Tag Archives: Macro

ENI and its alleged break-up value

Energy, English, On the cover, Sin categoría
Over recent weeks,Knight Vinke has suggested that splitting the company into utility gas and traditional oil businesses would unlock significant value.
They value ENI between €27.8 and €32.
My biggest discrepancy with them is a) that the issue is not the Gas & Power business but the E&P, and b) I find it hard to believe that both parts would trade at top-of-subsector multiples if separate.
First in the Snam and Gas & Power business… They take the assumption of Snam trading at a 20% premium to RAB, which is crazy compared to other utility stocks. They also use the rest of the gas & power division at a 30% premium to Enel, Edison, Hera, Acea (which all trade at 5.6-6x EBITDA 1yr fwd). They totally disregard the constant process of de-rating of the Italian utilities in the past six years and the impact on power prices of stalled demand and excessive capacity from gas oversupply.
The refining business is put at Neste multiples, which is OK to me
Chemicals are valued at much higher than anyone can imagine (7.5x EBITDA)
Corporate charges are drastically reduced (probably as part o the assumption that, as separate entities, cost savings and job cuts would happen). This is difficult to believe in Italy, but can be acceptable as a thesis.
Then Knight Vinke value the E&P business at the multiples of a BG, which is too radical given the poor growth, high capex and returns.
In essence they use consensus Sum of the Parts, reduce the traditional Megacap oil discount (21% to 15%) to zero by cutting corporate charges and others, pumping up the valuation of the Italian G&P to multiples of non-Italian (and therefore more attractive) utilities and applying a premium to the Snam RAB that it has never enjoyed in the past (Snam is a mature asset and growth RAB is very limited versus maintenance RAB, something that KV seem to value in the same way).
The key, as some analysts (e.g Nomura) point out is that where Eni trades (a 40% discount to its invested capital) is no different to that of other large-cap oils (BP, RDS, FP and STL). I think the value argument can be applied equally to all these companies, but unlocking it is not about addressing a small part (Gas & Power is only 15% of Eni’s invested capital base) but about turning around the core E&P businesses where returns have fallen a staggering 400-500 basis points in four years (while oil prices rose).
That is why, even if separated, it is an illusion to believe that oil investors would see ENI as a high multiple E&P and see it trade at the same multiples as Tullow, Dana, etc… First, because it would still be a State owned entity and its resource base would still be heavily impacted by resource nationalism, low returns and OPEC quotas.
In the meantime, the bet on the stock from here is a full break up not only of the utility assets (which as Scaroni has said, would be regulaywise impossible) but also the disposal (at current market price, no discount) of the Saipem stake.

Calling the bottom on power prices in Europe

Energy, On the cover, Sin categoría,

Although overcapacity in Europe plus excessive renewable installations remain the biggest threat to power prices, and a quick price recovery seems highly unlikely, these are the main reasons why i believe we could be reaching a bottom:

  • . I believe CO2 has reached a very strong support level at €13/MT. Utilities keep adding to their hedges at this level despite demand concerns. Even with -1% demand in 2010-2011 a CO2 price of €12-13/MT is widely accepted as a solid risk-reward price (basically the NPV of 2013 €23/MT with a 10% discount).
  • . I believe demand is showing some small but encouraging signals of bottoming. We have seen encouraging data from the countries with highest overcapacity like Spain and Italy. Demand data for Spain for June is down only 2.7%, versus down 8% in May. This is temperature and working days adjusted, so not influenced by external factors. Same trend was seen in Italy with June figures only down 3% adjusted.
  • . Capex cuts could reach 15% in 2010. Moody’s and S&P are demanding (expecting) power capex cuts in 2010 to reach up to 15% in Europe’s rated power groups. I had a chat with Neil Bissett from Moody’s yesterday in which they believed that generation companies should start thinking about moving closer to more cyclical company-type of gearing. That is c30% net debt/nd+equity!. Not only large groups are facing higher pressure to control capex and gearing, but smaller power companies are likely to be unable to finance agressive growth plans in current conditions. The effect is likely to be evident in 2011 and will hopefully bring reserve margins to tighter levels in Europe.
  • . Gas prices look well supported into summer by ongoing Norwegian supply discipline (and more worryingly, inability to offset decline) and revamped Russia-Ukraine dispute risk. However, winter looks uncertain. The gas market is the key uncertainty to this picture as it looks awful considering LNG.
  • . …But maybe the threat of LNG could be less agressive. You know me, I always trust Exxon, and so far it works. BP, Exxon and BG are seeing enough Asia demand to close large long term contracts. Additionally BP believes through TNK that Russian gas production could be peaking as reserves could be overstated. Exxon wants LNG in the US for two reasons: a) lower US gas prices benefit them and b) lowers the valuation of gas assets which they would takeover gladly.
  • . In coal we are seeing supportive data from recent broker comments of a tender for met coal out of Australia completed recently at US$132/t, which is the first deal above the benchmark price of US$129/t. Spot prices have rebounded from US$115–118/t last month, due to months of strong purchasing activity by the Chinese. Strong Chinese steel production, signs of an end to steel destocking in the world ex-China, as well as infrastructure constraints in Australia (Dalrymple Bay vessel queues up from 25 to 40 ships), have contributed to the move upwards.

Energy, On the cover, Sin categoría

Picture2

Just wanted to share some thoughts as I am seeing brokers call a bounce on utilities based on mean reversion and sector rotation. 

Despite being the biggest underperformer YTD, the utilities sector has four mounting problems:

a) €65bn to refinance to 2010
b) €35bn in asset disposals to keep single A rating
c) ROCE keeps sliding after five years of M&A at peak multiples
d) €20bn in capital increases (Enel, Gas Nat, Snam, Vestas, SSE, Centrica…)
Look at the chart attached, because it’s scary. The utilities have been re-rating year on year on commodity exposure, asset valuation increase from M&A and multiple expansion from new technologies (renewables) and at the same time it has become more cyclical, but with very inflexible capex (the sector spends 33% of its market cap every year on capex to deliver 3-4% EPS growth)… while ROCE has been deteriorating steadily (see chart).
On top of this, the sector trades on “growth” multiples (7x EV/EBITDA), but considering the loss of industrial demand and the forward cruve on spark and dark spreads, we could see a continued de-rating of the sector to ex-growth multiples.

Why the market can’t go up… and one positive

Energy, English, Markets, On the cover
In a letter to investors last week, Warren Buffett admitted having made some serious mistakes last October when he bought a  large stake in Conoco (purchased at $7bn worth $4bn now) and other stocks. His famous letter “buy equities, I am”, was full of confident messages about deep value and the possibilities of the American economy to recover.
All these messages were hit by harsh reality… If we distort the market dynamics through bank bail-outs, short-selling bans, rescue plans for declining industries and false messages of speedy recovery, confidence plummets further. That is what has happened.
Now for the positive. Two words: Corporate bonds.
I have seen and participated in very attractive corporate issues of three to five year bonds that yield 6% to 6.5%, with very high quality rating (single 
A) and low risk. When the bonds yield more than the equity, and the balance sheet is strong, you get 3% risk premium for free.
So far the CDS of most single A companies have stabilized, and the healthy appetite for bonds and the good quality of their balance sheets show that when the crisis is over these companies will have survived. This is not a signal to  buy their equities yet, as multiples keep expanding while EPS is downgraded, creating a fake view that the stocks are “cheap”. It’s a signal to keep investing in corporate bonds and avoid the equity market problems for a while.
Meanwhile, the VIX keeps going crazy, so if you want to be in equities, stick to the golden rule of my previous posts… 2008 outperformers with solid balance sheets will repeat their performance this year.