ENLAY - Enel's Tenacity: Revealing Revival And Sustainable Growth Amidst Market Volatility

2023-11-27 16:07:37 ET

Summary

• Enel's turnaround seems to have begun as the company shows financial resilience, debt reduction, and enhanced profitability.
• The company's leaner approach drives efficiency and targets profitable investments.
• Enel's appeal to income investors is now sustainable thanks to positive FCF generation.

Introduction

Even though it is a blue chip and even though it is a utility, Enel ( ENLAY ) has certainly not been a SWAN stock in the past few years. Just look at its price, and we see a rollercoaster going up and down with sudden swings and then big surges. We have even gotten to the point where the 2020 Covid-related crash just seems a little drop compared to how the sock plummeted and lost almost 70% of its market value from its 2021 highs to its bottom in October 2022.

Since then, the stock has been in recovery mode, and it is now attacking the $7 resistance.

What we have seen in the past is a perfect example of Mr. Market's fluctuations. As the pandemic hit, the stock market suddenly tanked, and then it quickly recovered, led by ESG stocks. Enel was seen as one of the go-to renewable energy stocks, and this is why it reached its highs. All of a sudden, investors started rotating out of these "growth" stocks and then, forecasting high interest rates, sold out of Enel because, as many other utilities, it had a levered balance sheet. As investors are not expecting further interest rate hikes, a business like Enel suddenly appeared cheap once again. True, in the meantime, as we will see in this article, the company has worked hard to divest from less-productive assets and reduce its capex and its debt.

Now, Enel's IR team has been quite active in November. First, the company released its 9M interim report . Then, a few days ago, the company held its Capital Markets Day, presenting the 2024-2026 strategic plan .

Q3 Earnings

First of all, let's see what Enel's latest financials are to get an idea of where the company is at right now.

For the first nine months, EBITDA was up 29% YoY to €16.4 billion. This also led to a very nice 65% increase in net profit to €5 billion. FFO improved dramatically to €10.6 billion, up €9.5 billion YoY. This is because Enel had to make major investments in 2022 while also setting aside several billion for accruals, releases and utilization of provisions, while this year it is already in cash-generation mode. In other words, we are seeing a recovery in working capital. Considering its performance, the company upwardly revised its 2023 goals, targeting €21.5-€22.5 billion in EBITDA and net income of €6.4-€6.7 billion. Even more important, the company is improving its balance sheet, with an ND/EBITDA ratio that should come in close to 2.5x as the year ends. A year ago, we were at 3.6x. This is quite an achievement for a utility (the industry sees different companies with a ratio above 4.0). Enel also closed and announced deals worth around €6.5 billion, which will be used to reduce net debt. Currently, Enel's debt cost is around 4%, and in the following years, it is expected to decrease to around 3.4-3.5%.

What led to these results is an improvement in operating performance, with renewable production up by 12 TWh and B2C electricity sales up 5% YoY. In fact, if we look at the EBITDA bridge on slide 5 of the earnings presentation , we can clearly see how integrated business growth alone generated €3.3 billion of extra EBITDA YoY.

The company has also made it clear it wants to increase its investments in the most predictable and most profitable geographies and businesses. This is why it is investing in Western Europe - mainly Italy and Spain - Latam (Brazil having the lion's share) and the U.S. Moreover, it just spent €3.9 billion in grids to expand and upgrade its networks, increasing the regulated asset base. The strong focus on core geographies will enable Enel to protect its margins and cash generation thanks to visible regulatory frameworks.

The New Strategic Plan

Due to changing conditions, Enel had to revise its strategic plan and present it to the Markets on November 22. What was really positive was to see a company not blaming the environment for possible unmet targets. Actually, the company is taking advantage of harsher conditions to become leaner and more efficient, and it aims at going down the road of improved capital allocation and increased profitability.

As we can see below, capex will be optimized by around €1.8 billion. Another €1 billion will come by new efficiencies, such as organization streamlining, an optimized mix of insourcing and outsourcing, and simplification of productivity processes.

If we zoom out to the broader picture, what I think is most convincing about the new plan is its focus on 2024. In other words, the company is not pushing its goals forward, but it is committing itself to delivering right away at the beginning of the plan a 10% increase in EBITDA, a 13% net income increase, and an ND/EBITDA ratio at 2.4x.

These results will be further supported by sound progress on the overall asset optimization the company has undertaken. As we can see, important deals in Peru, Greece, and the U.S. have already been signed for a total value of €5.4 billion. Overall, the company sees €8 billion cash-in carry over to 2024 linked to mandatory approvals by regulators. This means 2024 will see further benefits in terms of leverage. Moreover, the net impact this M&A will have is €2 billion greater than previously expected due to higher multiples used during the transactions.

But Enel won't only rely on selling non-core assets. It is also focusing on being financially sustainable, with FFO growth year after year. This will help Enel improve its credit ratios.

Most importantly, I finally found the company addressing an issue I was seeing. Up until now, most of Enel's dividends were funded by debt borrowed against the balance sheet. No need to say I don't like this type of choice unless in very particular circumstances. In no way it can be done regularly. Enel's FFO improvement is going to generate €1.1 billion in FCF this year. Finally, we are seeing positive FCF generation after years of cash burn. As a consequence, Enel will be able to support both its capex and its dividends thanks to its FFO, ending up with an FCF-neutral position.

For this reason, I believe Enel's dividend policy should finally be sustainable and appealing, with a €0.43 floor dividend (paid semi-annually in January and July) that should actually increase thanks to net income growth. This is a 6.1% dividend yield that can actually increase if Enel keeps on delivering as it has done so far this year.

Valuation and Conclusion

Enel currently trades at a PE of 8.5 and an EV/EBITDA of 6.8 against the sector median of 16.8 and 11.1, respectively. With an estimate of €6.7 billion in net income, we should expect 2024 EPS of €0.66. This means the company is currently trading at a fwd 2024 PE of 10.6 which is still below the industry average. Though the stock has indeed appreciated, it is still below the 12.5 multiple I am willing to give the company, according to which my target price is €8.25. I believe Enel is now a much safer play, yielding above bonds while offering more clearly that it can also generate capital gains for its shareholders.

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