The surge in international oil prices is expected to have a significant impact on Korea Electric Power Corporation. With structural limits that make it hard to fully pass energy procurement costs through to retail electricity prices, the likelihood that Korea Electric Power Corporation will swing to a loss in the second half of this year is growing.
As major governments push ahead with building new nuclear power plants, the rally in Korea Electric Power Corporation shares that rode the nuclear theme has also hit a speed bump. Concerns about an immediate deterioration in earnings before any benefits from new nuclear construction materialize appear to be weighing on the stock.
On top of that, Korea Electric Power Corporation's dilemma is deepening as a state-owned company and listed firm that monopolizes domestic power supply and must walk a tightrope between "public interest" and "profitability."
◇ If the oil price surge persists, losses and interest expense will rise in a "vicious cycle"
Recently, some securities firm research centers downgraded their investment views and target prices on Korea Electric Power Corporation. Hana Securities lowered its target price on Korea Electric Power Corporation to 55,000 won from 73,000 won, saying a swing to a loss by year-end is inevitable.
Yoo Jae-seon, an analyst at Hana Securities, said, "Since March, Asia LNG prices have surged, so KEPCO's procurement cost, the system marginal price (SMP), will gradually rise," adding, "Even assuming some stabilization in raw material prices, there is significant room for expectations for Korea Electric Power Corporation's future earnings to be revised down."
Hana Securities projected that the SMP, which averaged 107 won/kWh in the first quarter, will climb to 180 won/kWh in the third quarter. Some have even mentioned introducing an "SMP cap system" to cushion the shock from the spike in oil prices.
Korea Investment & Securities Co. offered a "neutral" investment view on Korea Electric Power Corporation. Jang Nam-hyeon, an analyst at Korea Investment & Securities Co., said, "Rising oil prices will lead to higher expense, which is expected to reduce Korea Electric Power Corporation's profit," adding, "It will be hard to avoid damage to earnings through next year."
Korea Electric Power Corporation's worsening earnings directly translate into heavier financial burdens. The company has more than 200 trillion won in total liabilities, of which borrowing fund alone amounts to 130 trillion won. It spends 4 trillion won a year just to pay interest on this debt with proceeds from electricity sales. If the company swings to a loss due to surging oil prices, it will have to increase borrowing to pay interest. That would deepen a vicious cycle of losses and rising financing costs.
Jang Nam-hyeon said, "Korea Electric Power Corporation's share price currently reflects a mix of concerns stemming from macro uncertainty and expectations of increased nuclear orders," adding, "A decline in net profit from macro uncertainty is inevitable, so it is advisable to delay buying until concerns about deteriorating earnings are fully priced in."
◇ Despite worsening earnings… management has few defensive tools
Korea Electric Power Corporation, which posted record results last year, now faces the risk of swinging to a loss this year, intensifying its dilemma.
As recently as early this year, Korea Electric Power Corporation faced strong calls to increase dividends. Last year, the company posted its highest-ever operating profit, and as net profit—funding source for dividends—neared 9 trillion won, shareholders' demands for higher payouts grew louder.
But after the war in Iran, international energy prices spiked and the mood shifted abruptly. In particular, following the enforcement this year of amendments to the Commercial Act that expanded directors' duty of loyalty from the "company" to "shareholders," KEPCO's quandary has deepened.
Loyalty to shareholders ultimately means higher share prices through improved profitability and greater shareholder returns. When energy prices rise, the decision KEPCO can make to defend against deteriorating profitability is to raise electricity rates. As of the end of last year, KEPCO had more than 640,000 retail shareholders.
The problem is that, when earnings are expected to worsen, it is not easy to make decisions that can defend against it. At a time of inflation concerns, it is virtually impossible for KEPCO, a state-owned monopoly supplier of electricity, to unilaterally decide to raise electricity rates.
However, if the United States and Iran succeed in negotiations and traffic through the Strait of Hormuz returns to normal this month, some say KEPCO could turn a profit this year without raising electricity rates. NH Investment & Securities projected that KEPCO will post a surplus of 13 trillion won this year, saying, "As the U.S.-Iran war strengthens the global trend of expanding nuclear investment, KEPCO is expected to benefit."