CFA INVESTMENT RESEARCH CHALLENGE FEBRUARY 1, … Files/CFA Institute Research Challenge...CFA...

TEAM ECEZ GROUP

1INVESTMENT RECOMMENDATION TO DECEMBER 21, 2010 1

CFA INVESTMENT RESEARCH CHALLENGE

FEBRUARY 1, 2011

PRAGUE

TEAM EVALUATION ASSUMPTIONS

22

VALUATION

Company profile

Industry profile

Financial analysis

Planned statements

Free cash flow

prediction

Beta, cost of capital

ASSIGNMENT

• Risk averse investor

• Three years perspective

• Valuation to 21.12.2010

• Investment recommendation

TARGET PRICE 807 CZK

• Valuation based on 2 phases DCF equity method

• Value drivers

• Investment risks

• Actual issues

RECOMMENDATION HOLD

ASSUMPTIONS CEZ GROUPPEER GROUP

COMPARISONFINANCIAL ANALYSIS

VALUATIONINVESTMENT

RISKSRECOMMENDATION 2

TEAM ECEZ AS INTERNATIONAL UTILITY

3

Source: Company data, Team E research

MAJOR ELECTRICITY PRODUCER IN THE CZECH REPUBIC

74% of market 70% MoF 32.707 emp

ONE OF TEN BIGGEST EUROPEAN POWER UTILITIES

65,3 TWh 17 countries 60 plants

PRODUCTION BASED ON LIGNITE AND NUCLEAR POWER

45% lignite 42% nuclear 13% other

44% OF REVENUES IN POWER PRODUCTION

39% distribution 4% mining 14% other

3ASSUMPTIONS CEZ GROUPPEER GROUP


VALUATIONINVESTMENT


0.0

10.0

20.0

30.0

40.0

50.0 EBITDA margin

Industry average 25,5

TEAM ECOMPANY COMPARISON

4

Source: Team E estimates, Reuters

4

0.0

5.0

10.0

15.0

20.0 P/E

9,7x

Industry average 12,1x

0

2

4

6

8

10

12

14

Dividend yield

6,48%

02468

101214

EV/EBITDA

Industry average 7,6x

6x

43

Industry average 5,6%



VALUATIONINVESTMENT


Data to 21/12/2010

TEAM EFINANCIAL ANALYSIS

55

Source: Company data, Team E estimates



VALUATIONINVESTMENT


0%

50%

100%

150%

200%

250%EBIT/Assets

Revenues/Assets

Revenues/Current Assets

Equity/Assets

ROE

ROA

ROS

ROC

ROCE

EBITDA margin

2005

2006


66




VALUATIONINVESTMENT


0%

50%

100%

150%

200%

250%EBIT/Assets

Revenues/Assets


Equity/Assets

ROE

ROA

ROS

ROC

ROCE

EBITDA margin

2005

2006


77




VALUATIONINVESTMENT


0%

50%

100%

150%

200%

250%EBIT/Assets

Revenues/Assets


Equity/Assets

ROE

ROA

ROS

ROC

ROCE

EBITDA margin

2005

2007


88




VALUATIONINVESTMENT


0%

50%

100%

150%

200%

250%EBIT/Assets

Revenues/Assets


Equity/Assets

ROE

ROA

ROS

ROC

ROCE

EBITDA margin

2005

2008


99




VALUATIONINVESTMENT


0%

50%

100%

150%

200%

250%EBIT/Assets

Revenues/Assets


Equity/Assets

ROE

ROA

ROS

ROC

ROCE

EBITDA margin

2005

2009


1010




VALUATIONINVESTMENT


0%

50%

100%

150%

200%

250%EBIT/Assets

Revenues/Assets


Equity/Assets

ROE

ROA

ROS

ROC

ROCE

EBITDA margin

2005

2010


1111

Source: Reuters, Bloomberg, Company data, Team E estimates

0

5

10

15

20

25

30

35

2005 2006 2007 2008 2009 2010*

ROEEnel

CEZ

EDF

RWE

Iberdrola

E.ON

0

2

4

6

8

10

12 ROA 2010*



VALUATIONINVESTMENT


75%

80%

85%

90%

95%

100%EBIT/Assets

Revenues/Assets


Equity/Assets

ROE

ROA

ROS

ROC

ROCE

EBITDA margin

2009

2010

TEAM E

1212

TEAM EVALUATION BASE

20,000

25,000

30,000

35,000

40,000

Estimated free cash flows to equity (mil. CZK)


-10.00%

-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

2,010 2,011 2,012 2,013 2,014 2,015 2,016 2,017 2,018 2,019 2,020

Relative changes of chosen value drivers

Y.oY.change of EBITDA margin Y.oY.change of sales Y.oY.change of dividends Y.oY.change of Price Y.oY.change of EAT



VALUATIONINVESTMENT


TEAM E

1313

TEAM EVALUATION

Ratio between phases of DCF equity

34%

66%

1. PHASE

2. PHASE


Phase 1 : 2011 - 2017 Phase 2 : 2018 - ∞

Levered β 0,99 0,99

Rm 6,29% 6,99%

Rf 3,64% 4,00%

Re 6,26% 8,50%

g 1,49%

Values in mil. CZK

Value of phase 1 148 795

Continuing value (perpetuity) 436 668

Value of phase 2 285 405

TOTAL VALUE 434 201

Number of issued shares (pieces)

537 989 759

VALUE OF SHARE (in CZK) 807,080

Enterprise value 532 200

Indebtness 32,61%



VALUATIONINVESTMENT


Ratio between phases of DCF equity

max, 942

min, 741.5

700

750

800

850

900

950

Target price, 807

Market price, 772

Share price as for 21/12/2010 (in CZK per diluted share)

In 52 weeks

TEAM E

14

Volatility of exchange rate

Possible drop in rating

• Possible price increase of debt

Unstable political situation

• In the Czech Republic and in other countries

Low power prices

• Contra high fixed costs

14

TEAM EINVESTMENT RISKS



VALUATIONINVESTMENT


TEAM EPOWER PRICES

1515

30

50

70

90

1/1/2005 1/1/2006 1/1/2007 1/1/2008 1/1/2009 1/1/2010

Historical power prices (EUR)

52 52 51 5254

56 5759

6163

65

40

45

50

55

60

65

70

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

PXE

EEX

ČEZ

Estimated power prices (EUR)

Source: EEX, PXE, Team E estimates



VALUATIONINVESTMENT


TEAM EACTUAL ISSUES

16

Development of subsidiary, taxed and bought emission allowances (mil. CZK)

12 13 14 15 16 17 18 19 20

16

4569.6 4636.8 40046344.8

945011970

1396515960

1795519950Emission allowances - gift tax

Emission allowances - buy

Estimated prices of emission allowances (EUR)

0

10

20

30

40

50

60

70 Dividend per share (CZK)

Source: Team E estimates



VALUATIONINVESTMENT


TEAM ESENSITIVITY ANALYSIS

1717

-4,811

8,889

-766

4,290

Return on capital

Influence of 1% change ofthe factor to the value of

Equity (mil. CZK)

Dividends Emmision allowancesSales Return on capital

-100,000

-80,000

-60,000

-40,000

-20,000

0

20,000

40,000

60,000

80,000

100,000

-9% -5% -2% 0% 2% 5% 9%

Sensitivity of value to the factor (mil. CZK)

Return on capital Sales

Emmision Allowances Dividends




VALUATIONINVESTMENT


TEAM E

1818

TEAM ESUMMARY

TICKER NYSE

EURONEXT: CEZ

HOLD

TARGET PRICE:807 CZK

Good stable company with Czech political support

Majority of indexes around industry average or higher

Reasonable financial analysis indicators

Stable production of free cash flow

UNDERVALUED

Necessity of cutting down costs

Uncertainty about allowances

Existing drop in dividends

Investment risks



VALUATIONINVESTMENT


TEAM E

1919

TEAM ESUMMARY



VALUATIONINVESTMENT


550

650

750

850

950

1050

1/7/2010 20/8/2010 9/10/2010 28/11/2010 17/1/2011

CZK

Date

Target price 807 CZK / Share to 21 December 2010TICKER NYSE

EURONEXT: CEZ

HOLD



TEAM E

2020

TEAM ESUMMARY



VALUATIONINVESTMENT


TICKER NYSE

EURONEXT: CEZ

HOLD


Extreme

Extremely pesimistic

Very pesimistic

Pesimistic

Neutral

Optimistic

Very optimistic

Extremely optimistic

Extreme

0 20 40 60 80 100 120

209.56

239.44

299.19

508.32

807.08

1404.6

1822.6

1942.37

2002.12


TEAM E

TICKER NYSE EURONEXT: CEZ

HOLD

TARGET PRICE: 807 CZK

21

TEAM ERECOMMENDATION TO DECEMBER 21, 2010



VALUATIONINVESTMENT


TEAM E

APPENDIX

22

Source: Team E estimates, Company data

TEAM EAPPENDIX - HIGHLIGHTS

23

0

200

400

600

800

1000

1200

1400

1600

I/20

07

III/20

07

V/2

00

7

VII/2

00

7

IX/2

00

7

XI/2

00

7

I/20

08

III/20

08

V/2

00

8

VII/2

00

8

IX/2

00

8

XI/2

00

8

I/20

09

III/20

09

V/2

00

9

VII/2

00

9

IX/2

00

9

XI/2

00

9

I/20

10

III/20

10

V/2

01

0

VII/2

01

0

IX/2

01

0

XI/2

01

0

CEZ stock price (CZK)

Market profile

52 Week Price Range 950,00 – 736,00

Average Daily Volume 490 953,30

Beta 0,99

Dividend Yield (Estimated) 6,48%

Shares Outstanding 537 989 759

Market Capitalization 415 059

Institutional Holdings 79,86 %

Insider Holdings 0,84%

Book Value per Share 1 018,94CZK

Debt to Total Equity 35%

Return on Equity 21%

Source: Team E estimates, Company data, Eurostoxx50

TEAM EAPPENDIX – INVESTMENT SUMMARY

24

5,000

55,000

105,000

155,000

2,010 2,011 2,012 2,013 2,014 2,015 2,016 2,017 2,018 2,019 2,020

FCFE and EBITDA (mil CZK)

FCFE EBITDA

0

200

400

600

800

1000

1200

1400

1600

0

1000

2000

3000

4000

5000

I/20

07

III/20

07

V/2

00

7

VII/2

00

7

IX/2

00

7

XI/2

00

7

I/20

08

III/20

08

V/2

00

8

VII/2

00

8

IX/2

00

8

XI/2

00

8

I/20

09

III/20

09

V/2

00

9

VII/2

00

9

IX/2

00

9

XI/2

00

9

I/20

10

III/20

10

V/2

01

0

VII/2

01

0

IX/2

01

0

XI/2

01

0

CEZ

(CZK

)

EU5

0 (

EUR

)

EU50 : CEZ

EU50

CEZ


TEAM EAPPENDIX – STATEMENT OF CASH FLOW

25

2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E

EAT 47 163 44 259 42 877 45 790 49 149 50 320 52 861 55 655 58 669

Amortization 22 634 22 860 23 089 23 320 23 553 23 788 23 500 23 500 23 500

CASH GENERATED FROM OPERATIONS

69 797 67 119 65 966 69 109 72 702 74 109 76 361 79 155 82 169

CAPEX 67 751 59 610 61 468 45 723 47 706 33 380 35 000 35 000 50 000

∆ Current assets 6 168 774 -456 5 744 8 960 6 319 6 193 6 297 6 564

∆ Current liabilities 7 011 880 -518 6 529 10 185 7 183 7 039 7 158 7 462

∆ Working capital -843 -105 62 -785 -1 225 -863 -847 -860 -897

Financial investments 8 078 3 035 2 300 426 0 0 0 0 0

CASH USED IN INVESTING ACTIVITIES

74 986 62 539 63 830 45 363 46 481 32 516 34 153 34 139 49 103

Dividends 28 520 25 940 24 342 23 583 25 184 27 032 27 676 29 073 30 610

Part payment of debts 5 797 5 797 5 797 5 797 5 797 5 797 5 797 5 797 5 797

CASH USED IN FINANCING ACTIVITIES

34 317 31 736,51 30 139 29 379 30 981 32 829 33 473 34 870 36 407

DIFFERENCE OF CASH FLOW -39 506 -27 156 -28 003 -5 633 -4 760 8 763 8 734 10145 -3 341

Net debts 39 506 27 157 28 003 5 634 4 760 -8 763 -8 734 -10 146 3 341

Condition of debts 190 519 211 879 234 086 233 922 232 886 218 325 203 794 187 851 185 395

Statement of Cash Flows (in millions CZK)


TEAM EAPPENDIX – BALANCE SHEET (ASSETS)

26

Balance Sheet (in millions CZK)

2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E

ASSETS 530 259 584 179 621 702 659 626 687 773 720 886 736 796 754 489 772 286 805 351

NON-CURRENT ASSETS 414 955 462 707 499 457 537 836 560 239 584 392 593 984 605 484 616 984 643 484

Plant in service 509 618 577 369 636 979 698 447 744 170 791 876 825 256 860 256 895 256 945 256

Less accumulated provision for depreciation 266 377 -289 011 -311 871 -334 960 -358 280 -381 833 -405 621 -429 121 -452 621 -476 121

Net plant in service 243 241 288 358 325 108 363 487 385 890 410 043 419 635 431 135 442 635 469 135

Nuclear fuel, at amortized cost 5 439 6 000 6 000 6 000 6 000 6 000 6 000 6 000 6 000 6 000

Construction work in progress 80 125 80 125 80 125 80 125 80 125 80 125 80 125 80 125 80 125 80 125

Investment in associates and jointventures 17 250 17 400 17 400 17 400 17 400 17 400 17 400 17 400 17 400 17 400

Investments and other financial assets 49 423 50 000 50 000 50 000 50 000 50 000 50 000 50 000 50 000 50 000

Intangible assets, net 18 653 20 000 20 000 20 000 20 000 20 000 20 000 20 000 20 000 20 000

Deferred tax assets 824 824 824 824 824 824 824 824 824 824

CURRENT ASSETS 115 304 121 472 122 246 121 790 127 534 136 494 142 812 149 005 155 302 161 867

Cash and cash equivalents 26 727 38 537 43 258 42 333 47 884 56 429 61 815 67 083 72 449 78 063

Receivables, net 47 347 41000 37000 37500 38000 38500 39000 39500 40000 40500

Materials and supplies, net 4 959 5 224 5 258 5 238 5 485 5 870 6 142 6 408 6 679 6 962

Fossil fuel stocks 2 944 3 101 3 121 3 110 3 256 3 485 3 646 3 804 3 965 4 133

Emission rights 1 212 1 400 1 400 1 400 700 0 0 0 0 0

Other financial assets 29 706 29800 29800 29800 29800 29800 29800 29800 29800 29800

Other current assets 2 409 2 409 2 409 2 409 2 409 2 409 2 409 2 409 2 409 2 409


TEAM EAPPENDIX – BALANCE SHEET (LIABILITIES)

27

Balance Sheet (in millions CZK)

2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E

EQUITY AND LIABILITIES 530 259 584 179 621 702 659 626 687 773 720 886 736 796 754 489 772 286 805 351

TOTAL EQUITY 206 675 219 861 235 146 251 381 273 162 297 127 320 415 345 599 372 181 400 240

Equity attributable to equity holders of the parent 200 361 214 361 229 646 245 881 267 662 291 627 314 915 340 099 366 681 394 740

Stated capital 53 799 53 799 53 799 53 799 53 799 53 799 53 799 53 799 53 799 53 799

Treasury shares -5 151 -4 600 -4 600 -4 600 -4 600 -4 600 -4 600 -4 600 -4 600 -4 600

Retained earnings and other reserves 151 713 165 162 180 447 196 682 218 463 242 428 265 716 290 900 317 482 345 541

Non controlling interests 6 314 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500 5 500

TOTAL LIABILITIES 323 584 364 317 386 557 408 245 414 611 423 759 416 382 408 890 400 105 405 111

LONG-TERM LIABILITIES 177 181 211 238 232 598 254 805 254 641 253 605 239 044 224 513 208 570 206 114

Long-term debt, net of current portion 118 921 152 630 173 990 196 197 196 033 194 997 180 436 165 905 149 962 147 506

Accumulated provision for nucleardecommissioning and fuel storage

37 152 37 500 37 500 37 500 37 500 37 500 37 500 37 500 37 500 37 500

Other long-term liabilities 21 108 21 108 21 108 21 108 21 108 21 108 21 108 21 108 21 108 21 108

DEFERRED TAX LIABILITY 15 335 15 000 15 000 15 000 15 000 15 000 15 000 15 000 15 000 15 000

CURRENT LIABILITIES 131 068 138 079 138 959 138 441 144 970 155 155 162 337 169 376 176 535 183 997

Short term loans and current portion of long-term debt

37 889 37 889 37 889 37 889 37 889 37 889 37 889 37 889 37 889 37 889

Trade and other payables 78 212 87 670 88 550 88 032 94 561 107 250 116 436 125 077 133 518 142 005

Accurated liabilities 14 967 12 520 12 520 12 520 12 520 10 016 8 013 6 410 5 128 4 103


TEAM EAPPENDIX – INCOME STATEMENT

28

Income statement (in millions CZK)

2 009 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E

REVENUES 196 352 206 855 208 173 207 397 217 179 232 436 243 196 253 742 264 466 275 644

Sales of electricity 173 494 188 050 189 248 188 543 197 453 211 305 221 088 230 674 240 423 250 585

Heat sales and other revenues 22 858 18 805 18 925 18 854 19 744 21 131 22 109 23 067 24 042 25 059

Operating costs 128 153 118 155 116 577 116 142 121 620 130 164 136 190 142 095 148 101 154 361

Gift tax 4 570 4 637

Allowances 4 004 6 345 9 450 11 970 13 965 15 960

OPERATING COSTS AFTER ALLOWANCES128153

118 155 121 146 120 779 125 624 136 509 145 640 154 065 162 066 170 321

Amortization 22 876 22 634 22 860 23 089 23 320 23 553 23 788 23 500 23 500 23 500

EBITDA 97 075 88 700 87 026 86 618 91 555 95 927 97 556 99 676 102 400 105 323

EBIT 68 199 66 066 64 166 63 529 68 235 72 374 73 768 76 176 78 900 81 823

Interests 3 303 7 841 9 526 10 594 11 704 11 696 11 644 10 916 10 190 9 393

EBT 64 946 58 226 54 640 52 935 56 531 60 678 62 124 65 260 68 710 72 431

Income tax 13 091 11 063 10 382 10 058 10 741 11 529 11 803 12 399 13 055 13 762

EAT 51 855 47 163 44 259 42 877 45 790 49 149 50 320 52 861 55 655 58 669

Dividends 26 899 28 520 25 940 24 342 23 583 25 184 27 032 27 676 29 073 30 610

EAR 24 956 18 642 18 319 18 535 22 207 23 965 23 288 25 185 26 582 28 059


TEAM EAPPENDIX – FREE CASH FLOW

29

FCFF 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E

EAT 47 163 44 259 42 877 45 790 49 149 50 320 52 861 55 655 58 669

ODPISY 22 634 22 860 23 089 23 320 23 553 23 788 23 500 23 500 23 500

změna ČPK -843 -106 62 -785 -1 225 -864 -847 -861 -897

INV 67 751 59 610 61 468 45 723 47 706 33 380 35 000 35 000 50 000

úroky 7 841 9 526 10 594 11 704 11 696 11 644 10 916 10 190 9 393

úroky(1-t) 6 351 7 716 8 581 9 480 9 474 9 432 8 842 8 254 7 608

FCFF 9 240 15 331 13 017 33 652 35 695 51 024 51 049 53 270 40 674

FCFE 2 010 2 011 2 012 2 013 2 014 2 015 2 016 2 017 2 018

EAT 47 163 44 259 42 877 45 790 49 149 50 320 52 861 55 655 58 669

Odpisy 22 634 22 860 23 089 23 320 23 553 23 788 23 500 23 500 23 500

ČPK -843 -106 62 -785 -1 225 -864 -847 -861 -897

INV 67 751 59 610 61 468 45 723 47 706 33 380 35 000 35 000 50 000

Saldo U 33 709 21 360 22 206 -163 -1 037 -14 560 -14 531 -15 943 -2 456

FCFE 36 598 28 975 26 642 24 009 25 184 27 032 27 676 29 073 30 610

Free cashflow (in millions CZK)


TEAM EAPPENDIX – VALUATION

30

DCF method2 010 2 011 2 012 2 013 2 014 2 015 2 016 2 017 2 018

Free cash flow to the equity 36 598 28 975 26 642 24 009 25 184 27 032 27 676 29 073 30 610

Discounted free cash flow 27266,7 23594,0 20008,4 19751,2 19950,7 19222,1 19002,3

Values in CZK Phase 1 : 2011 - 2017 Phase 2 : 2018 and more

Value od phase 1 148 795 Levered β 0,99 Levered β 0,99

Continuing value (perpetuity) 436 668 Re 6,26% Re 8,50%

Value od phase 2 285 405 Rm 6,29% Rm 6,99%

Total value 434 201 Rf 3,64% Rf 4,00%

Number of issued shares 537989759 CZ/A 32,61% CZ/A 23,02%

Value of share 807,080 E/A 37,64% E/A 49,70%

Counted growth in the second phase was 1,49%

based on planned growth of sales

Source: ČEPS

TEAM EAPPENDIX

31

STATE TRANSMISSION SYSTEM PLAN FACT

Germany 50 Hertz Trans. -3720 GWh -1400 GWh

TenneT -4077 GWh -6321 GWh

Poland PSE Operator -726 GWh 5849 GWh

Slovakia SEPS -5229 GWh -5825 GWh

Austria APG -1997 GWh -6599GWh

Czech Republic ČEPS -14297 GWh -14296GWh

Cross-border power flows (2009)

DE - 51,14€/MWh

SK – 49,15€/MWh

HU - 51,05€/MWh

PL – 50,25€/MWh

Source: Comapny data, Team E estimates

TEAM EAPPENDIX

32

0%

20%

40%

60%

80%

100%EAT/Equity

EBIT/Assets

Revenues/Assets


Equity/Assets

ROE

ROA

ROS

ROC

EBITDA margin

2009 2010

0%

10%

20%

30%

40%

50%

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

Rentability

ROC

ROS

ROE

ROA

0%

20%

40%

60%

80%

100%

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

Financial stabilityTotal Indebtedness

Debt on Equity

Financial Independence

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