Robert Anderson in Prague -
CEZ, the largest power group in post-communist Central Europe by market capitalisation, is reacting to the serious challenges it faces by playing "double or quits" with a possible large acquisition.
Power prices are expected to stay near current lows, the EU is putting together a tougher carbon credit regime and CEZ’s foreign investments have soured, yet nevertheless the state-owned Czech group is planning to bid for its Slovak counterpart Slovenske Elektrarne and build new nuclear reactors at home.
Martin Novak, finance director, admits that the short-term outlook for power prices (and CEZ profitability) is unpromising. “We don’t see any signs of significant change [in prices],” he says in an interview, pointing out that forward contracts for next year – CEZ is almost sold out – are barely above the current low price of around €35 per megawatt hour (MWh).
According to some analysts, this price level will soon make CEZ cash-flow negative. “If your generating portfolio is a bunch of large inflexible power plants [like CEZ's], you will not make much money,” says Jan Ondrich of Candole Partners, a Prague-based consultancy.
CEZ used to make big profits from electricity exports to Germany when prices were high, exploiting its low-cost installed base of lignite-burning and nuclear power stations. Since the global financial crisis, howere, power demand has fallen back – a shift accentuated by improvements in the energy efficiency of industrial companies and “non-market mechanisms” introduced by governments to boost renewable power, Novak says.
The power price has also slumped because of low coal prices and a glut of carbon credits. CEZ continues to benefit from a generous allocation of carbon credits secured from its government owners, which it has been able to sell for a profit in the market. However, the European Commission now plans to tighten the carbon credit regime, which could threaten the viability of CEZ’s lignite plants in the long term.
Novak argues that the lignite plants are being retrofitted to extend their life and make them cleaner, and that in the shorter term CEZ will actually benefit from an increase in the carbon credit price and the knock-on effect on power prices. He says CEZ will receive carbon credits for free until 2020, and any rise in the price of credits will therefore boost its profitability. “For our profitability, the higher the carbon credit price the better,” he says.
During the boom years of high prices, CEZ used its cash pile to go on a spending spree in Southeast Europe, snapping up distribution companies in Bulgaria, Romania and Albania, and building Europe’s largest onshore wind farm in Romania. Many of these investments, made from 2005 onwards, went sour after the global financial crisis as local energy regulators intervened to cut power prices to struggling households, and governments made renewable energy subsidies less generous.
Ondrich blames CEZ for what he calls “terrible value destruction” and compares its speed of reaction to the changing market unfavourably with E.ON of Germany. “E.ON recognised things were going wrong sooner and acted,” he says. “CEZ was reluctant, so they sat on the assets.”
CEZ has recently reached a settlement with the Albanian government to sell its distribution company back for the €102m it paid, but it is still in dispute with Bulgaria and Romania over issues such as the investment commitments it made, as well as the level of domestic power prices or subsidies for renewable energy.
Novak blames the global financial crisis for the group’s woes. “There was a big portion of bad luck,” he says, before adding that most of the investments were relatively cheap anyway. He says that all of CEZ’s investments are Ebitda positive now, but admits that “some generate profits lower than expected.”
“I would not look at it negatively. We learned a lot," he insists.
Undaunted by this record, or the unpromising outlook for power prices, CEZ now plans to bid for the 66% of Slovakian utility Slovenske Elektrarne that Enel of Italy has put up for sale. Novak argues that the cultural and technical similarities of the two companies – which were once united in the former Czechoslovakia – offer substantial synergies. “There is nothing that would better suit us,” he says, though he stresses that the shape of the sale is still unclear. “It is all about price and risk-sharing... Are we obsessed with it? I don’t think so.”
The Czech centre-left government so far appears divided over the merits of such an acquisition. Social Democrat Economy Minister Jan Mládek is a supporter, but Andrej Babis, the powerful finance minister and leader of the centrist ANO party, has questioned it on the basis of CEZ’s troubled acquisition record. Babis, whose ministry controls the government’s 67% stake in CEZ, recently cleared out the group’s supervisory board to tighten his grip on the country’s flagship state-owned enterprise.
Some analysts fear that acquiring Slovenske Elektrárne (and its debt and nuclear liabilities) could endanger CEZ’s A- credit rating. “Acquisition of whole SE would probably lead to lower dividends and negative market reaction,” commented Petr Bartek of Erste Bank Group in a recent note.
Patrick Hummel of UBS has estimated that Slovenske Elektrarne has an enterprise value (equity plus debt) of up to €4bn, plus nuclear liabilities of a further €3bn, and that there would be a risk that CEZ would have to issue new equity or hybrid debt to pay for it.
Novak dismisses such concerns, arguing that CEZ remains one of the most profitable (in terms of Ebitda margin) and least indebted utilities in Europe, and points out that the company recently announced plans for a 16% cut in costs over the next two years. He says the group could buy Slovenske Elektrarne without needing to raise equity. “An equity increase is one of the last things we would do,” he says.
Looking longer term, CEZ remains keen on expanding the nuclear power stations at Temelin and Dukovany, which would maintain security of supply – and make the country more energy independent – when the ageing lignite plants eventually have to close as lignite supplies dwindle.
However, CEZ had to cancel the tender for a partner for Temelin in April after Brussels began a probe into whether a similar investment contract between EDF of France and the UK government to build Hinkley Point C was illegal state aid. A settlement between the UK and Brussels has now been reached, which could enable the Czech tender to be reopened.
CEZ continues to push for the project, but Novak admits that without some kind of power price guarantee it will not fly. “Without this kind of support, nobody would be able to take the risk of building the plant,” he says, though he insists that it will happen one day.
Economy Minister Mladek also remains keen on the project, pointing out that “the Ukraine crisis supports the case for building nuclear power in the Czech Republic,” as the country needs to become more energy independent, though he says that perhaps a fully state-owned entity might have to build the plants. The government should publish a new nuclear power strategy by the end of the year.
Novak admits that both acquiring its Slovak counterpart and expanding its nuclear plants would keep CEZ’s asset portfolio focused on generation, at a time when other struggling European utilities are trying to move away from this. But he points out that CEZ is also diversifying by investing into renewable energy, gas supply, small co-generation plants and customer services such as telecommunications. CEZ’s strong fundamentals mean, he contends, that “there can be growth through acquisitions to extend our business further.”
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