The nuclear power generating industry faces numerous business and political headwinds, but the problems may prove particularly noteworthy at Electricite de France, whose earnings quality is already under siege.
The nuclear power generation industry has many issues overshadowing it, and the costs of addressing them can weigh on a company’s earnings quality, as the example of Electricite de France (EDF.PA) illustrates clearly.
The Fukushima nuclear disaster in Japan two years ago caused many governments to re-think their reliance on nuclear power, despite the fact that it is relatively ‘green’, at least with respect to carbon dioxide emissions. But while de-emphasizing nuclear power is feasible for some European countries, like Germany, where coal-fueled plants are still a major part of the nation’s generating capacity, that is less of an option in France, where 80% of all power generating capacity is owned by EDF (in which the government has an 85% stake), and relies on its 59 nuclear power stations to generate more than three quarters of the electrical power it provides to its core customers in France. Since the Fukushima meltdown, EDF has spent and continues to spend billions of euros to ensure that such disasters are avoided in the company’s own reactors – a prudent move, but one that has only produced high costs and a higher debt load.
Indeed, the company is struggling with an array of problems that appear to be taking a toll on its earnings quality. EDF is constructing new nuclear power generating facilities whose costs have risen well over their original budget. As you can see from the chart below, EDF has reported profits in each of the last ten years. In spite of that, the company’s free cash flow has been negative in each of the last five years, reaching its highest level in 2012, during which EDF reported negative free cash flow of 2.87 billion euros.
Part of the reason for that poor cash flow is related to the increased level of capital spending that the company has had to incur to update its generating facilities in the wake of the lessons learned from the Fukushima disaster. Those capital expenditures aren’t being funded by cash flow from operations. As you can see in the chart above, in each of the last five years, capital spending has exceeded EDF’s cash flow from operations. That isn’t sustainable in the long run, and it is one fact that contributes to the company’s poor EQ score.
Together, these factors explains why EDF scores only 9 out a possible 100 on the StarMine Earnings Quality Model, reflecting the fact that its profits are not only variable but far from sustainable.
In order to finance its capital spending, EDF raised about 6.2 billion euros in total proceeds by selling multicurrency hybrid notes. (These notes, issued in U.S. dollars, euros and British pounds sterling and which rank senior only to the company’s share capital, earned a rating of A- from Fitch Ratings.)EDF’s debt already stood at 60 billion euros, a company record, meaning that the new issue will simply add to its interest burden. The company’s high debt level is the reason it scores so poorly – only 5 out of a possible 100 — on the leverage component of the StarMine SmartRatios Credit Risk (SRCR) Model. That model assigns an implied credit rating of B+ to the company’s debt.
There are other factors that warn potential investors of poor earnings quality. In 2012, the company’s pension expense was 3.4% of sales. That expense is not likely to decrease any time soon and will likely be a drag on earnings for the foreseeable future.
EDF does have some factors that weigh in its favor. For instance, thanks to the low-cost nuclear energy production, the company is well positioned to keep its market share in France, which still accounts for the lion’s share of its revenues and earnings. The company is making efforts to diversify its energy portfolio by increasing its renewable energy projects that are likely to benefit the company in the much longer run.
But EDF also faces some headwinds, not all of which are purely business-related. For instance, the Socialist government of President François Hollande has capped the ability of power companies to increase the rates charged to consumers as part of an effort to maximize household income and support the economy. Moreover, in the run up to last year’s election, Hollande and his party made election promises to close down a number of nuclear power plants, a move that could put a dent in EDF’s revenues and earnings. To address some of these headwinds, EDF has said it is planning a cost reduction program.
For the next year or so, however, it may be wise to expect EDF’s earnings to be volatile and inconsistent, as the company’s poor score on the StarMine Earnings Quality Model suggests. Over the last 90 days, analysts have responded to these less than upbeat fundamentals by trimming their earnings estimates for the current 2013 fiscal year by 8.7%, to a current consensus of only 1.79 euros per share, down from the 2.29 euros per share EDF reported in 2012. It seems as if the low earnings quality score may already be about to take a toll on EDF’s bottom line.
Learn more about how StarMine analytics can help you pinpoint critical developments in your portfolio or watch list.
Request a free trial today
