E.ON: You Are Missing 250% Annualized Returns

Summary

• If you read my last article on E.ON, you know that I advocated investors to take a look at this company based on the multiple expansion potential inherent in valuation.
• Well, the company now trades close to €10/share on the native listing. The upside is far lower now than only 2 weeks ago. Returns since the last article are massive.
• The company is still a "BUY", but the potential upside is slimming quickly, and on 2021E, it is already low.

Photo by Teka77/iStock Editorial via Getty Images

I don't typically write articles with intervals these short. However, I figured this company deserves a second article considering what's happened in less than 2 weeks.

You can disagree with valuations, and you can disagree with the upsides I'm seeing. However, realize that these sorts of developments aren't unusual.

(Source: Seeking Alpha, E.ON Article)

11.17% returns on a 1-month basis come to about ~250% annualized. In less than a month, the annualized returns go up into quadruple digits. It's only numbers, but this is what can happen when you invest at an undervaluation.

This article is about revisiting the article and thesis.

I'm going to explain to you why I believe that even after 11.17% in less than a month, there's still long-term upside here, and what you have missed out on.

(Source: E.ON)

E.ON - A quick revisiting

So, remember that article on E.ON? (OTCPK:EONGY) I told you that based on the valuation, company forecasts, and other factors, E.ON was set to outperform, both in the short and the long term.

Since that time, the company released its annual 2020 report. The report was full of positives.

(Source: E.ON)

The reason for the company's recent outperformance becomes apparent when we view the recent results. Full-year EBIT on an adjusted basis came in at the top of the range, and the dividend bump came as expected, at around 1 cent increase per share. Paltry for certain, but a good start.

The main reason can be found in the company's fundamental safeties, however. Despite ongoing regulatory reviews with regards to the company's pricing and terms, E.ON has managed to defend and retains its earnings successfully in every geography where regulatory updates have been performed, or are being done. For the UK, the transformation for E.ON is actually ahead of the company's initial plans of winding down Npower, migrating customer accounts, and starting up the "next" operations.

In my last article, I spoke of the company's synergies with regard to recent M&As and restructuring. These are on track.

(Source: E.ON)

And the company clarifies what it has done during the past 10 years to reinvent itself, which includes complete nuclear exit, transfer of nuclear liabilities, spinning off Uniper which signifies the company's fossil fuel generation exit, and scaling up the renewable business. All of these, ending with Innogy, have put E.ON on track to fulfill its strategic priorities moving forward, with the following growth target.

(Source: E.ON)

E.ON guides for a continually, annually growing dividend, both until 2023 and beyond. Expecting 8-10% annual CAGR in EBIT and 12-14% in EPS, E.ON expects to raise the dividend up to 5% annually until 2023 at the very least.

The company ended the fiscal 2020 with zero economic COVID-19 and weather impacts, related to recoverable earnings effects, and combining this with ending EBIT at the high end of the guidance, we start to understand why the company's valuation is essentially outperforming here. Strong operational performance in Eastern Europe, restructuring in UK, and other factors really drove things home.

(Source: E.ON)

The company was even able to, thanks to strong pension developments and divestments, reduce its economic net debt to around €40B. The company also gives us guidance for the next coming few years which we can then track as the company delivers quarterly reports. For 2021, the company expects EBIT improvement of up to €200M more than 2020 YoY. Beyond that, the company expects 8-10% annual improvements until 2023. EPS is expected to grow beyond that, at around 12-14% per year until 2023, which can easily absorb the impact of the raised dividend the company is suggesting.

The company also focuses on its debt, which to a large part is pension obligations and asset retirement obligations. Settlement of nuclear lawsuits is expected to bring in another €500M for the company which can be used on debt, and together with the other measures, E.ON's relatively high leverage doesn't look like anything of a problem here.

(Source: E.ON)

Overall, the company's delivery plan until 2023 seems firmly set, with only manageable or smaller risk factors that could disrupt the company here. The combination of a 5% p.a. dividend growth, 8-10% EBIT CAGR, and 12-14% EPS CAGR while maintaining cash conversion rates of 100% and BBB investment-grade credit makes E.ON a ridiculously valued utility company for what it offers.

That was what I said in my last article, only weeks ago, and this is what I am here to tell you again today.

So let's look at that valuation, shall we?

E.ON - What is the valuation?

(Source: F.A.S.T. Graphs)

These are my current returns for that investment, with my initial stake being around $10,000 in the company. I've extended this to around twice that. While I'm fully cognizant and aware of the fact that E.ON tends to jojo up and down around these valuations, the risk to investors is that the market is recognizing the 1-3 year upside to the company, and may trade E.ON above its 14-15X multiple for a more extended period of time. At this particular time, it is trading at around 15.38X 5-year average P/E for the ADR.

I mentioned that the forecast looked extremely positive, which is something we once again can see in the analyst expectations here.

(Source: F.A.S.T. Graphs)

Yes, E.ON often misses analyst forecasts - or forecasts mis-forecast E.ON, which is quite rare for a utility like this. This is because of the company's shift and reorganization, which is causing some trouble in the visibility for the company. However, at the valuations I invested in, the eventual visibility of future earnings growth, as long as the trajectory was correct, was something I considered moot.

At well over 5% dividend yield p.a. and potential growth of 9-11% per year on a 3-year basis, returns could have reached 50% in 3 years. Even at today's higher valuation, a 13.5X average weighted P/E would bring you 40.25% in 2023 if it materializes. Even lower RoR and lower targets bring in well over 30%, which despite the company's recent valuation growth makes it a question whether you should invest here or no.

Me, I've stopped investing in E.ON here, and I don't think I'll buy more at this time. This is because my portfolio now has a 2%+ E.ON position, which is sort of where I want to be.

There is still an upside to be had here, however. I showed you the analyst targets and where most expectations place E.ON in 3 years. The visibility until 2023 seems extremely good, and the guidance for increased dividends over the next 3 years seems good as well. The fact that the company has done away with its riskier assets and obligations means that investors who are merely looking for somewhere to put cash for the next 3 years or so at appealing rates of growth could do much worse than putting it in the hands of E.ON.

(Source: Google Sheets, S&P Global)

So, a few facts since the last article.

1. Analysts have bumped their overall mean targets and low targets by not insignificant amounts.

2. E.ON has appreciated over 10% in less than 2 weeks.

3. Despite appreciation, this shows us that E.ON still has ways to go, in the eyes of these analysts.

Are they correct? Well, what I can say is that investors who failed to invest during clear undervaluation, either in the ADR or in the native German listing, have clearly missed out on some significant short-term profits as well as positioning themselves for long-term market-beating capital appreciation and 5.4%+ dividend yield. However, there's still room for investors at this price point.

A moderation of return expectations means you can expect around 30-40% 3-year returns, while your YoC for 2023, if the company bumps its dividends around 5% p.a., would be around 5.46% if the company bumps this dividend to €0.544/share. For someone who invested at around €8.4 or around there, like me, that number is 6.5% which once again goes to show the impact of undervaluation investment in a company such as this.

Thesis

The fact is that I have an extremely conservative price target on E.ON, given its historical volatility. It's around €9.9/share, which makes the company either just around fair value or a few percentage points overvalued at this particular time.

However, opportunities like these don't grow on trees, and E.ON is a utility major that in the span of around 3 years is expected to grow rather significantly. Even in the case this doesn't materialize, the company could still grow at or above expected market development here.

You know from my previous work that if E.ON ever grew to overvalued levels, I would be the first one to offer my shares up on the market to anyone willing to buy in order to make a tidy profit. I have no specific love or loyalty to any one of my investments, and this isn't me beating the "E.ON drum" for any other reason than that I see the potential for you to make money here.

The fact that the market is in such a bad position for investing capital - and make no mistake, that's where we are - means that every opportunity needs to be treasured in a way you may not be used to. It also means that opportunities disappear like leaves in a fall storm, sometimes very quickly.

What I've found in this market is that the space for consideration, if you're a valuation investor, has grown slim. There are several examples of this, where I myself failed to act accordingly. As a result of this, the companies are now overvalued and I can no longer buy them to realize returns that I view as conservatively market-beating.

I really want to highlight that E.ON could be an opportunity such as this for you, even if you might have missed out on the real undervaluation here for the time being.

Take a look at the company, if you haven't, and let me know what you think.

Thank you for reading.

Analyst’s Disclosure: I am/we are long EONGY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved. I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles. Option Disclosure: