We initiate coverage on Transcorp Power Plc (TPP) with a 12-month Target Price (TP) and projected market capitalisation of N323.64 and N2.4 trillion, respectively. Our TP implies a price return of 22.6% and a BUY recommendation on the stock. Our outlook on the stock is premised on projected improvements in return metrics and is consistent with the following:
- The company currently accounts for 7.0% of Nigeria's installed grid capacity but generates 10.0% of the country’s power needs, with its leadership position in the West African Power Pool (WAPP) and planned strategic alliances with DISCOs, eligible customers, and state governments leaving legroom for output growth in the near term.
- The material export component of revenue is likely to continue providing some important hedge against the negative impact of Naira devaluation on costs linked to energy and equipment maintenance.
- The company's average dividend payout ratio of c.75.0% over the last five years is materially higher than the mean of 48.0% for EMEA peers ex GEREGU over the same period. Our expectations for operating cash flow and dividend paid CAGRs of 17.4% and 26.1%, respectively, between FY'24 and FY'28, are likely to keep investors mostly interested in the stock in the near to medium term.
- Our projection for a relatively low mean financial leverage of 328.6% over our forecast horizon (vs 487.3% in the last five years) and robust cash position make the ticker suitable for investors looking to outperform in a macroeconomic environment characterised by hawkish monetary policy and rising interest rates.
- The government's plan to clear legacy debt owed to power sector players bodes well for receivables management and the overall cash flow position of the company.
- The company's involvement in the black starting of the entire grid upon collapses may have conferred a level of systemic importance that may be critical to its outlook.
Valuation: We deployed a discounted cash flow (DCF) methodology to arrive at our TP. The DCF methodology resulted in a 12-month equity value of N2.4 trillion for TPP and a TP of N323.64/share. The assumptions underlying our DCF include a beta of 0.62 (using beta conversion with GEREGU as the listed peer), a terminal growth of 5.0%, a cost of equity of 24.2%, and an effective interest rate on debt of 11.5%.
Risks to expectations: In this report, we have identified the following broad categories of risks, namely: 1) risk of Naira devaluation, 2) risk of competition, 3) risk of unfavourable changes in interest rates, and 4) risk of higher trade receivables balances.
