Transcorp has reported what we view as a weak set of financials for 2015. Postponed naira devaluation, difficulties in improving power utilisation rates and stagnating hospitality flows are just some of the difficulties the company faces. Nevertheless, we believe 2016 could surprise investors on the upside with robust profitability growth, while the current depressed share price does not reflect the company’s fundamental value even in such difficult times, in our view. Consequently we upgrade our rating to BUY, from Hold, with a new TP, on our revised estimates, of NGN1.9/share (from NGN2.7/share).
Power business – more power needed
In our view, Transcorp is consistently delivering on expectations to increase the installed capacity of its main power asset, with Ughelli Power capacity reaching 634 MW in 2015. However, we believe the government is not following suit – capacity revenue is still linked to power plant utilisation (as opposed to available capacity, as was promised when reforms were announced), while the postponement of naira devaluation caps tariff growth. Nevertheless, we think the January-February 2016 tariff increase of 54% is likely to be the main driver of Transcorp’s results in 2016 – we expect an additional NGN8.5bn of revenue on the back of this move. At the same time, risks remain – gas supply disturbances are still common, while the ability of the regulator to swiftly pass on any future naira devaluation remains in doubt, in our view.
Hospitality business – hard to pass on naira devaluation
Transcorp is well on track with its Hilton Abuja hotel refurbishment, and additional projects in Ikoyi are close to the ground-breaking phase. What concerns us, however, is the inability of Hilton to pass on any naira devaluation in its tariffs. Moreover, taking into account higher competition, we believe the company is facing a deterioration in room rates, with our calculations indicating a c. 9% decline in 2015, in naira terms. This business faces further headwinds in that the Hilton Abuja depends significantly on government orders, competition is getting stronger and expanding the hospitality business requires steady access to financing – which is limited by the general economic situation and substantial debt burdens at Transcorp, given the FX revaluation of its dollar-denominated debt.
Upgrade to BUY
We adjust our model for the reported results, tariff adjustments and our updated outlook for the hospitality business. Despite our more conservative stance in many respects (ongoing depressed utilisation rates, an indefinite postponement of the apartment construction project, etc.), we derive a DCF-based fair value of NGN1.9/share, implying 78% upside potential in the name. We see significant risks (FX, lower occupancy rates, gas supply disruptions) that could limit the company’s long-term growth potential, but view the current share price weakness as unjustified, implying 2016E P/E of 5.2x and EV/EBITDA of 6.4x.