Tag Archives: E.on AG

Energiedienst Holding AG (ISIN CH0039651184) and German electricity prices

I started my small 2013 utilites project with E.On 2 weeks ago. Instead of working through the list of German utilities I wanted to focus on Swiss listed Energiedienst Holding AG first.

Energiedienst is a slightly unusual stock. It is listed on the Swiss stock exchange, but its balance sheet is in EUR. The company basically runs a number of big Hydro power plants along the Rhine River plus some smaller Hydro Power plants in Southern Germany and Switzerland as this map shows:

Market cap: 1.3 bn Swiss Francs
P/B 1.1
P/E 12.0
EV/EBITDA 7.1
Dividend yield 2.3%

From a simple valuation point of view, Energiedienst does not look overly attractive, however one should mention that they do have net cash which is quite uncommon for utilities.

The company is majority owned by German ENBW (67%) plus a company called “Services Industriels de Genève (SIG)” which bought a 15% stake in 2011 from ENBW (remark: ENBW itself is in quite big trouble because of the Nuclear exit in Germany).

Business model

In addition to the Hydro plants, Energiedienst owns a distribution network with around 750 tsd clients in Switzerland and Southwestern Germany. The focus is clearly Germany with more than 80% of sales there. Energiedienst produces around 25% of its energy itself, the rest is bought in the market.

The interesting point is that their own electricity production is almost 100% Hydro power. Hydro power, in contrast to power from fossil fuel, is more or less a pure fixed cost business. You build the hydro plant, depreciate and that’s it. If electricity prices go up, you earn more, if they go down you earn less. You don’t have to worry about oil or coal prices. On the flip side, hydro power depends on the amount of water available, so in dry years you can produce less or more in wet years which introduces some uncertainty.

But in any case, a Hydro Power “pure play” is more or less a “bet” on electricity prices. In order to check this theory, I let’s look at EDHN’s share price (in EUR) against 1 year forward prices for German electricity (as a comparison, I plotted E.on as well):

edhn eon 12m strom

I find it fascinating that over the past 2.5 years, Energiedienst more or less directly followed German power prices. We can see that E.on is much more volatile and most likely exposed to general stock market fluctuations.

Just for the complete picture a history of German wholesale electricity prices since 2007:

electricity since 2007

It is interesting to see that German power prices seem to be at the lowest level since the beginning of this time series in 2007. After the surprise phase out of nuclear power after Fukushima and the corresponding propaganda from E.on & Co, one might have expected exploding electricity prices. But it looks like that the new supply of alternative energy plus maybe reduction in consumption led to a dramatic decrease in electricity prices.

Digging deeper, I found for instance this German publication from 2011 which confirms the point, that the subsidized renewable energy will lower electricity prices in general. So for a renewable hydro player like Energiedienst, the subsidies to solar and wind have the “perverse” effect of lowering the profit of this very cheap type of electricity significantly.

The “trick” is that the electricity distributors have to buy the renewable electricity at fixed subsidized prices, but have to sell it at current market prices into the German electricity exchanges. The difference then gets charged to consumers. According to the paper, the electricity price clears at the level of the most expensive supplier. The mechanism for the renewable providers however introduces practically a big source of potentially extremely cheap electricity as it gets sold at market prices no matter how low they might be and “unelastic” to the actual demand.

Due to the low interest rates, subsidized wind parks and solar plants are still attractive investments despite the price for electricity being at multi year lows and demand being rather weak.

So the low prices are not a result of low demand, but mostly of subsidized renewable energy which will be sold as long as the price is higher than zero.

Zero hedge just had a post in its usual style, claiming that the falling energy prices are a harbinger for falling stock prices. That is correct for utilities but other than that it is just a result of the mechanism described above.

Summary:

The current system for renewable energy in Germany (selling renewable electricity into the market at any price with the consumer paying the difference) is hell for “traditional” utilities including hydro power.

The German utilities have maybe underestimated the extent of renewable production, otherwise they could have done the exactly same thing themselves. Now howver, the are in a kind of “death grip” between having to run their expensive black coal and gas plants for peaks and the articificially low electricity prices. Combined with unfavourable natural gas delivery contracts, especially for E.on the air will remain quite thin.

So unless something changes significantly, German utilities (including Energiedienst) will need a long long time to adjust capacity and change their business models.

Warren Buffet seems to be much more clever: If you can’t beat them, join them. I think this is the reason why his US utility is investing so much into Solar and Wind.

Listed German utility companies – part 1: Overview and E.on (ISIN DE000ENAG999)

In my small series about utility companies, it might make sense to start with those companies which are at least geographically in my “circle of competence”, Germany.

There are currently 8 listed companies which qualifiy one way or the other as “utilities” which are:

Ticker Name Mkt Cap EV/EBITDA T12M P/B P/E Dvd Yld
 
EOAN GR Equity E.ON SE 28,194 7.5 0.7   7.8
RWE GR Equity RWE AG 19,099 4.7 1.2 8.3 6.3
EBK GR Equity ENBW ENERGIE BADEN-WUERTTEMB 8,340 5.6 1.4 31.0 2.7
MVV1 GR Equity MVV ENERGIE AG 1,549 8.3 1.4 25.3 3.8
FHW GR Equity FERNHEIZWERK NEUKOELLN AG 72 6.8 2.1 15.6 4.5
MNV6 GR Equity MAINOVA AG 2,031 22.9 2.2 20.8 2.5
WWG GR Equity GELSENWASSER AG 1,887 17.8 2.3 19.3 3.2
LEC GR Equity LECHWERKE AG 2,198 20.0 2.7 22.6 3.2

Obviously, the large companies look the cheapest. Most of the smaller companies are in fact subsidiaries of the large players or owned by the Government such as:

– Lechwerke is owned ~90% by RWE
– Mainova is part of EON (91.3%)
– Gelsenwasser is owned by the government (92%)
– MVV is majority owned by the city of Mannheim (50.1%)
– EnbW is majority owned by the Government (85-90%)
– Fernheizwerk Neukölln is owned by Sweidish Vattenfall (80.1%)

RWE is de facto controlled by the regional government as well, only E.On to my knowledge does not have a controlling shareholder or significant Government influence.
A
s one could read in the press, the regulatory environment in Germany is supposed to be quite ugly, among others, the major issues are:

– unpredictable politics (close down of Nuclear power plants following Fukushima), the utilities are actually trying to sue the Governemnt for this
– heavily subsidized renewable energy (costs are added to the electricity bill for retail customers)
– relative low allowed yields on infrastructure which led the major players to shed electricity grids and gas pipelines
– heavy competition for instance for electricity. I just checked, where I am living (Munich), I got ~44 different offers for electricity

Going back to the “Buffet on utilities” approach, especially suing the Government (i.e. regulator) is maybe not a ver good long-term strategy if you then want to negotiate your next investment.

Another interesting aspect in my opinion is the fact, that especially the subsidiaries with purely local (regulated) focus show quite satisfying longterm ROEs.

10Y ROE 5Y ROE Debt/Equity
FERNHEIZWERK NEUKOELLN AG 18.6% 19.6% 0.0%
LECHWERKE AG 24.5% 13.9% 0.2%
GELSENWASSER AG 17.7% 12.5% 2.1%
MAINOVA AG 17.1% 9.1% 70.3%
ENBW ENERGIE BADEN-WUERTTEMB 21.0% 12.8% 94.1%
MVV ENERGIE AG 10.3% 11.3% 107.6%
       
 
RWE AG 17.4% 15.4% 122.4%
E.ON AG 10.2% 1.8% 79.2%

I find especially Lechwerke, Fernheizwerk and Gelsenwasser fascinating. Without any leverage they manage to produce solid double-digit ROE’s over long periods of time. So looking at this one might think that both, for RWE and EON, the German regulator is maybe not the real reason for their current problems.

Rather bad management and failed international expansion are the drivers between the rather bad performance in the last few years. Eon for instance lost lot of money with gas contracts outside Germany.

This is also the major issue I have with E.on. For some reason, they believe that they must grow outside Germany, just recently they swapped German Hydro plants with Austrian Verbund against a 50% stake in a Turkish utility group. Earlier in 2012 they teamed up with Brazil’s Eike Batista to invest in Brazil. Some people might like this exposure to “growth markets”, but personally I think this is a quite risky strategy.

Again, if we look at the comparable performance between E.on and its listed German subsidiary Mainova, we can see that at least this German business performs quite well and consistent despite E.on’s claims of bad German regulation:

Some additional thoughts about E.on based on the 2011 annual report:

– Nuclear is not coming back, that was more than 1 bn of EBIT which is missing going forward
– 60% of sales are actually energy trading revenues. The results of this “sector” look quite volatile
– they show huge swings in the net results of financial derivatives. In 2010 for instance, E.on showed a net gain of 2.5 bn against a 2011 loss of -1 bn .
– E.on has around 17 bn liabilities for nuclear waste etc. This liability is hard to analyse and could be grossly over-/understated. In the notes they state that the discount rate they use is 5.2%. I think this is a rather high rate. Combined with the long duration of those liabilities, there could lurk a potential multi billion hole there as well as in the 14 bn pension liabilities
– another “whopper” are the 325 bn EUR (yes that’s three hundred twenty five billion) of outstanding fossil fuel purchase commitments. Disclosure is rather limited here but I guess this is one of the big problem areas where they have locked in Russian NatGas purchases at too high rates

On the plus side we could add:

+ maybe earnings were understated to put pressure on regulators and trade unions
+ positive effect from future reduction in interest rates

All in all, EON in the current form looks like a big black box to me. mostly due to the large trading activities which are not transparent at all. I would be not able to value the company. I also don’t think it is particularly well-managed. As there is no dominant shareholder, the major “upside catalyst” could come from an activist investor. In contrast, I think current management will most likely waste the cash flow in stupid “growth investments”.

Another issue, and that goes for most of the German utilities is the fact, that the combination of Nuclear exit and strongly subsidised local renewal energy production might have altered the business model going forward. So betting on a “reversion to the mean” might not necessarily work here, at least not in the short run.

Last but not least, I don’t see how I could have any “edge” in valueing E.on. It is a liquid large cap stock, with plenty of analyst coverage. True, sentiment is quite bad which is maybe a chance at some point in time but as a private investor with a small portfolio, this is not the first place to look for “value”.

Yes I know, for many “value investors”, a P/B of 0.77 and dividend yield of 7.6% would already be enough and maybe yield starved investors will bid up E.On stocks for the dividend, but looking 3.5 years ahead, I don’t see a real “Margin of safety” at current prices with the current management and strategy plus taking into account the fundamental issues mentioned above.