Gas Natural: Cash-Flow Will Support Capex And Dividend Without Need To Hike Debt

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Gas Natural’s shares have been volatile in the last few months due to results which were worse than analysts’ consensus, coupled with a strategic plan which disappointed the market. But the stock price has recovered in the last two months and has outperformed the Ibex 35 index by 7.6% so far this year.

Medium-Long term investment opportunity

But the forecasts provided by the management during the first half results’ presentation added visibility, after the cautious message relayed with the Strategic Plan. We believe that there is a high probability that the company will beat its forecasts. Its trading ratios are also attractive: PER 17e of 13.2x and EV/EBITDA 17e of 7.45x, below those of its peers (15.2x and 9.4x for the sector in Spain). Gas Natural offers a healthier financial situation, a similar growth profile and a more regulated business, which in our view makes it an interesting investment opportunity in the medium-long term.

Business model

Gas Natural Fenosa is the leading integrated gas and electricity company in Spain and Latin America, and one of the top ten utilities in Europe. It is present in over 30 countries and has more than 23 million clients. With the acquisition of Unión Fenosa in 2008, the third largest electricity company in the market, Gas Natural fulfilled its goal of integrating its gas and electricity business in one company able to compete efficiently in markets where integration, globalisation and competition is on the rise.

Its business model is based on an adequate balance between its regulated and non-regulated activities in the gas and electricity markets, with a diversified and increasing contribution from its international business. This generates 44% of group EBITDA. The regulated business accounts for 74% of EBITDA, while non-regulated activities account for the remaining 26%.

The structure of Gas Natural’s business is divided into four activities: two regulated (gas and electricity distribution) and two non-regulated (electricity generation and commercialisation ):

  • Gas distribution. The company is the leader in this business in Spain and Latin America and also has a solid presence in the Italian market.
  • Electricity distribution. In Spain, Moldavia and Latin America. In Spain, Gas Natural is the third largest operator in Spain, with nearly 4 million customers, while in Moldavia it is the leader, with nearly 1 million. It also operates in Latin America ,with almost 6 million customers in Argentina, Colombia, Chile and Panamá.
  • Electricity generation. Gas Natural’s electricity production capacity (14,78 GW) is underpinned by a balanced generation mix, which is competitive and respects the environment. It consists mainly of combined cycle natural gas. It also has nuclear, thermal, hydraulic and wind energy plants. The electricity generation business in Spain includes hydraulic, nuclear, coal, fuel oil and combined cycle natural gas, as well as wind energy, co-generation and photvoltaic.
  • Gas commercialisation. The company has a large portfolio of customers in the gas commercialisation business in Spain’s non-regulated market. And the commercialisation of gas overseas is also growing strongly thanks to the large amount of contracts with final clients in three geographical areas: Europe, the Caribbean and Latin America and Asia.

Caixabank is Gas Natural’s largest shareholder with 34.4%, followed by Repsol with 30%. Algeria’s Sonatrach owns 3.85%, while the remaining 31.75% is free-float.

 

Strategic Plan 2016-20

Coinciding with the presentation of its Q1’16 results in May, Gas Natural revealed the main elements of its Strategic Plan 2016-2018. In general terms, analysts were disappointed with this, considering that it is too conservative. The company is predicting hardly any EBITDA growth in the coming years (CAGR 2016-2018 of 0.6%).

The Strategic Plan is based on three main pillars, which are the trends defining the energy sector:

  • Global energy demand will continue to rise, although it will decouple from economic growth and the increase will be mainly in the emerging markets.
  • The trend towards renewables and gas in the generation mix which, particularly in the emerging markets, will be a big investment opportunity. On the other hand, LNG’s weighting in the global gas market will continue to increase.
  • The appearance of new business models: distributed generation, smart grids etc.

The Strategic Plan envisages capex of €14 billion in 2016-2020, which implies an increasing level of investment ((€2.7 billion/year compared with the former € 1.4 billion average). Of the total investment, 80% will be earmarked for regulated or contracted activities.

In spite of the forecast increase in investments, there will be hardly any growth in the next few years, with a CAGR 2016-2018 of 0.6% in EBITDA (€5.4 billion in 2018e compared with €5.3 billion in 2015) and with declines in 2016 and 2017. To see any sustained growth, we will have to wait until 2018-2020. The company is predicting EBITDA of over €6 billion in 2020e.

 

Expected performance by division:

  • Networks (58% of EBITDA): this will be the only business line showing growth thanks to expansion in Spain and Latin America (Chile, Mexico and Colombia). In the coming years, there will be important regulatory reviews in different Latin American countries (Mexico, Colombia, Brazil, Argentina and Chile). The EBITDA target for this division is €3.3 billion in 2018e, which implies a CAGR 2016-18e of 2%, with Spain accounting for about 50%.
  • Generation (19% of EBITDA): the EBITDA will decline over the period affected by weak margins in the domestic commercialisation business, with the international portfolio still not compensating for this. In Spain, the company will implement an efficiency programme, as well as boost growth in the renewables platform. It will also develop its international generation business via its subsidiary GPG.
  • Gas (18% of EBITDA): the company is forecasting a stable EBITDA trend, with a decline in LNG (CAGR-6% in EBITDA) which will be offset by a greater operating contribution from upstream and midstream infrastructures. The company will look to renegotiate supply contracts and develop new downstream markets, incorporating midstream assets where necessary. It will also optimise its fleet and the management of the different risks related to commodities in supplies and sales.

Despite the fact the company is predicting weak operating growth in the next two years, debt will remain stable at levels of 3x DN/EBITDA in 2016-2018 and will drop to levels of 2.5x in 2020e. Cash flow generation (€20 billion in 2016-2020) will support the dividend payment (estimated at €7 billion in 2016-2020) and the capex requirements (approximately €13 billion), without the need to increase debt. As far as the dividend policy is concerned, the pay-out will increase to 70% (67% in 2015), with a mínimum dividend of 1 euro per share, which was paid against 2015 results. At current prices, this is a dividend yield of 5.5%.

 

Financial situation

Gas Natural had net debt of €15.6 billion at end-2015, implying a DN/EBITDA level of 3x, which is very attractive compared to the average of companies in the sector. Particularly taking into account levels of a few years ago (6x post the acquisition of Unión Fenosa). Positive cash flow has allowed the company to reduce its debt levels without recourse to any extraordinary measures (asset sales…), as well as finance its dividend policy and maintain investment earmarked for growing its business. Gas Natural’s strict financial discipline will allow it to cut its gearing ratio to 2.5x DN/EBITDA in 2020e (3x in 2015) and 3.2x adjusted DN/EBITDA in 2020e (3.6x in 2015). The company’s debt maturities calendar is comfortable, with only 16% of debt maturing before 2017. It also has enough liquidity to meet over 24 months of its financial requirements, with over €7.5 billion in credit lines and loans with the EIB which mature after 2016.

The financial goals included in the Strategic Plan envisage a stable and predictable cost of debt in the long-term, with a targeted average cost of 4.3% in 2020e, maintaining a minimum of 70% of debt at fixed cost. With an average maturity of €2.5-3.0 billion a year.