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Jose Vasquez
Jose Vasquez
Articles (13)  | Author's Website |

E.ON: Another Gift from Germany

May 23, 2011 | About:

I just made myself another little gift from Germany to complement my Munich Re position in that productive industrial country. This time I bought E.ON, a major European energy player. I'll try to explain why; I will not focus excessively on technicalities or P/Es or whatever is your favorite evaluation technique. I am sure that the good investor already knows how to do such things, and I think that an investment has to strike out immediately without the need to justify it excessively with too much financial math, which is in any case quite basic.

E.ON stock is at a multi-year low. Negative press due to the European sovereign debt woes coming from the PIIGS, the nuclear moratorium and recent expectations of lower profitability gave me an additional opportunity to enter on the cheap side.

Lets start by exposing the negative factors. I started to follow E.ON after the Japanese earthquake when two of its plants were shut down for three months. I checked out the year reports and while it affects it, it has a small impact on earnings and as long as those 2 plants are not permanently shut it would just be blip on earnings. But there are some other mid term impacts to earnings. First, the margins on the gas business are at a low point because gas based energy is currently being sold at a low price on the spot market but the gas to produce it was procured at high acquisition costs that were negotiated by past contracts on long term futures. That is a temporary situation inherent to the business because as months go by new acquisition costs are being negotiated at much more reasonable prices reverting the situation. Another concern is that there are plans to extend all nuclear plants by at least a decade and people fear that they will not be extended. In any case even if they are not it is not a drama since E.ON gets a minor part of their earnings from those older plants and even if they are extended the lion's share of the profits is going to the government anyways. And the last concern is an additional nuclear tax which is fortunately offset in 2011 by gains derived from their trading unit but that will affect earnings from 2012 on, It is expected therefore quite understandably for the reasons just exposed that 2011 and 2012 will have lower earnings and that the 2010 level will be reached back in 2013, In any case the reduction is nothing dramatically smaller, you can check the exact expectations in several sources, the questions then are; does it justify such a pronounced reduction on the P/E; does it deserve to trade under book; are write downs expected?

On the fundamental side, the P/E is low. It's below book value, which has almost never been the case for this company. It has an excellent dividend of 1.5 euros per share, so you can calculate the yield depending on where the stock price is when you read this. It has a commitment to pay between 50 to 60% of their earnings via dividends and since they expect to earn less next year, they already announced that for 2011 and 2012 they will not lower the dividend beyond 1.3 euros/share even if it that mean paying more than 60% of their profits, so that puts an interesting floor on the stock.

E.ON is big mainly in Germany, but in the last recent years it has built a big presence in five other major European countries and now is strategically focusing on expanding to eastern Russia (with gas), the U.S. (with renewables) and two other continents; South America and Asia is my guess but it could be north Africa. I say this because north Africa is part of a multi-year, multi-company and multi-country project to build the worlds biggest solar plant in the Sahara desert to supply more than 15% of the European consumption. There are few companies that have the scale and know-how to do that. Some people think the debt is high; I personally do not consider the interest to be high compared to their earnings. In 2010 they had earnings before interests and taxes (EBIT) of 9.5 billion euros and paid 2.3 billions in interest. And in 2009 the relation was the same, so the interest coverage looks to me quite decent. (Side note: You can get very well informed at their investor relations website, with all the documents in English and several video presentations of conference calls). Their debt leverage has been enormously reduced in the recent years due to disposals of non strategic businesses. For example, they sold to the American company Pennsylvania Power and Light (PPL) their American unit for $6.7 billion, and now PPL is quite a bit more leveraged than they used to be. That is just one example. In only the last two years they had disposals which resulted in cash-effective effects totaling €9,601 million in 2010 (prior year: €5,384 million) which was used to pay back debt reducing it materially.

On the country side, I feel comfortable buying this company in Germany for several reasons:

- It is the strongest economy in Europe.

- They hate inflation and have proven they want to control it; they are averse to printing currency.

- They are strong exporters.

- They are strong savers.

- Their economy is based on industrial excellency; the root economical nucleus is not finance and banking.

Some others are worried that they are investing in a populist government. Here is what I think of that: German social control is good, period, and workless people are well taken care of and at the same time have incentives to work. That is a good combination. Health insurance is good. In simple words: I would rather be sick or without a job in Germany than in many other parts of the world, not to mention specific countries (I do not want to hurt nationalistic sensibilities here).

I do not consider Germans to be populists with regards to company control; actually I would have liked more control back when E.ON started growing inorganically by buying companies in the 2002-2007 period. The government does push energy companies to develop renewable energy, but that is for social benefits, that is the reason why E.ON is world-class in renewables, specially hydraulic and wind, and it is now expanding to solar (see it's huge project in the U.S.). There is also a government-sponsored project to build a solar plant in the Sahara desert to provide 25% of the European energy needs.

Also, I like regulations when they seek to control carbon dioxide emissions. By the end of 2013 the CO2 emissions market will be fully operational in Europe, giving an example to the world. Regarding German power sales regulation: E.ON used to be mainly a German player in the past, but not as much anymore. From their $92 billion sales in 2010, $43 billion came from central Europe, and from that only $11 billion were sold in regulated markets.

That said, not all is rosy: Gas margins are low due to high acquisition (procurement) costs and low spot prices, but new contracts are being renewed at better prices. And there is uncertainty whether older nuclear plants will be renewed, but I explained in the beginning of the article why I think those concerns are overblown. And personally, I think that well-controlled nuclear power is an excellent source of energy with very low variable costs and no emissions. France alone gets more than 50% of their energy from nuclear, Norway almost is only dependent on it, and UK has a big program to build nuclear plants. I do not think nuclear will disappear (see Buffett's opinion on nuclear power in the last shareholder meeting). For those who fear that nuclear power will be reduced you can think about the recent nuclear 3 month moratorium. Seven plants were idled for inspection after the Japanese disaster, and it's consequences are having this side effects: It has had such an impact that Germany went from being a net exporter of energy to being a net importer (see recent quarter report), and the principal country benefited is France which is exporting their nuclear energy to the Germans. Now those German readers who know about their people can tell us, does the government like to be in such a situation for the long term?

I think that the German government’s interests are aligned with E.ON’s because Germany has a strong political interest for renewables and they depend on Energy companies to build them. On the other hand, energy companies need to be profitable enough to be able to invest in renewables, so they cannot be over regulated, especially due to the fact that renewables are expensive to build and operate, making them less economically interesting than traditional sources.

E.ON recognizes that renewables are just a part of the whole energy picture because they cannot provide a constant baseload energy flow and therefore need to coexist with traditional energy sources such as gas sources, but what should be adequately recognized is that it has all the resources and the know-how to integrate them on the grid to complement traditional energy sources in order to have a constant flow when the sun is not shining and wind is not blowing.

Regarding growth, I acknowledge that it will not grow like Google (NASDAQ:GOOG) (which by the way I also own), but it has a solid tangible product that will not disappear fast. They also have good know-how in building top-class energy plants, especially new gas-efficient plants. They are needed to expand in eastern Europe and in Russia. Russia alone is the biggest energy market in the world, and it needs to renew 40% of their plants. E.ON is getting several projects to do just that. Additionally, Eastern Europe and foreign countries are on their radar. They have the scale, knowledge and strong competitive barriers. It's not an investment to get rich but it can have quite a decent return.

Conclusion: safe long-term play, with an excellent dividend and inherent protection against inflation and has some wild cards for future growth. All in all I am still studying; I just bought a small percentage of my portfolio (100 shares). But if I get more and more convinced that the company is good and the price is cheap I will add substantially more, especially because I want to diversify away from the U.S., too many of my eggs are in that basket for my taste. Let's hope that we can still get more negative news coming from Europe to push the prices even lower to let us buy at an even deeper discount!


Juan Velasco

About the author:

Jose Vasquez
I was born in Spain and lived in France, Chile, USA and Belgium. I used to work in IT and Banking. I am a family man, I have a lovely wife, 3 sons and one step daughter. I have humble tastes, I like to stay home and read about companies. I started investing before the internet bubble. I knew little and liked technical analysis so my results were bad. Fortunately I did not have much to lose. Some years later in 2006, bored of doing real state investments, I opened an interactive brokers account and restarted. This time, not wanting to make mistakes, I decided to follow a model: Warren Buffett, he was at good making money via stocks. So I started reading about him, his shareholders letters, the books that he recommended, etc... I started applying his principles, reading 10K's digesting all sources of information. I started buying good and cheap companies to hold forever unless something changed fundamentally. When the housing crisis started I was 75% cash. By then I had identified good companies at very cheap prices so I invested most of my savings in stocks. It doubled fast. By the second semester of 2009 I turned my software company into an investment vehicle and dedicated myself full time to it. I changed lifestyle and moved from Belgium to the beach, Brazil, north east coast (www.kuchita.com). The goal was to keep fixed costs low in order to be able to live with a minimum 6-8% yearly return, to move away from the inhuman life of civilization and to have some peace and sunny weather. Now I can think and study about companies 60 hours/week. I can finally do what I want full time and can say that I have never been so happy, specially also with my just born 4th son, my other great kids and my sweet wife who supports me fully while I study most of the day and patiently wait for the opportunity to make a swing ! My portfolio is disclosed here: http://www.kuchita.com/view/sumo.php For more:

Visit Jose Vasquez's Website

Rating: 4.2/5 (25 votes)


Graemew - 8 years ago    Report SPAM
Hi Juan, I used to own E.ON but sold it about a year and half ago...together with the other utility stocks I owned at the time. My reason for this is that I noted that the company had a huge investment program scheduled for coming years...I mean HUGE...such a lot of capital investment...which involves risk if things were to go wrong. Also the company had a lot of debt at the time I sold and I was worried that an increase in interest rates could put the company into difficulties. I also am afraid that if raw material input prices increase dramatically (such as coal, oil and gas) or in the case of an increase in interest rates, that the German government will not pass on these costs to consumers for obvious political motives. I just looked at figures on Bloomberg and it appears to be trading at a PE of around 6...which is very low.....maybe I should look at it again..but avoiding risk is now my highest priority.
Jose Vasquez
Jose Vasquez - 8 years ago    Report SPAM
Hi Graemew, Yes I was reading the 2002-2007 annual reports and their planned investments were absolutely huge (60 billions). I think their previous CEO had too much testosterone (see his letters to shareholders). Specially for a company their size the investments were to big. But it has changed since the past 2-3 years, it's now a complete reversal to divesting, and they did quite a good job at it. Its worth you take a look at it because it changed since you owned it, it seems. Related to that, I mentioned in the article, the divestment of their USA operations, their interest coverage and how there debt has been reduced increasing cash in the last 2 years. With utilities you always run risks with regulators (i.e. government). The German government is focused on renewables and carbon emissions control, they need E.ON to invest there and therefore they should not over regulate them because investing in renewables requires a healthy balance sheet. If you now look at the numbers and compare then with to those in 2007 its another company, the balance sheet is stronger, I think it has almost never been cheaper. For me the best way to avoid risk is buying a good company, as cheap as possible.
Adib Motiwala
Adib Motiwala - 8 years ago    Report SPAM
Hi Juan,

Firstly, thanks for taking the time to post this.You know a lot more about this company. But, here are some of my concerns.

1) Pre-tax Returns on capital are not great (avg 14% for last 5 years)

2) Capex has been very high. 50-75% of Cash Flow from operations. I read your comments that the new CEO is trying to change things.I dont see that yet in the numbers.

3) How regulated is the company and the industry?

Seeing historical valuations, I can certainly agree that the company is trading at 30-50% discount from historical valuations. P/E 6.4 verus 13 average. 0.7 EV/ Sales v/s 1.2 avg.

- Adib
Graemew - 8 years ago    Report SPAM
Hi Juan, thanks for answering my questions above...however just two points. Firstly from the figures above...EBIT of 9.5B and interest of 2.3B, that is an interest coverage of only 4 times. If interest rates were to double and if raw materials increased, this could put the company into trouble. (A doubling of interest rates may seem ridiculous, but historically this has happened many times). In addition the company is now divesting assets..whereas prior to 2007 the company was buying everything in site at high valuations using debt finance. So now after having done that they have to sell off assets on the cheap to reduce debt...shows a lack of foresight...However I will look at the company again and keep following it...utilities are very much out of favour at the moment and may fall further to very attractive prices.
Jose Vasquez
Jose Vasquez - 8 years ago    Report SPAM
Hi Greamew,

Regarding the past acquisition spree:

I agree that on hindsight it looks bad when you buy and then sell, I do not like that neither when I place myself at this point of time and look on the rear window but then again that is a reason why the price might have overshot to the value side giving an entry opportunity. Consider that they are not selling everything that they bought, and neither did they buy everything that was on the original plan, for example Endesa, huge acquisition price, from Spain, was not bought. And by looking at all the sales they have done until now on a case by case basis it seems to me that they sold pretty good. As an example you can check how they divested their USA operations to PPL. They are almost done divesting 15 billions ahead of time becausd they could sell conveniently, I do not see too many writedowns, and even after divesting, the company is bigger than some years ago, their assets increased yes but if you check at the earnings power they have increased substantially more. What you have to decide before investing is if those same concerns that you have have pushed the price down more than deserved.

Regarding interests:

I agree it would be a problem if interests rates doubled impacting all their outstanding debt, and also if they could not sell at higher prices. But I feel comfortable that it does not work that way. Their current debt, which is mainly fixed, would largely remain unaffected no matter how high the interests go up to. The problem would be for the new or rolling debt, and you may check there how much of their debt matures in the coming years to quantify the risk. But even then the margins could be unnaffected or not as severly impacted as you might think, since historically, when inflation goes up, energy prices go up too (actually that is inflation) earning more on sales because they sell at higher prices.

Conclusion: I think the price starts to be attractive, that is why I bought a little (100 shares), that said, if it is as good as I am more and more convinced it is, I hope it goes down much further to add substantially more.

Cheers! Juan

PD: Adib, as soon as I have time I answer you.
Rmoesker premium member - 8 years ago

Hi Juan, sounds interesting.

According to the CEO the company is in a transition period.

Forward p/e around 9, excl. specific risks.

In 2013 the company should be on the level of 2010 again.

After that, probably (healthy) growth. Dividend should help.


Rough guess 2013: 8 * 3,5 (eps 2010) + 2,6 (2 times 1,3 dividend) = 33,2.

From the current level (20) eon has a potential of 25% per year over 2 years.

Maybe someone has better numbers?


Can anyone assess the possibility of their nuclear power station to return to service after the moratorium? and the (financial) impact if not? the CEO mentions considerable consequences.

Regards, Ronald

Kefa - 8 years ago    Report SPAM

funny but I read interim reports of E.On and RWE just yesterday.

1) Where did you get information that E.On's policy is to pay 50-60% of their income as dividend? I know this is policy of RWE but can't find this in E.On documents. Ditto for 1.3EUR dividend promise. Enlighten me, please!

2) Did you have a look at RWE, another German utility? They are even cheaper than E.On. Their preferred stock sells with 5% discount (why?) to common stock and yields more than 9% (will be slashed as E.On's dividend). What are your thoughts?

As to impact of nuclear moratorium...E.On sells their power production for 1-3 years in advance. This means that they sold production of halted plants and will have to buy power on energy market to fulfill their obligations. This will have a negative effect on income, but nothing serious (read their reports). Next year they will increase production in their other plants to offset this (should those plants stay shut down).

Interesting tidbit from RWE interim report:

On 18 March, RWE Power took Biblis A offline as ordered by the Hessian Ministry for the Environment, Energy, Agriculture and Consumer Protection. .... The German government draws the legal basis for their action from paragraph 19 of the German Nuclear Act, according to which the operation of nuclear facilities can be forbidden if they pose a danger. In our legal opinion, however, the prerequisites for the legal basis for a cessation of operation have not been met. On 1 April, RWE Power therefore initiated a legal action with the Kassel Higher Administrative Court against the order of the Hessian regulatory authority to interrupt the operation of Biblis. Our grounds for the legal recourse is that Biblis – along with all the other German nuclear power stations – fulfils the safety standards in force.

If E.On and RWE are successful in suing government (and I think they will be) they will get compensation for imposed moratorium.

Long E.On (100 shares)
Kefa - 8 years ago    Report SPAM
Flash news!!!!


Merkel preparing to drop nuclear tax in deal with industry
Rmoesker premium member - 8 years ago
Hi Kefa:

The future dividend info is in the speech of mr Teyssen (ceo):


page 5

Rmoesker premium member - 8 years ago

It's getting exciting:

Hoffen auf das Ende der Atomsteuer

25.05.2011, 15:29 Uhr


but also:

FDP weist Spekulation zurück

zuletzt aktualisiert: 25.05.2011 - 13:09


Worst case scenario as I understand it:

- eon extends the plants in exchange for the tax and the tax will cost approx up to 1b per year (800m 2011, 900m 2012)

- or eon phases out the plants and in return the tax is skipped, building replacments will cost<1b per year (anyone better guesstimates?)

If I adjust 2013 estimate with some worst case numbers (1b per year):

Rough guess 2013: 8 * 3,0 (worst case eps 2010) + 2,6 (2 times worst case 1,0 dividend) = 26.

From the current level (20) eon still has a potential of 13 to 14% per year over 2 years.

Rmoesker premium member - 8 years ago
Mistake, update:

Rough guess 2013: 8 * 3,0 (worst case eps 2010) + 2,0 (2 times worst case 1,0 dividend) = 26.

From the current level (20) eon still has a potential of 13 to 14% per year over 2 years.
Jose Vasquez
Jose Vasquez - 8 years ago    Report SPAM
Hi Kefa, Besides being unnecessarely ironic with your "enlighten me" comment,

you proved you do not read carefully or that you have a very bad memory for someone who, as a stock owner, should not be ignorant of the company's dividend policy and should have read at least the year reports.

That said for the rest who might not know, here is the dividend policy section from the most recent year report:

Over the years, our stable, consistent dividend policy has been

a key element of our finance strategy, and we intend to con-

tinue it. Our target payout ratio—which determines our per-

share dividend—will remain at 50 to 60 percent of adjusted

net income. We are proposing a dividend of €1.50 per share for

the 2010 financial year, unchanged from the prior-year divi-

dend. We also plan to propose a dividend of at least €1.30 per

share for the 2011 and 2012 financial years. This ensures that

our shareholders have a long-term, value-enhancing investment

with a stable return.

Source : page 34, 2010_E.ON_Annual_Report_.pdf

PD: Kefa, I never implied that the moratorium would have a big impact, don't misinterpret me, if I had those fears I might have not even bought. As to your second question, I suggest (not impose), that you take a look at how the moratorium affected RWE and compare that to E.ON, compare the size/quality/age of their nuclear plants. Also compare the percentage of RWE's earnings that come from nuclear power to the respective percentage for E.ON and then ask yourself who would be more impacted under stronger nuclear regulation.
Kefa - 8 years ago    Report SPAM
Hi Juan,

thank you for your response. English is not my native language and I didn't know that "Enlighten me" had a negative connotation. I read reports of both companies in 1 evening and simply overlooked that. That's why I was asking.

Neither was I trying to misinterpret you regarding the impact of moratorium. In 6th post, Rmoesker is asking what would be the impact if plants are not revived after moratorium. I was replying to him.

Anyway, I must confess that I am very much attracted to current yield of RWE. I know it will be slashed. The forecasts for RWE are much more grim than for E.On. Also some metrics like debt, sales growth or P/B are worse. On the other hand ROE, ROI, net margin, EPS growth are better at RWE. I read somewhere that RWE's coal plants are dirtier than those operated by E.On and that will cost them more after 2013 (CO2 allowances). Still, they seem to be priced very low.

I think your analysis are one of the better I read and was wondering if you had a look also on RWE. If yes, I would be very interested to see your analysis.
Jose Vasquez
Jose Vasquez - 8 years ago    Report SPAM
Hi Kefa, sorry for the confussion. I read supperficially some months ago about RWE, when I was to decide if I should invest most of my time studying E.ON or RWE and my first impression was that they were too dependent on nuclear and I do not like that because it is very capital intensive and tends to be the center of regulation, and I do not want to speculate on what the government will do. I think that the doubt over the reliance on nuclear profits is key on explaining why the current price seems low. That said I will most probably study soon RWE, specially because it is a competitor and because I am evaluating if I should expand my E.ON position. If I do I will let you know my opinion.
Superguru - 8 years ago    Report SPAM
Many utilities are near multiyear lows for the same reasons you mentioned. Is it a good time to buy utilities?

Yields are good - 5%+. If nothing else, they are like bonds. Any appreciation in stock price is like a bonus.
Bishk1301 - 8 years ago    Report SPAM
In recent years there has been some active insider buying by CEO of RWE, but mostly insider selling in EON. While this is not a strong argument, may be seen from the CEO prospective is the coming time of heavy investment and nuclear disengagement not so bad. Actually German politicians are not any more susceptible to act on populism as the do act on industry behalf. Both RWE and EON have leading positions in their respective regions and it would be suicidal to let them go bankrupt, this is not populism.
Superguru - 8 years ago    Report SPAM
What would be the impact on E.ON (and RWE) due to German policy decision to offline all nuclear power generation in Germany by 2022.
Jose Vasquez
Jose Vasquez - 8 years ago    Report SPAM
A way to find out is to see how reliant each company is on nuclear energy. E.ON's nuclear production coming from germany represents 1/8th of all its energy production. So in 10 years it will lose that 12.5% just in 2010 terms (because it will have new sources of energy like gas, renewables, hydro...). You can go much deeper if you check the year reports. Last time I checked RWE was even more reliant on German nuclear production. Note that this does not mean the stock will drop more as this was maybe already priced in. After the announcement today from the governement that they will stop all nuclear production by 2012 the stocks dropped just 2%. Anyways even with nuclear energy not phased out, the prospects were bad, due to the heavy taxes. And finally note that this is only for Germany. E.ON still has nuclear operations in Sweden and is in conversations to start a big nuclear project in Ingland.
Adib Motiwala
Adib Motiwala - 8 years ago    Report SPAM
Did the stock get a hair cut due to the news? Maybe a buying opportunity if selling is over done....

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