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A strong first half

GDF Suez (OTCPK:GDFZY) has recorded a 10.6% increase in its revenue in the first half of the year, driven in part by:

  • expansion into developing markets (Latin America and Asia)
  • a particularly chilly spring in France.

EBITDA increased by 4.2% and reached €9.2 billion ($11.3 billion) in the first half of the year. EBITDA have benefited from a larger contribution from exploration-production operations (Gas and LNG), and the effect of favorable weather conditions in Europe. The Global Gas and the LNG business line have recorded the strongest growth with an EBITDA increase of +13.6% to €1.4 million ($1.7 million) thanks to a favorable evolution of commodities prices and an improved performance of the LNG activity in Asia.

But net profit slid 14.9% to €2.33 billion ($2.9 billion) from €2.74 billion ($ 3.4 billion) a year earlier, but the first half of 2011 was favorably impacted by an exceptional capital gain of €595 million ($731 m) due to a change in fair value of derivatives.

The company has stated that a French government decision to limit gas price rises to 2% would prevent it from covering its supply costs, leading to a shortfall of €30 million ($37 m) on third-quarter core profit. The impact could be greater in the last quarter of the year. However, the company is considering whether to take further action against the French government to be able to charge a price for domestic gas that will cover its costs.

H1 2011

H1 2012

Revenues

$56.2 billion

$62.1 billion

+10.6%

EBITDA

$10.9 billion

$11.3 billion

+4.2%

Net income

$3.3 billion

$2.8 billion

-14.9%

Free cash flow

$5.5 billion

$5.8 billion

+5.4%

Besides, the French utility has maintained its full-year goals:

  • recurring net income of €3.7-4.2 billion ($4.5-5.2 b)illion, up from €3.5 billion ($4.3 billion) last year,

  • EBITDA of €17 billion ($20.9 billion),

  • ordinary dividend stable or higher than in 2011

  • Net debt/EBITDA ratio around 2.5x

GDF Suez, a worldwide integrated utility

The French Group is still focused on growth and continued to develop its business, particularly its LNG business line and power generation in fast-growing markets. GDF Suez has an attractive exposure to global LNG, as No.3 supplier in the world. Also, the company has leading positions in Asian, Middle-East, and Latin American power markets. 30% of its 2011 net recurrent income (including full IPR ownership) stems from fast-growing markets and the management estimates that 40-50% of medium-term investment will take place on these same fast-growing markets. Consequently, Mr Mestrallet, Chairman and CEO of GDF Suez, has asked that "no longer regard the company as an European utility because it invests more of its money in Latin America, Asia and the Middle East".

Thus, GDF Suez has signed an agreement with the national carrier Korean Kogas to supply him between 2013 and 2014 about 1.6 million tones of additional LNG. At current prices in Asia, neighboring $865 per ton, the contract can be estimated at $1.4 billion. This new contract is the sixth medium-term agreement for GDF Suez in Asia, after the five already signed with Kogas, CNOOC China (OTCQB:CEOHF), Malaysia's Petronas, India's Petronet and Thai PTT, for a total of 10 million tons available between 2010 and 2016.

Possible clouds on the horizon and challenges to overcome

For the second-half, Mr. Mestrallet, will pursue "its action plan aimed at optimizing costs and Group performance". But its European business is under threat politically specially in France and Belgium.

In France, following the cancellation of tariff freeze the new socialist government only approved a 2% gas-tariff increase from July 1 in order to reduce the impact on the energy users' purchasing power. If the tariff took full account of supply costs, the hike should be around 7%. GDF Suez will bill its customers an extra €290 million ($357 million) over a period of 18 months, to compensate for the freezing of gas prices from October 1 until January 1. In the fall, the French government plans to launch a reform of energy prices to "protect" the energy users' purchasing power. As a result, utilities companies could face difficulties in obtaining higher regulated-tariff increases from the government. Regarding insufficient margins in French gas, the management could undertake a strong action of cost-reduction and control of investments.

In Belgium, regulation is hostile the government has already doubled a tax on nuclear power to €550 million ($676 million) a year and still intends to levy additional taxes on the nuclear industry. Moreover, GDF Suez is expecting more details and clarifications on nuclear energy plans in the country. Belgium has seven nuclear reactors of combined capacity 5.9 GW, most of which is controlled by GDF Suez. In early July, the Belgian government has announced its intention to close in 2015 two of the oldest nuclear reactors operated by GDF Suez (Doel-1 and Doel-2). Besides, it has only granted a ten-year license extension for the nuclear reactor Tihange-1 which was expected to be decommissioned in 2015. According to GDF Suez, the closing of Doel 1 and 2 should trim net result before tax by approximately €100 million ($123 million) after 2015. At the same time, the Belgian government has announced that 1,000MW of nuclear production would be made available to the market. It could be a sign that the Belgian government aims to reduce GDF Suez market share or increase competition to cut tariffs. Indeed, the Paris based company is the dominant power producer in Belgium, which gets about half its electricity from seven reactors.

Moreover, the Doel 3 reactor operated by GDF Suez has been temporarily shut down after the country's atomic energy regulator discovered several problems including possible cracks.Consequently, this investigation casts doubt over the decision to keep it open until 2022. Outside Belgium, GDF Suez's nuclear activities are limited to France where it has a 5% stake in an uranium enrichment plant and drawing rights in two nuclear power plants. The company has nuclear projects in the U.K, U.S.A, Brazil, Saudi Arabia and Turkey but the situation in Belgium could call into question the Group's nuclear strategy. Its competitors RWE (OTC:RWED) and EON (OTCQX:EONGY) are reviewing their business models after Germany's decision to phase out nuclear power by 2022. They are now investing heavily on renewable energy and foreign expansion.

Furthermore, underachievement from its consolidated subsidiary Suez Environment (OTCPK:SZEVF), might mitigate the solid results of the Group. The subsidiary reported a -8.1% drop in EBITDA, in particular due to the deterioration in its waste business in Europe and to write-downs on a construction project in Melbourne.

Is GDF Suez a growth or value stock?

Since then, the stock provides a dividend yield around 8%. The management confirmed it would pay a stable or increased dividend for 2012 and an interim dividend of €0.83 ($1) a share in October. Following, the buyout of International Power minority interests, GDF Suez shareholders have exceptionally the possibility of receiving this interim dividend in the form of shares. In 2013, its main shareholders could demand full cash payment of dividends and it can generate an issue. Indeed, the company is paying out as much of its earnings and has a lack of EPS progress (-17% in 2011 and -4.5% in 2012 on my estimates). As a result, the return to cash dividend could add financial pressure and to maintain the dividend GDF Suez should increase its disposals and/or cut Capex.

Nonetheless, the firm can decide to be viewed as a growth play and cut dividends. The IPR buy-out provides GDF Suez opportunities to divest businesses that do not enhance its growth potential, for instance its nuclear business line. Indeed, the IPR buy-out enabled GDF Suez to reinforce in Asia and Latin America where energy needs are soaring. The French company could sell part of its assets from mature markets threatened by higher regulation and economic slowdown.

For the moment, GDF Suez needs better visibility in Belgian nuclear and French gas tariffs. The market is focused on these challenges and might be not satisfied regarding the quality of the growth. That could explain the slow progress of the stock. GDF Suez has multiplied power generation projects in Asia and Latin America but which the Group only owns minority interests. Above all, the French utility is lagging in offshore renewable energy. Indeed, it has failed to win any of the large off-shore wind tenders. In April 2012, four projects totaling 1.9GW were awarded and GDF Suez got none.

As far as I am concerned, I would play GDF Suez as a growth stock despite its current dividend yield. The growth projects and a sustained level of Capex should enable to increase earnings in medium-term. Moreover, by cutting its dividend (~$6 billion of savings) GDF Suez could also raise its Capex and accelerate its growth in emerging markets.

(€1=$1.23)

Source: GDF Suez: Growth Or Value Play?