* 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 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.
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
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.
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)