Tag Archives: Utilities

Updates: MIFA & Nuclear decommissioning liabilities

Just a few quick comments on events that caught my eye while I was on vacation:

MIFA

As predicted in my post some weeks ago, the troubles of MIFA were clearly not a temporary 2013 “accounting system” issue but a result of dubious inventory accounting over multiple years (or simply stated – fraud):

This is the quote from the news release last week:

In the course of investigations by the Management Board and Supervisory Board of MIFA, it has been detected that also the previous years’ financial statements contain material misstatements. These misstatements relate to the inventories of raw materials, consumables and supplies as well as finished goods. Recent findings show a cumulative inventory difference in the amount of approximately EUR 19 million, which originate from the financial statement 2012 and previous years.

This is what I wrote 7 weeks ago, just based on public information:

I do not claim to really understand what MIFA was doing and I have no idea if they will survive or not. However, just by looking at their historical material costs and inventory level, it seems unlikely that the newly introduced accounting system could be responsible for a 15 mn loss. For me it is much more likely that the inventory build up at least since mid 2012 lead to overstated results over a longer period of time. The 15 mn loss announced seems to contain a significant write down on inventory as well. I could imagine that they might have to restate older financial statements as well.

Both, stock and bond look like “terminal decline”:

It looks like that the company lost money for a long time and made profits only by faking inventory levels.

I have often said that Grman listed Chinese companies are fraud, but clearly we have a lot of “home grown fraud” here as well. It will be interesting to see if someone is going to jail for this. I guess not

German utilities / decommissioning liabilites

Some months ago, I looked briefly at Eon’s nuclear decommissioning liabilites, which, in my opinion were clearly under reserved as the discount rate of 5% is far above anything being used elsewhere. That’s what I wrote back then:

EON has 16 bn EUR of reserves on its balance sheet for the decommissioning of nuclear power plants. Those 16 bn are clearly already reserved in the balance sheet, but as they will be due in cash rather sooner than later, they should be clearly treated as debt and added to Enterprise value.

However, there is a second issue with them: For some reasons, they are allowed to discount those amounts with 5% p.a. This is around 2% higher than for pension liabilities which in my opinion is already quite “optimistic”. They do not offer any hint about the duration of those liabilities, but if we assume something like 10-15, just adjusting the discount rate to pension levels would increase those reserves by 3-5 bn and reduce book value by the same amount.

I was therefore quite surprised that there seem to be negotiations that the German Government will take over those liabilities. Here is a “Spiegel” article in German which points ut that there seem to be supporters for this on the political side.

The argument made is that if the Government takes over the liabilities, they would not bear the credit risk of the utilities. However that argumentation has some serious flwas:

– the German utilities have indeed made reserves on their liability side, but they are clearly NOT backed by cash on the asset side. In the table I linked to one can clearly see that the liabilites are only partly financed by liquid assets. If we take out working capital requirements, my assumption would be that less than 50% is backed by liquidi assets.

– as I said before, the current liabilites are clearly underreserved. Without knowing anything about the technical aspects, alone the 5% discount rate used indicates 20-40% under reserveing depending on the duration of the liabilites and based on EON’s cost of debt. Clearly if the German Government would take over the liabilities, we would need to discount at German Government rates meaning the fair value or better cost to the taxpayer might be more than 50% more than reserves.

If the utilities would be succesfull with this, both, EON and RWE would be a strong buy and the German taxpayer a strong sell. Maybe I should hedge my position as a German tax payer with a long position in RWE and EON ?

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.