Morningstar | Market Has Been Too Lenient on RWE’s Coal Risk; Trimming FVE to EUR 19.30
We are trimming our fair value estimate to EUR 19.30 per share from EUR 20.30Â after a German court suspended RWE's allowance to clear the Hambach Forest to extend the operation of its biggest lignite mine. RWE's share price tumbled following the news release on Oct. 5, reflecting its coal risk, which the market has recently underestimated, in our view. However, after the sell-off, we believe the shares are now slightly undervalued. We reiterate our no-moat, stable trend ratings.On Oct. 5, the Munster Higher Administrative Court granted the appeal of the environmentalist group Bund, suspending the allowance to clear the Hambach Forest to extend the operation of RWE's Hambach lignite mine. With reserves of 1.3 billion tons and annual extraction of 35 million-40 million tons, Hambach is RWE's largest lignite mine and supplies its biggest lignite power plants. The final decision is potentially pushed back to year-end 2020. The group estimates the economic loss resulting from the expected operational restrictions to be in the low three-digit million euro amount from 2019 onwards. Accordingly, we factor in a negative impact of EUR 100 million at the EBITDA level in 2019 and 2020, reducing our 2019-20 EPS estimates by 7% on average. Beyond 2020, we factor in a 50% likelihood that RWE will get the allowance to clear the forest, which is a EUR 50 million negative impact on EBITDA to perpetuity. As a reminder, we assume that management will implement an additional cost-cutting plan of EUR 200 million at its lignite assets.
The current consensus average target price of EUR 24.80 shows that the market has been too lenient on RWE’s coal risk, in our view. Generation from hard-coal and lignite plants accounts for half of RWE’s total generation and 40% of electricity produced in Germany. As most Western European countries will exit or drastically reduce the share of coal in their generation mix in the 2020s, pressure will increase on Germany to follow the pack.
RWE is an electricity and gas company. The Conventional Power Generation segment consists of the activities of RWE Power, Essent and RWE npower. The Supply/Distribution Networks Germany segment supplies electricity, gas and heat. The Supply Netherlands/Belgium segment comprises the activities of Essent in the Netherlands. The Supply United Kingdom segment comprises the operations of RWE npower. The Central Eastern and South Eastern European segment contains activities in the Czech Republic, Hungary, Poland, Slovakia, Turkey and Croatia. The Renewables, Upstream Gas & Oil and Trading/Gas Midstream segments include the activities of RWE Innogy, RWE Dea and RWE Supply & Trading, respectively.
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