Russian hydro generators
INITIATION
Wade in the water
Russian hydro generators will likely benefit from the ongoing
liberalisation of the Russian electricity and capacity markets more than
thermal generators (OGKs and TGKs), due to having: 1) almost the same
access to market prices, but 2) much lower operating costs.
We initiate on RusHydro, Russia’s largest power generator (and in the
long term, likely the biggest alternative energy producer), and one of the
largest hydro companies globally, with an Outperform rating and target
price of US$0.11, giving potential upside of 42%. RusHydro will likely
continue to consolidate hydro-generating assets in the medium term. We
expect the stock to remain the most liquid utility equity post UES’ breakup
on 1 July and is to become a new sector proxy.
We also initiate coverage of Krasnoyarskaya GES, a stand-alone hydro
power plant which, in our opinion, could be consolidated into RusHydro—
whose fundamentals could benefit in the process—with an Outperform
rating and target price of US$6.7, giving potential upside of 65%.
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Leveraged to liberalisation. Free electricity prices are already offering
better economics to generators, as they allow the generators to pass on
rising fuel costs. The addition of the capacity market would be a further
benefit, as it would allow the funding of investments in new capacity. Hydro
generators, with their low cost base, should see their revenues grow and
margins expand more than those of thermal generators. We forecast
RusHydro’s EBITDA margin to expand from 17% in 2006 to 72% in 2012E
and to have an EPS CAGR of 31% for 2006–12E.
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A potential new blue chip for the Russian market. RusHydro has the
largest installed capacity in Russia (24.1GW), is among the biggest publicly
traded hydro generators globally, and post break-up of UES will have the
largest free float among the Russian utilities.
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RusHydro’s possible future M&A—play through KRSG. We think
RusHydro will emerge as the consolidation centre of hydro generation
assets, as this, in our view, falls in line with the government’s utility strategy.
We highlight Krasnoyarskaya GES as medium-term exposure to that theme.
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Compelling valuations. RusHydro’s valuations are arguably the most
attractive among our covered Russian utilities universe, with a 2009E P/E of
9.7x and an EV/EBITDA multiple of 6.3x. These valuations represent very
significant discounts to other Russian OGKs.
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Long-term risks. We think that medium-term capex inflation could be higher
than current company guidance, due to cost inflation, which in the long term
RusHydro may be made by the government to invest in projects of suboptimal
economic benefit. There is also a degree of lower transparency in
the business—the sales to aluminium producer Rusal. The government has
yet to adopt rules for the capacity market, which we think would be a major
value driver for RusHydro.

Table of contents
RusHydro: The new blue chip 4
Three biggest facts to keep in mind 4
Strong financial outlook—better than for the OGKs 6
Superior earnings growth merits higher valuations 8
Emerging as potential consolidator for hydro assets 9
ESOP: Significant motivational tool 9
Risks 10
Long-term capex unclear 10
Medium-term capex likely to increase 11
Price formula for Rusal unlikely to be disclosed 11
Timing of capacity market launch still unclear 12
Water tax is a sensitive issue for the long term 13
Far East capacity to remain regulated 14
Dilution at UES break-up 15
GDR programme: Not a significant catalyst 15
Dividend policy likely to replicate that of UES 15
Valuation 17
APV DCF is our preferred approach 17
Adding NPV of BEMA project 18
Valuing the company on a fully diluted basis 19
Multiples are attractive 20
Model and main assumptions 21
Installed capacity and capex 21
Load factors 21
Electricity and capacity prices 22
Siberian and Far East price zones 23
Further consolidation is likely 28
Krasnoyarskaya GES: Play on potential M&A 31
Appendices 35
Appendix 1: RusHydro financial forecasts 35
Appendix 2: Krasnoyarskaya GES financial forecasts 36
Appendix 3: RusHydro production assets 37
Appendix 4: RusHydro capex programme 38
Appendix 5: The BEMA project 39
Appendix 6: Russian power market overview 40
Electricity market liberalisation: set in stone 40
Capacity market: as yet only a promise 42