Electrica SA Update – Annual Report 2014 & Q1 2015 and AGM

Time to update on my Electrica case which I have presented in December last year.

Let’s start with some bad news:

I had mentioned two potential “upside options”, which could drive the value of Electrica even higher than in my simple base case:

1. Potential M&A opportunities with regard to ENEL’S Romanian assets
2. Clean up of 22% minority holdings in all major subsidiaries

Both options, for the time being did not materialize. Already in February, ENEL said that they will not sell their Romanian subsidiaries. Additionally, Electrica could not agree with Fondul Proprietatea on the price. The differences in valuation were still significant:

Fondul Proprietatea holds stakes of about 22% in each of these companies, which are valued at EUR 173 million in its portfolio. Electrica, which is 49% controlled by the state, was looking to pay a price closer to EUR 100 million, according to sources familiar with the negotiations.

So none of those two options seem to be realistic for now, but on the other hand I haven’t priced them in anyway.

So now let’s look at the good stuff, starting with the 2014 annual report:

Profit AT, before minorities has been 401 mn RON for 2014, which translates into 288 mn RON after minorities, that is around +15% against what I had projected for 2014. However Electrica stresses that this is due to a one-time effect in the supply segment where they were able to by electricity cheaply during the year. In contrast to many other companies, I can gladly live with positive one time effects…

Operating cash flow was very strong, especially they seem to be able to reduce their outstanding receivables significantly which in my opinion is VERY positive. Payroll costs decreased significantly, it seems to be that privatization is clearly motivator for more efficiency.

They also now show the regulated assets as a separate balance sheet line. They are however lower than I had initially assumed but more on that later.

Q1 2015

According to the Q1 report, the year started quite well. Profit increased by around 25%, Profit after minority increased by almost 50%. Again there is a positive one-time effect, in this case it is the de-consolidation of one the 100% owned but loss making service operations which had negative equity. Without this effect, earnings would have increased only slightly, maybe between 5-10%.

I think these 100% service subsidiaries and this effect is also the reason why one reader could not reconcile 2014 results and the 2015 plan from the operating entities which all have 22% minority interests.

All in all I would say a very solid first quarter.

Shareholder meeting & Investment budget

A reader already pointed out the following: In the April shareholder meeting something interesting happened: Shareholders rejected the presented investment plan of Electrica for 2015. Honestly I did not look at the investment plan before but the issue seems to be the following according to this article:

The Energy Ministry rejected electricity distributor Electrica’s investment plan for 2015, in the general shareholders meeting on Tuesday, April 28.

The ministry is Electrica’s biggest shareholder as it owns almost 49% of its shares. The remaining 51% are held by local and international investors who bought shares in the company’s initial public offering (IPO), in June last year, and afterwards, from the Bucharest Stock Exchange and London Stock Exchange. EBRD has an 8.6% stake.

Electrica’s total investment budget for 2015 was about EUR 151 million, EUR 135 million of which was for revamping the group’s electricity distribution network, according to the report the group presented to investors.

The state’s representatives have asked Electrica to correlate the investment plan for 2015 with that it had in the listing prospectus. According to the prospectus, Electrica should invest some EUR 317 million this year.

I have double checked the IPO prospectus and indeed on page 166 we can find the 1,4 bn RON (~400 mn) investment budget and thereof 3/4 for regulated assets. So the Government shareholder clearly has a point here. Honestly, I have no idea why Electrica presented now a much smaller budget. I only can speculate that they maybe want to make a point to the government because of the unexpected reduction on guaranteed returns after the IPO. For my investment case it would be important that they actually do grow their regulated asset base, so this is something to watch.

Another interesting aspect of this episode for me is the fact that shareholders do have pretty much to say in Romania. In any other country, an investment budegt for the next year would not be subject to a vote. The reason for this is most likely that trust is still very low in Romanian society when it comes to large organizations.

So how will this be resolved ? Romanian companies do have quite frequently extraordinary shareholder meetings. So I guess they willhold one pretty soon and present a different investment budget. Maybe not the initial 2015 number but maybe something in between.

Summary:

Overall, I do think the investment case for Electrica has not changed. Some frictions with the Government and possible delays in the build up of the regulated asset base are countered with unexpected positive effects and a good operational development. It remains to e seen how quickly Electrica and the Government will align themselves, but overall I still think that over 3-5years this wilbe a VERY GOOD investment.

19 comments

  • Romanian state goes after state-owned listed company for EUR 1.3 bln damages
    http://www.romania-insider.com/mind-blowing-romanian-state-goes-after-state-owned-listed-company-for-eur-1-3-bln-damages/155232/

    Even if the chances of success for SAPE might be negligible, it doesn’t increase my comfort level of owning Romanian shares.

    What’s your take?

    • Hi,

      thanks for the link, haven’t seen it. As I wrote in my post “cheap for a reason”, there is always a reason why a stock is cheap. In a country like Romania with newly privatized companies, the relationship between the Government and the company has to develop. As you don’t know how this works beforehand, the stocks are cheap because you take a risk. As Romania is however a EU member, I do think that in the end reason will prevail, but in the short term one will need to live with this.

      I am willing to take this risk as I think the potential upside compensates for the risk and it is within the range of what is acceptable for me. I could be wrong, but that’s part of the game.

      If you feel very uncomfortable with such a situation, you should not own such stocks.

      mmi

      • Thx for your reply. I read your post “cheap for a reason” and agree with your assessment. I feel somewhat uncomfortable, but not enough in order not to own the shares at this price point 😉

        • Hello,

          Just a quick update: SAPE’s chances of success are minimal at best (their arguments are contradicted by existing documents). However, the way the Romanian state and Electrica managed the whole situation really left a lot of investors (including us, local ones) puzzled.
          The issues with Electrica is that they didn’t seem to give a damn about the whole issue: they issued a statement, held a quick conference and that was it, subject closed.

          Romanian politicians have a long history of messing with State-owned companies, but most public companies have been partially insulated from them so far. Hopefully things won’t change in the future :).

          Regarding private companies on the Bucharest Stock Exchange: corporate governance is actually pretty good – comparable with a lot of other, more mature economies. Unfortunately, most companies only have reports published in Romanian and that severely limits the number of potential investors.

          Hopefully Electrica will not disappoint you guys :).

  • I´m curious how you handle the “dividend-matter” ? Ex-date was beginning of July, payment-date some days ago. As I have invested via GDR´s representing 4 shares end of March 2015, should the dividends not be automatically transferred ?
    Why I´m asking, if you visit Investor Relations of Electrica there´s a lot of “confusing” stuff about registrating in Romania…by the way: same applies to Romgaz…

    I´d be very happy if you could let me know your dealing with this…

    Thanks in advance!

    Robert

  • On June 8th new capex plan will be made public before special shareholder meeting. http://www.electrica.ro/en/general-meeting-of-shareholders-as-of-July-9th-2015/

  • Hello,

    Just one point to make regarding the budget: because the IPO money went to Electrica SA (the holding company) and the investments need to be performed by the distribution and supply companies, the company wants to issue new stock in order to inject the capital.
    However, the minority shareholder (Fondul Proprietatea) is not too happy about this, as it means they have to also contribute to the capital increase in order to preserve their percentage ownership. Their first way of defending against these massive increases was to sell their shares to Electrica. Having failed to do so, they are now trying to push the company to reduce the size of the issue.

    This might have something to do with the conflicting numbers for the investment budget.

    P.S.: I’d also like to add a small disclaimer, since I’ve been adding a lot of comments regarding Romanian companies. I don’t own (or am affiliated with) either Romgaz or Electrica. The only reason for adding all these comments is because it’s great to see people interested in local companies.

  • Good update. Agree on those points and I am very surprised that the company would want a smaller budget given the very large excess cash position on their balance sheet which is earning very little. As shareholders, today almost 70% of the value we are purchasing is cash — which earns a low rate of return — and 30% is the operating business, which, due to current valuation, has a very high rate of return. The opportunity to shift that cash into a slightly higher returning asset should be welcomed! The company generates an enormous amount of FCF annually and will still have more than enough flexibility to buy out Fondul and/or consolidate Enel’s assets down the line. In the meantime, they can eliminate part of the drag on investor returns that cash creates and use the increased net income to pay a higher dividend, which is basically what these companies trade on.

    • After the AGM Electrica has published a letter to shareholders in which it explains why its investment budget is substantially below the IPO plan (http://www.electrica.ro/en/wp-content/uploads/2015/05/ELSA_EN_Letter_to_shareholders_15May2015.pdf ). Apparently the regulatory authority (ANRE) did not approve Electrica’s full Investment plan and forced them reduced planned capex.
      So I guess for Electrica Investments only make sense, if they increase the RAB, otherwise the Investments won’t yield any return.
      But somehow it is strange to have the regulator capping the capex budget and then the government as key shareholder voting down the budget plan (which was revised according to the input from the regulator).

      • Thanks for the link, I haven’t seen this. It seems to be that the Regulator ANRE and the shareholding Government have slightly different views…..

        One remark: Non regulated investments are not by definittion worthless. If they allow Electrica for instance to reduce staff and reduce costs then the return could be quite significant.

        Overall, communication seems to be quite good if one actually finds the documents.

        Thanky again for your input !!

      • Interesting read, thanks. The compensation will rise, but the correlation between pay and performance will rise, too. This leads to better overall performance in most cases. I wonder how dilutive those phantom shares will actually be over the long run.

        They also plan to invest in non regulatory assets to improve efficiency. I wonder if they then set the right base for the variable compensation. I presume it would be very easy with new IT&C and investments to improve efficiencies from the current levels. This means if they would use current efficiency as the base line the executives would have no need to work to get their bonuses.

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