BMI View: The r egulatory uncertainty that is plaguing Iberdrola's domestic market and heavy tax charges during the last six months have certainly taken a toll on the company's H113 financial credentials, but gains in renewables , a clamp down on investment and the sale of non-core assets have helped alleviate some of the company's troubles. Iberdrola's reduction of net debt is perhaps the most optimistic element of its results, highlighting the company's continued commitment to its cost-cutting strategy.
Iberdrola's financial results for H113 are indicative of the challenging operating environment the company continues to endure , as it is adversely affected by both macroeconomic and sector-specific issues. Net profits were down 2.0% and total revenues decreased by 0.9% (to 1.68EURbn) on H112 results. EBITDA was mostly stable; however , EBIT posted the most marked reduction - falling 65.3% y-o-y .
| Dropping |
|Iberdrola's Financial Results (EUR, mn)|
The r eduction in earnings (before interest and tax) is mostly due to accounting features linked to depreciation registered over the quarters, particularly with in the company's renewable energy project portfolio and also due to adjustments to asset values in the US and Canada . Although net profits were down, it was widely expected that the fall in profits would be more pronounced. However, corporate taxation laws that allowed for advantageous asset revaluations in Iberdrola's Spanish business portfolio helped to boost profits marginally.
In our previous company analysis we highlighted several factors that could present challenges to Iberdrola going forward and a number of these issues have had a detrimental impact on the company's performance over the beginning of 2013 - most pertinently, the operating environment in its domestic Spanish market.
Difficulties In Spain
Spain still accounts for a significant proportion of Iberdrola's total net profit (30% in 2012) ; however , this is a significantly lower contribution than that witnessed in previous years (net profit from Spain in 2012 was at its lowest since 2000). In fact, Iberdrola's domestic market remains the key problem area for the company , with the precarious macroeconomic situation crimping power demand and the government's tariff deficit weighing heavily on many utilities' profits.
The stagnation of Spain's economy (we have recently downgraded our forecast for GDP growth to a contraction of 1.7% in 2013, as the country continues to suffer from massive structural imbalances) is likely to have a knock-on effect on power demand , and we expect the power sector to register only muted growth over our forecast period. This will adversely affect the company's power generation division in Spain, squeezing profits further .
| Bleak Prospects In Domestic Market |
|Spain GDP Growth and Electricity Consumption, % y-o-y, 2012-2022|
In order to reduce the mounting debt it owes Spain's energy sector, the Spanish government is moving ahead with plans to cut the country's tariff deficit, which has spiralled to EUR26bn (US$34bn) following years of setting electricity prices at artificially low levels; as an anti-inflationary measure. With Spain currently crippled by its huge public deficit and having spent four of the last five years in recession, the move aligns with Prime Minister Maria no Rajoy's austerity programme.
The government's latest move to cut the burgeoning power tariff deficit (announced in July) is likely to weigh on the embattled power sector and has been met with harsh criticism from Iberdrola, which stated that the reform will deter investment into the market and cap profits. In fact, Iberdrola estimated that the energy reforms would reduce its 2013 pre-tax earnings by at least EUR170mn, and potentially as much as EUR260mn in 2014. Under the latest plans to overhaul the sector, regulated costs, which include renewable energy subsides, will be slashed by EUR2.7bn a year. Meanwhile, consumers will likely have to pay an extra EUR900mn in energy bills - with the government now also set to contribute EUR900mn as it moves to plug the deficit. The government will also move to implement a policy of 'reasonable profitability', which will initially limit the returns on investment that can be made by Spanish renewable companies to 7.5% and electricity distributors to 6.5% - moves that are certain to create uncertainty for investors in the Spanish power sector and further dent confidence in an already troubled market. This is reflected in the volatile share prices of the major Spanish utilities (including Iberdrola, Endesa , Acciona and Abengoa ).
| Utilities Taking A Hit |
|Iberdrola, Endesa, Acciona And Abengoa Share Price, Rebased As Of January 2012|
The tariff deficit issues, coupled with the uncertainty with regards to other areas of Spain 's energy regulatory framework - the government suspende d its Feed-in Tariff programme ( FiTs) for all renewable energy installations indefinitely in January 2012 - will no doubt be pressing issues for Iberdrola going forward.
Renewables To The Re s cue...But For How Long?
Iberdrola's Renewables segment remains fundamental to the company , and renewable power accounts for the largest share of total installed capacity. Although renewables is the smallest contributor in terms of EBITDA by business segment, this figure increased by 10.5% between H112 and H113, whilst the other two segments ('networks' and 'generation and supply' contracted by 0.8% and 6.1% respectively). Driving the growth in renewables EBITDA - despite only small capacity additions over the year in terms of renewables - was a boost in average load factor. Iberdrola remains committed to its renewable energy business segment and it was announced in June that since 2002, the company has invested roughly US$33bn into the industry .
| Renewables Remain Crucial |
|Iberdrola's H113 EBITDA, By Business (LHS) and Breakdown Of Installed Capacity In H113 and H112|
That said, austerity measures and financial insecurity in developed markets are prompting many countries to re-evaluate their green energy agendas, and in some cases, alter the regulatory environment for the renewables industry. Subsidy programmes and green energy funds are looking increasingly more unstable and will no doubt affect the company's ability to develop projects. Furthermore, recent setbacks within the company's renewables business have the potential to negatively affect Iberdrola's renewables portfolio down the line if not resolved promptly. For example, a number of Iberdrola's offshore wind power projects in the UK are facing delays (such as the Argyll Array project), on account of grid connectivity, environmental concerns and regulatory uncertainty.
Despite this, Iberdrola's activity within the renewables industry has undoubtedly helped to offset some of the domestic troubles facing the company . Iberdrola's share price has been erratic, reflecting both its successful operations in the renewables segment and emerging markets and the difficulties within its core markets. Although , we have seen a recovery of sorts during the latter half of 2012 and 2013 ; the company is still struggling relatively speaking. During the first half of 2011, Iberdrola outperform ed both the Bloomberg World Utilities Index and the Bloomberg European Utilities Index. However, since January 2012, the company has been underperforming against the two ind ices .
| Erratic Share Price |
|Iberdrola Vs Bloomberg World Utilities Index and Bloomberg European Utilities Index, Rebased as Of January 2011 (LHS) and Iberdrola's Share Price, As Of January 2012 (RHS)|
Cost-cutting Strategy Beginning To Reap Rewards
In a cost-cutting effort, Iberdrola is looking to scale down its investment, dispose of non-strategic assets (EUR2bn worth of assets) and reduce its workforce; in line with its strategic outlook for 2012-2014, wh ich focuses on debt reduction.
So far the company has made progress in this regard, and divestments have now surpassed the EUR1.2bn level, of which EUR800mn has been received. We have repeatedly highlighted that assets outside the company's key markets (US, UK, Spain, Mexico and Brazil) were most vulnerable to disposal. We continue to see this view play out - most recently in May when EDF announced that it had acquired 30 French wind farms from Iberdrola, with a combined capacity of 305MW.
This strategy is clearly beginning to pay off , with net debt falling by 6% from H112 to H113 (excluding the tariff deficit debt) . T his development is perhaps the most optimistic component of the H113 financial results. We have long-highlighted Iberdrola's substantial debt pile as a concern in our previous analysis of the company, and believe that this continued conviction as it undertakes its cost-cutting strategy will help to restore investor confidence, and help the utility weather the storm that is likely to continue throughout the rest of the year.
| Debt Heading Lower |
|Iberdrola's Adjusted Net Financial Debt (EURmn)|