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Energias for adventurous income seekers

INTERNATIONAL STOCK OF THE YEAR: The risks with this Portuguese energy utility are clear but overstated, the rewards are also obvious for those who care to take a second look at these cheap shares.
January 4, 2013

How about buying in shares in a utility company that is dominant in its market, has 90 per cent of its earnings coming from regulated assets, is forecasting a stable earnings outlook next year, and has reaffirmed a dividend that yields over 8 per cent? Too good to be true? Our overseas tip of the year has all these things, but there is a tricky problem - it is in the eye of the eurozone’s financial storm. Despite that, we reckon that investors will be well rewarded to take on the risks that come with Energias de Portugal (EDP).

IC TIP: Buy at 2.4€
Tip style
Income
Risk rating
High
Timescale
Long Term
Bull points
  • Cash flow set to surge
  • Fat dividend yield
  • Debt levels at their peak
  • Backing from Chinese money
Bear points
  • Exposed to weak economies
  • Currency risk

EDP makes almost two thirds of its operating profits generating, supplying and distributing electricity in Spain and Portugal. The remaining third is split evenly between supplying power in Brazil and a renewable wind energy business, EDPR. This exposes it to two of western Europe’s weakest economies, though there are encouraging signs. Sovereign risk in Spain and Portugal is falling as the European Central Bank’s bond-buying programme has the desired effect. Yields on both Portuguese and Spanish sovereign debt are falling fast.

EDP, being a utility, also has very predictable revenues. The most recent results for the nine months to end September showed earnings before interest, tax and depreciation (so-called 'EBITDA') of €2.74bn, which was "bang in line with estimates", said analysts at investment bank JP Morgan Cazenove. Analysts at UBS have full-year EBITDA forecasts of €3.73bn, much the same as 2011's figure. Next year's target of €3.82bn requires growth of only 2 per cent.

 

 

The other big draw of EDP's shares is that dividend. Usually when a dividend yield drifts as high as EDP's, investors expect a cut in the payout and it is true that 2012's payout, costing €670m will effectively be funded by debt. However, analysts at UBS think EDP has reached a tipping point, with cash set to flood in from next year thanks to three factors. First, there should be a €500m cut in capital spending between 2011 and 2013; second, a build up in receivables should be turned into cash; third, a programme of disposals will continue. Analysts at Santander forecast a reversal from an €869m outflow of cash in 2012 to a €357m inflow next year, rising to a €1.4bn in 2014 and €1.9bn in 2015.

The cash inflow should ease concerns about EDP's debt. The EDP net debt mountain is forecast to hit €18.5bn at the end of the year. But the debt is backed by over €21bn in tangible assets and, as cash comes in, net debt is set to fall by €1bn to €17.5bn by the end of 2013.

ENERGIAS DE PORTUGAL (EDP)

ORD PRICE:€2.24MARKET VALUE:€ 8.2bn
TOUCH:€2.23-2.2412M HIGH:€2.48LOW: €1.63
DIVIDEND YIELD:8.3%PE RATIO:8
NET ASSET VALUE:€ 1.15NET DEBT:225%

Year to 31 Dec Turnover (€bn)Pre-tax profit (€bn)Earnings per share (€)Dividend per share (€)
200912.21.570.280.16
201014.21.660.290.17
201115.11.590.310.19
2012*14.81.560.280.19
2013*15.01.650.280.19
% change+2+6nilnil

BETA:1.1

* UBS forecasts £1 = €1.24

Investment from China next year could also provide a catalyst. EDP's biggest shareholder is a Chinese renewable-energy company, China Three Gorges (CTG), with a 21 per cent stake. CTG intends to buy a further 4.1 per cent and its chief executive, Cao Guangjing, was in Lisbon in December to discuss increased cooperation between the two groups, according to a Portuguese news agency. An announcement on CTG's intention to invest in Portuguese wind farms is expected soon and would be a major boost for renewable power specialist EDPR, in which EDP holds a 78 per cent stake. China Development Bank already provides some €1.8bn in funding for EDP.

Elsewhere, EDP is exposed to the slowing economy in Latin America through the Energies do Brazil. But there was good news from this quarter as the Brazilian government granted permission at the start of December for the commercial operation of the 360 megawatt Pecem plant.