ENLAY - Enel: New Priorities Set By Management Should Help Close Valuation Gap

2023-07-28 07:36:07 ET

Summary

• Enel's 1H23 EBITDA was 4% higher than expected, driven by rapid expansion in Italy and positive developments in energy generation and retail customers.
• New management has set priorities to boost productivity, improve capital allocation, and maintain focus on Enel's integrated strategy.
• Despite impressive performance, Enel's valuation still lags behind the index, but the upcoming capital market day could close the valuation gap.

Summary

Following my coverage on Enel ( ENLAY ), which I recommended a buy rating due to my expectation that ENLAY is one of the world's foremost leaders in accelerating the energy transition on account of its global reach and the scalability afforded by its vertically integrated business model. This post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating for ENLAY as I expect the valuation gap to close between itself and the index, and the catalyst to this closure will likely be the specific disclosure or discussion (likely in the coming capital market day) on how management will seek to achieve the priorities they have set.

Results

Enel's EBITDA for 1H23 was €10.7 billion , which was 4% higher than expected. It appears that rapid expansion in Italy is largely responsible for the impressive results. In particular, energy generation that is closer to what management expected, which has resulted in large repurchase costs, and the repricing of free market retail customers are the main drivers of positive development in Italy. Management also expressed optimism that the company would complete its €12.2 billion 2023 divestment program as planned. So far in 2023, the company has finalised or announced the sale of €6 billion in assets (up from €5 billion in 1Q23), with another €4 billion in asset sales now in advanced negotiations. Additionally, management restated their full confidence in their FY23 projection, which calls for €20.4 to 21 billion in Ordinary EBITDA and €6.1-6.3bn in Net Ordinary Income. It was also announced that the FY23 DPS will be set at €0.43, in keeping with the five-year plan presented at the 2022 CMD.

New Management, New Priorities

The new management presented their first set of financial figures on 1H23. Management has three main priorities. The first is to operate a leaner ship and boost productivity. The second is to prioritize value creation and improved capital allocation to increase risk-adjusted returns. Third is to maintain focus on Enel's integrated strategy. While specifics are being kept under wraps, the message seems to indicate that the company is shifting its strategic priorities but rather deploy a more efficient capital allocation process. My analysis of these developments and the reasons I see them optimistic for the company are provided below.

Maximizing risk-adjusted returns, which I interpret as providing value to shareholders, and enhancing efficiency are the two primary goals. As for the first, it's great news since it shows that the management is committed to restoring profit margins, which I benchmark against their historical highs (a sustainable EBIT margin of about 15%). As for the second point, I believe investors will be pleased to hear that it likely meant that dividends will be distributed more consistently and that management will be intent on maximizing cash flows. The recent elimination of C-suite roles, which has resulted in a more streamlined management structure (discussed in the call), is, in my opinion, strong proof that management is keeping its word. The scale of the cost savings that ENLAY can achieve as a result of this is made clear by the fact that management has made a point of emphasizing the complexity of the processes they have discovered within the organization.

Overall, I believe that Enel's new management has restored a commitment to efficiency, and I expect long-term investors will approve of the company's efforts to boost cash flow through increased efficiencies and a more discerning approach to allocating resources.

Balance Sheet Should Get Stronger

Even if the firm falls short of the targeted €12.2bn in profits from disposals, management has made it plain they would still be aiming for a net debt of €3.0bn by the end of 2023. As was previously noted, FY23 disposal proceeds are highly predictable as all acquisitions have either concluded or are in the early stages of negotiation, as such, I am even more confident now that ENLAY will be able to hit its leverage target.

Valuation

ENLAY continues to trade at a steep discount to the index, despite the strong growth this quarter, a fresh update by the new management team on their focus (which is very positive), and a clear outlook for deleveraging the balance sheet. I think the key catalyst to closing the valuation gap is the next capital market day, in which the new management team will share their specific plans for achieving the three focuses they mentioned in this call. ENLAY trades at 10x forward PE today, suppose it trades at 13x, in line with the index, the stock should be worth EUR8.10, or 30% upside.

Conclusion

ENLAY remains a compelling investment opportunity with strong growth prospects and a promising outlook under the new management team. The new management has set clear priorities, aiming to operate more efficiently, create value for shareholders, and maintain focus on Enel's integrated strategy. This commitment to improving capital allocation and maximizing risk-adjusted returns bodes well for long-term investors.

Despite its impressive performance, ENLAY's valuation still lags behind the index. However, I believe this valuation gap is likely to close, and the catalyst for this could be the upcoming capital market day, where the management team will reveal specific plans to achieve their strategic goals.

Considering the potential for further growth and efficiency gains, I maintain my buy rating for ENLAY.

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