EUR 850.00 For Business Accounts Only

Morningstar | Engie's New Strategic Plan Disappoints on Cash Flow, but Share Price Reaction Is Excessive

Engie released 2018 results and 2019 guidance in line with expectations and unveiled its strategic plan for 2019-21. Free cash flow over the period is below expectations. Also, though it is the first time that Engie has set medium-term earnings growth targets, it gave no firm earnings and dividend targets, unlike other diversified utilities like Enel, Iberdrola or Naturgy. That might have disappointed investors. Altogether, we should not materially change our long-term estimates upon this new plan and therefore reiterate our fair value estimate of EUR 14.50 along with our no-moat, stable trend ratings. We think the pullback offers an entry point for investment.

Through 2021, Engie targets a recurring net income compound annual growth rate of 7%-9% based on an indicative current operating income CAGR of 6.5%-8.5%. Taking the middle of the range points to 2021 recurring net income of EUR 3.1 billion, 4% below our and consensus' EUR 3.24 billion estimate. We have not yet factored in the imminent disposal of Glow, which will reduce our 2021 net income outlook to EUR 3.1 billion.

The group targets EUR 6.5 billion-8.5 billion average operating cash flow over 2019-21, in line with our EUR 7.3 billion average. On the other hand, its investment budget of EUR 20 billion, of which 60% is dedicated to growth, is well above our EUR 15 billion forecast. However, management mentioned that there will be EUR 3 billion of unproductive assets at year-end 2021. Applying to them our 9% long-term return on invested capital points to additional EBITDA of around EUR 500 million, offsetting lost cash flows due to higher investments over 2019-21.

Dividend through 2021 will be based on a 65%-75% payout involving a dividend of EUR 0.90 in 2021, below our current EUR 0.94, implying a 2018-21 CAGR of 6.4%. After the share price fall, the 2018 dividend yield is 5.7%, well above the sector average, which is unjustified given lower leverage than peers and business risk in line, in our view.

The fastest-growing divisions through 2021 will be the client solutions and renewables. Regarding the former, Engie intends to focus on services such as on-site cogeneration, heating and cooling networks, or electric vehicle charging stations. Regarding the last, Engie intends to commission 9 gigawatts of incremental capacity through 2021. On the negative side, Engie expects networks' current operating income will annually decline by 1%-4% on average through 2021 due to the assumption that French gas distribution networks' returns will be cut as of 2020 versus flat returns for us. Related downside should be offset by the new cost-cutting plan of EUR 800 million by 2021, a bit shy of the EUR 1 billion recently reported by the press. Thermal generation's current operating income will decline by 3%-6% annually, notably due to disposal of contracted coal plants. The group targets EUR 6 billion of disposals through 2021, half of it from Glow. After a terrible 2018 marked by massive unplanned outages, Belgian nuclear plants' current operating income is targeted to be break-even by 2021 versus a EUR 1.1 billion loss in 2018.

During the conference call, the CEO reiterated openness to a partial exit from the French gas transmission assets through a partnership with other European players. That could drive a better valuation of these assets, in our view.

In 2018, the group's recurring net income came in at EUR 2.5 billion, in line with consensus though slightly above our EUR 2.4 billion estimate. For 2019, Engie targets recurring net income of EUR 2.5 billion-2.7 billion based on an indicative EBITDA range of EUR 9.9 billion-10.3 billion versus our EUR 10.2 billion estimate. The downside to our net income estimate of EUR 2.8 billion comes from our too-low financial cost estimates and the fact that we have not yet factored in the disposal of Glow.