Enel is embarking onto an emerging markets and new growth business expansion strategy. Whilst that can deliver growth, it is a risky strategy of which I anticipate markets will be wary. The company has existing operations in its target areas, but performance is very patchy. Enel has been the second strongest performer in the European peer group since the trough and now trades in line with the sector but with a yield at the low end. A necessarily increasing risk premium at this stage outweighs the potential growth attraction in my view. For the renewables part of the strategy, investors can get direct exposure through Enel Green Power.
Enel has said it is looking to diversify capex away from Europe and into emerging markets, particularly Africa, the Americas and the Middle East. Investment is to be focused on gas and renewables. Growth capex would increase by almost 30% in a shift of weight away from maintenance capex, and as per management, improvement of maintenance capex efficiency.
The new CEO is looking to deliver structural growth beyond the impact of efficiency. Current growth is almost entirely driven by the benefit of de-leveraging (and Enel Green Power). But the impact of that will be coming to an end over the next two years. Like the rest of the European utilities, Enel needs to reinvent itself as it struggles with oversupplied markets and weak generation profitability.
The strategy very much echoes that of E.ON. That E.ON's emerging market expansion has not brought the desired earnings growth and been rather disappointing so far, is a well documented fact. Enel's performance in the international operations has not been much better. Without exception, they have delivered negative earnings growth contributions and margin compression in the last quarter.
Enel has an important existing base of operations outside of Europe already with c 42% of EBITDA from emerging markets, Latam being the most important. And, a lot of the investment in new regions will go through Enel Green Power which has a very good track record of execution. Those could be comforting factors in terms of experience and synergies with existing operations. But investors should make themselves no illusion: the company will likely go beyond the current comfort zone.
Enel has performed very strongly since the trough last year, but broadly in line with the sector. Since the trough, Enel has been the second strongest performer in the European peer group. The shares are now trading in line with the sector average of a 2014E P/E of 13.8x but at a yield at the low end. An undoubtedly increasing risk premium at this stage outweighs the potential growth attraction in my view. Conventional utility business growth from emerging markets expansion is a risky proposition. And for the renewables part, that can be achieved directly through positioning in Enel Green Power.