Engie is no longer risky, it's time to buy (rating upgrade). (OTCMKTS:ENGIY)

Here at the lab we like utilities and our team recently upgraded Enel and E.ON. Today we comment again on Engie (OTCPK:ENGIY). Regarding the French player, we were in to Wait and see So, and as we reported in our last analysis, we expected a reassuring outlook and a simplified business model before changing our rating. That said, before commenting on the company, it is worth taking a step back and looking at the sector.

Looking at the utilities sector, it is clear that it has underperformed the market since 2022 (Fig. 1). Taking into account the current war between Russia and Ukraine and its impact on energy prices, we believe that the sector could benefit from lower interest rates. Wall Street is awaiting communications from major central banks on the timing of the first-rate cuts, which are expected to begin in June. While June could It will be a good time, nothing has been decided yet. The ECB and the FED maintain that their decisions will depend on economic and inflation data. Given the sector's weak growth and historically high and stable dividends, even if we don't foresee a cut in June, we believe integrated utility players will likely benefit from a decrease in rates in the long term. Furthermore, until very recently, utilities were considered similar to high-quality bonds. However, with power grids scaling to unprecedented levels, we see better growth than before in low-risk regulated assets. This was already evident in Engie's fiscal 2023 results.

Fountain: S&P 500 Utilities – Figure 1

For our new readers, Engie SA is a global energy player based in France that operates through four divisions: renewable energy, networks, energy solutions and flexible generation and retail. Additionally, Engie has nuclear operations in Belgium. Here at the Laboratory, we previously anticipated increased provisions for extending the useful lives of nuclear assets, as well as their waste liabilities. However, we believe the company is now likely to increase substantially eliminate risk.

Fountain: Presentation of Engie's 2023 financial year results – Figure 2

Why are we positive?

1. With its fourth quarter and fiscal 2023 results, the company reassured investors with a positive medium-term guidance (Figure 3). After checking Engie's financials and forecasting lower energy prices, we report that the company's low-end outlook is still above consensus. Therefore, this could positively impact the evolution of its share price;
2. Engie has an attractive capital remuneration policy. In detail, the company's board will propose a DPS of 1.43 euros per share. At the current market price, this represents a dividend yield of 9.2%. Engie has a shareholder remuneration set with a payout ratio of 65/75% and a minimum dividend of 0.65 euros until 2026 (Fig. 4). Therefore, in a depressed scenario, there is downside protection. As a reminder, the company goes ex-dividend on May 2. In our forecast, we anticipate a decreasing DPS set at €1.18, €1.16 and €1.17 for 2024-2025-2026;

3. Engie signed a final agreement on the Belgian nuclear plan and fundamentally de-risked the Group's portfolio (Fig. 5). The company now expects a contribution of €200 to €400 million to core operating profits from nuclear energy after 2026. This removed Engie's long-standing uncertainty about nuclear waste liabilities. Here at the lab, we believe this also simplified the group structure and eliminated another salient;

4. The key to the report is Engie's structural growth expected in the coming years. We think the market has overlooked the company's EBIT growth. According to our vision for the future, Engie's growth drivers will be batteries and renewable energy development, which are very well supported by the company's resilient revenue generator, namely the networks division. Looking back, we must report that the company delivered a core operating profit CAGR of 13% between 2021 and 2023. Even if we forecast a gradual deterioration in the group's commodity-driven profits, the new core operating profit guidance of the Engie network supports our financial estimates. ;

5. Looking at the GEMS & Retail division (Fig. 6), we believe the company is forecasting a cautious orientation. We have a different view supported by three key conclusions: 1) there is increased volatility after the COVID-Ukraine war on energy prices; 2) we believe there are higher margins in battery storage assets; and 3) the retail division is more profitable due to higher demand for renewable electricity (from B2B customers);
6. With commodity-driven earnings normalizing and Engie's nuclear EBITDA generation slowing, we expect Engie's hard work to bear fruit. Here at the Lab we project declining EBITDA over our visible three-year period. In figures, our EBITDA 2024-2025-2026 is set at 14.54, 14.46 and 14.14 billion euros, respectively. Following an aggressive CAPEX plan, our EBIT is forecast at €9.07, €8.89 and €8.96 billion with EPS of €1.81, €1.66 and €1.67;
7. Furthermore, even if we don't speculate on portfolio turnover, we know that disposition could play a crucial role in internal management. This also provides flexibility in the net debt profile. Over our three-year visible period, we anticipate financial leverage of less than 4x.

Fig. 3

figure 4

Fig 5

figure 6

Valuation

We recently valued Enel, so we are building on our previous post. In fact, if we analyze the sector, companies integrated in the EU are listed with a P/E and EV/EBITDA of 14.86x and >7x, respectively. In our 2024 figures, Engie trades at a P/E of 8.56x with an EV/EBITDA of approximately 5.5x. At this stage, we see limited value placed by the market on Engie's growth prospects. Additionally, the grid/GEMS upgrades will likely allow the French player to more gracefully deal with low energy prices. Gas storage levels in France are quite high and the coming winter 2024/2025 should be reasonably secure from a supply point of view. More importantly, excess nuclear responsibilities have been eliminated.

We see no reason why Engie should trade at a discount. That said, applying a P/E of 10x due to a lower expected EPS evolution until 2026, we value Engie with a target price of 18.1 euros per share ($19.5 in ADR). This means a Buy rating valuation with an expected total return of approximately 26% on one-year estimates.

Risks

Engie's critical risks to our price target include a prolonged low energy price environment, delayed CAPEX without growth in net solar and wind capacity additions, lower credit for battery and renewables growth beyond 2024 , GEMS EBIT returns to pre-energy crisis level, and provisions in the retail division. Higher interest rates also negatively affect Engie.

Conclusion

We believe Engie will outperform the market in 2024. Our analysis is supported by 1) attractive valuation, 2) earnings defensiveness driven by network division, 3) lower risks in Nuclear and 4) simplified structure. Even if we are not speculating on rate cuts, the sector is sensitive to interest rate movements and we believe we are in a rate election. Therefore, Engie is now Mare Evidence Lab's top choice.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.