Mytilineos — Power & gas, the growth engine of Mytilineos

We expect the power & gas business to recover strongly in 2019 and forecast that its expansion will be a key driver of growth. Mytilineos will report H1 results on 12 September 2019. We forecast EBITDA for the business to grow almost three times in H119, thanks to higher volumes and margins, and driving most of the 23% H1 group EBITDA y-o-y growth. In this note, we focus on the drivers of the strong competitive position of this business, which represents a growing proportion of the company’s earnings, as well as the trends supporting its growth outlook, especially in light of the evolving energy policy in Greece following the recent elections. In particular we see Mytilineos’s leading role in the Greek gas market as a key driver of the position of the company’s gas plants at the bottom end of the thermal cost curve – we expect H1 results to confirm that gas sourcing at attractive terms is boosting power generation’s profitability. Furthermore, we estimate the recently announced construction of a new 826MW combined cycle gas turbine (CCGT) (24% larger than previously expected) will generate a project IRR of 19% (base case) and will add €60m/year to our EBITDA forecasts and €29m to our net income forecasts for the group. We estimate the value created by the project (not included in our base case valuation of €12.3/share) at €1.9/share or 16% of the base-case valuation. We expect the project to receive the remaining formal authorisations in the next few months at which point we will include it in our forecasts. Our FY19 and FY20 forecasts are therefore broadly unchanged.

Following a weak FY18 result for Mytilineos’s power generation business (due to mild weather and high hydro volumes in Greece), we expect strong recovery to be the key driver for the group’s EBITDA growth. We introduce H119 estimates and forecast EBITDA for power & gas to grow 293% y-o-y to €48m (vs €12m in H118), driving 23% y-o-y growth for the group to €178m. Our forecasts are based on the following points:

We believe Mytilineos’s power & gas business is well positioned to capture growth opportunities in the Greek market. We highlight what we believe are the key strengths of its competitive positioning:

We believe the low cost of the gas utilised, efficiency of the plants and low emissions vs lignite plants are the key drivers of the position of Mytilineos’s plants at the low end of the cost curve for Greek power generators.

On 7 July, the centre-right New Democracy party won the Greek general elections and achieved an absolute majority in the parliament with 158 seats (out of a total of 300). We believe recent comments by new Prime Minister Kyriakos Mitsotakis suggest that one of the key priorities of the new government will be energy policy and the role of state-owned power incumbent PPC. We believe this may have significant positive implications for Mytilineos’s power business as a result of the changes in the competitive landscape. Currently, the key challenges for PPC are the unfavourable economics of its lignite-fired power plants as a result of the large increase in the price of carbon emissions, as well as a large amount of overdue receivables (€2.4bn at the end of FY18). PPC posted a 45% y-o-y reduction in EBITDA in FY18 and a €542m net loss. In the 2018 annual report PPC’s certified auditor Ernst & Young raised concerns about sustainability of the company’s operations (‘existence of a material uncertainty, which may cast significant doubt on the company’s and the group’s ability to continue its operations as a going concern’). The negative trend for PPC continued in the first quarter of 2019, with an EBITDA loss of €51m (vs +€157m in Q118) and a net loss of €205m (vs €13m net loss in Q118).

Ahead of the elections, New Democracy submitted a proposal to the EU Commission about how it would deal with PPC’s financial situation if it won. New Democracy proposed a three-stage rescue plan for PPC focused on cost cutting (including job cuts), receivables recovery, sale of hydro/lignite assets to third parties, reducing PPC’s market share to below 50% and, eventually, the entry of a strategic partner (see Energypress.eu, 24 June 2019). While it is too early to take a view on the new government’s ability to implement drastic changes (previous governments have resisted plant closures in order to safeguard employment), we believe the new political landscape increases the likelihood that market-based solutions are adopted. If this is the case, there are two areas where we believe Mytilineos could significantly benefit:

We believe the new Greek government will need to tackle energy policy issues early on its mandate, so the coming quarters may provide significant catalysts for Mytilineos.

Lignite plants in Greece have a capacity of 3.9GW, producing 16TWh and representing c 30% of Greek power generation (FY18). These are old plants (mostly built in the 1970–80s) with high carbon emissions (responsible for >30% of total Greek carbon emissions, according to WWF) and face significant regulatory and economic challenges:

PPC has announced the closure of 1,212MW of lignite capacity by 2021 amid challenging market and regulatory conditions, and environmental concerns. In addition, the Amyntaio power plant (330MW) is likely to close due to environmental restrictions (it is already operating in breach of EU regulations as of 2019). Were these plants to close, assuming no new thermal capacity comes on line and even assuming a large pick-up in renewable investments, our Greek power market model indicates a significant reduction in power reserve margins (ie the difference between the available capacity of the plants and the peak demand of the system), indicating a situation of undersupply and the need for a large increase in gas plant utilisation (see Exhibits 7 and 8).

On 17 July 2019, Mytilineos announced that it will start the construction of a new 826MW CCGT plant (24% larger than initially planned) in Aghios Nikolaos, in the Voiotia region of Central Greece. The plant will be equipped with a GE H-class gas turbine with a thermal efficiency of 63%, the highest in Europe, and the total investment is expected to be €300m. The construction is expected to start in Q4 of 2019, provided a construction licence is granted, and should be commissioned by Q4 of 2021.

Because of the favourable environment for gas plants in Greece, we view the announcement positively, as this plant would likely achieve high load factors (the company expects to run it at a baseload level, ie throughout the year without many interruptions) and increasing spreads as the market tightens.

In our base case (70% load factor, €14/MWh achieved clean spark spread) we estimate a 19% project IRR for Mytilineos’s CCGT plant project and annual contributions of €60m to group EBITDA and €29m to net income (16/12% of 2022e group EBITDA/net income). Based on the same assumptions we preliminarily estimate an NPV for the project of €274m or €1.9/share (16% of our valuation of €12.3/share). We provide a project IRR sensitivity to higher and lower load factors and achieved spreads in Exhibit 12.

In 2018, the previous Greek government launched a large renewable investment plan, which targets wind and solar additions for a total capacity of 2.6GW (equivalent to c 15% of the country’s current total installed capacity and c 50% of current renewable capacity) requiring investment of €2.5–3.0bn. The projects are assigned through tender auctions in the period 2018–20 (300MW/year for both wind and solar and two 400MW technology-neutral auctions where wind and solar compete against each other). The first auction was carried out in July 2018 (average price €70/MWh) and the second one in December 2018 (€59/MWh). It is unclear at this stage how the new government will deal with this renewables plan, but we believe renewable investments are a key part of the solution to Greece’s energy challenges. We see significant renewable investment opportunities for Mytilineos, although we recognise that historically renewable projects were subject to significant delays as a result of a complex authorisation process. As an indication of profit potential, an extra 100MW in the period 2018–20 would generate an additional c €10m/year EBITDA and a project IRR of 9%, on our estimates.

As shown in Exhibit 13, Mytilineos has built a track record of sourcing gas internationally at prices at a discount to Greek wholesale levels. We identify the following drivers:

In Exhibit 14 we provide an overview of the forecasts for the power & gas business. Our forecasts are broadly unchanged (higher assumed volumes and spreads for the existing plants are offset by lower assumed flexibility payments; group FY19–22 EBITDA changes by less than 1%). We assume a moderate expansion in margins (all-in clean spark spread, including plant restart payments, of around €10/MWh in 2019, growing to €12/MWh in 2022) and a gradual increase in gas plant load factors (as the market tightens), additional remuneration to compensate plants for providing flexibility to the market (a permanent mechanism is under evaluation by the EU, we assume €15m/year) and 30MW/year wind additions.

Overall, we expect an 18% EBITDA CAGR in 2018–22e, excluding the contribution from the new CCGT plant. We view our forecasts for the power & gas business as conservative because, although we have included a gradual increase in margins and load factors, we have not included the full impact of the lignite closures (large increase in spreads and gas-fired production), due to current uncertainty on the timing of the shutdowns. As a sensitivity, we estimate that a ±€5/MWh change in spreads would increase or decrease EBITDA by 6%.

In exhibit 15 we set out a sensitivity analysis to show what would be the impact of the inclusion into the power & gas business of the new CCGT power plant from the last quarter of 2021, with EBITDA CAGR FY18-FY22e increasing to 30% (from 18%).

The power & gas business represents 27% of our EV for the group based on a sum-of-the-parts, mostly DCF-based. The valuation implies 6.9x 2019e EV/EBITDA, which we believe is broadly consistent with thermal power utilities in Europe (see our initiation report Cash flow miner, growth generator, published on 15 April 2019). Looking at the value per unit of capacity installed, gas-fired plants are valued at €0.74m/MW and wind plants at €1.24m/MW, using an 8.5% WACC.

A recent transaction may be seen by investors as providing a valuation benchmark for gas-fired plants, but we believe that looking at EV/MW for this transaction may be misleading. Italy’s Edison and Greece’s Hellenic Petroleum recently acquired a 22.74% stake in Elpedison for €20m from HED and Elvahalcor, increasing their respective stakes to 50% and 50%. The transaction suggests an enterprise value of Elpedison (which has two gas-fired plants with total 810MW capacity and 150,000 gas supply clients) at c €280m, implying a rather low €0.34m/MW (even attributing zero value to the supply portfolio). However, we note that the transaction (for a minority stake) appears to reflect a lower profitability for the assets than for Mytilineos, which likely justifies a low valuation on a per MW basis. Looking at 2018 (a low profit year for gas-fired plants in Greece), the valuation of Elpedison implies 12x 2018 EV/EBITDA, vs c 9x 2018 EV/EBITDA implied by our valuation for Mytilineos’s gas plants (or 6.4x 2019e EV/EBITDA). Hence, considering the difference in profitability, the EV/MW implied by the transaction does not provide a fair valuation benchmark for Mytilineos assets, in our view.

Mytilineos’s stock performed very well in H119 (+39% to 30 June), helped by a large reduction in country risk (the spread between Greek and German 10-year bond yields reduced by 45% in H1). However, despite the recent recovery, valuation metrics appear undemanding, with an FY19e P/E of 7.8x and EV/EBITDA of 5.6x, at a large discount to diversified European industrial groups. Free cash flow yield of 12–14% pa (pre growth-capex) in FY19–22e remains a key attraction, in our view.

Our valuation of €12.3/share (unchanged) implies further upside to the current share price. This valuation does not include the value created by the recently announced CCGT project, which, based on our initial calculations, would add €1.9/share (or 16%) under the assumptions explained above. Furthermore the recent reduction in Greek country risk, if it persists, would provide further upside risks to our valuation. As for sensitivity, a 1% reduction to the WACC we currently use (8.5%) would push our valuation up by 16%.