EDPFY - EDP Is Trending In The Right Direction Thanks To Hydro

2023-03-05 11:13:32 ET

Summary

• EDP sees decent capacity growth, which together with operating leverage created great EBITDA growth of 21%.
• Hydro conditions improved in Q4, while being weak for the 9 months, so we should see some uplift from improved hydro volumes in 2023 with some mean reversion in rains.
• Thermal generation had to step in hydro's stead, and that helped hit the pretty great EBITDA growth achieved by the company.
• Also, the networks business benefits from revisions to regulatory WACCs as inflation rates rise.
• It's a decent valuation, and the reinvestment economics are decent as developers of their own capacity. 20x is a buy-level for EDP, and works for safer investors especially.

Energias de Portugal (EDPFY) is a very solid utility play with great reinvestment economics and a relatively low valuation considering internal ROIs. Newbuilds in renewables have added to the EBITDA, as well as step up from thermal generation in order to compensate for the declines in hydrology. Moreover, inflation has allowed for increases in the regulatory WACC paid on RAB. The key thing is the 20x multiple is actually low when you consider that the reinvestment economics are about a 15-20% ROI on new capacity, and we're glad debt is growing in order to capitalise on that.

FY Results

The FY results are pretty easy to parse:

Growth in capacity plus some operating leverage has made good contribution to the net income in the wind and solar developments.

Networks are regulated utilities where income is based on a regulated asset base ((RAB)) and the companies are remunerated on that base with a regulatory WACC that is revised upwards as inflation and other benchmarks grow. That has happened, and networks, which is a super safe and stable business from a commodity and operational point of view, has managed to be a growth contributor in terms of EBITDA. The contribution is from Brazil where a traditionally more volatile benchmark gets revised frequently on higher inflation or other key macro data.

Hydro production is down substantially by about 30% due to dryness in Iberia. 50% growth in thermal production has compensated for the weakness in hydrology. This isn't very green, so the recovery in hydro in Q4 is a good sign, and we've seen improvements in hydrology conditions across our coverage universe. We should see some more EBITDA uplift thanks to those volumes in 2023.

Bottom Line

The reinvestment economics are pretty excellent. The ROI is between 13-20% on reinvesting into development of new renewable capacity, and the debt has grown by about 30%, despite positive cash flow contributions from operations, in order to plough as much money as possible into that. Reinvestment economics are an exceptionally important driver of value. On top of capacity to produce income growth, the ROIs that will create mature and valuable cash streams as the developments are completed mean that a 20x multiple, which is a medium growth multiple assuming no exceptional reinvestment economics, looks pretty low.

Companies with both good growth and reinvestment economics substantially in excess of WACC, where WACCs are low for utilities, can easily exceed 20x valuations and get up to the thirties. For safe investors looking for both some decent yield above 4% but also have them undergirded by utility economics and have a value proposition too might consider EDP.

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