Enel: Debt In Focus (OTCMKTS:ENLAY)

Charging station for electric cars of the Enel-x company

Cristian Storto Fotografia

Over the last months, Enel (OTCPK:ENLAY) stock has underperformed the market. This is true for European shareholders, but even more so for US-based investors as dollar strength has further depressed the value of ENLAY shares.

Looking at the longer term, however, the strategy focuses on growth without sacrificing the dividend. This may seem contradictory until one realizes EBITDA has been growing according to plan, but was outpaced by growth of net debt. In spite of this, actual interest payments have decreased due to the low interest environment of the last years. In spite of the high debt load and potential risks ahead, Enel is undervalued compared to its peers.

Long-term earnings growth

More than a decade ago Enel laid out the thesis to focus on the growing demand for Renewables in Europe and an increasing demand for electricity in Latin America. The company has been in transition ever since and set new targets every three years. The latest strategic plan covers the period 2022-2024. These short to mid-term strategic plans serve as an implementation towards the long-term goal in which the company aims to have more than 150GW of installed capacity while serving 86 million customers by 2030.

Enel is on track to deliver on the strategic plan for the period 2022 till 2024. Figure 1 displays the financial targets as laid out in the 2021 annual report. During the 1H22 results presentation, management confirmed the financial targets, but also indicated it was on track to deliver about 6GW of additional renewable capacity in 2022. This matters as the expansion of renewable generation capacity is the driver for earnings growth.

Enel 2022-2024 targets

Figure 1 – Enel 2022-2024 targets (enel.com)

The importance of the Generation business segment in relation to the expansion of earnings is further supported by figure 2. The Generation segment accounts for €2.9Bn out of €5.4Bn in business growth.

Enel EBITDA evolution

Figure 2 – EBITDA evolution (enel.com)

Obviously, the expansion plans come at a cost. Enel expects to spend nearly €19Bn per annum on capex after it upped the targets last year. The relation between capex and the costs to develop renewable energy sources was discussed extensively before. How this steep increase in capex affects the company’s debt will be looked into next.

Debt evolution

Enel maintained a relative constant net debt level up to 2017, see figure 3. In 2018 the company began to aggressively expand the renewable generation capacity and consequently net debt rose steadily.

Net debt and net-debt-to-ebitda enel

Figure 3 – Net debt and net-debt-to-ebitda (enel.com; chart by author)

Rising debt doesn’t necessarily need to be an issue as long as the company displays the ability to convert the investments, funded by this debt, into earnings. Although EBITDA has been growing according to plan, it was outpaced by growth of net debt leading to a higher net-debt-to-ebitda ratio, again see figure 3. The deterioration of net-debt-to-ebitda does not come as a surprise as it aligns with guidance given by management:

We expect the use of debt to remain stable at a ratio of net debt to EBITDA for the group of 2.9 times over the period of the Plan, with net debt for the Group expected to be €61-62 billion by 2024, up from €52 billion in 2021.

In relation to this guidance, it is worthwhile to show the debt evolution as presented during the 1H22 earnings call, see figure 4. Net debt came in at a level of €62Bn after which accounting effects were used to polish up the numbers.

Enel 1H22 net debt evolution

Figure 4 – Enel 1H22 net debt evolution (enel.com)

With the EBITDA target confirmed, €19.6Bn for 2022, the current level of debt implies the company operates a net-debt-to-ebitda ratio of more than 2.9 while carrying a debt load close to the 2024 target. The development of net debt therefore has my attention, not only during the upcoming results presentation on the 3rd of November, but also for the years to come.

Ahead of peers

As utilities are infamous for carrying high debt loads, the debt-to-equity ratio for three different companies is shown in the next figure. In addition to Enel, Iberdrola (OTCPK:IBDRY, OTCPK:IBDSF) is shown as both companies are based in Southern Europe and are rapidly developing renewable generation capacity. Next to these two European companies, Dominion (D) is shown as it has made a firm commitment to the construction of renewable capacity by building an offshore wind turbine installation vessel.

Chart, line chart Description automatically generated

Figure 5 – Debt to Equity ratio for Enel, Iberdrola and Dominion (Seeking Alpha, Ycharts)

Referencing the ratios for these three companies it becomes clear Enel is rapidly expanding leverage compared to its peers. The increased leverage is a logical consequence of the capacity expansion, but simultaneously Iberdrola is investing massively as well, yet does not show a similar ascension in the debt-to-equity ratio.

On the other hand, based on the latest information from Iberdrola, the company grew renewable capacity by 2GW over the last 12 months. If this is referenced against Enel’s expected expansion of 6GW in 2022, it’s understandable why Enel shows a higher ratio. Given the strategic plan Iberdrola is executing at the moment, it is not unlikely the ratio has entered an uptrend (blue line in figure 5) and will trend higher as well over the coming years.

As for Dominion, at the 2022 annual meeting the company shared an investment plan of US$37Bn for the period 2022-2026. Moreover, based on progress of the offshore wind efforts, an increase in capex will likely start by the end of 2023 when the wind turbine installation vessel Charybdis will be delivered and construction works for the US$10 Bn wind farm off the Virginia coast will start. By this time, the debt-to-equity ratio may play catch-up with Enel and Iberdrola.

Interest coverage

In the low interest rate environment companies and investors have been faced with over the past decade, increasing leverage seemed sensible. Enel used this as an opportunity to increase net debt to invest in the business, while simultaneously lowering interest expenses. Taking 2017 as a start, the interest coverage ratio (ebitda/interest expenses) was 6.4. Thanks to a combination of earnings growth and debt management this number rose to 8.1 in 2021. At first glance this may not seem spectacular, but net debt did increase from €37Bn (2017) to €52Bn (2021) over the same time frame.

This implies the debt burden, although high, will not immediately affect the bottom line. Enel is more leveraged than its peers, but in my opinion, this is due to the fact the company made a head start expanding the renewable capacity.

Valuation

The stock price of Enel has come down quite a bit over the last months. Especially for US based investors this has been exacerbated by the strengthening dollar. As a result, based on the PE ratio Enel is relatively cheap compared to aforementioned peers Dominion and Iberdrola. The same holds for the EV/EBITDA and Price/Book ratios.

At the same time Enel committed itself to a EUR 0.40 dividend per share (2022) which it will increase to EUR 0.43 next year. With the euro-dollar exchange rate near parity this translates into a forward dividend yield of nearly 10%.

Although there are some challenges, I still view Enel as undervalued and consider the current stock price a buy opportunity.

Before placing an order, investors should be aware Italy has a 26% dividend withholding tax. On top of this the exchange rate may play a role for US based investors, but more important, dividend fees can be levied reducing the net dividend payment even further.

Risks

The world is facing high inflation prompting central banks to (aggressively) raise interest rates. For a company with a high debt burden this doesn’t bode well as debt servicing costs will rise. At the same time, the European Central Bank needs to perform a delicate balancing act as the spreads between different Eurozone members cannot diverge too much. Effectively this means the ECB can’t increase rates as aggressively as the FED has been doing. For Enel this may work out in its favor as the debt servicing costs will remain relatively muted.

Interest rates aside, the risk of increased costs for renewable development may pose a larger risk. In my recent articles on Enel, I’ve kept a close eye on the cost per gigawatt for renewable development. Enel did a tremendous job bringing down these costs, but the tide may be turning as developers can’t squeeze the supply chain much further. For example, Siemens Gamesa (OTCPK:GCTAF) has difficulties within the onshore wind business unit and Vestas (OTCPK:VWDRY) expects to post a loss this year as well. A supply chain where healthy profit margins are absent, combined with a highly inflationary environment, may be one of the larger risks as it eventually means less capacity will be developed for the same amount of capex. This undermines the business case unless selling prices will be increased. The thing is that price hikes by energy firms have the attention of politicians, consider for example the recent announcement of windfall taxes.

Conclusion

Enel is on track to deliver on the financial targets for the period 2022 till 2024. Capacity expansion is growing according plan as is earnings growth. A downside is the current debt level implies the company operates a net-debt-to-ebitda ratio at the top end of its forecast, meaning the net debt development remains a point of focus.

Although the high debt load of Enel requires attention, a larger risk may be posed by increased costs for renewable development. Increased costs would undermine the business case for Enel’s transition. So far however, the company is displaying the ability to meet its financial targets.

Summarizing, Enel is more leveraged than its peers, but in my opinion, this is due to the fact the company made a head start expanding the renewable capacity. Although there are some challenges, I still view Enel as undervalued and consider the current stock price (US$4.43) a buy opportunity.

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