Management / shareholder disconnect- E.ON SE edition

Normally, I don’t care that much about quarterly results, but in the case of German utilities I sometimes make an exception simply because often they are too entertaining to miss.

Yesterday, for instance E.ON the German utility company reported Q3 figures. The press release reads pretty “upbeat”:

E.ON affirms 2014 forecast
11/12/14 | Posted in: Finance
Adjusted for portfolio and currency-translation effects, EDITDA above prior-year level
Renewables’ share of earnings rises to 17 percent
Economic net debt reduced by €1.2 billion
E.ON today reported nine-month earnings that were in line with its expectations. It therefore continues to anticipate full-year 2014 EBITDA of €8 to 8.6 billion and underlying net income of €1.5 to €1.9 billion. Nine-month EBITDA declined by seven percent year on year to €6.6 billion. The absence of earnings streams from divested companies and adverse currency-translation effects were the main factors. On a like-for-like basis—that is, adjusted for portfolio changes and currency-translation effects—E.ON’s EBITDA was above the prior-year level.

I would call this kind of disclosure “Level 1”: How the company wants to be seen

So with “adjustments” things look better than last year. However this time even a relatively “mainstream” German magazine remarked that the earnings disclosure of EON is relatively difficult to understand.

Level 2: P&L – Some kind of truth

In their quarterly report, EON has to use Accounting standards at some point. After 15 pages of useless “Management report” the first “real” accounting number shows up on page 16.

In fat type you can see the following:
Net income 255
for YTD 2014, which is around 90% lower than 2014. Then in small print they show the following:

Attributable to shareholders of E.ON SE -14
Attributable to non-controlling interests 269

So under IFRS, EON actually lost 14 mn EUR in the first 9 months.But anyone who is reading this blog regularily knows that this is still only “half of the truth”:

Level 3: What really happened – Comprehensive income

Only on page 25 we see the comprehensive income statement of EON for the first 9 months. And this looks really ugly.

-1,7 bn losses from the increase in pension liability
-0,6 bn FX and hedging losses

then lead to a total loss of 2,2 bn EUR or -1,1 EUR per share for E.ON’s shareholders for the first 9 months.

If we look at the stock price, we see that the positive “spin” only lasted for around 20 minutes before the stock price started to drop.

Why are they doing this ?

Well, this is pretty easy and straight forward: This allows the Management to award them nice bonuses independent of what the total result for the shareholder looks like.

Total comp in 2013 according to the annual report for management was 18,5 mn, thereof around 13 mn “bonus”. And this in a year where the were only able to generate a comprehensive income o ~600 mn EUR or 2% ROE.

EON’s target achievement is measured the following way according to the annual report:

As under the old plan, the metric used for the operating-
earnings target is EBITDA. The EBITDA target for a particular
financial year is the plan figure approved by the Supervisory
Board. If E.ON’s actual EBITDA is equal to the EBITDA target,
this constitutes 100 percent attainment. If it is 30 percentage
points or more below the target, this constitutes zero percent
achievement. If it is 30 percentage points or more above the
target, this constitutes 200 percent attainment. Linear inter-
polation is used to translate intermediate EBITDA figures
into percentage

For a capital-intensive business like a utility, EBITDA in absolute is pretty useless. However it is pretty easy to achieve or beat for Management. As a shareholder you can be sure that your interests are not aligned well with those of the management. In my opinion, that whole mess at EON has a lot to do with this pretty obvious “detachment” between management and shareholders and only to a smaller extent with German energy policy.

Finally some other stuff

The most interesting item in the whole Q3 report for me was the fact that Electrical Power generation was actually 50% better (EBITDA) than in 2013 and more than 100% better on EBIT basis. The biggest drop yoy actually came from the natural gas business.


EON’s Q3 report for me is a prime example for a badly managed company. The disconnect between management incentives and shareholders leads to nonsense reporting, mostly in order to avoid the hard truth of losses to shareholders. For instance anyone who wondered why they bought crappy assets in Brazil and Turkey instead of paying back debt should understand that this actually increased the bonuses of management irrespective of FX losses, write-offs etc. As an investor, one should stay as far away as possible from such companies, no matter how cheap they are because at some point in the future they will “hit the brick wall”.


  • What do you expect considering that E.On had a chief financial officer for a number of years up until September 2013 who was a “Goldiger Sachse” alumnus ?

  • Hello mmi,

    Thank you for your report about this tragicomedy.

    By the way regarding your portfolio, how do you calculate your returns? Do you use IRR (XINTZINSFUSS)?
    Can you recommend any software for portfolio accounting?



    • Hi Milud,

      I use simply Excel. For the model portfolio, I do not assume any in-/or outflows from the “fund”, so I can simply divide the current portfolio value 8including cash) against any historic value and annualize it.

      For my private portfolio I use a simplifed IRR method.


  • Hey, very nice article. You are right in saying, that sometimes earning reports like this are very entertaining. Even if it usually doesn´t pay off materially to read them, it is at least a learning experience of how far away management can get in measuring “success”.

    In Austria there are also countless examples. For instance the Telekom Austria AG uses to measure it`s financial stability by a net debt to adjusted EBITDA measure. They are basically saying: “We are a healthy company because we could pay off our debt in, say, 3 years, if we wouldn`t have to spend capex, pay interest and taxes”. And what are the supervisory board and the auditors doing? They are just signing it.

  • Nice to see the German utilities are at it too – I found some rental companies which were quoting EBITDA figures the other day.

    When a rental company – a company paid to take assets off someone else’s balance sheet and absorb the operating costs (depreciation) for them – starts quoting figures WITHOUT depreciation as their ‘headline metric’, you know something’s wrong..

  • I cannot agree more with you. Just measuring Ebitda per se is not useful unless other parameters are included into the management compensation (i.e. net profit attributable to shareholders and net debt evolution). Having said this, in this specific case, I like the distortion between cash-flow value and P&L. It is a good example of long term value (apart from regulatory matters, obviously) but the problem with E.On is, in my view, that they are moving exactly against the economic cycle (exiting mature European markets and entering into emerging) and that it’s going to take them a long time to overcome (in the meantime, dead money).

    • cash flow is another interesting topic which I didn’t even touch. For 9m 2014 the show 7,5 bn “operating cashflow”. They paid out 1 bn in dividends and had addionally 1,6 bn in investment. Capex was 3 bn. SO I would asume net debt should be ~5 bn lower. But it is not. There is at least a 2 bn unexplained difference.

      • I cannot agree more, once again. Having said this, the company (understood as a purely economic proposal) is clearly undervalued. Avg. FCF of 3,5 bnx13 gives plenty of room for valuation upgrade in the range of 18 €/share (PE is a different issue). I am sure they will get there but the problem is that management, as you correctly appointed is very poorly result driven. I am seriously considering exiting the company (and put a close eye when the right moment comes -unfortunately not before 18-24 months-).

  • Hi, nice post.

    As far as I know, EBITDA is a common earnings target for all big utilitiy companies. The same with mining companies. All of E.ON’s nuclear power plants are written off and do still produce cashflows. So, the question is does a post D/A earning figure give more insights.

    Here again, I have to say that I do not understand utilities. I had to learn this the hard way 😦
    Best regards

    • thanks for the comment. The fact that many utilities use it, doesn’t make it better. “Au contraire”….

      With regard to nuclear power plants: Yes, the asset is wirtten down, but as I have written before, the “decommissioning liabilitie” are greatly under reserved.

      In general, for capital intensive businesses, gross EBITDA is not useful. Capital intensive businesses have to produce return on capital.

      • Yes. but my point is: What is the use of a post D/A earnings figure if most assets have been already written off. If you use post D/A figures for a valuation, you consider depreciation as substitute for capex. But this approach distorts your earnings if there is nothong to be written off.

        I think what one really has to do is to add future EBITDA minus future capex – and that for each plant. I doubt that private investores have the time and skills to do that.

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