Refreshing Our Thoughts on REE: More Domestic Energy Policy Risk

REE-gridsREE-grids

UBS | REE delivered an impressive annual total return of over 20% in the past 5 years. This was driven by EPS growth, supportive regulation and above all, falling sovereign bond yields. The trend however was halted this year as bond yields recovered and yield expansion impacted the stock – a risk which continues to keep us cautious on REE, and on regulated names in general. Yet, under a scenario where inflation and bond yields would be stable REE could deliver an attractive total return of at least 12% pa, given its 5.3% DY and DPS growth of 7% pa, one of the best and most solid div. policies in the sector.

Risks on domestic energy policy have been increasing slightly recently…

The regulatory environment in Spain has been quiet stable since 2013 and we do not expect any material changes at least until the end of the current period by end-2019. However, recent news that the new Spanish Govt. is planning to keep the regulated component on electricity tariffs flat in 2017 raises concerns on whether this means caps on revenues for REE. Also, regarding the social tariff, several major political parties (PSOE and Podemos) have recently pushed for all energy players including REE rather than just power distributors, to bear the costs. Although the impact would be likely limited, it certainly adds up uncertainty.

Stable capex outlook supports RAB growth visibility

REE expects to spend around €400-450m in domestic growth capex by the FY, below its €600m avg. to 2019. According to the company this has been driven by delays in approval processes for new projects, although it expects to catch up towards the end of the period. From 2020, REE expects the development of several interconnectors – three between Spain-France and one between the Spanish peninsula and the Balearic Islands – with an attributable capex of c€2.5bn, to keep up with an avg. capex of €400-500m pa and continuing to support low-single digit RAB growth.

Valuation: Neutral rating; New €18.5 PT

We fine-tuned our EPS estimates ahead of the FY by an avg. of 1-2%, and cut our PT to €18.5 (€19.75) as we slightly changed our target PE to 15x (15.5x) and DY to 5.0% (4.5%), to be more in line with the peer group, cross-checked by our DD model.