German Utilities : No aspirin for the Energiewende hangover [Investec Securities]
Germany’s Energiewende is testing the resilience of both E.ON and RWE’s business models.

Consensus ‘hard times’ until 2016 are now baked into share prices.

However, we remain cautious beyond 2016, in contrast to some more bullish assessments.

Capacity is adequate and capacity payments will be slow to materialise.

The nuclear issue still embeds some risks.

Valuations remain relatively unsupportive at our cost of capital estimates. * Energy policy: German energy policy is dominated by the Energiewende, and by the country’s Delphic gas policy.

The latter is complex and our focus is on the former.

We have great sympathy with the German utilities.

In good faith, and with a good deal of prodding from EU regulators, they prepared for an EU energy market structure that has not emerged.

They are now faced with the rough end of a ‘nuclear bargain’ and undermining from a renewables revolution that will not go away.

The short term (to 2016) prospects for E.ON and RWE are difficult at best.

The real issue is whether post 2016 holds any relief. * Capacity payments and nuclear liabilities: We retain a cautious view on the prospects for E.ON and RWE post 2016.

We fail to see any easy recovery in power prices, given the capacity situation, and given further renewables growth.

We fear capacity payments will be slow to emerge and bedevilled by politics.

Moreover, the whole nuclear issue in Germany remains a good deal murkier than is commonly supposed, and we do not foresee ‘easy wins’ for the utilities in the courts.

Any future grand bargains on the nuclear phase out and decommissioning are distant in our view, and maybe even far-fetched.

Battles remain to be fought, with the utilities not in a strong bargaining position. * Strategy: E.ON and RWE are to be commended on relatively clear and ruthless strategies to weather the storm.

These are aimed at achieving structural debt reduction, through operational efficiencies, tight capex control, asset sales and dividend caution.

Beyond that, there are differences starting to emerge between the ‘old twins’.

E.ON remains committed to upstream oil and gas, and emerging markets growth.

Conversely, RWE is setting a new moat up around a core EU perimeter, with a skew to distribution/supply.

Which is better? Perhaps the safest judgement is Zhou Enlai’s observation on the significance of French revolution nearly 200 years later, ‘it is too early to say’. * Valuation: Current valuations are not particularly supportive of the German utilities, based on our DCF methodology.

We acknowledge important 2-sided risk around estimates of the ‘fair’ cost of capital.

While retaining our bearish stance, we admit that cost of capital considerations are likely to assume an ever greater role in explaining share price volatility at both E.ON and RWE in future, given their emerging business mixes with a strong regulated component, especially at RWE.
To access the full note please click here Analyst: Harold Hutchinson +44 (0)20 7597 5069
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