More EPS downgrades to come and major dislocations within the sector: time to cherry pick
Commodity move and sell-off created major dislocations: changing views…
Over the past 10 years, the dispersion between the best and worst performing utilities has averaged 85%: this is a sector where it is possible to generate alpha. Following the recent drop in commodities and emerging markets FX, we have re-run our power price models and updated our earnings estimates. As a result, we turn incrementally cautious on commodity names where we envisage (i) c25% downside risk to consensus EPS, (ii) 2017E PE above 17x, and (iii) double-digit dividend risk. We would skew our Utilities portfolio even more in favour of Southern EU integrated (13x PE, 16-15.5% DY) and regulated names (c14.5x PE, >5% DY) where the EPS power is largely unchanged.
Turning incrementally negative on commodity names: -25% consensus EPS risk
Our new forecasts on commodity names are c25% below consensus. However, stocks appear to discount the current backdrop differently: French names largely reflect the new commodity scenario; German utilities only partially discount balance sheet risks, whilst purely unregulated utilities (FUM, VER, CEZ, CNA) do not discount the new scenario and face 10-20% downside to our base-case fair values, with 35-45% downside risk in a downside scenario. For all these names, the earnings guidance that will be disclosed at 9M and FY results is likely to be a negative catalyst.
SE integrated & Networks: cheaper, more growth and better strategies
We continue to prefer integrated utilities in Southern Europe – Enel and EDP above all – on stronger growth prospects, larger share of regulated/contracted profits and higher dividends. The relative attractiveness of fully regulated names has also risen, thanks to the lower-for-longer outlook on interest rates and the recent sell-off: we favour Snam.
Still significant downside on some commodity names; rest of sector looks ok
The earnings downgrades on commodity names will put pressure on 1/3 of the sector market cap. For the rest of the space, however, we estimate a smaller or non-existent EPS risk. In fact, most regulated / Southern EU integrated names (i) invest for growth, (ii) pay >5% (and growing) yield and, in many cases, (iii) are well positioned to capture the wind, solar and smart grid megatrends. The main risk to our "commodity" thesis is a move up in coal/gas forward curves. This would most likely depend on economic growth in Asia, which accounts for ¾ of seaborne coal and LNG global consumption.