EDF's share price has underperformed its close sector peers by 18% since the union claim that the French state was going to place 15%. An arguably justified increase in the risk premium has also played its part. Political risk has undoubtedly increased, with the weak position of the government, electoral and industrial pressure on tariff policies, and most recently after the energy minister's comments on tariffs.
Now, the shares look still full of risk over the long term, but due for a catch up and recovery near term.
Short term news flow will be marginally positive: Over the summer, the announced tariff increase will come through, likely in the order of 5%, unchanged. The recent supreme court judgment that tariffs have to be cost reflective has lent new support to increases and there should be some incremental positive from the required adjustment coming through. In the immediate, that should weigh higher than the comments by the energy minister that EDF has to reduce costs and that tariff increases need to be questioned. The 2015 trajectory is one of very low increases and still below cost reflectiveness.
Consensus has not moved much since the energy minister's comments, and I do not see near term pressure from the political risk element.
EDF is one of the few names in the European generator space with positive EPS growth, driven by core operations.
Longer term, I see the market's concerns of political risk, profit share, execution risk on nuclear new build and capex burden as very valid. That being said, there are other names in the sector with high political risk and very deep structural problems.
The company's ageing fleet means margin pressure, maintenance and outages being the main cost driver. Life extensions are likely and will be profitable, even if there is profit share. But those will require cape and come with incrementally lower operating profitability. On the other hand, there is also some protection from this for tariffs: The government has justification and interest to protect EDF's earnings base. Recently, the chairman of the parliamentary commission on nuclear has said, tariffs will need to increase to foot the upgrade and new build bills. Even a public study by the Cour des Comptes has estimated nuclear generation costs will increase significantly, towards Eur 62 and above EDF's own estimate of Eur 56/MWh by 2025. The report clearly states fleet maintenance due to older plant as a prime driver. That should support the tariff case alongside pressure from the EU and regulatory institutions for cost reflectiveness.
There should be a good recovery but not a full elimination of the discount of EDF's valuation vs the sector peers. The current discount of 16% on P/E and 24% on EV/EBITDA, both 2014E is too large when considering the earnings outlooks of the close peers in European generation.