Utilities are a safe haven for risk-averse investors. Populations are expanding, more people are living in cities and global demand for electricity is rising. Due to regulation, returns tend to be predictable, allowing bumper dividends to be paid. So why have shares in Enel, Italy's largest power firm, tanked over the past 15 months, putting the stock on a forward p/e ratio of just 7.3 with a 5.5% dividend yield?
It's largely been down to the ongoing crisis in southern Europe. Enel has net debt of €47.6bn, equivalent to 2.9 times EBITDA. If the central bank doesn't bring down sovereign spreads, Enel's debt costs could rise from today's 4.9%. Yet the average loan maturity is about 6.5 years, with 68% paying a fixed rate. This should give Enel room to bring the debt load down, which is what CEO Fulvio Conti is doing.
He has laid out cost-cutting plans to generate €5.9bn of additional annual cash flow by 2015. So EBITDA should come in at €16.5bn for 2012, €17bn in 2014 and €19bn in 2016. Net borrowing should fall to €43bn in 2012, €39bn in 2014 and €30bn in 2016. That would almost halve gearing levels.
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Enel (MI: ENEL), rated a BUY by Goldman Sachs
Enel's merger with Spain's Endesa has been completed and €1bn of synergies were extracted in 2011. Weaker demand in Italy (32% of sales) and Iberia (33%) should be offset by its operations in Latin America (19%), Russia (8%) and eastern Europe (8%). It also benefits from not being dependent on a single fuel source, supplying power to 61 million customers from its renewable (28%), coal (32%), nuclear (14%) and gas/oil (26%) assets. There are opportunities to further reduce costs by re-negotiating expensive gas supply agreements with Russia and investing in new smart-grid technology.
Enel is exposed to European politics, including possible new consumption taxes in Spain aimed at reducing the country's deficit. Volatile commodity and foreign-exchange prices need to be watched too. All the same, this is not a high-risk play buying a stock that supplies something that everyone needs every day is a sound move.
I value the company on 6.5 times EBITDA. Adjusting for debt, a €3bn pension deficit and €7.6bn of legacy liabilities delivers an intrinsic worth of more than €3.50 per share. Goldman Sachs has a target of €3.80 and third-quarter results are due out in November.
Rating: BUY at €2.70
Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments. See www.moneyweek.com/PGI, or phone 020-7633 3634 for more.
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