CRUZ JUSTIN RICHMOND CHENG

RESEARCH ANALYST RESEARCH ANALYST RESEARCH ANALYST
rolfa.nicolas@colfinancial.com andy.delacruz@colfinancial.com justin.cheng@colfinancial.com

KYLE JEMMRIC VELASCO JOHN MARTIN LUCIANO ADRIAN ALEXANDER YU

RESEARCH ANALYST RESEARCH ANALYST RESEARCH ANALYST
kyle.velasco@colfinancial.com john.luciano@colfinancial.com adrian.yu@colfinancial.com

COL FINANCIAL GROUP, INC.

2402-D EAST TOWER, PHILIPPINE STOCK EXCHANGE CENTRE,
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TEL NO. +632 636-5411
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COL Financial Group, Inc. 5