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Morningstar | Iberdrola's Hefty Investments Support Earnings Growth in Medium Term, but ROICs Still Unappealing

Iberdrola is the biggest Spanish utility and one of the biggest in Europe. It is the European utility with the largest exposure to the United States due to its wind development and the acquisition of UIL in 2015. Its U.S. assets are now grouped in 81.5%-owned Avangrid. Iberdrola boasts the largest wind portfolio in the world with 16 gigawatts of capacity mostly in Spain, the U.S., and the United Kingdom. The group invests heavily in onshore and offshore wind farms, mostly in Spain, the U.K., and the U.S. Renewables will be the fastest-growing segment; on our estimates, it will account for 32% of the group's EBITDA in 2023 versus 26% in 2018. Revenue tends to be relatively secure through purchase power agreements. Still, increasing competition at new auctions drives declining prices for new capacity PPAs, in turn damping returns on capital.Networks form the largest division, contributing more than 50% of EBITDA. Around 60% of the division's EBITDA comes from Spain and the U.S.; the remaining 40% is evenly distributed between the U.K. and Brazil. Regulated returns should be cut in Spain and the U.K. in 2020, 2021, and 2023. Returns are higher in the U.S. and Brazil, where investments will be focused, driving a 2018-23 EBITDA compound annual growth rate of 3.7%.Generation and supply account for 22% of the group's EBITDA. Commissioning of 2.6 GW of new combined-cycle gas turbines in Mexico in 2019 and 2020, whose earnings are secured through capacity payments, will boost the division's profitability.We appreciate the group's business mix, which is focused on networks and renewables with a strong footprint in the U.S. We forecast an 8% EPS CAGR over 2018-23. Still, growth will be fuelled by hefty investments funded by increasing debt, while interest rates could rise due to normalisation of monetary policies. Also, we dislike that the firm's return on capital is well below that of peers and the weighted average cost of capital. We forecast it to modestly improve to 6.1% in 2023. The dividend currently provides a yield of about 4.8%, below the sector average, and we project 6.1% annual dividend growth through 2023.