Wednesday 6 March 2013, Amsterdam
RWE Dea is a part of RWE AG, which is one of the largest energy utility companies in Europe. RWE AG is involved in the generation, trading, transmission and supply of electricity and natural gas. The company’s financial performance has been at a relatively low level since 2009. This has been due primarily to a low electricity pricing scenario, the result of weakened demand in the European power markets, coupled with increasing demand for renewable fuels and the prevailing euro zone crisis. All of these factors adversely affected RWE AG’s electricity and gas business, with the result that the company’s net profit margin declined consistently between 2009 and 2011. Moreover, its performance in 2011 was further affected by the newly imposed Nuclear Fuel Tax, which was levied from 2011 onwards by the German Government.
RWE AG reported a decline in its Net Profit Margin, Return on Equity, and Return on Capital Employed between 2009 and 2011. Moreover, the growth of the company’s EBITDA and Net Profit also slowed between 2009 and 2010. Furthermore, RWE AG’s EBITDA and Net Income fell in 2011 compared to 2010, representing a continuing decline.
In order to improve its profitability and weather the slowed activity in the utility markets, RWE AG has focused on expanding its renewable production capacity and geographic footprints in other international markets in recent years. The company increased its renewable energy production capacity by 49.8% to 3,744 Megawatts (MW) in 2011 compared to 2,500 MW in 2009. RWE AG plans to have expanded this capacity to 4,500 MW (in construction or in operation) by 2014. This expansion requires the company to invest around €4 billion ($5.4 billion) between 2012 and 2014. Moreover, RWE AG plans to maintain its focus on renewable energy development further in the future, and plans to derive around 20% of its total production capacity from renewable energy projects by 2020. In line with this, the company is currently involved in the development of around 13,900 MW of renewable energy production capacity through its subsidiary RWE Innogy. Although RWE AG has been focusing on the development of renewable energy projects, the company has not generated major cash flows from these operations so far. This has meant that the company has been forced to approach external sources in order to fund its acquisition and expansion plans.
RWE AG carried out a series of acquisitions in 2009, of which the major transactions included the acquisition of Essent, the European Utility company and the acquisition of 70%interest in the Breagh field in the UK North Sea. These acquisitions, together with RWE AG’s limited cash flows, forced the company to raise additional debt, with the result that its debt increased from €18.7 billion ($27.5 billion) in 2008 to €25.8 billon ($36 billion) in 2009, which further increased to €29 billion ($38.5 billion) in 2010 and €30 billion ($41.8 billion) in 2011. RWE AG’s increasing debt, and a scenario of weakening economic conditions and declining profitability led to a setback in its liquidity position, which is clear from its increasing debt to equity ratio, debt to capital ratio, and debt to EBITDA ratio from 2009 to 2011.
Furthermore, the new rules for CO2 emission are expected to be effective from 2013. These rules eliminate the availability of CO2 allowance for free (no charge), which will now be available through auctions. Thus, these new costs will also impact the company’s net profitability from 2013 onwards. This poses concerns over RWE AG’s margins in future.
The dampened prospects of RWE AG’s future profitability, together with its heavy investment in the development of renewable energy resources, has raised questions over the company’s ability to meet its cash requirements, and has therefore raised concerns regarding its credit rating. In light of this, RWE AG announced a divestment plan to raise €8 billion ($10.7 billion) in February 2011. This divestment plan included the sale of Net4Gas, the partial sale of transmission and distribution business in Germany, and the complete sale of the company’s upstream operations, which are carried out through RWE Dea. However, the company has not reported any major progress on this divestment program so far, due primarily to the outlook envisaged for the utility market in the near future, which is not very promising. Moreover, RWE AG’s plan to divest RWE Dea in a scenario of high crude oil and natural gas prices indicates that the company’s profitability could potentially decline further in future. This has raised concerns over the company’s future profitability.
Concerns over RWE AG’s future performance were aggravated in June 2011, when the German government issued new regulations for the gradual phase out of the production of nuclear energy by 2022. These new regulations enforced the closure of RWE AG’s Gundremmingen B by 2017, Gundremmingen C by 2021, and Emsland Nuclear Power Plants by 2022. Consequently, RWE AG is required to report provisions for the decommissioning of its nuclear power plants, which will impose a financial burden on the company in future. In addition to the closure of these nuclear power plants, RWE AG was also been prohibited from resuming operations at the Biblis A and B units. Therefore, the company incurred a write-off for the Biblis power plants and thus reported the liability for the decommissioning of these plants. Moreover, the German government also levied the Nuclear Fuel Tax from 2011 onwards. These requirements thus forced the company to make an early exit from the operation of its nuclear plants. This reduced the time available with the company to operate these plants and recover the capital invested in their construction. Eventually, this affected RWE’s cash flow generation capacity and, consequently, its liquidity. The company has failed to maintain its credit rating, which was cut by Standards and Poor’s (S&P) from A to BBB+ in July 2011.
This cut in the company’s credit rating indicated negative signs about the company among investors and the company was therefore required to follow a disciplined capital approach. In line with this, RWE AG modified its plan to avail additional cash flows in Q1 2012, when the company raised its divestment target to €11 billion ($14.7 billion) from €8 billion ($10.7 billion) targeted as disclosed in February 2011. This divestment plan included the partial sale of RWE AG’s stake in Net4Gas, the partial sale of utility assets in Germany, and the sale of RWE Dea’s interest in certain projects, which are in the initial stages of development. The company expected to complete these divestments over the course of 2013.
However, the company worked on cost reduction initiatives during 2011–2012. Moreover, it also raised additional cash flows through debt and equity issuance. Consequently, it managed to offset its cash requirements to some extent and hence, reduced the divestment targets to $9.4 billion (€7.0 billion) in Q1 2012. Following this, the company withdrew its plan to exit upstream operations. The company now intends to divest these operations partially, thereby retaining its exposure to diversified operations. RWE AG’s decision to continue E&P operations is envisaged as a relevant strategy considering the future outlook of oil and gas markets, coupled with RWE Dea’s significant contributions to RWE AG’s operating performance.
Thus, the new fundraising and cost saving initiatives ruled out the possibility of the complete divestment of RWE Dea’s assets, which has ensured the continuity of RWE Dea’s operations as part of RWE AG. However, the latest divestment plan includes the divestment of only those projects for which activities are in the initial stages of development, as the development of these projects would require the investment of additional capex. Therefore, exiting these projects will reduce the company’s future capex outlay. Moreover, these projects were not expected to contribute to production capacity in the near future. Therefore, the loss of these assets can be compensated for in the long-term, once RWE AG’s liquidity improves.
Although, RWE AG has been working towards the divestment for around two years, however, the company has not reported significant divestment proceeds so far. It has closed the divestments of only around $2 billion (€1,560m) until Q3 2012. This represents slightly higher than 20% of its latest divestment target. This slow progress in the divestment program is mainly due to weakened demand scenario in the European markets.
RWE AG’s upstream divestments (RWE Dea’s assets) completed so far comprises only the sale of a 20% interest in the Edvard Grieg project, which fetched around €250m ($335m). Moreover, this sale is expected to save RWE Dea €650m ($870m), which it would otherwise have needed to invest in the development of this project.
RWE Dea also followed the same strategy in Egypt, where it has plans to divest a number of undeveloped assets. The company entered into an agreement with Apache Corporation for the sale of a 50% interest in the East Yidma Concession in Egypt with Industrija Nafte dd (INA) in December 2012. Moreover, the company also signed an agreement with Apache Corporation, through which it sold a 35% interest in the West Mediterranean Area (Block 1) in Egypt in Q4 2012. Furthermore, the company also entered into a Joint Venture (JV) with INA for the development of the Disouq concession in December 2012. This JV will provide RWE Dea with additional cash flows and enable it to accelerate its development activities in the concession.
Thus, RWE AG’s latest plan ruled out the complete divestment of RWE Dea, thereby ensuring certainty over its upstream operations. RWE AG plans to expand RWE Dea’s geographic footprints, and has, recently acquired new leases in Egypt and Norway, which will support its growth in the long term. Although RWE Dea’s interest in selective projects will be divested, the growth of the company’s production in the near future is expected to continue unaffected, since most of the projects planned for divestment would have contributed to production only in the long term. GlobalData expects RWE AG’s liquidity to improve in the medium to long term on the back of the cash flow growth anticipated from its renewable energy expansion plan. RWE Dea is therefore expected to continue its operations and progress with a trajectory of growth in the long term
