Italy represents the third largest market for energy service in Europe. A brief background catch up of the Italian market should be given: Italy’s main energy supplier is ENEL S.p.A, holding a 45% market share; that is to say, the remaining side of the supply is left for all the other competitors.
With the new decree from the Renzi government that aims the re-organization of public spending we expect to see some incentives for the thousands of enterprises, which in part, are held by the State. How does the incentive mechanism works? SMEs in the energy sector are those responsible for bearing the main cost inefficiencies in the industry. This inefficiencies are reduced only when these SMEs are acquired by the large industries that naturally enjoy competitive advantages such as Economies of Scale and Scope, know-how, stronger bargaining power, etc.
To throw in some numbers: this decree’s starting point is the closure of “empty boxes” these are around 3,000 publicly held companies with less than 6 employees and another 1,300 with less than 100,000 euro in revenues. Moreover, a stop will be imposed to a phenomenon known as “micropartecipazione” this are 1,400 companies in which the state holds less than 5%.
This decree triggered a trend of largest companies acquiring (or at least merging with) the smallest. An example is the latest acquisitions of A2A (in September 2014), which increased its stakes from 70% to 80% of the total outstanding in Edipower, an energy company based in Lombardy.
Getting into the specifics of A2A’s business plan two main things first pop up: cost efficiency and growth rate.
Even though revenues decreased by 800m, mainly due to the shrinking demand of the year and a 1Bn drop in the operating cost, the EBITDA of 2012 to 2013 has increased by around 6.08% to 1,133m keeping past records’ trend. However, since the creation of A2A from the merger the Municipalities of Milan and Brescia, the net income experienced quite significant volatility due to depreciation costs incurred by the firm; most remarkably, the change in net income between 2012 to 2013 with a drop from 260M to 62M, a 76,2% decrease.
Even though the scenario may look discouraging, taking into account the adjusted Net Income it increases by 34,5% from 2012 to 2014 reporting a positive change of 40M. As a matter of fact, the drastic change in Net Income is not a function of Revenues nor of the business cycle, but a mere write-down by impairment on assets, joint venture companies and depreciation expenses that reduced Net Income by 237M. There is strong evidence that it was concentrated in one single fiscal year (by analyzing Financial Reports) in order to take full-benefit of tax advantages. `
The prolonged, negative situation in Italy caused a sudden drop in demand for electricity. In relation with the first semester of 2013, the net operating profit of the Energy Division reached 262M in 2014 that is a 31M drop as a consequence of the reduction on 22M of the subsidiary EPCG; given that in the first semester of 2013 it benefited from a higher hydroelectric production.
Taking all this into account, the net effect is actually positive. The Net Operating Margin of the Energy Division is in line with respect to the first semester of 2013 thanks to the larger margins obtained in the waste-treatment market and to the positive trading strategies.
The Net Operating Profit of the best performing division of the company, that is, the Waste Collection and Treatment, amounts to 115M, a 25% drop with respect to 2013’s first semester.
This is mainly due to the lower prices of electricity in the market cause by the expiration of the favorable convention named “Comitato Interministeriali Prezzi” in which those producing energy through renewable sources may sell them at a higher price in the market.
Moreover, from a macro point of view, the tensions between Ukraine and Russia affected negatively the energy sector as a whole, but in particular, given the fact that A2A has no take-or-pay contract with its suppliers, mainly gas ones, rendered the situation unstable which forced the company to search for other sources of raw materials such as Algeria.
Interpreting the multiple analysis we are able to infer that the company is slightly undervalued, reporting a 0.85 P/B lower than its competitors such as Hera (1.33 b/p), Acea (1.50 b/p) and Enel (1.09 b/p). The enterprise value/EBITDA suggests the same, being the lowest among the other competitors with a 5.62 compare with an average 7.1 in the Italian energy sector.
Furthermore, the EV/Sales, which is the ration between the sum of the market capitalization, debt, the preferred shares minus cash (and cash equivalents) over the annual sales, for A2A (1.17) is again the lowest compared with the market, which is 1.27.
One may argue that the multiples might be low by a reduction in revenues; however, the shrinking sales revenues affected the energy sector as a whole due to both, the reduction of the selling price and the lower demand. Therefore, we could say the actual market capitalization (2.35B) is low.
In fact the closing price of the stock on Friday was .758 close to the minimum of 8th August that was the year’s minimum. From a technical point of view, the stock price’s bar are closer to the lower bound of the Bollinger band, which signals a hyper sale.
Analyzing the slope of the regression line and the R (square) both computed on a 20 days period provide us with a strong buy signal since the slope (-0.0054) it is at the minimum level excluding the one registered on the 20th August. The R (squared), on the other hand, is on a very high level (0.8981) suggesting accuracy of the model.
Considering other technical charts such as the Williams %R and the Relative Strength Index, both computed in the same time period as the latter, gives us a buy notice since both are below the respective threshold of 80 and 30, which indicates that the stock is actually oversold.
To conclude, even though the financial statement analysis provided us with negative reviews because of the shrinking revenues and net income, we may explain it through the general macro situation. Anyhow, since the monopolistic role of A2A in the waste collection and treatment we may expect an increase in revenues from this division; while on the other hand; the energy division that registers fierce competition pushes the company to look for possible acquisitions thanks to the incentives provided by the Government.
Moreover the rumors of a possible merger with Iren, the Reggio Emilia-based company may boost the stock price given the enormous economies of scale in the sector and massive cost reduction that may be realized.
We think, the stock should be priced around 1 euro for the upcoming 12 months, if the proper political incentives are respected and the rumors are true.
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