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Summary

  • RWE reports a 62% fall in first-half profits.
  • Energy reforms in Germany have so far not been as comprehensive as initially expected.
  • With the substantial rise in the value of the shares since the election, RWE is relatively unattractive against UK and French peers.

RWE (OTCPK:RWEOY) reported recurrent net income fell 62% to €749 million ($1.00 billion) for the first half of 2014. Operating profit fell 40% to €2.27 billion ($3.03 billion), following a mild winter in Germany and the non-recurring impact of the price renegotiation with Gazprom in the same period last year. The combination of rising renewable generation capacity and declining coal prices had put further downward pressure on wholesale electricity prices. This would mean that many conventional power plants in Germany would no longer be profitable to operate. With the outlook looking bleak, RWE intends to shut down up to three more coal power plants, bringing a total reduction in capacity of approximately 6.3 GW by 2017. Management has provided guidance for recurrent net income for 2014 to be between €1.2 billion and €1.4 billion (between $1.6 billion and $1.9 billion). With management targeting a dividend payout ratio of 40% to 50% of recurrent net income, we should expect the dividend to be unchanged in 2014. This would give a prospective dividend yield of 3.4%.

In my previous article on the company, "RWE And The German Federal Elections", I expressed optimism with the potential impact of the energy reforms that would be introduced following the September elections. It took a full ten months for the German government to pass through the long awaited energy reforms to curb the total amount of subsidies for renewable generation, and set limits on the net installed capacity generated from renewable sources. The reforms include capping the total capacity that can earn the full rate of the feed in tariff from onshore wind and solar panels at 2.5 GW per year. Although this would moderate the addition of renewable generation capacity to the electricity markets, conventional power generation would struggle to remain operationally profitable in the coming years. Despite this, conventional sources of electricity generation will continue to play an important role in ensuring the reliability of electricity supplies. The UK and France are proposing to introduce a capacity market, which would compensate conventional power plants and energy storage providers for providing reliable capacity to meet demand when needed. The current German reforms fall short of introducing the same, but for how long can they ignore the need for reliable electricity?

Although RWE would benefit from the proposed introduction of the capacity market in UK, given its sizeable generation capacity there, the weakness elsewhere in the group would offset much of the potential gains. With RWE's shares having already risen significantly since the elections last year, you could probably find better value and less risk with British and French utility firms, such as SSE (OTCPK:SSEZY) and GDF Suez (OTCPK:GDFZY).

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

Source: Update: RWE H1 Earnings