EUR 850.00 For Business Accounts Only

Morningstar | Innogy Maintains Full-Year Outlook Thanks to One-Offs; Shares Fairly Valued

We reiterate our fair value estimate of EUR 40 per share, along with our no-moat, stable trend ratings, after Innogy released nine-month results in line with expectations while reaffirming its full-year guidance. Our fair value estimate is in line with the takeover price from E.On. At the end of its extended offer period in late July, E.On had acquired 9.4% of Innogy stock out of total minorities' share of 23.2%. The remaining 13.8% of minorities that did not tender their shares to E.On could be compensated through shares in the merged new company, guaranteed dividend, or compensation payment. Altogether, the stock is being driven by risk arbitrage and not by fundamentals.

Adjusted EBIT decreased 11% to EUR 1.87 billion, in line with the first half's 10% decline and consensus expectations. Adjusted net income dropped 26% to EUR 721 million versus 23% in the first half, in line with consensus expectations.

In line with the first half, the key negative driver was the retail business, which saw EBIT drop 24% on fierce competition and commodity cost increases in the Netherlands in the first quarter due to cold weather. Consequently, Innogy lowered the division's full-year EBIT outlook from around EUR 750 million to over EUR 700 million, still above our EUR 0.67 billion estimate. Renewables' adjusted EBIT fell 14% versus 12% in the first half on low wind levels. Consequently, the group lowered the division's 2018 EBIT outlook from EUR 350 million to EUR 300 million. Grid and infrastructure's EBIT slid 3%, in line with the first half chiefly due to lower returns for German gas networks in the new regulatory period. Still, Innogy raised its outlook for the division from around EUR 1,850 million to around EUR 1,950 million thanks to provision releases and higher equity income. That enabled the group to maintain its full-year guidance of adjusted EBIT of EUR 2.7 billion and adjusted net income above EUR 1.1 billion, in line with our estimates.

Underlying issues faced by the retail and infrastructure businesses will persist in future years and will affect E.On, which will acquire these businesses upon the transformative deal with RWE. That highlights the poor rationale of the deal for E.On that we have already highlighted.

On Nov. 8, Innogy and SSE decided to enter into negotiations to adjust the terms of the merger of their respective U.K. retail arms. An update of the discussions should be provided by mid-December, and the merger will probably be delayed beyond the first quarter of 2019, according to SSE. The reason for these "adjustments" is the pressure from credit rating agencies requiring the new company to post higher collateral to obtain and retain an ''appropriate credit rating'' against a tough backdrop marked by the default tariff cap and high commodity cost increases over the last months. That evidences the structural weakness of a pure retail player and should have been anticipated by respective managements. So far, we have calculated that the deal would be value-neutral for SSE as synergies will be offset by poor profitability of Innogy's U.K. retail arm, Npower. On the flip side, we estimated that it would be value-accretive for Innogy, though that does not matter anymore because our Innogy's fair value estimate is aligned with E.On's takeover bid. In all, additional cash injections would be value-destructive for SSE, which is due to have a 66% stake in the new company. Should the deal be eventually scrapped, that would further dent SSE management's credibility.