Morningstar | The market has been too lenient on RWE's coal risk.
Since 2011, RWE has been heavily hit by the collapse of power prices and the upheaval of German energy policy; shareholders have felt this pain through cancellation of the dividend since 2015. RWE has pledged to pay a EUR 0.50 per share dividend in 2018. It is also retiring debt and plans a EUR 1 per share special dividend in 2018 to return the EUR 1.7 billion nuclear fuel tax refund it received in mid-2017. After splitting off its noncommodity businesses into Innogy in October 2016, RWE retains only its conventional generation and commodities businesses, along with a 76.8% share of Innogy. We were impressed that Innogy priced at the high end of management's target range, enabling RWE to collect EUR 3 billion of cash. RWE considers this stake to be a financial investment, implying a potential divestiture. For the moment, the EUR 680 million annual dividend RWE receives from Innogy helps to cover provision accretions and boost cash for shareholders starting in 2020.The political backdrop has recently improved for RWE. It appears the firm will avoid the worst-case scenario of massive shutdowns of hard-coal and lignite plants around 2020, owing to the failure of a "Jamaica coalition" that would have included the anticoal Green Party. The new SPD-CDU coalition is more coal-friendly. The potential implementation of a U.K.-like capacity market to offset the closure of the last nuclear reactors in 2022 could boost RWE's cash flow.RWE is the European utility most sensitive to changes in power prices. We calculate that a EUR 1.00 per megawatt-hour increase in generation spreads would add EUR 2.70 per share (14%) to our fair value estimate. RWE should highly benefit from the rise in European power prices since the beginning of 2016, which we believe is not fully priced in. Despite its coal-weighted generation fleet, we estimate that rising carbon prices would be cash-flow-neutral because RWE's carbon intensity is slightly below the correlation between carbon and power prices. Altogether, we believe the sharp improvement of RWE's operating backdrop is not fully priced in, and RWE suits non-risk-averse investors seeking exposure to rising European power prices.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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