Georgia Capital Regulatory News (CGEO)

Georgia Capital PLC

2nd half and full year 2018 preliminary results

Name of authorised official of issuer responsible for making notification:

Nino Rekhviashvili, Head of Investor Relations and Funding

www.georgiacapital.ge

For an user-friendly copy of this announcement, please click on the link below to open a PDF version:

http://www.rns-pdf.londonstockexchange.com/rns/6779Q_1-2019-2-21.pdf

About Georgia Capital PLC

Georgia Capital PLC ("Georgia Capital" or "the Group" - LSE: CGEO LN) is a UK listed holding company of a diversified group of companies focused on investing in businesses in Georgia with holdings in industries that are expected to benefit from the continued strong growth and diversification of the Georgian economy. The Group seeks to create value by driving the development of high growth potential businesses in Georgia, aiming to consolidate fragmented or underdeveloped markets. We either acquire our businesses during their early development stage or establish them on a greenfield basis.

Georgia Capital currently has six private company holdings: (i) a water utility business, owned through GGU, (ii) a renewable energy business, owned through GGU; (iii) a housing development business, owned through m2 (iv) a hospitality and commercial real estate business, owned through m2; (v) a property and casualty insurance business, owned through Aldagi and (vi) a beverages business, owned through Georgia Beverages, and two public company holdings (London Stock Exchange premium-listed Georgian companies): (i) Georgia Healthcare Group PLC ("GHG"), (57% equity stake), a UK incorporated holding company of the largest healthcare services provider in Georgia, which is also the largest pharmaceuticals retailer and wholesaler in the country; and (ii) Bank of Georgia Group PLC ("BoG"), (19.9% equity stake), a leading universal bank in Georgia.

Georgia Capital aims to deliver total shareholder returns of 10-times over 10-years[1]

10x = 10y

FORWARD LOOKING STATEMENTS

This announcement contains forward-looking statements, including, but not limited to, statements concerning expectations, projections, objectives, targets, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions, competitive strengths and weaknesses, plans or goals relating to financial position and future operations and development. Although Georgia Capital PLC believes that the expectations and opinions reflected in such forward-looking statements are reasonable, no assurance can be given that such expectations and opinions will prove to have been correct. By their nature, these forward-looking statements are subject to a number of known and unknown risks, uncertainties and contingencies, and actual results and events could differ materially from those currently being anticipated as reflected in such statements. Important factors that could cause actual results to differ materially from those expressed or implied in forward-looking statements, certain of which are beyond our control, include, among other things: currency fluctuations, including depreciation of the Georgian Lari, and macroeconomic risk; regional tensions and instability; regulatory risk across a wide range of industries; investment strategy risk; investment risk and liquidity risk and other key factors that indicated could adversely affect our business and financial performance, which are contained elsewhere in this document and in our past and future filings and reports and also the 'Principal Risks and Uncertainties' included in Georgia Capital PLC's 1H18 results announcement and in BGEO Group PLC's Annual Report and Accounts 2017. No part of this document constitutes, or shall be taken to constitute, an invitation or inducement to invest in Georgia Capital PLC or any other entity, and must not be relied upon in any way in connection with any investment decision. Georgia Capital PLC and other entities undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except to the extent legally required. Nothing in this document should be construed as a profit forecast.

Content

Georgia Capital PLC announces the Group's second half 2018 and full year 2018 financial results. Throughout this document, "Georgia Capital" and the "Group" refer to Georgia Capital PLC and its portfolio companies as a whole, while "GCAP" refers to the aggregation of stand-alone Georgia Capital PLC and stand-alone JSC Georgia Capital accounts[2]. This announcement contains financial results presented on two different bases: under International Financial Reporting Standards ("IFRS") as adopted by the European Union and under an adjusted IFRS methodology[3]. The financial results are unaudited and derived from management accounts.

The information in this Announcement in respect of full year 2018 preliminary results, which was approved by the Board of Directors on 20 February 2019, does not constitute the Group's full financial statements. The financial statements for the year ended 31 December 2018 will be included in the Annual Report and Accounts to be published in April 2019 and filed with the Registrar of Companies in due course.

An investor/analyst conference call, organised by the Group, will be held on 21 February 2019, at 15:00 UK / 16:00 CET / 10:00 U.S Eastern Time. The duration of the call will be 60 minutes and will consist of a 15-minute update and a 45-minute Q&A session.

FINANCIAL HIGHLIGHTS

Double-digit revenue growth coupled with strong operating cash flow generation

GEORGIA CAPITAL HIGHLIGHTS (MANAGEMENT ACCOUNTS[4]) (GEL'000)

PERFORMANCE HIGHLIGHTS (IFRS) (GEL'000)

KEY POINTS

§ Fair value NAV at GEL 1.7 billion vs book value NAV of GEL 1.5 billion, an uplift of 14%[7]

§ Total portfolio value up 1.8% to GEL 1.9 billion and NAV per share up 0.9% to GEL 47.1 on the back of the contribution of the Bank of Georgia shares as part of the demerger (GEL 457 million addition)

§ Absent the Bank of Georgia addition, NAV was down as emerging and frontier markets experienced valuation pressure

§ GEL 188 million attributable income from portfolio companies for FY18

§ GCAP stand-alone cash inflow of GEL 100 million in 2018 driven by GEL 72 million dividends received

§ GEL 605 million dry powder available for deployment subject to 360⁰ opportunity analysis

§ GEL 25.8 million value created in Hospitality & Commercial from hotel revaluation

§ Housing Development paid first-ever dividends of GEL 10 million 

§ BoG declared an annual dividend for 2018 of GEL 2.55 per share subject to AGM approval, representing a 30% payout ratio and a 4.5% increase over 2017 dividend per share

RETURN ON INVESTMENTS AT A GLANCE

We use the Management Account figures to calculate different returns on our portfolio companies. Internal Rate of Return (IRR) and Return on Investment (ROI) are metrics that help us evaluate the historical track record[8] of each listed and private portfolio company, respectively.[9]

IRR for listed portfolio companies is calculated based on a) historical contributions to the listed portfolio company, b) dividends received and c) market value of the portfolio company at 31 December 2018.

ROI for private portfolio companies is an annual return on net investment (gross investments less capital returns) calculated at each investment level. Inputs into the ROI calculation are as follows: (i) the numerator is an annual attributable income of the private portfolio company less allocated GCAP interest expense, and (ii) the denominator, is the net investment less allocated gross debt of GCAP.

Listed Portfolio Companies

Total ROI 37.9% 

CHAIRMAN AND CEO'S STATEMENT

2018 was the first year for Georgia Capital as an independent premium listed company on the London Stock Exchange, following the completion of our demerger from BGEO Group PLC on 29 May 2018. During 2018 we remained focused on developing and instutionalising our diverse set of businesses in Georgia, while also building on our 3C foundations by improving access to capital, focusing on cash generation and developing C level talent. As discussed in our last trading update, we are now introducing management estimated fair values of our private portfolio businesses. These fair values, which form an integral part of our FY18 management NAV statement, have been estimated based on the valuation multiples of carefully selected listed peer companies in comparable frontier and emerging market countries.

Portfolio Valuation and Performance

Following the introduction of these fair values for our private portfolio companies, our portfolio value reached GEL 2 billion at 31 December 2018, a 1.8% y-o-y increase. NAV per share increased by 0.9% to GEL 47.1, while NAV stood at GEL 1.7 billion, down 8.3% y-o-y. Given negative stock market conditions during 4Q18, valuations of our listed and unlisted companies were unfavourably affected; however, the underlying business performances were outstanding with double-digit revenue growth and strong operating cash flow generation supporting increased earnings. This leads us to be confident that the intrinsic values of our portfolio companies have increased at a much higher level than their underlying valuations at 31 December 2018.

Turning to the management income statement, I am pleased to see the Group delivered GEL 164 million net income in 2018 reflecting strong performances across our portfolio companies. GCAP net operating income was GEL 49 million, driven by dividend receipts from portfolio companies and interest income from liquid funds and issued loans, part of which was offset by operating expenses. During our first incomplete year of operations, we collected GEL 100 million cash at the stand-alone GCAP level, of which GEL 72 million were dividends from portfolio companies and GEL 28 million were interest receipts.

Our portfolio companies continued to deliver strong results as attributable income from the listed portfolio companies increased to GEL 113 million, while attributable income from the private portfolio companies increased to GEL 75 million. At the same time, consolidated revenues of portfolio companies increased by 13.8% to GEL 1.3 billion in 2018. Let me touch on the performance of each portfolio company in more detail:

Georgia Healthcare Group successfully completed its substantial three-year business investment programme during 2018. This resulted in a record full-year EBITDA of GEL 132 million, an increase of 22.3% y-o-y. At the same time, revenues increased by 14% and management increased positive operating cash flow generation by 71% y-o-y. We are delighted with GHG's progress; their focus on generating significant free cash flow over the next few years; and their intention to gradually reduce business leverage and further improve returns on invested capital in the coming years.

Bank of Georgia's 2018 adjusted net income and adjusted ROAE were record-high at GEL 458 million and 26.1%, respectively, in 2018. We like BOG's focus on profitability, while also maintaining strong liquidity, high NPL coverage and improving cost to income ratios. We are also pleased with the Bank's improved capital adequacy ratios and increased dividend per share. In addition, we expect that BOG's strong franchise will allow its new CEO to successfully take advantage of significant growth opportunities in Georgia.

The water utility business, our largest private portfolio business, delivered GEL 83 million EBITDA, up 14.9% y-o-y, in 2018. The double-digit increase was driven by higher revenues from water sales and continued efficiency improvements, which were offset by lower than expected revenues from electricity sales. Record-low water intakes at Zhinvali reservoir resulted in lower electricity generation, which in turn led to a GEL 6 million revenue shortfall against management's expectations. The business management team continues to be well positioned to successfully deliver on their strategy to complete the existing capex programme and extract further efficiencies.

The housing development business continued its successful project execution and apartment sales reached 87% of on-going projects. Gross real estate profit was up 79.7% to GEL 14.9 million, excluding revaluation gains. Strong sales allowed the business to make its first-ever GEL 10 million dividend payment. The business has also recently received an approval from Tbilisi City Hall to develop its largest ever in-house affordable housing project in Digomi, Tbilisi, which will add around 168,000 sq.m. residential area to Housing Development's portfolio. The project will be developed in three stages, where phase I has already added 22,000 sq.m. to the company's inventory in 1Q19, a threefold increase over the 31 December 2018 level. Pre-sales started at the beginning of February 2019 and, to date 6,614 sq.m. has either been sold or reserved, at an average price of US$ 1,025 per sq.m..

The property & casualty insurance business' net underwriting profit increased by 12.8% to GEL 32.2 million in 2018, supported by the introduction of compulsory border third-party liability insurance and implementation of efficient risk management practices. Recurring adjusted ROAE stood at 34.4%, which allowed the business to increase dividend payments by 43% y-o-y to GEL 10 million.

Within our early stage private businesses, the renewable energy business continued the construction of Mestiachala HPPs, which remains within its original budget and is on track to be commissioned in 1H19. We estimate approximately GEL 12-15 million EBITDA from Mestiachala HPPs in 2019. The business is also on track to launch the development of c. 100 MWs of wind power plants and c. 46 MWs of HPPs in 2019.

The hospitality & commercial real estate business is also delivering on its strategy and has targeted 1,000 operational rooms by the end of 2021. The business continued strong project execution and created GEL 27.6 million additional value in 4Q18, of which GEL 25.8 million was from revaluation of hotels and GEL 1.8 million from revaluation of commercial properties. The business also secured US$ 30 million funding for the development of pipeline hotels by tapping the local debt capital market in December 2018.

Finally, the beverages business underwent significant transformation in 2018 whilst achieving 36.8% y-o-y revenue growth. On one hand, the wine business significantly expanded its vineyard base by acquiring 350 hectares through the acquisition of the Kindzmarauli business and developed additional export markets, which resulted in a 31.8% increase in EBITDA to GEL 7.2 million. On the other hand, the beer business was adversely affected by delays in launching Heineken beer brands which contributed to an EBITDA loss of GEL 13.8 million. However, our state-of-the-art brewery successfully passed the latest on-site operational audit from Heineken in January 2019 and we remain on track for the commercial launch of Amstel in April, followed by the Heineken launch by the end of 1H19.

Capital allocation

During 2018 we allocated GEL 85 million of capital across our portfolio companies in order to make progress towards established business goals. We allocated GEL 5 million to our renewable energy business and GEL 32.9 million to the hospitality business for development of pipeline projects, while GEL 40.6 million went to Beverages for bolt-on acquisitions to increase its scale. We also added the Education business to our pipeline by investing GEL 6 million in land for high school development, where we expect to build a portfolio of affordable high schools to capitalise on our scale advantage in what is currently a very fragmented, private high school education market. We target investing GEL 140 million equity capital in Education and aim to reach 30,000 pupils by the end of 2025.

Our capital allocation decisions are aimed at maximising real economic benefits. Given that market price significantly undervalued the Group's economic value during 2018, we invested in the Georgia Capital portfolio through share buybacks. Since the launch of the buyback programme on 14 June 2018, we have bought back 1,251,829 shares and utilised US$ 17.9 million of our US$ 45 million buyback programme.

We manage our capital needs such that we do not depend on potentially premature liquidation of our listed portfolio companies. Our ability to capitalise on the benefits of better capital allocation constitutes a pathway towards improving returns and therefore we constantly look for favourable investment opportunities in Georgia, preferably within capital light service industries. The proceeds from the placement of our inaugural international US$ 300 million 6.125% corporate bonds due 2024 allow us to remain well-funded for our expected capital allocation outlook through 2022 and potential acquisitions at attractive valuations. Based on our capital allocation outlook through the end of 2022, as described on page 19, we currently plan to invest approximately GEL 413 million and expect to receive dividends of GEL 400 million, leading to net capital outflows of GEL 13 million. This investment need will be comfortably funded through the existing liquidity of Georgia Capital, which stood at GEL 605 million at 31 December 2018.

Macroeconomic environment

The Georgian economy continues to perform strongly as real GDP growth was an estimated 4.8% in 2018 on the back of strong external demand driven by double-digit growth in exports, remittances and tourism revenues. Inflation was well-contained at 2.6% in 2018, close to the targeted 3% level, while the Georgian Lari remained resilient to regional turbulence in Turkey and Russia and showed only 3.3% depreciation against the US Dollar in 2018. The current account deficit continued to shrink in 2018 and for the first time in Georgia's history, we had a current account surplus in 3Q18. The fiscal deficit is also expected to decrease to 2.3% of GDP in 2018 from 2.9% in 2017. As upward risks to inflation neutralised, the National Bank of Georgia started a gradual exit from its moderately tightened monetary policy and decreased its refinancing rate by 25 basis points in July 2018 and then again in January 2019 to 6.75%. The National Bank of Georgia also signaled that the refinancing rate will likely return to its neutral level of 5.5% to 6% over the next two years. We expect this trend to lead to lower local currency cost of funding and higher economic activity for our portfolio companies in the medium-term.

Outlook

Economic activity in Georgia continues to grow and our outlook remains positive for 2019. Asset prices have improved since the end of 2018, thereby increasing the value of our listed portfolio companies and NAV per share to GEL 1.1 billion and GEL 51.5 per share (an equivalent of GBP 15.0), respectively, as of the close of business on 20 February 2019. We expect continued strong cash flow generation across our late stage businesses, while within the early state portfolio we are on track to commission our first hydro power plant, open two new hotels in the Gudauri and Svaneti regions, fully launch our brewery and open all periodic vehicle inspection centres. We remain well positioned to take advantage of attractive opportunities with clear discipline, and to create sustainable long-term value for our shareholders.

Irakli Gilauri,

Chairman and CEO

20 February 2019

DISCUSSION OF RESULTS

Management Accounts

Management monitors the Group's performance on a regular basis based on developments in a management account income statement and statement of Net Asset Value (NAV) prepared under the adjusted IFRS methodologies described in the relevant section below. The management accounts are an alternative performance measure ("APM"); they have not been audited or reviewed. A reconciliation of our management accounts to the IFRS statements is provided on pages 36-38.

Net Asset Value (NAV) Statement

Our Management Accounts include a Net Asset Value (NAV) statement which breaks down NAV into its components and follows the changes therein, providing management with a snapshot of the Group's financial position at any given time. NAV statement provides a value of Georgia Capital that management uses as a tool for measuring its investment performance. Georgia Capital management closely monitors NAV in connection with capital allocation decisions. The following methodology underlies the presentation of the NAV for period end dates:

· NAV is calculated at stand-alone GCAP level, which represents the aggregation of the stand-alone assets and liabilities of Georgia Capital PLC and JSC Georgia Capital

· Holdings in listed and private portfolio companies are valued for the purposes of NAV according to the following methodology:

o Listed portfolio companies are carried at the period-end market values based on closing share prices on respective reputable stock exchanges

o Private businesses are carried at fair value based on a valuation technique believed to be most appropriate to that investment as described below

§ NAV per share represents total NAV divided by the number of outstanding shares at the end of the period under IFRS, i.e. issued shares less treasury shares. Treasury shares for these purposes are the sum of shares repurchased under our $45 million buyback programme and shares held by the management trust (unawarded and/or unvested).

In addition to the investment return calculations, described above in this document, we also measure total return of each portfolio investment in numeric terms as follows: we aggregate a) change in beginning and ending fair values, b) gains from realized sales (if any) and c) dividend income during period. We then adjust the net result to remove capital injections (if any) to arrive at the total investment return.

Private portfolio valuation overview

Prior to 31 December 2018, management NAV reflected private businesses at their IFRS book values, however, starting from FY18 results announcement we are disclosing NAV based on management's estimated fair values for the private businesses. While the estimated fair values do not necessarily reflect management's view of their intrinsic values, we believe they provide valuable insights based on how the stock markets value similar businesses. We estimate the fair values of our different private businesses as follows:

· For businesses, where values are typically derived based on valuation multiples in public stock markets, we use different measures depending on the type of business and circumstances. In each case we apply multiples for relevant peers.

o For businesses in non-financial industries, estimated fair values are generally based on Enterprise Value (EV)/EBITDA multiples (in exceptional cases, where EBITDA is negative and if deemed reasonable, an EV/Sales multiple is applied).

o For businesses in the financial sector, estimated fair values are based on price to earnings (P/E) multiples.

The Group identifies peer group for each private portfolio company by taking into account similarities in aspects such as industry, business model, company size, economic and regulatory factors, growth prospects and risk profiles. Peers are selected from frontier and emerging market economies. When estimating the applicable multiple, certain peers can be more heavily weighted when their characteristics are closer to those of the portfolio company being valued than others. We generally focus on recurring last twelve months (LTM) earnings when evaluating the performance of our companies. From the estimated EV, period end net debt is deducted, and the remaining equity value is apportioned to Georgia Capital based on its ownership stake in the company. We use discounted cash flow (DCF) analysis to validate fair values derived by applying listed peer group multiples (in case of Water Utility, EV/EBITDA less maintenance capex multiple is also used for validation).

· For businesses where values are derived primarily from the underlying value of the assets, and such assets are carried at fair value (usually determined by independent international valuation companies) on their books and records, we consider the book value of the equity investment to be its fair value at the reporting date.

· For greenfield businesses, where the business operations have not been fully launched, we also believe that book value is an appropriate estimate of fair value.

· Finally, acquisitions within the previous 12 months are valued at the original investment amount adjusted for earnings or losses recorded following the acquisition.

The table below summarizes fair valuation of our holdings in private portfolio companies excluding pipeline as at 31 December 2018:

NAV STATEMENT

All businesses are supported by strong operating fundamentals, but equity market valuations remain under pressure from stock market conditions in emerging and frontier economies.

NAV per share in GEL terms was up 0.9%, while total NAV decreased by 8.3% to GEL 1.7 billion at 31 December 2018 as a result of the following movements:

I. Listed portfolio companies - The value of holdings in listed portfolio companies increased with the contribution of 19.9% BoG equity stake, valued at GEL 457 million at 31 December 2018, into the Group's equity as part of the demerger from BGEO Group. At the same time, the market value of our 57% equity stake in GHG decreased by 44.3% y-o-y as a result of the weak market conditions.

Despite delivering a very strong operating performance in 2018 (y-o-y full year EBITDA up by 22.3%), GHG's share price retreated from GBP 3.55 at 31 December 2017 to GBP 2.04 at 31 December 2018 resulting in a GEL 413 million reduction in the market value of the Group's holding. We did not sell any GHG shares during 2018 as we believe that the stock price was highly undervalued.

Following the demerger completion, the BoG share price closed at GBP 18.64 on 29 May 2018, its first trading day. The share price retreated in 2H18 and closed at GBP 13.77 on 31 December 2018 even though the bank delivered a strong 26%+ ROAE. As a result, the market value of 19.9% equity stake in BOG decreased by GEL 249 million during 2018. In July 2018, Georgia Capital received GEL 23.9 million dividend payment from BoG and as a result, net market value change after dividends amounted to negative GEL 225 million in 2018.

II. Private portfolio companies - The private portfolio companies continued to perform strongly in 2018, however, valuations were unfavourably affected by negative trends in emerging and frontier markets. Late stage businesses delivered negative 5.7% investment return, despite of the record-high GEL 49 million dividend inflows to GCAP on the back of their strong trading performances.

The early stage portfolio companies continued development to the next levels of their greenfield lifecycles, delivering negative 3.3% return mainly as a result of the underperformance of the beer business, which incurred a GEL 14 million EBITDA loss in 2018 and resulted in GEL 48.4 million mark down in its fair value in 2018. The hospitality and commercial real estate business demonstrated outstanding performance by earning 51.8% investment return driven by GEL 27.6 million revaluation gains from hotels and commercial properties.

The table below summarizes total returns across our listed and private portfolio companies:

a) The 15% increase in Water Utility's EBITDA created approximately GEL 102 million value, however, this was more than offset by multiple contraction from 9.4 to 8.8 (GEL 48 million decrease) and net debt widening of GEL 121 million. As a result, fair value decreased by GEL 67 million in 2018.

b) Housing Development's fair value was down by GEL 8.8 million mainly on the back of net capital distribution of GEL 7.3 million. FY18 net profit was at break-even level, amounting to GEL 0.4 million, due to slow down in sales momentum driven by low levels of inventory.

c) For P&C Insurance the 8.8% increase in net income adjusted for demerger related non-recurring items created a GEL 12 million value, however it was offset by multiple contraction from 8.7 to 7.4 (GEL 23 million decrease), leading to an overall fair value decrease by GEL 11 million.

d) The GEL 9.7 million increase in the fair value for Renewable Energy was mainly driven by GEL 5 million capital allocation from Georgia Capital and by positive impact from exchange rate movements, as the company assets are denominated in US Dollars.

e) Fair value of Hospitality & Commercial increased by GEL 70.9 million on the back of GEL 27.6 million revaluation gains recorded on hotels and commercial properties and GEL 32.9 million capital allocation from Georgia Capital in 2018.

f) Fair value decrease of GEL 11.4 million of Beverages was largely driven by beer business underperformance, where GEL 14 million EBITDA loss in 2018 triggered a mark down of the beverage business value by GEL 48.4 million. The decrease in value was partially offset by the wine business, where the GEL 25.8 million increase in fair value was related to the capital allocations from Georgia Capital for the acquisition of Kindzmarauli.

III. Net debt - The GEL 189.2 million increase in net debt resulted from:

a. Increase of GEL 529.8 million in Gross Debt (debt securities issued and borrowings). Georgia Capital issued US$ 300 million 6.125% six-year Eurobonds due 2024 in March 2018 and raised US$ 291 million (GEL 716 million) net proceeds, of which GEL 270 million was used to repay borrowing from the Group's previous parent company, BGEO Group. The outstanding balance of debt securities issued at 31 December 2018 was GEL 802 million.

b. Loans issued in the amount of GEL 305 million during 2018, primarily relate to three facilities: (i) a GEL 104.6 million (US$ 39.1 million) loan to the hospitality & commercial real estate business for on-going development, construction and growth of the hotel pipeline (ii) a GEL 46.1 million (US$ 17.2 million) to the housing development business to refinance some of the existing borrowings and (iii) a GEL 133.8 million (US$ 50 million) loan issued to the BoG holding company as part of the demerger, maturing in March 2020. The loans are issued at market terms and interest income from loans issued amounted to GEL 24.6 million in 2018, significantly up from GEL 0.2 million in 2017.

c. The increase of GEL 35 million in cash and liquid funds, amounting to GEL 299.7 million at 31 December 2018, is primarily driven by the proceeds from the milestone US$ 300 million 6-year bond issuance. In line with its risk management practices, the Group actively monitors the allocation of its liquid resources and its commitment to maintain at least US$ 50 million liquid funds. At 31 December 2018, cash and liquid funds were allocated as follows:

Internationally listed debt securities include Eurobonds issued by Georgian corporates (GEL 102 million) and sovereign Georgian Eurobonds (GEL 27 million). Locally listed debt securities are local bonds issued by Georgian corporates, which are listed and traded on the Georgian Stock Exchange. Interest income from cash and liquid funds amounted to GEL 15.0 million in 2018, up from GEL 1.2 million in 2017.

d. During 2018 Georgia Capital deployed cash for share buybacks of GEL 87.4 million, of which management trust purchases were GEL 42.6 million and GEL 44.8 million was bought back as part of the US$45 million share buyback programme.

Income Statement (Management accounts)

Management views Georgia Capital's income statement as a two-fold document that reflects performance of the stand-alone GCAP as well as the performance of each portfolio company. The management P&L is an aggregation of the bottom lines of the attributable stand-alone IFRS P&Ls of listed and private portfolio companies together with GCAP's stand-alone P&L. For details on the methodology underling the preparation of management account income statement, please refer to page 52.

INCOME STATEMENT (Management accounts)

Georgia Capital generated Gross operating income of GEL 40.4 million in 2H18 (up 49.5% h-o-h and up by GEL 28.8 million y-o-y) and GEL 67.4 million in 2018 (up by GEL 47.3 million). Gross operating income was up both y-o-y and h-o-h on the back of strong dividend inflows. The housing development business paid the first-ever dividend of GEL 9.8 million to GCAP. The y-o-y increase in gross operating income in 2H18 and in 2018 also reflects the addition of the 19.9% BoG equity stake to the listed portfolio companies, which paid GEL 23.9 million dividend in July 2018. Excluding the positive impact of dividends received from BoG, 2018 dividend income was up by 38.9% y-o-y. Dividend income is accrued based on paid, declared or expected dividend stream from portfolio companies during the calendar year. The following table summarises the dividend income breakdown:

The significant increase in both Interest income and Interest expense in 2H18 and 2018 was driven by the issuance of the inaugural US$ 300 million bonds and investment of related proceeds into investment securities and loans issued. Georgia Capital earned an average yield of 7.7% on the liquid assets and issued loans, of which 9.8% was earned on the loans issued and 5.1% on the liquid funds. The coupon on the $300 million bond is 6.125%.

The components of GCAP's Operating expenses for both 2H18 and in 2018, are presented in the table below:

Following the demerger from the BGEO Group, administrative and management expenses are now fully borne by the Group, while prior to the demerger (before 29 May 2018) only a portion of the expenses were allocated to the Group. As a result, operating expenses are not directly comparable h-o-h and y-o-y. GCAP operating expenses have a targeted cap of 2% of Georgia Capital's market capitalisation. 2018 operating expenses were only 1.4% of market capitalisation at 31 December 2018 given the start-up year effect.

Total portfolio company attributable income increased from GEL 39.8 million in 2H17 to 76.8 million in 1H18 and to GEL 111.1 million in 2H18, while it doubled y-o-y from GEL 93.9 million to GEL 187.9 million in 2018. However, 2017 and 2018 are not directly comparable since BoG's attributable income is not reflected in 2017, while it added GEL 47.0 million in 2H18 and GEL 91.2 million in 2018. Excluding BoG attributable profit, portfolio company attributable income was up 60.8% y-o-y in 2H18. The 60.8% (GEL 24 million) y-o-y increase in 2H18 in total portfolio company attributable income excluding BoG was mainly driven by GEL 27.6 million revaluation gains from the hospitality & commercial real estate business, which were partly offset by different developments in the other private portfolio businesses discussed below. In addition, 1H17 was positively affected by a similar revaluation gain, and as a result, total portfolio company attributable income excluding BoG was up only 2.9% y-o-y in 2018.

GHG's attributable income was up 7.9% y-o-y in 2H18 and up 2.3% y-o-y in 2018. The 2.3% y-o-y growth in 2018 reflects the impact of the sell down of a 7% equity stake by Georgia Capital in May 2017, which reduced the portion of attributable net income on y-o-y basis. Had we not reduced our stake in GHG, related attributable income would have increased by 8.3%. GHG's attributable income decreased by 15.6% h-o-h in 2H18 due to net foreign currency losses, while GHG continued to deliver on its strategic priorities leading to 22.2% y-o-y and 11.2% h-o-h growth in EBITDA to GEL 69.6 million during the second half of 2018. GHG achieved a record full year EBITDA of GEL 132.3 million (up 22.3% y-o-y), as GHG has started to capture benefits from major investments in 2016 and 2017. GHG's strong performance also resulted in 13.9% adjusted ROIC for roll-outs in 2018 (up 110bps y-o-y). The performance of GHG, in which we continue to hold a 57% stake, is discussed in more details on pages 34 to 35.

Attributable income of BoG was GEL 47.0 million during the second half of 2018 and GEL 91.2 million on a full-year basis driven by its strong performance across corporate and retail businesses as business momentum continues to accelerate in Georgia, while cost of risk remained well-contained at 1.6% in 2018 down from 2.2% in 2017. BoG successfully delivered on its strategy, with adjusted ROAE of 26.1% in 2018, well above the targeted through-the-cycle ROAE of 20%+. On 9 July 2018, BoG declared a dividend in respect of 2017 year of GEL 2.44 per ordinary share (c.30% payout ratio), which was paid to its ordinary shareholders on 31 July 2018. The Group received a GBP 7.4 million (GEL 23.9 million) dividend payment from BoG. In 4Q18 & FY18 earnings release BoG recommended an annual dividend for 2018 of GEL 2.55 per share subject to shareholders approval. This represents a payout ratio of 30% and a 4.5% increase over last year's dividend. GCAP is expected to receive a GEL 25 million dividend inflow from BoG in 2019. Please refer to Bank of Georgia Group's 4Q18 & FY18 earnings release for further details at http://bankofgeorgiagroup.com/.

Attributable income from private portfolio companies in 2H18 increased significantly both y-o-y and h-o-h, while it increased by a more modest 3.1% y-o-y to GEL 75.3 million in 2018.

Late stage portfolio companies demonstrated positive performance in their recurring businesses in 2018. In the housing development business, excluding the GEL 21 million commercial property revaluation gains in 1H17 attributable income was up in 2018, even though the overall sales momentum in 2018 was hurt by low inventory levels due to the delay in the process of receiving new construction permits; Attributable income from the water utility business was up by double digits despite extraordinarily lower precipitation related water inflows to Zhinvali HPP. P&C insurance made steady progress. The 11.9% y-o-y decline in the attributable income from private late stage businesses in 2018 is entirely attributable to the absence of the revaluation gains in Housing Development.

Early stage businesses continued development to the next levels of their greenfield lifecycle and related attributable income was GEL 19.0 million in 2H18 (up from negative GEL 1.6 million in 2H17 and up from negative GEL 10.4 million in 1H18) and GEL 8.6 million in 2018, which was driven by GEL 27.6 million revaluation gain booked in 2H18 on two under construction and one operational hotel and on rent-generating assets within the hospitality & commercial real estate business. The revaluation gain was partially offset by the beverages business, which recorded GEL 19.2 million loss in 2H18 and GEL 29.2 million loss on stand-alone basis in 2018 due to the delays in introduction of branded beers from the Heineken portfolio.

The performance of each private portfolio company is discussed on pages 22 to 35.

Net income of GEL 99.3 million in 2H18 and GEL 164.4 million in 2018 reflects the elimination of the dividend accrual from the GCAP attributable income of portfolio companies to avoid double-counting and a provision on our mezzanine loans to portfolio companies.

The Group's total comprehensive income is then driven by net foreign currency loss/(gain), non-recurring expense and realized gains from the sale of portfolio company shares. Other comprehensive income decreased from GEL 87.9 million in 2017 to GEL 86.9 million loss in 2018. The following table summarises the breakdown of other comprehensive income components:

The Group incurred net foreign currency loss of GEL 30.9 million in 2018 from USD/GEL and EUR/GEL exchange rate volatility at GCAP level and across its Water Utility and Beverages businesses. GCAP's GEL 24.8 million net foreign currency loss in 2018 was mostly related to USD/GEL exchange rate volatility, since GCAP has accounting short foreign currency position in US Dollars amounting to c. US$ 97.5 million (GEL 261 million) at 31 December 2018.

Non-recurring expenses in 2018 of GEL 55.9 million are not comparable to the GEL 3.7 million figure in 2017. 2018 Non-recurring expenses largely relate to the demerger from BGEO Group, which triggered recognition of fees for services received in connection with the demerger and acceleration of share-based compensation expenses for accounting purposes. GCAP's GEL 23.4 million non-recurring expense was entirely related to the demerger. The following table summarises the breakdown of non-recurring expenses:

The realised gain from sale of portfolio company shares of GEL 90 million in 1H17 resulted from the sale of 9.5 million shares of GHG (7.2%) by Georgia Capital in May 2017 for US$ 40 million cash proceeds, which decreased its stake in GHG to 57%. Georgia Capital did not sell any shares of its portfolio companies during 2018.

In line with the European Securities and Markets Authority ("ESMA") guidelines about the use of alternative performance measures (APMs) in the preliminary announcement, we discuss below the reconciliation of net income under management accounts with IFRS consolidated results.

FY18 net income under IFRS consolidated income statement was GEL 16.9 million as compared to net income under management accounts of GEL 164.4 million. The following items explain the drivers of differences between the two metrics:

a) BOG attributable income - IFRS consolidated financial statements include dividends declared and paid by BOG of GEL 23.9 million, while net income under management accounts include consolidation of attributable 19.9% of BOG's net profit of GEL 91 million, adjusted to exclude the impact of non-recurring items.

b) Revaluation of Hotels - revaluation gain of GEL 25.8 million is recorded within Hospitality & Commercial Real Estate business net income within management accounts, while under IFRS consolidated income statement hotels are carried at cost and no revaluation gains or losses are recognized.

c) Non-recurring items and FX gains and losses - GEL 31 million loss from foreign currency movements and GEL 56 million non-recurring expenses are reflected under IFRS consolidated income statement before arriving to net income, while under management accounts they are included below net income line and within other comprehensive income.

Apart from the items noted above, the income statement under management accounts mainly mirrors IFRS consolidated income statement and the performance of the underlying businesses as described above. IFRS results of each portfolio business together with management commentary are discussed on pages 22 to 35. A detailed reconciliation of our management income statement to the IFRS consolidated income statement is provided on page 36.

CAPITAL ALLOCATION HIGHLIGHTS

We continue to follow the capital allocation projections announced in our 1H18 earnings release. During 2018, actual net capital deployed was GEL 12.1 million, lower by GEL 52 million than our estimate at June 30, 2018. This was mainly driven by additional GEL 10 million dividend inflows from Housing development and GEL 40 million less capital allocation needs at early stage and pipeline businesses, which we expect to be instead deployed in 2019, i.e. increase previously projected 2019 capital allocations. The table below, which represents capital allocation projections for the existing portfolio businesses and the pipeline businesses, summarizes capital allocation outlook as of 31 December 2018. The table does not forecast potential capital deployments in acquisitions or potential capital inflows from exits from current portfolio businesses.

Capital allocation overview in 2018

In 2018 Georgia Capital received GEL 72.5 million in dividends, of which GEL 23.9 million was from BoG in 3Q18 and GEL 48.6 million from private late stage portfolio businesses: P&C insurance - GEL 10 million in 1H18, Water Utility - GEL 28.8 million in 4Q18 and Housing Development - GEL 9.8 million in 4Q18. During 2018 Georgia Capital invested GEL 84.6 million across its early stage businesses and new business lines, of which GEL 78.5 was capital for early stage portfolio companies. The capital was used primarily for bolt-on acquisitions to increase scale and accelerate progress to value creation goals. The following capital allocation decisions were made during 2018:

§ GEL 5.0 million was allocated to renewables, of which GEL 4 million was used for the development of hydro power plants (Zoti HPP and Bakhvi HPP) and the remaining amount was used for the development of wind power plants;

§ GEL 32.9 million was allocated to the hospitality business for the development of existing hotels and the acquisition of a land plot for hotel and office space development;

§ GEL 40.6 million was allocated to Beverages, of which, GEL 25.2 million and GEL 7.8 million were used for the acquisitions of Kindzmarauli and Black Lion, respectively. Additionally, GEL 6.8 million was used to finance the operating deficit of the beer business;

§ GEL 6.1 million was allocated to the Education business to acquire land for a high school development.

Capital allocation outlook through 2019-2022

Listed portfolio companies

BoG is a stable dividend payer with outstanding track record and significant growth momentum and strong profitability. We expect that BoG will maintain its dividend payout ratio within targeted 25-40% range. Over the last seven years, BoG has consistently paid out dividends at Compound Annual Growth Rate (CAGR) of 39% over the same period. Therefore, we estimate that dividend receipts from BoG will increase approximately by 7% annually and will deliver approximately GEL 112 million dividends in total to Georgia Capital through the end of 2022.

GHG, as the largest integrated player in healthcare ecosystem, is well-placed to benefit from significant new growth opportunities ahead in areas such as medical tourism, outpatient business where there is high growth in domestic demand, and related services like the provision of dental services, aesthetics, lab diagnostic etc. As GHG exited its capex heavy period, management expects to deliver improved return on capital invested and to generate substantially increased free cash flows. This reflects a combination of both expected double-digit compound annual growth in revenues and reduced investment requirements over the next few years. As GHG continues to mature, we expect it to adopt a capital return policy. Until GHG adopts such policy, we conservatively estimate no dividend income from GHG through the end of 2022.

Private portfolio companies: Late Stage

Water Utility is a stable dividend paying business with no additional equity capital or material debt capital needs. The water utility business paid GEL 29 million dividend in 2018 and we forecast approximately 5% CAGR in the water utility business dividend growth through the end of 2022 driven by higher energy efficiency, a key driver of future dividend growth potential, and overall growth in water consumption as the economy continues to grow. We estimate GEL 131 million dividend cash flow from Water Utility through the end of 2022.

Housing Development paid its first dividend of GEL 10 million in 2018 on the back of previously accumulated cash flows from successfully executed residential projects and confirmed outlook as a result of construction permits received at year-end. We had not estimated dividend inflows from Housing Development in 2018. As the business matures and continues transition into a real estate asset manager business model, we expect it to continue returning money through a combination of dividends and capital returns. Given the strong platform and brand name, Housing Development is well-placed to benefit from the continued growth in demand for private housing as the country's wealth grows. The housing development business does not have any additional equity capital needs through the end of 2022 as it has developed a leading real estate developer platform in Georgia. Housing Development mostly finances its projects through pre-sales. Debt capital needs are specific to individual projects and could appear for short-term periods only. Given the Housing Development's strong project pipeline and outstanding project execution skills, we estimate dividend inflow to remain at the same level of GEL 10 million in 2019, followed by an annual payout increase of GEL 5 million going forward, or GEL 70 million through the end of 2022.

Property & Casualty Insurance is yet another business with strong dividend payout track record and potential for growth as the insurance market remains highly underpenetrated in Georgia. Aldagi paid a GEL 7 million dividend in 2017, which grew by 43% to GEL 10 million in 2018 on the back of a strong growth in the bottom line. Given the business' strong track record and high growth potential we have estimated GEL 12 million dividend payout in 2019, which is expected to grow to GEL 22 million in 2022. Property & Casualty Insurance does not have needs for any additional equity capital or debt capital.

Private portfolio companies: Early Stage

Renewable Energy (65% ownership) has a medium-term target of 500MW operating power generation capacity, including the existing 152MW HPP of the water utility business. Energy consumption is forecasted to increase at least by 5% CAGR over the next fifteen years, driven by economic growth. The business currently has a 410MW pipeline in place, where it estimates GEL 177 million equity capital needs from Georgia Capital (i.e. 65% of the total equity capital needs) and GEL 968 million debt capital needs through 2022 based on the targeted average 70%:30% debt to equity leverage ratio.

Hospitality & Commercial Real Estate capital needs are estimated based on the 1,000 hotel room target on the back of projected double-digit growth in tourist inflows over the coming years. The business currently has 152 operational hotel rooms and 969 hotel rooms in its pipeline. In order to reach 1,000 fully operational hotel rooms within three years, the hospitality business needs a further GEL 39 million equity capital injection and GEL 186 million in debt capital. We target a 70%:30% debt to equity leverage ratio at hotels.

Beverages. The wine business is targeting 1,000 hectares of vineyards from the current 436 hectares to support the growing demand from export markets for Georgian wine. The beer business has launched the beer factory and is in process of launching additional beer brands to increase the product offering to tap the expected growth in low beer consumption levels of 27.5 liters per capita. As a result, the beverages business requires approximately GEL 37 million equity capital and GEL 67 million debt capital to finance its planned growth through 2020 and beyond.

Private portfolio companies: Pipeline Stage

Education. We have identified education as an attractive fragmented service industry with high growth potential driven by increased demand for quality education and low government spending. We expect to deploy GEL 140 million in equity capital, while the business will raise GEL 120 million in debt capital. Capital deployment will happen gradually over the next four to five years and by 2025 we expect the business to reach 30,000 pupils and to become the largest chain of affordable schools in Georgia.

Overall, based on the estimated dividend inflows, which do not include any dividend inflows from GHG, we continue to expect to collect sufficient cash inflows through the end of 2022 to accommodate the equity capital needs of early stage and pipeline stage portfolio companies during the same period. 2019 is a net equity capital investment year for Georgia Capital, followed by relatively neutral 2020 and 2021, while in 2022 we expect net equity capital returns from portfolio companies. Based on this outlook, and together with the available GEL 605 million funds at GCAP (liquid funds and issued loans) at 31 December 2018, we remain well-positioned to support the value creation across our private portfolio businesses and take advantage of new opportunities meeting our stringent acquisition criteria as and when they arise.

RETURN ON ALLOCATED CAPITAL

We use the Management Account figures to calculate Return on Allocated Capital (ROAC), a metric that provides us with a visibility into returns on current management values for each portfolio company. 

ROAC is an annual return on allocated capital as of 31 December 2018 and calculated at each private investment level. Inputs into the ROAC calculation are as follows: (i) the numerator is an annual attributable income of the private portfolio company, less allocated GCAP interest expense, and (ii) the denominator is the management estimated fair value, as included in the NAV statement, less allocated gross debt of GCAP.

Listed Portfolio Companies

Private Businesses

Portfolio company results 

Business description

Our Water Utility is a natural monopoly in Tbilisi and the surrounding area, where it provides water and wastewater services to 1.4 million residents representing more than one-third of Georgia's population and c. 33,000 legal entities. Water Utility also operates hydro power plants with total installed capacity of 152 MW.

Water Utility is 100% owned through GGU.

Investment rationale

§ Natural monopoly in Tbilisi and surrounding district

§ Utilities sector represents 3% of total Georgian economic output with c. 8.2% CAGR (2006-2017)

§ Stable regulatory environment with fair return on investment

§ Stable cash collection rates

Value creation potential

§ EU harmonization reforms in progress in utilities sector in accordance with Georgia's undertaking under the Association Agreement with the EU, expected to drive water tariffs up

§ High GDP growth combined with rapid tourism growth drive high demand from corporates

§ Energy market deregulation expected to positively affect electricity sales price

§ Upside opportunity from pursuing cost efficiencies by targeting decrease in self-consumption of electricity in order to free up energy for third party electricity sales

§ Growing dividend payment capacity

Value realisation outlook

IPO together with the renewable energy business

2H18 and FY18 performance

Positive operating leverage supports EBITDA margin expansion in 2018 

INCOME STATEMENT HIGHLIGHTS

The Water Utility's 2H18 revenues were up 6.6% y-o-y and 13.6% h-o-h, and FY18 revenues were up 10.5% over 2017 on the back of the strong performance of the water supply business.

Revenue from water supply to legal entities and individuals (2H18 up 9.6% y-o-y and 13.5% h-o-h and FY18 up 10.9% over 2017) benefitted from increases for both legal entities and individuals. Revenue from water supply to legal entities increased 7.3% y-o-y to GEL 92.2 million in 2018 reflecting strong business activity across various industries, while an 18.8% h-o-h increase to GEL 50.1 million was also positively affected by seasonality in water consumption. Revenue from Water supply to individuals increased 20.2% y-o-y to GEL 39.6 million in 2018. Most of the increase is attributable to the increased residential tariff effective from 1 January 2018. New connections, which more than doubled from 2,347 in 2017 to 5,015 in 2018, also contributed to the increase in water supply revenues.

2H18 energy revenue was down 35.0% y-o-y and 8.3% h-o-h and FY18 revenue was down 7.2% over 2017. The decrease in revenues from electricity power sales is attributable to extraordinarily lower than average precipitation related water inflows to Zhinvali HPP, partly offset by significant savings in the Water Utility's self-consumption of electricity, which decreased by 21.0% to 116,703 thousand kwh in 2H18 and by 18.4% to 237,145 thousand kwh in 2018. 2H18 other income was up 27.9% y-o-y and 46.0% h-o-h and FY18 other income was up 30.3% over 2017. The increase mainly reflects higher number of fines charged on illegal connections amounting to GEL 0.6 million in 2H18 and GEL 1.7 million in 2018.

2H18 operating expenses were down 3.8% y-o-y and up 5.3% h-o-h and FY18 operating expenses were flat. This reflects the efficient cost management and continued rehabilitation works, resulting in significant cost savings in infrastructure assets maintenance expenses and raw materials. Overall, in 2018 operating leverage was positive at 10.5 percentage points.

The increase in the provision for doubtful trade receivables to GEL 5.0 million in 2018 was primarily driven by the adoption of IFRS 9. IFRS 9 introduced a forward-looking expected credit loss (ECL) approach effective from 1 January 2018, which is intended to result in an earlier recognition of credit losses based on an ECL impairment approach, compared with the previous incurred-loss impairment approach for financial instruments under IAS 39. Provision for doubtful trade receivables was down 33.5% h-o-h due to seasonally high collection rates in the second half of the year.

The strong increase in water supply revenues coupled with the efficient cost management led to 11.2% y-o-y increase in EBITDA to GEL 46.1 million and to 14.9% y-o-y increase to GEL 83.4 million, respectively in 2H18 and in 2018.

Net interest expense was up 15.5% y-o-y in 2018 due to increased leverage obtained through international financial institutions and local banks to finance capital expenditures and refinance more expensive and short-term funding. Net non-recurring expenses increased in 2018 due to the acceleration of share-based payment expense recognition following Georgia Capital's demerger from BGEO Group in May 2018. Foreign exchange losses in 2018 reflect the accounting impact from Georgian Lari's depreciation against the Euro as part of GGU's outstanding borrowings are denominated in Euros and GGU recorded losses in 2018 on its unhedged short position of GEL 131 million in Euros at 31 December 2018.

As a result, Water Utility profit was GEL 15.7 million in 2H18 (down 28.3% y-o-y and down 6.3% h-o-h) and GEL 32.5 million in 2018, down 13.0% y-o-y.

BALANCE SHEET HIGHLIGHTS

The 32.8% increase in property, plant and equipment in 2018, was primarily due to development works on Water Utility infrastructure carried out during the year in order to upgrade the network. Additionally, GEL 45.6 million of the increase in FY18 is driven by rehabilitation works at the Gardabani wastewater treatment plant, which went through a major rehabilitation after c. 30 years of operation, and since July 2018 has been fully functional, servicing the whole population in Tbilisi and surrounding area. Total capex for Gardabani wastewater treatment plant rehabilitation was in line with the estimated GEL 60 million.

2017 and 2018 were capital-intensive years for the water utility business. Efficiency programs, such as upgrade of water and wastewater network, purchase of heavy machinery and metering of residential and commercial customers, will have a dual effect of reducing own electricity consumption and increasing third party electricity sales. Additionally, regulated CAPEX is included in Regulated Asset Base, used by the regulator to calculate fair return on investment. For the regulatory period 2018-2020, such return on investment (referred to as WACC in the tariff-setting methodology) is set at 15.99% (up from 13.54% in 2017). Capital expenditure level is expected to decrease in 2019 and gradually reach long-term run-rate level of c. GEL 52-70 million by 2022. The table below summarizes capex forecast through 2022:

The increase in total liabilities is due to increased borrowings obtained from international financial institutions and local banks at the end of 2017 to support capital expenditures for development of water supply network. During 2017, GGU secured long-term financing of EUR 81.5 million from international financial institutions (IFIs) for efficiency-related capital expenditure purposes, namely from European Investment Bank (EIB), The Netherlands Development Finance Company (FMO) and German Investment Corporation (DEG) at the GWP level (GGU's principal utility subsidiary). The borrowings were largely utilized in 2017 and the remaining undrawn balance of EUR 8.6 was drawn down during 1H18 from the IFI financing. Additionally, c. GEL 48 million was obtained from local banks during 2018 to support intensive capital expenditures.

CASH FLOW HIGHLIGHTS

GGU has an outstanding water supply receivable collection rate within the 95-99% range. During 2H18 and FY18, the collection rates for legal entities and households were 99% and 94%, respectively. Although the Georgian water utility sector historically had low receivables collection rates, as a result of GGU's arrangement with electricity suppliers since 2011, GGU's collection rates remain very strong at approximately 96%. As part of the arrangement non-paying water customers are disconnected from the electricity network and in return, electricity suppliers receive flat monetary compensation from GGU. Operating cash flow was up 16.3% y-o-y in 2018 as a result of the growth in revenues and positive operating leverage.

In 2H18, the water utility business distributed dividends in amount of GEL 28.8 million (up 3.0% y-o-y) to Georgia Capital.

2019 OUTLOOK

The water utility business's outlook for 2019 is positive as management expects further continued growth in revenues from water supply with limited increase in operating expenses, while continuing to reduce self-consumption of electricity and increasing third party electricity sales. Electricity market deregulation, currently expected to be fully enacted from 1 May 2019, is anticipated to positively impact revenue stream from electricity sales. The business plans to gradually decrease volume of capital expenditures after completing two years of accelerated capex program and maintain the increasing trend of dividend distribution.

(1) Capex figures are stated including VAT.

Key performance metrics

 (2) Please see definition on page 53.

Capital Outlook through 2022

(3) Gross capital needs, excluding dividend distribution.

(4) Please refer to page 38 for the reconciliation of FY18 stand-alone Water Utility net income to the attributable income from Water Utility as reported under the management account income statement on page 15.

Business description 

Our housing development business is a leading real estate developer on the US$ 1.1 billion Georgian real estate market with three business lines: (a) a residential development arm targeting mainly mass market customers by offering affordable, high quality and comfortable housing; (b) a construction arm, engaging in construction contracts for other businesses as well as third-parties; and (c) franchise platform for development of third-party land plots with fee sharing arrangements.

Housing Development is 100% owned through m2.

Investment rationale

§ Shortage of housing from Soviet era combined with Georgian tradition of multiple generations living under one roof, average household size is significantly higher at 3.3 compared to Eastern or Western Europe

§ Most of the housing stock dates back to Soviet era and is amortised 

§ In line with the economic growth, urbanization level is expected to increase from the current low level

Value creation potential

Asset light strategy

§ Unlock land value by developing housing projects

§ Development of third-party land - franchise m2 brand name. Undisputed market leading platform of at least 2,500 apartments1 to be delivered in 4-5 years

§ Earn construction management fees from third-party projects and bring construction works in-house

Value realisation outlook

Cash out by transformation into real estate asset manager

2H18 and FY18 performance

Solid GEL 10 million first-ever dividend payout following successful project execution

(1) 2,500 apartments relate to the signed Tbilisi Airport Highway deal.

(2) Value created on commercial property.

The Housing Development gross profit from apartment sales fluctuates with the cycle of projects and strength of demand in the market for affordable housing. 2H18 gross profit was down 48.4% y-o-y and 52.5% h-o-h, while FY18 gross profit was up 17.5% y-o-y. Market conditions remain strong and the FY18 y-o-y increase was driven by strong project execution. In 2H18 Housing Development has successfully completed two affordable residential projects located in the centre of Tbilisi. It reached total sales progress of 87% in on-going projects and managed to sell down large part of its inventory at higher per ticket prices due to the sales closer to full completion stage. Average price per square meter was up 24% in 2018 over 2017 and up 22% in 2H18 y-o-y. The development of apartment sales in the relevant periods are shown in the table below:

While in the process of receiving the new permits, Housing Development has not started new projects in 2018 and sales momentum was negatively affected by low levels of inventory. Inventory levels will increase by approximately 3,000 apartments over the next few years, since in November Tbilisi City Municipality Council approved the masterplan brief on Housing Development's largest ever in-house affordable housing project. The Digomi project will be developed in three stages and the construction and development of 168,000 sq.m. residential and 84,000 sq.m. commercial spaces will continue for approximately four years. Housing Development started pre-sales for stage one from February 2019, where the total sellable area is approximately 22,000 sq.m.. As of 19 February 2019, 3,176 sq.m. with US$ 3.3 million sales value has already been pre-sold and 3,437 sq.m. has been booked.

During 2018, housing gain from revaluation of commercial property in the amount of GEL 5.5 million was recorded on the apartments intended for lease out and on commercial spaces under development in our three major projects as compared to GEL 21.6 million in 2017. In 2017 revaluation was performed for commercial spaces under development in the above mentioned three major projects after reaching a construction progress threshold.

During 2H18 the construction segment achieved robust performance and gross profit was GEL 4.3 million, almost four times h-o-h result. Construction fees were mainly generated from two third-party construction agreements in addition to in-house development projects: (i) the shell and core construction of a new shopping mall located in Tbilisi's Saburtalo district and (ii) fit-out works for Radisson Tsinandali in Kakheti region. Gross profit from construction services was GEL 5.3 million in 2018, which was 79% driven by third-party projects.

Operating expenses were GEL 6.8 million in 2H18 (up 45.3% y-o-y and up 44.2% h-o-h) and GEL 11.6 million in 2018 (up 46.1% y-o-y). The y-o-y increase reflects increased administrative expenses within the construction arm in line with the business ramp up, while bringing construction works in-house will result in cost and project development efficiencies. The h-o-h increase is mainly driven by seasonally higher marketing and advertising expenses at the end of year.

Housing Development recorded profit of GEL 0.4 million for both 2H18 and FY18 reflects mainly the impact of non-recurring expenses. Non-recurring expenses amounted GEL 6.2 million in 2018 and were mainly driven by acceleration of share-based expense recognition as a result of the Group's demerger from BGEO Group in May and by expenses related to the construction of a college for vocational education in Western Georgia, which was officially opened in 2H18. The college, with a total project cost of GEL 3 million, offers 11 short-term vocational courses to more than 600 construction specialist/workers annually and most of the graduates are expected to be employed within the construction arm. Before net non-recurring items, 2018 Housing Development profit was GEL 2.1 million in the second half and GEL 6.6 million for the full year.

Housing Development currently has a land bank with a value of GEL 8.7 million, which decreased significantly y-o-y as a result of masterplan brief approval for Digomi land (respective land was transferred from investment property to inventory). Land bank is expected to decrease further over the coming years, in line with its asset light strategy, as Housing Development plans to develop third-party land plots under franchise agreements going forward.

Cash flow highlights

The Housing Development business continued to deploy cash for on-going project developments, while low levels of inventory negatively affected sales, which decreased from US$ 49.1 million sales value in 2017 to US$ 22.3 million in 2018 as noted above. Operating cash flow was, therefore, negative GEL 10.2 million in 2018, down from GEL 18.7 million in 2017.

In December 2018, Housing Development distributed GEL 10.0 million dividends. The first ever dividend payment was made on the back of accumulated cash inflows from successfully executed projects.

2019 OUTLOOK

During 2019, Housing Development expects to complete the construction of two ongoing residential projects and kick off the development of its largest housing project in Digomi, which will drive revenue growth and gross margin expansion on the back of expected scale efficiencies. Further, the business aims to complete the design stage and in 4Q19 start pre-sales of its largest-ever franchise project on a third-party land plot located in Tbilisi airport highway in a densely populated suburban area.

Key performance metrics

(3) Please see definition on page 53.

Capital Outlook through 2022

(4) Gross capital needs, excluding dividend distribution.

(5) Please refer to page 38 for the reconciliation of FY18 stand-alone Housing Development net income to the attributable income from Housing Development as reported under the management account income statement on page 15.

Business description

Our property and casualty Insurance (P&C Insurance) business is a leading player in the local P&C insurance market with a 32% market share based on gross premiums. P&C Insurance offers a wide range of insurance products to Georgian corporates and retail through five business lines: motor, property, credit life, liability and other insurance services.

P&C Insurance is 100% owned through Aldagi.

Investment rationale

§ Significantly underpenetrated insurance market in Georgia

§ Market leader with a powerful distribution network of point of sale and

sales agents

Value creation potential

§ Compulsory border TPL effective from 1 March 2018

§ Local TPL expected to kick in from 1 July 2019 and provide access to untapped retail casco insurance market

§ First mover advantage in underpenetrated SME segment

§ Growing dividend payout capacity

Value realisation outlook

Trade sale or IPO

2H18 and FY18 performance

Double-digit growth in net underwriting profit driven by efficient risk management