Electricite De France: Back To 'Bad Old Times' Of Political Risk

Jun.24.14 | About: Electricite de (ECIFF)


The French government has made very negative announcements on EDF's tariff prospect. That hits the company's single most important share price driver, tariff progression.

This year's guidance could be in danger. There will be pressure on consensus.

EDF's risk premium will increase. There is further downside from here.

The recent announcements by the French government on electricity tariffs increase political risk significantly. Affordability has won strongly over cost reflectivenesss. The final outcome might still get smoothed from the current zero increase in August and return to a tariff formula resembling old times of minimal increase. But Electricite de France's (OTC:ECIFF) guidance is in danger for this year. And, the risk premium will increase. The shares have been trading on a premium to its peers in reflection of an outlook of profitable nuclear generation. The government has taken the company several steps back, into tariff saga and political uncertainty again. That will be reflected in further under-performance vs the sector, as EDF's European peers are coming out of high political risk periods and trough earnings. I see 15-20% downside under the assumption that its EV/Ebitda premium will erode.

The French government has made a raft of very negative announcements for EDF. First and foremost, it has cancelled the already announced increase due for August. And, it is looking to revise the formula and make an announcement in October.

Further, the energy minister has repeated that EDF has to implement efficiency improvements rather than look forward to tariff increases. A new element has also been added. The minister has said market prices should be taken into account for tariffs, rather than production costs. Clearly, all of this points towards a tariff increase below expectations, if not a freeze. The government is looking to contain the tariff trajectory with all means.

The statement about market prices is a big negative as it provides an initial justification for lowering the trajectory. The ARENH price that the government calculates for generation even stands above market prices, at Eur 42/MWh.

That all is a big step backwards for EDF on its single biggest share price driver.

There are some minor positive considerations. The outright cancellation of the august increase will likely not stand. As in the last instance, the Constitutional Court will declare this illegal and oblige the government to revise. The same might happen to too low an increase in October. The government, though will have created political capital and point to forces beyond its control. It will also have won some way towards a lower than initially announced increase.

I believe the market price argument by the government will not hold up either as a justification. It is well understood that current market prices below generation costs across the board. Governments across the spectrum, and the EU are aware of the that.

There will be challenges from the EU as France is effectively going back to the NOME/TURP regime where prices where not covering costs and the EU had made it clear that that was not sustainable.

In my view, there will be some form of tariff increase for 2014. It will come in later, which is a negative, precisely 1-2 months of earnings loss related to the increase. The new formula will ensure a much lower increase, though.

But, there will be more negative impact on the share price of EDF. The earnings impact could be around to Eur 700m of EBITDA this year for flat tariffs. That would put the company's guidance of 3% y//y EBITDA growth in danger. There will be pressure on consensus.

More importantly, this is a move of several steps back, towards those times where EDF was characterised by constant uncertainty over tariffs. Only, this time round, there is less prospect of the profitability gap towards cost reflective tariffs closing. The government has put the consumer and voter first.

That must lead to an increase in the company's risk premium, widening of the discount against the sector peers and continued under-performance. Political risk is on the rise again. EDF trades on a 2014E EV/Ebitda of 7.7x, which is a 12% premium to the close European generation peer group. On that basis, I see now 15-20% downside.

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