KEP

Business Context and Reporting Period

Company: Korea Electric Power Corporation (KEPCO)
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2005
Business Overview: KEPCO is the sole integrated electric utility in the Republic of Korea, responsible for the transmission and distribution of electricity and, through six wholly-owned generation subsidiaries, the generation of substantially all electricity in the country. The company operates under a government-mandated restructuring plan that introduced a competitive bidding pool system for power generation while maintaining KEPCO's monopoly on transmission and distribution.

Key Financial Metrics (Year Ended Dec 31, 2005)

Note: Financial statements are prepared under Korean GAAP. Significant reconciling items to U.S. GAAP include asset revaluation, treatment of decommissioning costs, and regulatory accounting.

Material Changes vs. Prior Period (2004)

• Revenue Growth: Operating revenues increased 6.1% to Won 25,445 billion, driven primarily by a 6.5% increase in kilowatt-hours sold. Growth was led by the commercial sector (+9.2%), industrial sector (+5.2%), and residential sector (+5.1%).
• Profitability Decline: Net income decreased 16.5% to Won 2,408 billion. Operating income fell 12.2% to Won 3,922 billion.
• Cost Pressures: Operating expenses rose 10.4%, primarily due to a 14.7% increase in fuel costs (Won 7,568 billion) resulting from higher global fuel prices and increased power generation. Selling and administrative expenses increased 17.4% due to higher sales commissions and labor costs.
• Non-Operating Results: Net non-operating results shifted from a gain of Won 232 billion in 2004 to a loss of Won 90 billion in 2005. This was largely due to a 65.7% decrease in gains on foreign currency transactions and translation, offset partially by a 12.9% decrease in interest expense.
• Balance Sheet: Total assets increased slightly, while the net working capital deficit improved significantly from Won 2,291 billion in 2004 to Won 130 billion in 2005.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Fuel Price Impact: Management estimates that continued increases in fuel prices (coal, oil, LNG) have had a material adverse effect on profitability in 2006. The company expects operating income and net income to decrease significantly in 2006 and beyond compared to prior periods due to limited ability to pass costs to customers via regulated rates.
• Capital Investment: Capital expenditures are estimated at approximately Won 9.1 trillion in 2006 and Won 9.7 trillion in 2007 to fund the construction of new generation units and transmission/distribution expansion.
• Restructuring: The plan to privatize distribution subsidiaries was halted in 2004. Instead, the company is forming "strategy business units" to introduce internal competition. The privatization of non-nuclear generation subsidiaries (e.g., KOSEPCO) remains in progress but is subject to market conditions.

Key Risks and Contingencies

• Fuel Price Volatility: Fuel costs constitute approximately 30% of operating revenues. Prices are determined in foreign currencies, exposing the company to exchange rate fluctuations and global commodity price spikes.
• Foreign Exchange Risk: Approximately 29.2% of long-term debt is denominated in foreign currencies (primarily USD and Yen). Depreciation of the Korean Won increases debt service costs and fuel import costs.
• Regulatory and Political Risk: Electricity rates are government-regulated. Delays in rate adjustments to reflect cost increases can materially impact margins. Additionally, tensions with North Korea and potential labor unrest pose operational risks.
• Nuclear Safety: The company operates 20 nuclear units. While safety records are strong, inherent risks of nuclear operations, including potential accidents or community opposition to new construction, remain material.
• Decommissioning Costs: Significant liabilities exist for the decommissioning of nuclear facilities. Estimates are subject to change based on engineering studies and regulatory requirements.

Important Facts for Investor Verification

• GAAP Differences: Verify the reconciliation between Korean GAAP and U.S. GAAP, particularly regarding asset revaluation reserves and the accounting treatment of nuclear decommissioning costs, which significantly impact reported equity and net income.
• Rate Adjustment Lag: Confirm the timeline for government approval of electricity rate increases to offset rising fuel costs, as this is a primary driver of future profitability.
• Debt Maturity Profile: Review the schedule of debt maturities, noting significant principal repayments due in 2006-2008, and the company's ability to refinance foreign currency debt.
• Privatization Progress: Monitor the status of the privatization of generation subsidiaries (specifically KOSEPCO) and the implementation of the "strategy business units" for distribution.
• North Korea Project: Note the termination of the Light Water Reactor project in North Korea (KEDO) in May 2006 and assess any potential residual liabilities or impacts on the company's international portfolio.