As value opportunities become harder and harder to find in North America, I have set my sights on Europe. Europe has come a long way since the debt crisis of 2011 and the continent’s major stock indexes are now trading at levels not seen since before the financial crisis. Indeed, Europe’s leading benchmark index, the STOXX® 600 index collapsed 23% during 2011, as worries about the state of the continent’s economic situation spread. Now, the index has rebounded to levels not seen since 2006.
Still, despite these gains, there are plenty of companies within Europe’s markets that look attractive on a valuation basis. European utilities for example, have suffered more than most during the past few years as rising energy prices, falling revenues and ‘green’ taxes all eat away at profits. In addition, these utilities have been forced to close and write down numerous assets as energy demand has slumped.
Problems affecting European utilities
The scale of the problems affecting the European utility industry is best described with an excerpt from an Economist article, published back during October of last year entitled, ‘How to lose half a trillion euros’:
ON JUNE 16th something very peculiar happened in Germany’s electricity market. The wholesale price of electricity fell to minus €100 per megawatt hour (MWh). That is, generating companies were having to pay the managers of the grid to take their electricity. It was a bright, breezy Sunday. Demand was low. Between 2pm and 3pm, solar and wind generators produced 28.9 gigawatts (GW) of power, more than half the total. The grid at that time could not cope with more than 45GW without becoming unstable. At the peak, total generation was over 51GW; so prices went negative to encourage cutbacks and protect the grid from overloading.
Cheap energy from low-cost gas and renewable sources has pushed down wholesale energy prices across Europe to a point where many analysts believe 30-40% of Germany’s largest utility provider, RWE AG (ADR) (OTCMKTS:RWEOY) (ETR:RWE)’s power plants are losing money by generating and selling power. These problems are not just limited to Germany. Indeed, the whole of Europe is redesigning its power grid, focusing on renewables and cutting the cost of electricity, seeking new ways to save power and cut wastage.
All in all, this means that the old guard of utility giants are having to reinvent themselves in order to meet changing needs. It is estimated that the industry will need approximately €1 trillion, or $1.4 trillion worth of investment over the next few years to do this. The scale of this required investment is, in a word, colossal. For example, the STOXX® Europe 600 Utilities index is made up of 26 of Europe’s largest utility companies. Combined, their market cap is just under €300 billion.
Unsurprisingly, as a result of these industry-wide pressures the European utilities sector is lagging behind much of the wider market. The STOXX® Europe 600 Utilities index is still 12% below the five year high it reached back during 2009, lagging the wider STOXX® index by more than 70% over the comparable period.
But how does the industry plan to solve this problem? Well, it would appear that much of the industry is not even going to bother rising to the challenge. Instead, it would seem these giants are transforming themselves into service companies, intentional energy suppliers and providers of increasingly exotic “energy services”
Part of this strategy involves energy efficiency, installing smart devices in peoples homes to administer how much energy they use, cutting costs; described by Fulvio Conti, chief executive of Italian utility Enel S.p.A. (BIT:ENEL), “We are now providing customers with solutions, rather than just cubic meters of gas”. Elsewhere, Germany’s E.ON SE (ADR) (OTCMKTS:EONGY) (ETR:EOAN) is selling assets and investing the proceeds in renewable projects around the world, the most recent of which is a bet on US solar firm, Sungevity. Meanwhile, France’s GDF Suez SA (ADR) (OTCMKTS:GDFZY) (EPA:GSZ) is focused on the business of energy services, while closing down old power plants.
All in all then, the European utilities industry is changing, slimming itself down and moving into different markets; a turnaround story in progress.
Where can value be found?
After a terrible performance during the past few years, European utilities are now starting to look attractive after finally acknowledging that they will not be returning to the glory days of the past. Two of the continent’s biggest players, RWE AG (ADR) (OTCMKTS:RWEOY) (ETR:RWE) and GDF Suez SA (ADR) (OTCMKTS:GDFZY) (EPA:GSZ), have already cut dividend payouts by more than 30% during the past year, as well as taking pre-emptive write downs on their assets, stating that it is unlikely mothballed power stations will ever return to production.
With this in mind, the utility sector appears to be full of turnaround plays. Detailed below are 24 of the largest European utility companies along with key financial metrics in order of size, smallest to largest.
Notes on the table:
- Average figures are displayed along the bottom of the table
- Forward P/E’s below average are highlighted in green
- EV/EBITDA below average is highlighted in green
- Net debt/EBITDA above the average is highlighted in red
- ROIC 5yr average above the peer group average is highlighted in green
- P/B below peer group average is once again highlighted in green
- GDF Suez’s dividend yield is historic it is likely to be lower for this year, although management has committed to a payout of at least €1 per share.
Using the above metrics, France’s GDF and Germany’s E.ON SE (ADR) (OTCMKTS:EONGY) (ETR:EOAN) appear to be two of the best bets on the recovering industry. Specifically, both companies are currently trading below book (GDF has already taken significant write downs), debt is lower than average and P/E + EV/EBITDA multiples are below the peer group average. At the other end of the table, Poland’s ENEA SA (WSE:ENA) (OTCMKTS:ENEAY) appears attractive currently trading below book, at low valuation multiples and unusually for a utility, sitting on a net cash balance.
Conclusion for European utilities
In summary, European utilities are changing and many of the industry’s largest players now look attractive as turnaround plays. This being said, the industry is still struggling and the European economy is still on life support so many risks remain.