* Higher equity valuation of now listed 75%-owned innogy drives increase in our RWE target price to EUR15
* Innogy’s share price, influenced by its high yield, provides a new influence for the RWE share, but other headwinds remain
* Rating upgraded to Hold with EUR15 target price from Reduce with EUR13.50 target price
* Innogy: the tail that wags the dog
In our initiation note on innogy (IGY GR, EUR36, Hold, TP EUR39), also published today, we argue that with its 70-80% pay-out, dividend yield is likely to underpin market value. Given that innogy accounts for nearly c90% of RWE's gross sum-ofparts and 90% of its 2018-19e EBITDA, according to our estimates, innogy’s share price should provide a new and positive influence on its parent company's shares.
* However, more negative factors remain
Outside innogy, however, our view is that RWE remains fundamentally unattractive:
(i) we see risk of a loss of investment grade credit rating because RWE, in cutting its
stake in (innogy’s) defensive businesses by a quarter, raises its operational risk
profile; (ii) upcoming outgoings (premium for nuclear waste storage transfer, hybrid
first calls) are likely to eat up the proceeds from the disposal of innogy shares; (iii) we
expect no resumption of the dividend on 2016 earnings; (iv) upcoming German
elections provide some degree of uncertainty; and (v) RWE’s (in our view respected)
CEO and CFO have transferred to innogy. That said, there are some more positive
elements: (i) the transfer of the waste provisions will remove a source of fragility and
uncertainty albeit only when the transfer is completely concluded, (ii) we have seen
recent wholesale power price strength on French nuclear outages: although we do
not expect these to last, they show that the perennial sentiment of oversupply is not
set in stone, (iii) the UK capacity auction may provide a boost for 2017-18 earnings,
and (iv) there should be a Constitutional Court decision on the legality (or otherwise)
of Germany's nuclear tax over the coming months. In addition, the RWE share has
been weak recently, we believe on market concerns of slower ECB corporate bond
purchasing plus a view that RWE shareholders could switch into innogy.
* Upgrade to Hold, target price EUR15
We have raised our target price from EUR13.50 to EUR15 triggering an upgrade in
our rating to Hold. We value RWE equally on sum-of-parts (within which innogy on
asset value) with 40% discount (EUR15.5 from EUR15.0) and DCF (EUR15.4 from
EUR12.0 (WACC 7.0%, terminal growth 1.0%)).