* Equity investors should focus on the balance sheet, not the P&L
EDF appears to bulls a story of increasing tariff visibility (a 3 month tale we
don't really quibble with). We think instead it is a story of over-discounted
nuclear liabilities. Its pension liabilities look headed for a 3.0% discount rate,
yet nuclear costs are discounted at 4.8% (the undiscounted liabilities are
E70bn, discounted are E33bn; the market cap is E46bn). When (not if in our
view) the true scale of liabilities is faced some degree of financial restructuring
and dividend cut seems likely. We resume coverage of EDF with a Sell
recommendation and €18/share price target.
* EDF’s nuclear provisions look too low in a world of low interest rates
EDF estimates that it would cost €70bn in today’s money to deal with French
nuclear liabilities, but has a provision of €33bn on a discounted basis. We
value the liability at €53bn since we find EDF’s 4.8% nominal discount rate
implausibly high as a near ‘risk-free’ rate when EDF’s own 2033 bond is
yielding 2.7%. We use a 3% nominal discount rate to value the liabilities and
assume a 10% cost overrun. This gives an €18/share valuation. Using the
undiscounted provision would cut our valuation to €12/share. Using EDF’s
book value would increase our valuation to €26/share
* Investors should not be tempted by the 30% upside to sector P/E
Decisions on the French nuclear resale price and end user tariffs in the next 3
months should give more visibility on EDF’s revenues. Consensus earnings
expectations look plausible to us and a sector average 2015 P/E would suggest
a €31 share price (30% upside). However, we believe it would be dangerous to
ignore the balance sheet risks, which could threaten the long-term dividend
profile.
* Valuation and risks
We resume coverage on EDF after recently becoming derestricted, with a Sell
recommendation and €18/share target price. We value the shares using a sumof-
the-parts methodology, using a DCF for the French nuclear fleet (3.2% pa
tariff increases to 2018 ex renewables, 5.6% post-tax WACC) and UK
generation, and a 3% discount rate for the nuclear liabilities (vs 4.8% in the
accounts). Key upside risks would include higher tariff increases, and more
confidence in long term dividend security from energy policy statements