How Much Would You Pay For Nearly All of the Power in South Korea?
Ryan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When it comes to producing power in South Korea, one company absolutely dominates; Korea Electric Power (NYSE: KEP) controls 84.2% of the country's total electricity generation capacity. In many instances, companies with near-monopoly status are worth owning. Is that the case with Korea's No. 1 utility?
The Korean government is trying to increase competition
When competition is lacking among suppliers, customers can end up suffering as a result. Aware of this fact, the Korean government is taking steps to make the electricity industry more competitive.
Under the terms of the country's recently revealed sixth basic plan, the Ministry of Trade, Industry and Energy accepted applications from private power producers for the construction of additional coal-fired power plants.
Increased electricity production capacity could adversely affect the company. However, regardless of whether or not private power producers in Korea start generating more electricity, Korea Electric Power still has a 99% market share in terms of transmission and distribution capacity.
Establishing transmission and distribution capacity necessitates enormous capital expenditures. So even if private power producers end up generating more electricity, in all likelihood they'll just end up selling it to Korea Electric Power.
Capital expenditures are increasing
High capital investment requirements are common throughout the utility industry. Getting a power plant up and running isn't exactly cheap. But Korea Electric Power appears to be making large amounts of capital expenditures relative to large American utilities.
The market is offering to sell this company for $15.9 billion. Meanwhile, its capital expenditures have exceeded $10 billion in each of the past three years. Additionally, the company is projecting average annual capital expenditures of over $17.4 billion over the next three years.
Korea's government has adopted the renewable portfolio standard, or RPS. Under the terms of the RPS, each subsidiary of Korea Electric Power must generate at least 10% of its electricity from renewable sources by 2022. The company has already allocated over $40 billion dollars in order to implement the RPS.
Korea Electric Power's capital expenditures look large relative to those of PG&E (NYSE: PCG). Capital expenditures from that $19.9 billion dollar company averaged $4.3 billion between 2010 and 2012. PG&E expects 2013 capital expenditures of $5.1 billion. The same figure for Korea Electric Power is $17.54 billion.
Or take the Southern Company (NYSE: SO) a business being valued at over twice as much as Korea Electric Power. Projected 2013 capital expenditures for the Southern Company are $5.5 billion, the 2013-2015 average figure is also $5.5 billion.
Why are investors scared?
There are several reasons that Korea Electric Power is not a popular company right now. Foremost among them being the massive losses the company has reported in the last two years. Demand for electricity in Korea has grown at an annual rate of 4.9% over the past five years, yet the company is still losing money.
The company recorded positive operating income in every year since its inception (1981) until 2008. Prices of the fuels the company uses as inputs to generate power have gone up, and financial results have suffered as a result.
After minor losses in 2009 and 2010, the company posted net losses of nearly $3 billion in 2011 and 2012. All the while PG&E and the Southern Company remained solidly in the black.
But the company's results are improving. In the first quarter, its net operating loss was only $15 million. What's more, the government has been raising the rate the company is allowed to charge its customers, most recently in August 2012 and January 2013.
The Korean government has multiple incentives to legislate in ways that benefit the company. Applicable laws in Korea require the government to hold at least 51% of the company's outstanding stock. Additionally, Korea Electric Power provides a supremely important service that cannot possibly be provided by any other Korean company. Without Korea Electric Power the vast majority of Koreans would not have access to electricity.
Looking at the company's balance sheet also might scare away investors. Korea Electric Power has $42.2 billion in long term debt, versus $20.2 billion for Southern and only $11.5 billion for PG&E. But Korea Electric Power, the smallest of these three companies, also has the largest amount of shareholder's equity. As of the company's latest quarterly report, shareholder's equity totaled nearly $45 billion dollars. That's nearly three times the company's current market cap.
Foolish final thoughts
Investors employing more defensive tactics when making decisions prefer utilities for their stability and safety. Recent losses from Korea Electric Power show that the company's results, at times, can be far from stable. Meanwhile, Southern Company and PG&E are delivering the solid, consistent performance that utilities are known for.
However, I think it's possible that negative results from the recent past have resulted in the stock of Korea Electric Power falling farther than it deserved to. The company has a near monopoly position in providing power to one of the world's most advanced countries.
High debt levels are a cause for concern. But buying Korea Electric Power for $15.9 billion would still get you nearly $45 billion in equity, much more than either PG&E or the Southern Company.
Additionally, Korea Electric Power has been investing huge sums in its business, making capital expenditures that absolutely dwarf those of most other utility companies. Korea Electric Power is making investments that ensure it will retain its dominant position for decades to come. Paying around $16 billion for nearly all the power in South Korea sounds like a good deal to me.
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Ryan Palmer has no position in any stocks mentioned. The Motley Fool recommends Southern Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!