2023-11-27 07:02:39 ET
Summary
- Fortum is an interesting Nordic utility company that recently experienced two major setbacks.
- Its Russian investments were seized and its sizeable investments in Uniper were sold at a loss of €5.8B.
- The company is much more lean now and is focusing on consolidation before planning to return to growth.
- Fortum looks very profitable and has a nicely-looking dividend yield of 7.2%.
- Profits are heavily reliant on electricity prices though, which makes the company vulnerable.
Fortum Corporation (FOJCF) is an energy company from Finland that has been going through some rough times during the past two years. Its large investments in the German company Uniper (UNPRF) were sold with a huge loss, and its unfortunately timed business in Russia was seized by the government of Russia. After these changes, what's left looks to be a very profitable utility with a good balance sheet, decent cash flow generation, and a sizeable dividend. The company is very dependent on energy prices and is planning to focus on consolidation for the next years before it will shift its attention to growth opportunities again. In this article, I will try to give you an overview of the risks and opportunities of investing in Fortum.
Brief overview of Fortum
Fortum Corporation is a Nordic energy company focusing on the generation, distribution, and sale of electricity and heat. The company is headquartered in Espoo, Finland, and has significant operations in Finland, Sweden, Denmark, and Poland. There are also operations, partnerships, and energy projects in other parts of Europe. Until relatively recently, Fortum was the largest shareholder in the German company Uniper (UNPRF), and also owned major electricity plants in Russia.
As we can read in its latest investor presentation , Fortum currently owns a portfolio with an energy mix consisting mostly of nuclear and hydropower.
Note the difference between power generation and generation capacity; generation capacity is the maximum amount of electricity per time period that can be generated, and power generation is the amount of electricity actually generated. Hydro plants are not always running at full capacity due to seasons, while nuclear plants are much more often near full power.
As you can see on the map below, the bulk of Fortum's generation capacity is based in Sweden and Finland, where all of its hydropower and nuclear plants are situated:
Fortum has a very low-carbon energy generation mix and has a strong commitment to sustainability goals. This is not only focused on further limiting the emission of greenhouse gases or investing in clean energy, the company also invests in nuclear waste funds.
The energy mix of Fortum asks for relatively low variable costs since hydropower and nuclear power only use uranium and maintenance. In case of larger renovations though, or the building of new plants, fixed costs will be considerable. It is thus likely that the costs of Fortum will be relatively lumpy.
2 major hangovers: Russia and Uniper
As collateral damage of Russia's invasion of Ukraine and the subsequent international isolation of the country, Russian authorities seized control of Fortum's assets in Russia. In the second quarter of 2023, Russian assets were fully written down by Fortum, leading to large impairments. This was not a surprise, as the company had already partially written down its Russian assets in the quarters before, but it was still a hit to the company. Of course, Fortum is planning to bring an international investment arbitration claim against the Russian Federation for the unlawful seizure, but chances for a successful outcome seem minimal. The net cash loss of Fortum for their Russian investments is estimated to be €2B.
In 2018, Fortum acquired a major part of the German company Uniper, which was spun off from E.ON (EONGY). As recently as 2020, Fortum owned 75 percent of Uniper. Of course, the war in Ukraine also had its repercussions on the business of Uniper. Uniper also owned some businesses in Russia, but most importantly suffered greatly from skyrocketing natural gas prices. The German government bailed out Uniper and finally nationalized it entirely at the end of 2022, leading to a staggering loss in book value of €5.8B for Fortum.
Both of these events hurt the company badly, especially when compared with the current market capitalization of Fortum, which is just above €11B, or its EBITDA for the first 9 months of 2023, which was €1.4B. You could say that about half of the company was lost. This is also reflected by the share price of Fortum, dropping from €27 at the start of 2022 to below €13 today on the Finnish stock exchange.
Profits very much depend on electricity prices
As you can see in the graph below, electricity prices on Nord Pool (a large power market in Europe, and the leading one in the Nordics) have calmed down after dramatic fluctuations in 2022.
Please note that the prices on Nord Pool for the Nordic regions are very competitive by European standards. This is likely caused by at least two factors: the relative abundance of cheap hydropower, and the fragmentation of the power generation and electricity retail markets, leading to increased competition.
The fact that Fortum has most operations in such a competitive market is a limiting factor: The company needs to be lean and efficient in order to thrive, possessing very limited pricing power. Fortum is a price taker , and as such its profits depend to a great extent on market prices. Of course, Fortum can also use hedges to protect its profit margins (which the company does extensively, as I quoted below from the investor letter).
Generation's Nordic outright hedges:
- For the remainder of 2023: 75% at €50 /MWh
- For 2024: 65% hedged at €47 /MWh (Previously reported 50% at €46 /MWh)
- For 2025: 30% hedged at €43 /MWh (new)
Since Fortum's 'home markets' are so competitive, it's no wonder the company has searched for ways to enter more competitive markets to increase its profit margins. Russia and Uniper were big failures though.
Profitability is down in 2023, mainly because of lower power prices (in Fortum's generation business) and lower electricity sales margins (in Fortum's consumer solutions business). Considering the graphs and figures shown above, this should be no surprise. But then again, prices in 2022 were very volatile, so most likely 2022 was an outlier in this regard, and 2023 should be considered more normal.
Risks and opportunities
From the Q3 interim report:
Overall, geopolitical tensions are again on the rise and global economic growth is expected to be lackluster; inflation is still high and elevated interest rates are not supporting investments at the moment... Compared to a year ago, Fortum is a different and much smaller company. Therefore, we need to adjust to fit the new structure and purpose and are now launching an efficiency improvement program with the target to lower annual fixed costs by EUR 100 million gradually until the end of 2025. We are also addressing turnaround actions for underperforming businesses as well as the rescope of our focus areas.
Fortum seems to recognize that now is not the moment for strong investments, and also lowered its annual growth capital from €1.5B to €1B. By also trying to lower annual fixed costs, it is clear that the company is not focusing on growth but on consolidation.
As Fortum also states, the company is much smaller than it was previously. On the one hand, this likely carries the burden of a relatively larger share of overhead costs. On the other hand, there is scope for improvement here, as the company also mentions plans to carry out personnel reductions.
Decarbonization is an opportunity for Fortum since most of its energy generation plants carry a very low carbon load. It is the question though how much the company can improve in this aspect. Also, I believe it is questionable how committed Fortum truly is on the topic of decarbonization because of its Uniper investment which made the company one of Europe's largest carbon emitters. Fortum only divested its Uniper ownership when the German state took over, and showed little intention of improving emissions in its Uniper holdings. But on a more positive note, Fortum's annual growth capital, which the company mainly intends to spend on clean energy, is a potential source of growth. Also, electrification is likely to grow during the next decades, leading to increased demand.
The State of Finland is the majority owner of Fortum, possessing more than 51% of the shares. This means that shareholders in Fortum are dependent on the Finnish state because it has a say in important business decisions. This can be problematic because the interests of Fortum and Finnish taxpayers are often intertwined , but not always, potentially leading to political intervention if public opinion shifts. It could also lead to the company taking fewer calculated risks because of its major shareholder and impeding growth. Though the Finnish state is considered to be one of the most stable in the world with regard to financial and political stability, this is a risk that investors will need to accept before investing in Fortum.
Fortum lists its plans to reach growth on its website as follows:
In the first step, the focus will be on optimizing the best-in-class operations, focusing on earnings and cash flow, as well as returning to the bond markets to refinance the group's debt portfolio. This requires a balance between capital allocation, balance sheet and dividends. We will simultaneously build capabilities for future growth by exploring opportunities and developing a project pipeline together with industrial customers.
In a second step - and this might be in the mid of this decade - we will consider larger scale growth decisions which might require increased capital expenditure
This means that for the next couple of years, investors can expect the company to further consolidate. But 'larger plan growth decisions' that hurt the company so much in the past are still on the agenda after this. I believe this course of action is a prudent one.
Valuation
It is not easy to attach a fair value to Fortum shares at the moment. We have to consider that the company just recently recovered from its Russia and Uniper disasters, which mostly left the company with its more stable but slower-growing Finnish and Swedish assets. Fortum's balance sheet looks great, with low leverage and a BBB credit rating.
The net income of Fortum has been negative lately because of write-downs of its Russian business, but when looking at the comparable earnings per share based on continuing operations, these are €1.17 on a TTM basis. With a current share price of €12.7, this shows the shares currently have a P/E ratio of around 11. This seems cheap, but considering the focus on consolidation instead of growth and the dependency on energy prices, I would not dare to assign a higher ratio to the company at this moment. I believe the shares are fairly valued at the moment.
Fortum intends to pay out 60-90% of comparable earnings per share. For the financial year of 2022, €0.91 was paid, which currently translates to a yield of 7.2%. If annual comparable EPS will end up at €1.17, Fortum intends to pay €0.7 - €1.05 as a dividend for 2023. It is thus likely that Fortum's dividend will not change much during the next year, which means the company provides a decent yield for income investors.
Conclusion
Fortum is an interesting utility company that has experienced two major setbacks recently with its divestment of Uniper and the expropriation of its business in Russia. Right now, the company appears to be in steady waters and seems to have survived these setbacks well.
As the company is very dependent on electricity prices, I believe Fortum is not very likely to outperform the market unless the energy markets experience major turmoil again like in 2022. The State of Finland being the majority owner is another variable that investors need to consider before investing in Fortum. The company appears to be fairly valued at the moment and can be expected to only experience low growth during the coming years, considering stable energy prices. Fortum is currently focusing on consolidation after its recent hangovers, looking for growth opportunities that might come later. I would rate Fortum a hold.
For further details see:
Fortum: After The Purge