Germany's nuclear exit proves costly for energy group E.ON

Thu Nov 22, 2012 5:47pm IST

Stocks

   

* Profit warning has eroded investor confidence

* A third of analysts have slashed ratings

* Group may consider teaming up with peer, investors say

By Christoph Steitz

FRANKFURT, Nov 22 (Reuters) - Germany's exit from nuclear power is weighing on its largest energy group E.ON as it struggles in the economic downturn, and some shareholders say a merger could solve the company's problems.

E.ON's shares recorded their biggest ever intraday drop last week after it warned a weakening European economy was depressing power demand and would hit 2013 profits.

The company must now look for growth in new regions, requiring billions of euros in fresh investment. It is trying to cut costs to free up more cash, but the burden of decommissioning nuclear plants by 2022 makes that harder to achieve, handing an advantage to competitors.

It is the biggest test for Chief Executive Johannes Teyssen since he took the top job in 2010 - preparing the group for the post-nuclear age while keeping investors on board.

"E.ON is facing a structural problem. Through political decisions, its business model has partly become obsolete," said Stephan Thomas, fund manager at Frankfurt Trust, which is among E.ON's 20 biggest shareholders.

Atomic energy has long been unpopular in Germany and is anathema to an environmental movement that is a major player in a political system favouring coalitions and compromise.

Renewable energy had already taken over as the favoured alternative to fossil fuels but the Fukushima disaster in Japan in March 2011 dealt nuclear a final blow, forcing Chancellor Angela Merkel to drop her support for the fuel.

It still makes up around one fifth of the power that E.ON produces. The government's decision means companies must bear the cost of taking reactors out of service early and shifting power production to other energy sources.

About a third of the analysts covering E.ON shares cut their recommendations to either "sell" or "hold" after its profit warning, StarMine data shows.

For a company that was long considered a safe and stable dividend haven, that fall from grace among investors is a shock.

ETERNITY

The company has to show it can fight back and restore growth, but a costly expansion drive seems the last thing the world's top utility by sales can afford right now.

After years of overpriced takeovers in which it accumulated debts of 35.6 billion euros ($45.64 billion), E.ON now finds itself under pressure to cut jobs, investments and its precious dividend, raising the chance the group will fall behind peers.

E.ON - whose name bears an intended resemblance to the ancient Greek word for eternity - was formed in 2000 by the merger of German industrial giants VEBA and VIAG.

Years of expansion funded by a robust European economy allowed the company to pay out high dividends, making it a favourite among investors. The company is now worth 28 billion euros, based on its latest share price.

But the continent's debt crisis has taken its toll on energy consumption as well as E.ON's shares, which are now hovering around 14 euros, down 73 percent from a record high in 2008. Shares of its European peers have fallen 54 percent in the same period.

Growth in European power demand of 2 percent a year between 1990 and 2010 is set to slow to around 0.8 percent between now and 2035, according to the International Energy Agency (IEA).

E.ON's earnings per share are expected to drop 30 percent over the next twelve months, according to data from Thomson Reuters StarMine, which weights analyst forecasts according to their track records. This compares with an increase of 12 percent for the sector worldwide.

The group is now in a bind: it needs cash to renew its ageing power stations and expand abroad but will struggle to accelerate asset sales. Existing efforts to shed core operations are already drawing criticism from inside the company.

In an effort to stop profit margins falling, E.ON is slashing costs - in part by cutting 11,000 jobs or nearly 14 percent of its workforce and selling 15 billion euros worth of assets - to lower its debt and keep its credit rating.

John Musk, analyst at RBC Capital Markets, said targeting debt reduction over growth is the wrong strategy. He said the company may be forced to dilute its share price by raising equity to pay down debt next year.

MERGER?

Growing its way out of trouble will test the mettle of E.ON's management given that the success of acquisitions in the power industry often hangs on decisions down the line by regulators and elected officials.

Analysts have criticised E.ON's poor track record when it comes to takeovers, pointing to billions of writedowns it had to book on overpriced acquisitions in recent years.

After a failed attempt to buy Spanish peer Endesa in 2007, E.ON spent about 10 billion euros on plants and other activities in Spain, Italy, France, Turkey and Poland owned by Italy's Enel and Spain's Acciona.

The deal backfired when Europe's sovereign debt crisis broke out, dampening demand in southern Europe and forcing E.ON to book 2.6 billion euros in writedowns in late 2010, and another 3 billion a year later.

Another option to boost available cash is to cut E.ON's dividend. Analysts expect it to fall below 1 euro at least for the 2013-2015 period. For 2012, the group plans to pay out 1.10 euros a share.

With few options, the group will have to be inventive to find growth, said Thomas Deser, fund manager at Union Investment, which holds about 1 percent of E.ON shares.

Its low valuation looks attractive. The company trades at 6.3 times annual earnings per share, less than half the 13.9 times average for utility stocks worldwide.

"In the long-term, E.ON could think about whether a merger makes sense with, let's say, Iberdrola or Gas Natural ," said Deser. ($1 = 0.7801 euros) (Editing by Tom Pfeiffer)

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