ENGIY - Engie SA: New Nuclear Cap Is A Very Positive Catalyst

2023-07-05 11:39:58 ET

Summary

• Engie SA and the Belgian government have reached a nuclear cap agreement, mitigating market and political intervention risks and removing the possibility of a nuclear tax.
• The agreement outlines the restart of the Doel 4 and Tihange 3 nuclear units, with nuclear waste treatment expenses transferred to the Belgian government, protecting Engie from future cost increases.
• Engie's management has upgraded its guidance for FY23, reflecting positive performance and a favorable energy price environment, which could lead to a re-rating of the company's stock.

Recommendation

After the new Nuclear cap agreement, which I see as a very favorable catalyst for the stock, I am maintaining my buy rating for Engie SA ( OTCPK:ENGIY ). Upgrading management guidance is another source of positive momentum that should boost investor sentiment. In a nutshell, the ENGIY nuclear provisions in Belgium were €17.9bn at the end of FY 2022. The recent announcement increases these costs by €4.5bn in exchange for clarity on the cost of waste treatment. While this is bad news on the surface, I think it's a net good because it greatly lowers the execution risk. Since the announcement, the stock price has risen by 8 percent, so at least some investors are responding favorably to the news. However, the share price has remained exceptionally low at just 9x ahead PE. I believe that the path to mean reversion in multiples will eventually occur given the de-risked profile and improved outlook (I remind investors that ENGIE used to trade in the tight band of 12 to 14x forward PE pre-covid). Valuation potential alone would account for 30% of the total upside if the market were to re-rate the company to its 10Y average of 12x (assuming the SOTP thesis starts getting momentum).

Nuclear cap agreement

ENGIE and the Belgian government have reached a new nuclear cap agreement for the extension of the lives of the D4 and T3 nuclear reactors. The utility's vulnerability to market and political intervention risks will be mitigated thanks to the 50/50 JV with the Belgian State that will oversee the life extension of the reactors. This is crucial because it removes the possibility of ENGIE being subject to a nuclear tax like the one imposed in Belgium. The related nuclear liability cap negotiated for the entire nuclear fleet (i.e., the nuclear waste management provisions will be capped at €15.0bn compared to €9.1bn provisions) is, in my opinion, the more important factor here as it provides investors with higher confidence when modeling this asset.

Under the terms of the agreement, ENGIE and the government of Belgium will work toward restarting the Doel 4 and Tihange 3 nuclear units as early as November 2026 or, if an announced reduction of rules is really put into action, as early as November 2025. This includes creating a separate legal framework for the two expanded nuclear reactors, which are jointly owned by the Belgian government and the French energy company Engie. The goal is to use a contract for the difference to extend the agreement, with financial and technical performance incentives. According to the financial projections presented during the conference call, the return will be marginally higher than WACC at a total cost of €1.6bn-€2bn, of which ENGIE will be responsible for shouldering 50%.

In addition, the entire cost of future nuclear waste treatment expenses for all of ENGIE's nuclear reactors in Belgium have been agreed upon at €15bn. The first installment of this sum is due in the first half of 2024. The most important conclusion is that by transferring all nuclear waste responsibilities to the Belgian government, ENGIE is protected from any future increases in costs associated with waste treatment.

Overall, I think this agreement has removed one of the uncertainties that the market has been worried about, which should support a strong valuation re-rating over the near term. The removal of this overhang should also allow potential acquirers to start evaluating ENGIE as a potential target (my opinion).

Guidance

Both EBITDA and EBIT, excluding nuclear and NRIgs, were revised upward by management for FY23. The increase is due largely to GEMS' excellent performance, which has carried over from the first quarter of this year to the second. I expect the decline in European energy prices that began at the beginning of the year to continue being a tailwind for ENGIE relative to last year's comps, as reflected in management's updated forecast. Below is a better view of the upgrade in guidance:

1. EBITDA: €12.9-13.9bn vs. €10.9-11.9bn.
2. EBIT: €8.5-9.5bn vs. €6.6-7.6bn.
3. NRIgs: €4.7-5.3bn vs. €3.4-4bn (note this is the biggest upgrade).

Valuation

I reiterate my view that ENGIE is trading at a steep discount to its historicals despite having one of the major overhangs removed. In addition, the decrease in energy prices is also a favourable tailwind this year for ENGI - which I believe was also a key driver to the valuation decline since 2021. With the reversal, I expect the market to re-rate ENGIE back to its historical profile. This increase from 9x to 12x should yield 30% on top of any dividend (FY23 DPS estimated to be €1.29).

Risks

I believe another round of supply shock would cause commodity prices to increase to levels seen last year, which is a very bad thing for ENGIE given its significant exposure.

Summary

The new nuclear cap agreement for ENGIY is a positive catalyst for the stock as the agreement mitigates market and political intervention risks and removes the possibility of a nuclear tax. From a stock narrative perspective, the negotiated nuclear liability cap provides investors with higher confidence in modeling this asset. The agreement also outlines the restart of the Doel 4 and Tihange 3 nuclear units and transfers the responsibility of nuclear waste treatment expenses to the Belgian government, protecting Engie from future cost increases. The company's management has also upgraded its guidance for FY23, reflecting positive performance and a favorable energy price environment.

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