EUR 850.00 For Business Accounts Only

Morningstar | Potential Breakup and Increasing Power Prices Support EDF Investment Case

Given its low carbon intensity, EDF is the best-positioned utility in our coverage to benefit from increasing carbon prices.We calculate that a EUR 1 increase in carbon prices per metric ton would add EUR 0.50 per share, or 3%, to our fair value estimate. The benefit of increasing power prices driven by higher carbon prices is partially capped at EUR 42 per megawatt-hour due to the ARENH mechanism, which enables alternative suppliers in France to buy up to 100 terawatt-hours of electricity from EDF at that price.Alternative suppliers' demand for AREHN significantly exceeded 100 TWh in 2018, so they had to buy the shortfall at market prices. These costs are passed through to customers and mechanically increase EDF's exposure to rising market prices since EDF's selling prices for both regulated and nonregulated customers must reflect alternative suppliers' procurement conditions.Despite this current favorable backdrop, the ARENH mechanism is an option for alternative suppliers against increasing power prices but does not protect EDF against falling power prices. Therefore, the French government intends to reform the ARENH mechanism to protect EDF against falling prices and consumers against rising prices. That could be done through the creation of a corridor instead of a single price and with the obligation of alternative suppliers to buy a minimum volume from EDF.To make this reform acceptable by the European Commission, a separation of the French power generation business from the other activities is contemplated by the French government. Features of the breakup should be unveiled by year-end 2019.In any case, we estimate that a breakup would add EUR 7.50 per share, or 60%, to our unadjusted DCF-based fair value estimate due to a higher valuation of renewables and regulated assets, in line with comparables. Given the high uncertainty regarding the features and the timing of the breakup, we factor in a 25% likelihood of a breakup, which adds EUR 1.90 to our DCF-based fair value estimate.Altogether, EDF is a good investment for risk-arbitrageurs and investors willing to take the risk that EDF will benefit from higher carbon and power prices.