Tag Archives: utilities

Short EDF/ Long Engie: Why Investors Should Prefer Commodities Over Politics

Summary Engie’s share price has under-performed EDF despite its much stronger positioning in terms of strategy and financials. EDF is exposed to materially higher political risk than Engie and the Areva deal is does not mean an end to it. There is now increased execution risk for EDF, while recent short term headwinds should reverse for Engie. EDF (OTC: ECIFF ) and Engie (OTCPK: GDFZY ) are both major French energy companies with global operations. A short EDF / long Engie trade is based on political risk, balance sheet strength, growth prospects and corporate strategy. Some key points are: chosen (Engie) vs. forced acquisitions ; commodities exposure with reasonable hedge (Engie) vs. capped tariffs ; balance sheet strength (Engie) vs financial strain ; earnings growth (Engie) vs. flat earnings . EDF has outperformed Engie by 300bps year to date, even when including the period during which one of the arguably worst news flow for EDF has come into the market. Engie’s under-performance is largely due to commodity weakness. I expect relative performance to revert strongly. Key catalysts Potential catalysts for a reversal of performance are plentiful: · Any indication of a turn in commodities prices. Failing that, improvement in the LNG to oil spread would have the same result, even though it will take longer to feed into the share price. · News flow on a re-start of the Belgian nuclear reactors Tihange and Doel should remove an overhang for Engie and lead to out-performance. · Over the summer, there will be abundant news flow and uncertainty with regards to EDF’s regulated retail tariffs. · EDF will soon give an update on its investment decision with regards to the nuclear new build project at Hinkley Point in the UK. There is a high chance for a negative reaction either way: Either, EDF will proceed – then there may be concerns over financing, the company’s ability to source enough partners and long term cash generation and profitability of the project. Or, it does not go ahead. That would lead to a very negative reaction on the loss of a long term opportunity. Another possibility still, would be further delay, again likely to lead to EDF underperforming. · Engie management has communicated it is in acquisition mode. Judging by the company’s track record, a growth acquisition would likely lead to outperformance. EDF EDF is the dominant French power utility. It controls the country’s nuclear power plant base of 63 GW and has an 85% supply market share. It also runs 9GW of nuclear capacity in the UK and is engaged in the UK’s nuclear new build programme, by far the largest in Europe. In France, there is limited competition, with the most important competitors being Energie Direct (an independent supplier with very little vertical integration) and Engie (a global integrated energy company and the dominant national gas supplier). The French government owns 85% of EDF. Key bear points: · Political intervention. There is consistent intervention by the French government into electricity markets, regulation as well as the company’s strategy. The CEO is government appointed. The company is seen as a public good as well as political vehicle by the government. It is questionable to what degree minority shareholders are relevant for the crucial decisions by the government. This has been illustrated very strongly by the government orchestrated acquisition of Areva’s (OTCPK: ARVCY ) nuclear reactor business by EDF. The French government has decided, not surprisingly, to execute its plan A, EDF acquiring Areva’s entire nuclear reactor business. EDF’s offer stands at Eur 2.7bn, or 0.74x book. EDF will acquire a majority and Areva retain a minority stake in the business. The potential for the business to be structured in a joint venture, but with the same majority EDF/minority shareholding structure. Areva itself will become a front end and nuclear fuels company. The take out multiple is expensive for a business with large unknown liabilities. The most important liability is the Finnish project, but there are others, too. As I have previously argued, reactor construction and export is outside of EDF’s core competencies. EDF will further strain its balance sheet. In addition to the straight outlay for the deal, it will have to take on provisions. The benefit for EDF, streamlining of its own reactor build and maintenance will be marginal when compared to the risk and financial strain. · A very large part of the company’s revenues are conditioned on government regulated tariffs that are not reflective of EDF’s true cost base. There is little prospect for tariffs reaching a level that reflects costs any time soon. Rather, the prospect for any significant tariff increase has been pushed away further than ever. EDF is currently asking the government for a 2.5% increase to regulated tariffs over three years. It is the time of the year where the negotiations for the annual tariff increase begin, to be confirmed in August. This increase is particularly sensitive, because it comes after the Energy Minister froze tariffs, and now because of the Areva deal. There are suggestions that a stronger tariff increase might be a reward for EDF’s offer for Areva’s reactor business. The government will tread very carefully, in order to avoid any negative interpretation on the Areva re-capitalisation vs consumer vs taxpayer interests. Also, the new formula fixed by the government gives some framework for tariff increases. The government had just devised that formula last year, in order to reduce tariffs, and asked EDF to reduce costs. A u-turn would be difficult. Investors should keep in mind that nuclear energy is seen as a public good, the profits of which are not due alone to EDF shareholders. That opens the way for redistribution · EDF is very strained on capex and the balance sheet. Net debt exceeds 4.4x Ebitda. EDF needs to finance over Eur 60bn capex over the next five years, out of annual operating cash flow of Eur 12bn. The company has reported negative free cash flow before dividends for 2014. All of that is before the significant impact of nuclear new build capex yet to come. The company is engaged in the very sizeable nuclear new build programme in the UK. · The French government has just approved a bill that foresees the reduction of nuclear in the country’s power mix from 75% to 50%. That will likely mean early closures of EDF plant, even if only over a longer term horizon. Engie (GSZFP) Engie is a global integrated energy company. It is dominant in the French gas downstream market. It has a globally diversified portfolio of power generation assets and is one of the largest global LNG operators. The company owns a large energy services business. Key bull points: · The recent share price under-performance reflects pressure on global LNG margins as a result of weak pricing. That is now a consensus view. Meanwhile, Engie benefits from an LNG/oil price hedge that shelters its margins to a degree. Despite short term commodity headwinds, the company’s vertical integration gives it a very good hedge and margin protection. Its positioning across the energy value chain is second to none. · The company has the best positioned power generation portfolio in Europe, if not globally. It is the largest global IPP with a well-diversified portfolio. Its generation business is amongst the most profitable in the European sector. It benefits from the growth trend in renewables through well diversified assets. It globally has over 10GW of power generation assets of various kinds under construction. It proactively captures the renewables trend with a deep and diversified pipeline across the mature technologies. · Engie is largely deprived of political risk, contrary to EDF. Its regulated gas tariffs are governed by a transparent formula and are not high up on the current political agenda. It comes from a background as a fully private company and has never seen the same kind of intervention as EDF has. Even though there is now a state participation of 30% that is unlikely to change. The state has been almost completely hands off. There was no suggestion of Engie having to participate in the Areva restructuring, for example. · Engie’s balance sheet is amongst the strongest in the sector. Net debt stands at 2.4x Ebitda. Capex of Eur 6bn is well covered by operational cash flow of Eur 8bn. Along with portfolio rotation, the company will have Eur 6-7bn of growth capex pa available. Given its very strong asset base, opportunities with synergies and/or acquisitions with a fast impact are plentiful. · Engie’s energy services business captures the most important new growth trends in the energy sector: Energy efficiency, new capacity build and optimisation. The company’s market leadership is getting built out further and gains further speed. As an additional benefit, the business is characterised by high and stable margins, which compensates for current volatility in the commodity exposed businesses. EDF trades on a P/E of 9.6x, Engie on 13.7x 2016E. Engie’s P/E is in line with the sector, whereas I believe it merits a premium. Further, the difference reflects stronger earnings growth: Engie’s EPS are likely to growth 6% pa compound 2015-17, whereas EDF’s are flat over the same period. EDF has historically traded on a discount to the sector. Engie trades on a 2016E EV/Ebitda of 16.2x, EDF on. Engie’s 5.7% yield is much better underpinned than that of EDF of 5.8%. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Is Targa Resources The Next Energy Sector Takeover Candidate?

Summary In the current low energy price environment, strong companies are looking for assets or companies they can take over on the cheap. Targa Resources Corp. is the general partner of a quality MLP that has suffered with lower energy commodity prices. TRGP is down 35% even as dividend increased 6% every quarter. Several large cap energy midstream companies could start a bidding war for TRGP. A 30% premium on the current share price is not out of the question. The steep declines in the energy commodity prices have led to speculation about mergers or acquisitions in the sector. I primarily follow the MLP and related companies, and so far in 2015, acquisition activity has been light. Vanguard Natural Resources LLC (NASDAQ: VNR ) has agreed to acquire a couple of smaller upstream MLPs and Enterprise Product Partners LP (NYSE: EPD ) just announced a $2.1 billion private deal acquisition of gathering and processing assets. Outside of these I can’t think of any meaningful purchases. I think that Targa Resources Corp. (NYSE: TRGP ) could be ripe for a take over offer from an energy midstream company looking to add quality assets and a historically successful midstream operation. Targa Overview Targa Resources Corp. owns the general partner interest and 9.1% of the LP units of Targa Resources Partners LP (NYSE: NGLS ) a $7.9 billion market cap midstream MLP. NGLS generates about 40% of its operating margin from gathering services in Texas and Oklahoma and the balance comes from logistics and marketing, which includes the following services: Targa Resources Corp. has used the GP incentives growth model to produce a high level of dividend growth compared to the NGLS distribution growth rate. If you are not familiar with the GP growth potential, I covered how the partnership system works in this article . Over the last three years the TRGP dividend has increased 27% up to 35% year over year every quarter. This growth in the TRGP dividend was fueled by high single digit distribution growth at the MLP level. Targa Resource Partners has aggressively developed and acquired midstream assets. The company has invested over $2 billion in organic capex since 2012, bringing $1 billion worth of projects online in each of the last two years. In addition, over $8 billion in acquisitions have closed over the last three years. In February Targa Resources closed its acquisition of Atlas Pipeline Partners, LP and Atlas Energy, LP. Commodity Price Declines Slow DCF Growth In the current slower drilling and lower energy price environment, Targa Resources Partners most recent guidance is for 4% to 7% distribution growth in 2015 with 1.0 times distributable cash flow coverage. In 2014 the NGLS distribution grew by 8% on 1.5 times DCF coverage. The Targa Resources Corp dividend guidance for 2015 is 25% growth, compared to 27% growth in 2014. The market has noticed the significant drop in DCF coverage at the MLP level, pushing down the NGLS and TRGP share prices by 30% and 35% respectively since last September. In 2015, the TRGP share price has cycled a couple of times between about $90 and $107. In the last 6 weeks the price has dropped from the $107 cycle peak to currently trade around $90. Reasons for the decline seem to be around falling energy commodity prices and the failure of TRGP to announce some sort of MLP roll up plan similar to the recent Kinder Morgan Inc. (NYSE: KMI ) and Williams Companies (NYSE: WMB ) moves. See: Income Power Couple: Stacking Kinder Morgan Against Williams Companies The steep share price decline has pushed the TRGP yield up to 3.6%, well above the low 2% yield the company carried last year and the 2% to 2.5% rate the market current puts on 25% high visibility dividend growth. It seems that the market does not believe that this year’s growth guidance will be met and prospects have slowed for Targa Resource Partners in the longer term. Potential Acquirers In spite of the current downturn in values, the Targa Resources companies have a high quality book of assets and operations. The company’s gathering assets are in the heart of the Permian basin and the processing, storage and export assets are in prime locations on the Gulf Coast. To acquire these assets would be a boost to one of several large cap midstream companies. If a company buys up TRGP as the general partner, the MLP is then controlled, to be merged with other assets or left as a stand alone partnership. Here are a couple of large cap MLPs that would benefit from the acquisition of Targa Resources Corp and have the resources to make a $6 billion or higher bid for the company. Enterprise Product Partners : With its $60 billion market cap, EPD needs to make meaningful acquisitions to move the needle. The Targa assets would dovetail in nicely with the Enterprise holdings. EPD made a similar acquisition last year by first buying the privately held Oiltanking GP interests and then later making an offer for the publicly traded Oiltanking LP units. Williams Companies likes to view itself as one of the major natural gas infrastructure players. Acquiring Targa would be similar to last year’s absorption of Access Midstream Partners. Williams first picked up all of the Access GP ownership and then merged the MLP into Williams Partners. Energy Transfer Equity LP (NYSE: ETE ) : The Energy Transfer group has been a more of build by acquisition set of businesses. Last year they made a run at Targa, but nothing came of it. I would not surprise me if Energy Transfer made another offer for the company. If one of the listed companies made an offer for TRGP, it would not be a surprise to see a bidding war break out. An offer of $120 per share might be enough to obtain the company. Disclosure: The author is long TRGP, KMI, WMB. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.