P&L Check Debt Saps E.ON's Power

E.ON wiped the slate clean with a record loss in 2016. If the utility giant can handle its debt load, there's hope for the future.
Quelle: dpa
At least the lights are still on.
(Source: dpa)

While debt is high, there is hope for the future. That, at least, is the message E.ON Chief Executive Officer Johannes Teyssen is hoping to get across as Germany's second-largest utility firm struggles with the massive challenge of remaking itself into a viable renewable energy company.

And there are some good signs. The company on Tuesday reported profits for the first quarter of this year, a major step after a record loss in 2016. Looking ahead, it retained its outlook for a return to some degree of health over the course this year. That should calm the frazzled nerves of shareholders, who are gathering Wednesday for the company's annual meeting.

The company is still weighed down by debt related to its split into two companies, dividing responsibilities for old and new energy, a process that cost E.ON a spectacular €16 billion ($17.6 billion) in 2016, the second-biggest loss a German firm has ever posted. But many of the problems on the company's balance sheet affect the entire energy sector, which is being forced by the German government into an aggressive transition towards renewable sources, rather than specific management failings.

On the plus side, E.ON has a strong customer base and lucrative parts, including wind power. While its share price is near rock-bottom, it has increased since the start of the year and jumped 2.4 percent on Tuesday's announcement of a return to profit.

The Uniper IPO harshly exposed the loss of value in conventional power generation.

E.ON is desperately trying to look towards a brighter future. Its spun off company Uniper now manages conventional power generation with coal and gas-fired power plants, along with the wholesale business. That has allowed E.ON's remaining divisions, renewable energy, distribution and networks, to focus on the new energy world (though E.ON was forced to keep nuclear energy in its fold).

But the cost of that spin-off has massively hit E.ON’s earnings, balance sheet and equity. Uniper started operations at the beginning of 2016 and that fall, E.ON shareholders received one Uniper share for every 10 E.ON shares, shedding 53.35 percent of the group’s value in one fell swoop. Then, when Uniper went public in September, the old part of the business was given a market price and valued at just €4 billion. The problem was that during the split, the assets on E.ON's balance sheet were still posted at book values of €15.5 billion, forcing the group to write off €11 billion as part of the Uniper spin-off.

08 p26 E.ON in Numbers 2-01

The Uniper IPO harshly exposed the loss of value in conventional power generation. Coal and gas-fired power plants generated double-digit returns before Japan's Fukushima nuclear disaster, which prompted a rethink from the German government. Now, they are being forced out of the market by wind and solar plants. That switch to green energy led to the need for traditional power companies like E.ON to be completely restructured.

Another government-related burden that weighs on the balance sheet: E.ON and the other nuclear power companies agreed to set up a joint fund for the interim and final storage of nuclear waste. The deal finally put a price tag on a process that had long been uncertain, but it means E.ON will have to pony up €8 billion in reserves this summer, along with paying a risk premium of €2 billion to protect the government against possible cost increases going forward. As a result, E.ON's nuclear reserves were increased from €18.9 billion to €21.4 billion last year. This increase, together with write-offs associated with the reorganization, led to a €3.6 billion burden on its 2016 earnings.

Debt remains E.ON's biggest burden by far. While E.ON’s overall debt pile, which also includes the costs of nuclear waste disposal, may have actually fallen from €27.7 billion to €26.3 billion, the fact that it has far less revenue since the Uniper split means its ratio of debt to earnings has surged to the highest level in its history. Its debt factor – a measure of the ratio of net debt to earnings and an indicator of the ability to pay off its debts – climbed from 3.7 to 5.3 last year.

08 p26 E.ON in Numbers-01

Not only does E.ON have lots of debt, it doesn't have much cash on hand. The spin-off and write-downs have had a critical impact on E.ON's equity reserves, which declined from €19 billion to €1.3 billion (as measured by the International Financial Reporting Standards). The equity ratio fell from 17 to 2 percent, meaning E.ON has the lowest equity ratio among companies listed on the blue-chip DAX index.

The good news for Mr. Teyssen, however, is that these are one-time effects. The losses, while massive, have nothing to do with the new E.ON's core business, which is relatively stable and has growth potential. In its core business, earnings before interest and taxes (EBIT) adjusted for special effects was only slightly lower than in the previous year, at €2.5 billion, a decline of 3 percent. Some 65 percent of earnings came from regulated or long-term hedged transactions. While regulators cap profits in the network division, they also guarantee them for a certain period of time. Renewable energies benefit from long-term subsidies.

When divestitures are included, EBIT declined 13 percent to €3.1 billion but the figure was still near the upper edge of E.ON's own forecast. Based on this, the return on capital employed decreased only slightly from 10.9 to 10.4 percent. This is clearly above the capital costs of 5.8 percent, on the one hand, and above E.ON's target range of 8 to 10 percent, on the other.

Shareholders can also take solace in that, while they must accept a smaller dividend, at least they have one: given the massive loss, Mr. Teyssen could have cancelled this altogether. Instead he justified the payout by basing it on an adjusted group net profit, excluding the huge book losses and other special effects.

Mr. Teyssen argued that the one-time effects had "nothing" to do with the operational business and his CFO said operating performance was in line with expectations, despite a difficult business environment. The spectacular loss last year marks the last burden of the past, the company promised. If so, it would mean the energy giant has truly wiped the slate clean in 2016.

08 p26 E.ON in Numbers 3-01

Jürgen Flauger writes about energy for Handelsblatt. To contact the author: [email protected]