Mytilineos — Defensive in 2020 and with growth beyond

The headline figures for Q120 are set out in Exhibit 1. As the table shows, the figures demonstrate that profitability improved quarter-on-quarter (Q419 was hit by weaker margins in the EPC business) but recorded a decline compared with Q119. Mytilineos does not provide a full segmental breakdown of revenue or EBITDA at the Q1 stage; however, it did disclose that the power & gas business unit increased profitability compared to Q119, despite lower overall output and a lower system marginal price (SMP).

Although Mytilineos does not publish quarterly cash flow statements the rise in net debt to €530m (from €421m at FY19) suggests that capex remained high during Q120 with construction of the new CCGT likely to have accounted for the bulk of the expenditure.

When Mytilineos announced its FY19 results it maintained its DPS at €0.36 as a sign of its confidence in the business and despite the challenges of COVID-19. In its Q1 trading update Mytilineos reported that all its major production facilities remained fully operational and there had been no significant interruptions to the supply of raw materials or the delivery of its products to end customers. Mytilineos added that there had been no delays to customer payment and its liquidity remained strong. Since the Q1 trading update Mytilineos has announced the prepayment of the total nominal value (€1,000/bond) of a €300m bond (coupon of 3.1% due June 2022) and total accrued interest of €15.93/bond. Mytilineos now faces no further debt maturity before 2024.

In the following sections we discuss the principal factors driving profitability in each of the business units, consider the outlook in more detail and develop a number of potential scenarios for the business.

Mytilineos managed to sustain production in its alumina refinery and aluminium smelter with both plants operating at almost full capacity in Q120. Overall production rose from 158.5k tons in Q119 to 168.2k tons in Q120, although this headline number was helped by the first-time contribution of the EPALME recycled aluminium business. However, COVID-19 did have a negative impact on commodity prices. The LME price for aluminium in Q120 was $1,712.75/tonne versus Q119 $1,880.64/tonne (-8.4%) (we note the overall LME average aluminium price for 2019 of $1,810/tonne was down 14% versus FY18 $2,112/tonne). Mytilineos added that its product premia had also declined by c 33% we estimate to c $280/tonne). It is however important to note that post Q120 the LME price now stands at c $1,500–1,550/tonne (one to three months) although the futures indicate a pick up in prices later in H220 to c $1,600–1,700/tonne. Mytilineos also pointed to declining alumina prices, from c $387/tonne in Q119, to c $285/tonne in Q120. Again, current and shorter-term LME alumina prices sit in the range of $240–260/t.

Despite the weaker metal prices that prevailed in Q120 Mytilineos stated that profits from the metallurgy business have been ‘resilient’ (we interpret this as a modest decline) as lower sales prices have been offset by lower input costs (gas and raw materials) and cost efficiency as a result of its cost control programme (the programme is called Hephaestus, which commenced last July). In total, Hephaestus has a targeted benefit of €62m, of which €35m constitutes ongoing EBITDA enhancements and a further €27m of one-off items. As a result of its cost initiative, Mytilineos believes that it has further improved its position in the global top quartile (in terms of cost efficiency) for its alumina and aluminium production.

In FY19 power & gas made the standout divisional contribution to group profitability, (increasing EBITDA from €60.4m in FY18 to €100.9m in FY19) and the division posted another strong performance in Q120, with increased profitability compared to the same quarter of 2019.

Although the impact of CVOID-19 and warm weather reduced energy demand in Greece by 1.8% (Mytilineos’s output declined by 3.5% to 1,228 GWh) and the SMP was down 25.9% to €50.4/MWh, Mytilineos still managed to increase profitability. The key to the improved profitability was a lower gas price, which enabled the clean spark spread from its thermal plants to increase by 55% versus Q119. Although Mytilineos does not publish the spark spread, we calculate that, using a power price of €50/MWh, gas costs of €10/MWh and a CO2 price of €25/t, a spark spread of €25/MWh might have been achievable.

The renewable business continues to expand and we expect a further 35MW of capacity to be added in FY20, taking overall capacity to c 245MW by the end of FY20. In Q120 output rose by 17.5% to 141GWh (Edison estimate output to increase by 30% to 560GWh in FY20). In the supply market, access to competitively priced gas enabled the supply business, Protegia, to increase its share of the Greek market to 6.5% (March 2019: 4.7%) and the business now has almost 250,000 customers versus 183,000 at FY19.

The traditional EPC business, which suffered from margin erosion in Q419, experienced another tough quarter in Q120; a number of projects remained in the completion phase and there was a drop in the number of new projects. Mytilineos is conducting a strategic review of the potential way forward for the EPC business with a focus on sustainability projects. However, we expect a decline in the profitability of this business in FY20.

The prospects for the recently (January 2020) formed Renewable and Storage Development (RSD) business appear brighter, with a growing market for solar and storage assets globally. This business offers the potential for higher margins than the traditional EPC business, with lower risk and shorter construction periods and also benefits from a well diversified portfolio of assets geographically. The business unit continued to execute projects in Spain, the UK, Chile and Kazakhstan throughout Q1. In Q1 the unit also disposed of 47MW of solar assets for €45.8m which constitutes only a small part of a total pipeline of 600MW scheduled for disposal over the next 24 months.

While Mytilineos posted resilient profits in Q1, we expect Q2 to present sterner challenges. We expect lower metal prices in Q2 and some seasonal softening of the spark spreads in power & gas. We also anticipate that it is unlikely that the combined EPC/RSD business unit will recover in Q2. However, Mytilineos’s strong financial position should allow it to ride out the tough conditions. Forward curves on the LME point to higher prices in H220 and beyond, while low gas prices should present an opportunity for Mytilineos to restrain cost pressure in the metallurgy business and allow for generous spark spreads and a cost advantage for the supply business. We also expect continued expansion of the renewable portfolio in H2. Beyond FY20 the potential for economic growth and the continuing development of the renewable and supply businesses should facilitate improved profitability. The commissioning of the new efficient CCGT plant (826MW) in Q421 is likely to provide a strong stimulus to profitability in FY22.

Mytilineos reported a sound start to FY20 in difficult financial conditions. However, the ultimate impact of COVID-19 remains unclear and considerable uncertainty therefore surrounds projections for FY20 and beyond. To provide a guide for investors, we set out bull, bear and base case scenarios based on our updated forecasts. Each scenario attempts to model Mytilineos’s sensitivity to some of the more important variables as shown in Exhibit 2. For comparison we also show figures for FY19. Spark spreads are not disclosed by Mytilineos, so the figures shown are our estimates.

The financial impact of the scenario analysis can be seen in Exhibit 3 below. In our base case scenario, EBITDA of €282m represents a c 9.9% decline on the €313m achieved in FY19 (we note that Q120 EBITDA –12.4% versus Q119). We envisage a strong performance from the power & gas division with cheap gas supporting spark spreads (in the face of lower power prices) and the expansion of the supply business. Additional wind capacity should also help drive profitability. The metallurgy business should also benefit from lower input gas prices, a year-on-year expansion of the aluminium recycling capacity along with lower input prices for raw materials, although, in all scenarios, lower metal prices will reduce profitability versus FY19. The EPC/RSD unit suffered from a tough Q120 and we expect this trend to continue throughout FY20, with revenues and margins in the year lower than FY19 in all scenarios. For the time being, despite the stronger outlook for RSD, we continue to forecast EPC and RSD as a combined unit, although in time, as more data are published by Mytilineos, we expect to separate out the two businesses. Overall, it is only in the bull case scenario that FY20 EBITDA slightly exceeds that of FY19, while the bear case scenario represents a 19.8% decline in EBITDA versus FY19.

It is worth pointing out that in light of the impact of COVID-19 (lower metal prices) and ongoing difficulties in the traditional EPC business, our new base case forecasts represent a significant reduction to our previously published forecasts (December 2019). The principal changes are highlighted in Exhibit 4. Net debt projections rise principally as a result of lower EBITDA in FY20. Turnover rises as we have increased our forecasts for the energy supply business, which is a high turnover but relatively low margin operation.

Mytilineos has not escaped the decline in market valuations and the share now stands at c €7.1, a significant discount to the peak of €11.2 reached in July 2019, although the shares are currently some way above March’s trough of €5.02/share.

Using our base case forecast EPS of €0.93 for FY20e, Mytilineos is trading on an FY20e P/E of 7.6x versus a peer group of industrial conglomerates of 16.0x (a discount of 54%). By way of comparison, the Athens Composite Index forward P/E of 11.8x and the STOXX Europe 600 forward P/E of 18.2x.

Our updated DCF-based SOTP analysis suggests a valuation of €13.4 (Exhibit 4) before applying any adjustments to reflect the diversified business model. Significant synergies exist between Mytilineos’s businesses, particularly power and metallurgy and therefore the appropriateness and scale of any adjustments to the SOTP remains a moot point. However, applying an adjustment of 15% would reduce the equity valuation to c €11.4/share (versus €14.5 previously). Applying a less aggressive adjustment of 10% would produce a valuation of €12.1/share.

We have crossed-checked our valuation against the current EV/EBITDA multiples of peers (comparable stocks for each of Mytilineos’s businesses), applying them to the appropriate division within Mytilineos’s business. Using this peer group-based approach yields a valuation of €9.3/share.

We have also applied the median FY1 P/E (17.0x) and FY1 EV/EBITDA (8.6x) of a group of European diversified industrial companies to our updated Mytilineos forecasts. This analysis produces valuations of €15.8/share and €12.9/share respectively.

All valuation scenarios suggest upside to the current share price of c €7.1x. The median valuation of the four approaches, based on an adjustment to the DCF-based SOTP element of 15% (€10.9, €11.4, €12.9 and €15.8) is €12.2, indicating upside of c 71% from current levels. Applying a 10% adjustment to the DCF–based SOTP (€10.9, €12.1, €12.9 and €15.8), the median valuation stands at €12.5, indicating c 76% upside from current levels.