European utilities face unprecedented hurdles as demand for power wanes, energy prices fall and borrowing costs increase, ending the sector’s satus as a safe haven for investors’ money.
Power companies have delivered more than five years of rising profits that trebled the DJ Euro Stoxx utilities index but they have never been through a trough like the current one. Benchmark prices for power to be delivered next year in Germany, Europe’s largest power market and a benchmark for the rest of continental Europe, have dropped by a third since reaching records in July.
Refinancing needs estimated at €27 billion until the end of 2009 pose a “threat” to earnings and valuations as borrowing costs will increase steadily due to the finance crisis, analysts from JP Morgan said. The largest customers of RWE or GDF-Suez -- including chemicals company BASF, car manufacturer Peugeot-Citroen and steelmaker ArcelorMittal -- are cutting production to the extent that network operators forecast that normally stable demand for power will shrink.
“It’s all happening at the same time,” said Vinay Sharma, who helps manage $80 billion, focusing on European utilities, for WestLB Mellon Asset Management. “Once the market has realized that we have not been through something like this before, valuation premiums have to come down.”
European utility shares trade at 15 times estimated 2008 earnings, compared with 9 times for European banks and 7 times for European carmakers, according to Reuters data. Many of the sector’s largest stocks have a relatively short history on the stock market compared with other industries -- eight years for E.ON, three years for Electricite de France and less than a year for GDF-Suez.
Investors therefore lack the knowledge how their stocks fare when the going gets tough and analysts have to make educated guesses about the effects of a recession on their business. Analysts from Morgan Stanley estimate that net income of the sector will drop 5% if debt costs rise by 200 basis points (bps).
Electricite de France in November already paid some 170 bps more for a bond than it paid in August, even though it has to repay the bond issued in November earlier than the August one, which usually makes it cheaper. The Organisation for Economic Cooperation and Development expects the region’s economy to shrink 0.6% in 2009 -- a recession that will hit demand for power.
Britain’s National Grid, operator of the country’s long-distance power network, sees “larger electricity consumers reducing their electricity use” and Morgan Stanley forecasts no growth in demand for power in Germany, Italy and Spain. “These are exceptional times, there are a lot of uncertainties around -- when it comes to earnings expectations and decisions about new investments in power plants,” said JP Morgan analyst Chris Rogers. “Power companies have to wonder what kind of guidance to give investors about their earnings under those circumstances.”
In the medium term, the effects of the finance crisis are harder to predict -- and some might be beneficial for utilities. Lower investment in new power plants due to higher financing costs may reduce competition, benefiting generators such as CEZ and RWE. Sal Oppenheim analysts estimate that this effect might add as much as €2 to the price of one megawatt hour, boosting the incremental fair value of the two companies some 4%.
In the short term the effect is the opposite. Higher borrowing costs on liberalised wholesale markets such as Britain or Germany reduce profit margins as they cannot be passed on. The price of power is set by the costs of individual power plants for fuel and carbon certificates. (Reuters)