Romanian Utility Sector Report - The Worst Seems To Be Over

 

Romanian Utilities - Reinitiation of coverage from Concorde Ltd. [Hungary]

 

Company name	Electrica	Transelectrica	Transgaz
Recommendation	Accumulate	Neutral	Reduce
Target Price (12M ex-div)	RON 12.0	RON 19.8	RON 270.0
Share Price	RON 10.8	RON 20.2	RON 320.0
TR Upside/Downside	+18%	-2%	-12%

 

The Worst Seems to Be Over

 

• We resume our coverage on Romanian Utilities (EL, TEL, TGN), taking into account the unpredictable regulatory framework, Romanian macro outlook and CAPEX cycle.

 

• Perhaps the worst is over, but it doesn’t mean good news is right away. Romanian Utilities have lost their attractiveness over the last couple of years. Transmission System Operators (TSOs), including Transgaz and Transelectrica and the largest Romania Electricity Distribution System Operator (DSO) Electrica were very promising IPOs, implying compelling upside potential, gorgeous return on the shareholder’s invested capital and decent dividend yield on a frontier market in the CEE region.

 

• Investment case has overturned, in our view, as Romanian Utilities couldn’t reach enough efficiency gains during the previous regulatory period, which will have a negative impact during the ongoing 4^th regulatory period. Electrica, Transelectrica and Transgaz are natural monopolies, they are subject to a strict regulatory framework. In 2018, ANRE, the Romanian Regulator, reduced the regulated return from 7.7% to 5.66%/6.66% applied for old/new RAB, respectively, but Rom. Gov’t provisioned an RRR of 6.9% applied for TSOs and DSOs, with overruling ANRE’s previous order. The overall impact was amplified by the notorious case of GEO 114 introduced at the end of 2018, as the Government levied a 2% turnover tax on the energy sector. However, this has been repealed from 2020.

 

• In comparison with Western European peers, Romanian state-owned Utilities’ assets are outdated and inefficient. Companies need to invest huge amount of cash into their grid in the next decade to narrow the gap and improve the service. We believe that free cash flow generation will be generally depressed. Learning from the past, we suggest a step back. Our point of view is that investors should take a wait-and-see approach before making an investment decision as a couple of less risky W-European peers are trading at higher DIVY than Romanian Utilities.

 

• Risk profile:

• Romanian Utilities face high regulatory risk. Companies, in our report, are subject to a dozens of regulations as a result of their monopolistic nature.
• Due to dividend paying profile, yield environment also affects the performance of these shares.
• Liquidity risk: RO Utilities have generally lower liquidity on regional comparison if we take into consideration the very low liquidity and investor’s interest.
• Shareholder structure: Except Electrica, both Transelectrica and Transgaz are state-owned companies. In our view, Government revenues from taxes levied on utilities’ turnover may further erode minority shareholder’s interests, while the Govt. can optimise between dividend and tax incomes.
• Upside risk: Due to significant wage increases in the last few years, Romanian pension funds have been able to grow intensively. This is a strong support to the domestic equity market. In addition to this, Romania will be officially included into the FTSE EM Market index in September 2020. Although utilities will not be included into the index, FTSE's decision may attract new investors to the market, which could stimulate stock trading.

 

SUMMARY

 

• Electrica: We re-initiate coverage of Electrica with Accumulate recommendation. We set our 12m ex-div TP at RON 12.0 per share, implying 18% total return from the previous closing price. Electrica went through a significant CAPEX-cycle during the previous 5-yr regulatory period. We believe Electrica will capitalize on gradually increasing RAB, higher electricity consumption and growing market share of the supply segment. In our view, Electrica’s current share price fairly priced in the full impact of an approaching RRR reduction. Based on our calculation, if ANRE reset RRR of 5.66%/6.66% for old RAB and new investments, respectively, our 12m ex-div TP should be decreased by 1.9 RON/sh to RON 10.1 RON/sh. Next catalyst might be the buy-out of CEZ’s Romanian distribution assets. Given higher EBITDA margin of Distributie Oltenia, with assuming EL’s ’21 EV/EBITDA of 4.2x, the takeover would be value accretive, in our view, suggesting us to raise our TP by 0.8 RON/sh.

 

• Transelectrica: We re-initiate coverage on Transelectrica with a Neutral recommendation. We set our 12M ex-div TP at RON 19.8 per share, implying 2% downside from the previous closing price. Transelectrica could be a central player in the international electricity supply chain as Romania has been historically an electricity exporter. Instead of improving the grid, TEL missed to reinvest its operating cash-flow at a faster pace during RP3, leaving eroding the network. Despite bouncing profitability, we forecast zero DIV in 2020 for 2019 profit. However, we assume that Gov’t will force TEL to pay-out at least 50% of net distributable profit in the mid-term, thus the Company may share its profit with the owners from 2021. Based on our worst case scenario, assuming RRR of 5.66%/6.66% for old RAB and new investments, respectively, our 12m TP should be decreased by 3.4 RON/sh to RON 16.4 RON/sh.

 

• Transgaz: We re-initiate coverage on Transgaz with a Reduce recommendation. We set our 12M ex-div TP at RON 270 per share, implying 12% downside from the previous closing Transgaz faces a heavy CAPEX-cycle and a blurry future. On the one hand, importance of natural gas is an increasingly pressing issue in light of the more restrictive European climate policy. We think that once the BRUA pipelines were finalized, Romania would be promoted to strategic gas corridor operator. On the other, the future of the regional gas market raises a couple of questions. The region has traditionally been a transit area to Russian gas imports. Transgaz is a key operator of Trans Balkan Pipeline (TBP), but Russian flow can be easily diverted from TBP to Turk Stream, which could result in a 20%/45% drop in revenue or net profit terms, respectively. Although, we don’t believe that Gazprom contracts can be easily replaced, but TBP will operate in reverse flow, perhaps delivering LNG from Greek terminals to Ukraine in the long run. We see potential loss of transit revenues coupled with increasing costs of network development likely to dampen FCF yield during RP4. Based on our worst case scenario, assuming RRR of 5.66%/6.66% for old RAB and new investments, respectively, and zero transit revenues after 2023, our 12m TP should be decreased by 60+60 RON/sh to RON 210/150 RON/sh.

 

Source: Concorde, Annual reports

 

Source: Bloomberg, Concorde

 

Source: Bloomberg, Concorde

 

PEER COMPARISON

 

• Romanian Utility Sector doesn’t seem too attractive at this time and this is the least negative adjective, what we can use for describing the current situation. Over the previous regulatory period, EL, TEL and TGN have missed to invest enough cash into their system, however, in a different extent. Although, they offered outstanding dividend yields in the past, it is not the case in the short-term. If we take into account the upcoming CAPEX-cycle, these stocks are not fitting into an old-fashioned and defensive portfolio due to its poor dividend paying profile. In contrast, we can find a many peers in WE, trading on an avg. DIVY of 4.0% in EUR terms.

 

• Western European peers are unsurprisingly trading at premium vs. Romanian utility stocks, generally. This discount is well-deserved, in our view, due to significantly higher efficiency gains. Western European peers are trading at an avg. FY20/FY21 P/E of 17.6x/16.5x and an avg. FY20/FY21 EV/EBITDA of 9.8x/9.6x, while CEE utilities (CEZ and a few Polish peers) are trading at an avg. FY20/FY21 P/E of 7.0x/5.9x and FY20/FY21 EV/EBITDA of 4.2x/3.8x. This meaningful gap between WE & CEE peers is basically driven by the depressing opinion on Polish energy policy and Government’s intention, which promotes the operation of coal and nuclear power plants. Accordingly, reduction of Polish CO2 emission will likely be slower than the desired level of the EU. This absolutely opposes to Brussels’ intentions.

 

Source: Bloomberg consensus for WE/CEE Companies, Concorde estimate for RO Utilities

 

ELECTRICA’S OUTLOOK UNDERPINS OUR VIEW TO BE OVERVALUED VS. ROMANIAN PEERS

Source: Concorde, Bloomberg

 

 

 

 

 

 

Gabor Bukta
analyst

CONCORDE SECURITIES LTD.

Hillside
55-61 Alkotás street, H-1123 Budapest.
Phone: | Mobile:
|
MEMBER OF THE CONCORDE GROUP

 

This message and its attachments contain confidential information, and their disclosure is restricted by law and the relevant regulations. If you are not the intended recipient, it may be forbidden and illegal to disclose, copy, distribute or use the information in this message. If you are not the intended recipient, please notify the sender immediately and delete this message and its attachments. If you are a client of Concorde Securities Ltd., the standpoints and suggestions described in the message should be interpreted in accordance with the relevant parts of the agreement in effect between us.

 

DISCLAIMER

This research report has been prepared by Concorde Securities Ltd., a full-service Hungarian investment banking, investment management and brokerage firm. Concorde Securities Ltd. is under the supervision of the National Bank of Hungary in its capacity as financial supervisory authority.

Concorde Securities Ltd. is registered in Hungary and does not have any subsidiaries, branches or offices outside of Hungary. Therefore we are not allowed to provide direct investment banking services to US investors and restrictions may apply to our potential investment banking services according to your country’s jurisdiction. For important disclosures to U.S. investors, please refer of the “Notice to U.S. Investors” section at the end of this Disclaimer.

Our salespeople, traders and other professionals may provide oral or written market commentary or trading strategies to our clients that reflect opinions that are their own and may be contrary to the opinions expressed in our research products, and our proprietary trading and investing businesses may make investment decisions that are inconsistent with the recommendations expressed by our analysts or traders.

Our research, sales and trading professionals are paid based on the profitability of the respective divisions of Concorde Securities Ltd., which from time-to-time may include revenues from the firm’s capital market activity. Concorde Securities Ltd. does not prohibit analysts, salespeople and traders from maintaining a financial interest in the securities or futures of any companies that they cover or trade on their clients’ behalf in strict compliance with the Hungarian Capital Markets Act.

ANALYSTS CERTIFICATION

The research analysts undersigned and responsible for the preparation of this report hereby certify that (i) the views expressed in this research report accurately reflect their personal views about any and all of the securities or issuers referred to in this research report; (ii) no part of the analysts’ compensation was, is or will be directly or indirectly related to the specific recommendation or views expressed in this report and (iii) no part of their compensation is tied to any specific investment transactions performed by Concorde Securities Ltd.

Name and job title of individuals involved in the production of this report are disclosed at the end of this report.

Concorde Securities Ltd. is a leading manager and underwriter of Hungarian equity offerings. We have investment banking and other business relations with a substantial percentage of the companies traded on the Budapest Stock Exchange and covered by our research department. Concorde Securities Ltd, its directors and employees may have a position in these securities, which may change at any time.

Concorde Securities Ltd. acted as Lead Manager of the private and public share placement of the shares of FHB in 2003, Masterplast in 2012 and Duna House in 2016. Concorde Securities Ltd. acted as the Co-lead Manager of Gedeon Richter’s exchangeable bond issue in September 2004. Concorde Securities Ltd. has provided financial advice to Magyar Telekom.

 

EXPLANATION OF RATINGS AND METHODOLOGY

Rating	Trigger
Buy	Total return is expected to exceed 20% in the next 12 months
Accumulate	Total return is expected to be in the range of 10-20%
Neutral	Total return is expected to be in the range of 10%-(-10%)
Reduce	Total return is expected to be in the range of -10-(-20%)
Sell	Total return is expected to be lower than -20%
Under Revision	The stock is put Under Revision if covering analyst considers new information may change the valuation materially and if this may take more time.
Coverage in transition	Coverage in transition rating is assigned to a stock if there is a change in analyst.

 

Securities prices:

Prices are taken as of the previous day’s close on the home market unless otherwise stated.

Valuations and risks:

Analysis of specific risks to set stock target prices highlighted in our investment case(s) are outlined throughout the report. For details of methodologies used to determine our price targets and risks related to the achievement of the targets referred to in the main body of the report or at on our website. ()

Research disclosures:

Concorde Securities Ltd. may have published other investment recommendations in respect of the same securities/instruments recommended in this report during the preceding 12 months. Disclosure of previous investment recommendations produced by Concorde Securities Ltd. in the previous 12 months can be found at . ()

GENERAL

This report is provided for information purposes only and does not represent an offer for sale, or the solicitation of any offer to buy or sell any securities.

The information, and any opinions, estimates and forecast have been obtained from sources believed by us to be reliable, but no representation or warranty, express or implied is made by us as to their accuracy or completeness. The information, opinions, estimates and forecasts may well be affected by subsequent changes in market conditions. This document may not be reproduced in whole or in part, or published for any purpose.

REPRODUCTION OR REBROADCAST OF ANY PORTION OF THIS RESEARCH REPORT IS STRICTLY PROHIBITED WITHOUT THE WRITTEN PERMISSION OF CONCORDE SECURITIES LTD.

 

NOTICE TO US INVESTORS  

This report was prepared, approved, published and distributed Concorde Securities Ltd. located outside of the United States (a “non-US Group Company”). This report is distributed in the U.S. by LXM LLP USA, a U.S. registered broker dealer, on behalf of   Concorde Securities Ltd. only to major U.S. institutional investors (as defined in Rule 15a-6 under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”)) pursuant to the exemption in Rule 15a-6 and any transaction effected by a U.S. customer in the securities described in this report must be effected through LXM LLP USA.

Neither the report nor any analyst who prepared or approved the report is subject to U.S. legal requirements or the Financial Industry Regulatory Authority, Inc. (“FINRA”) or other regulatory requirements pertaining to research reports or research analysts. No non-US Group Company is registered as a broker-dealer under the Exchange Act or is a member of the Financial Industry Regulatory Authority, Inc. or any other U.S. self-regulatory organization.

Analyst Certification. Each of the analysts identified in this report certifies, with respect to the companies or securities that the individual analyses, that (1) the views expressed in this report reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly dependent on the specific recommendations or views expressed in this report. Please bear in mind that (i) Concorde Securities Ltd.  is the employer of the research analyst(s) responsible for the content of this report and (ii) research analysts preparing this report are resident outside the United States and are not associated persons of any US regulated broker-dealer and that therefore the analyst(s) is/are not subject to supervision by a US broker-dealer, and are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with US rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.

 Important US Regulatory Disclosures on Subject Companies. This material was produced by Concorde Securities Ltd. solely for information purposes and for the use of the recipient. It is not to be reproduced under any circumstances and is not to be copied or made available to any person other than the recipient. It is distributed in the United States of America by LXM LLP USA and elsewhere in the world by Concorde Securities Ltd. or an authorized affiliate Concorde Securities Ltd. This document does not constitute an offer of, or an invitation by or on behalf of Concorde Securities Ltd. or its affiliates or any other company to any person, to buy or sell any security. The information contained herein has been obtained from published information and other sources, which Concorde Securities Ltd. or its Affiliates consider to be reliable. None of Concorde Securities Ltd. accepts any liability or responsibility whatsoever for the accuracy or completeness of any such information. All estimates, expressions of opinion and other subjective judgments contained herein are made as of the date of this document. Emerging securities markets may be subject to risks significantly higher than more established markets. In particular, the political and economic environment, company practices and market prices and volumes may be subject to significant variations. The ability to assess such risks may also be limited due to significantly lower information quantity and quality. By accepting this document, you agree to be bound by all the foregoing provisions.

LXM LLP USA assumes responsibility for the research reports content in regards to research distributed in the U.S.  LXM LLP USA or its affiliates has not managed or co-managed a public offering of securities for the subject company in the past 12 months, has not received compensation for investment banking services from the subject company in the past 12 months, does not expect to receive and does not intend to seek compensation for investment banking services from the subject company in the next 3 months.  LXM LLP USA has never owned any class of equity securities of the subject company. There are not any other actual, material conflicts of interest of LXM LLP USA at the time of the publication of this research report.  As of the publication of this report LXM LLP USA, does not make a market in the subject securities.