GDF Suez Is Still A Good Long-Term Play With A Price Target Of $25

by: Pierre Sookiew

GDF Suez (GDFZY.PK) reported its FY-12 results in line with previous guidance and expectations.

- Revenues rose 7% to €97 billion ($126 billion)
- EBITDA +3% to €17 billion ($22 billion), strong contribution of gas and LNG business above all in Asia.
- Net profit fell to €1.6 billion ($2.10 billion) from 4 billion, mainly due to €2 billion ($2.6 billion) worth of post-tax impairment losses on assets in Europe.
- Dividends confirmed at €1.50 ($1.95), same level as in 2012, implying a dividend yield above 10%

- Net debt roughly in line with estimates at €43.9 billion ($57,1 billion), and €42.8 billion ($55.6 billion) adjusted by the recent disposal of SPP (closed early 2013), net debt/EBITDA ratio stands at 2.5x, i.e. in line with target.

Key growth factors in 2012:

- an increase in gas and electricity sales in France due to more favorable weather conditions than in 2011 and a tariff catch-up,

- a greater contribution from exploration & production and LNG,

- the group's continued expansion overseas, particularly in Latin America and Asia.

These growth factors offset the decrease in EBITDA from the companies sold as part of the group "portfolio optimization" program, the impact of the changes in gas/electricity spreads on the utilization of the Group's gas-fired power plants, the unavailability of the Doel 3 and Tihange 2 nuclear power plants in Belgium, as well as the continuing impact of the tough economic and regulatory conditions in the Group's mature markets.

Its net income group share was dented by impairments, primarily on European assets, and amounted to €1.6 billion ($2.1 billion). However, its net recurring income group share amounted to €3.8 billion (4.9 billion), namely a 10.9% increase compared to 2011 thanks to a rise in current operating income and despite a higher tax charge.

Its balance sheet remains strong with Net debt/EBITDA ratio at 2.5x. net debt, which amounted to €43.9 billion ($57.1 billion) at the end of December 2012, including the impact of the buyout of the minority interests in International Power. Taking into account the cash received in early 2013 related to the disposal of SPP, the adjusted net debt amounted to €42.8 billion ($55.6 billion). Cash flow from operations is steady and enables to cover capex.

A rebound expected in 2015 with higher contribution from emerging markets

The guidance is reiterated after the recent update from December 2012. Moreover, the new formula to calculate gas prices (now revised every month), coupled with the renegotiation of supply contracts offers more visibility to GDF Suez.

- Suez Environnement (OTCPK:SZEVF) will be accounted for under the equity method as from July 2013 in the GDF SUEZ's consolidated financial statements. On December 5, 2012, GDF Suez announced by mutual agreement with the other members its intention not to renew the shareholders' agreement when it expires in July 2013.

- EBITDA is at €13-14 billion ($16.9-18.2 billion) for 2013 but the management provides an estimation of €13.4 billion ($17.4 billion) during the presentation. The positive decision from Conseil d'Etat on French gas tariffs in 2013 will have a €150 million ($195 million)positive impact at EBITDA and €100 million ($130 milllion) at net income. GDF Suez also expects a restart of Doel 3 and Tihange 2 nuclear plants in Q2.

- Net recurring income of €3.1-3.5 billion ($4-4.6 billion) for 2013 and 2014.

- Capex between €7-8 billion ($9-10 billion) and €11 billion ($14 billion) of disposals by end of 2014. 40%-50% of growth Capex allocated to fast-growing markets over 2013-2015.

- Net debt/EBITDA ratio below or equal to 2.5x and a reduction in net debt to approximately €30 billion ($39 billion) by year-end 2014.

Furthermore, GDF Suez emphasized on its Perform 2015 cost cutting plan and expects to have a gross contribution of €3.5 billion ($4.6 billion) and a net impact on net recurring income of €200 million ($260 million) per year 2013 onwards. The company will accelerate power plant closures in Europe and focus its capex in fast-growing markets.

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*2012A represents pro-forma with Suez Environment as investment in associates

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*2012A represents pro-forma with Suez Environment as investment in associates

New Price Target of $25 (vs. $26.5)

Economic conditions are expected to remain weak in Europe: sluggish demand, power-production over-capacity and increased competition leading to prices drop. Moreover, the eurozone debt crisis is still threatening with political uncertainties in Italia where the law prohibits companies that are directly or indirectly controlled by a state from taking part in public competitive bidding for the grant of gas distribution concessions.

Investment case:

- Weak U.K. and unfavourable market conditions in Europe will impact earnings in 2013 and 2014. I expect European generation profitability to recover in 2015.

- EBITDA under pressure over 2013-2014. I expect a sharp increase in EBITDA margin by 2015 thanks to LNG contribution and higher margins in Energy International business.

- Capex reduction to limit an increase in debt borrowing and to keep its "A" debt rating at S&P.

-Net Debt to EBITDA below or equal to 2.5x

- Positive impact of the asset optimization program on cash flow generation through disposals, $9-10 billion per annum in 2013 and 2014. The Group had already finalized two disposals (SPP and IP Maestrale) in January and February 2013 and expects to finalize the disposal of part of its interest in Sohar Power Company during the first half of 2013.

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My target price of $25 is the result of a DCF Valuation (terminal growth of 2%, long-term Operating Profit margin of 10.4% and a WACC of 6.56%). This target price offers a 24% premium considering the current price of $19.

Despite the recent stock price drop, my view is still positive on the stock and I think that it is not time to get rid of GDFZY.

It is long-term investment with a strong balance sheet and a well-balanced business model. I think we have to be patient with GDFZY. However, the company is lagging in renewables compared to its peers, it accounts for only 3% of its generation capacity, vs. 24% for Iberdrola (IBDRY.PK). Furthermore, GDF Suez offers an attractive dividend policy with a 10% yield (vs 7% for the sector), a good argument to keep the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.