Acciona - Sell

Spain:

1. Highly exposed to changes in regulation

a. After elections, the elected government will have to tackle the eur 3bn/year deficit that already amounts to 20bn

2. Exposed to the (wholesale) energy prices

a. Most of its generation capacity is unhedged, ie, top-line exposed to the wholesale price fluctuations

b. Expected GDP contraction due to the economic slowdown and the additional austerity measures to be taken by the new government (defitic has to be reduced from 7ish% currently to under 3% to comply with the European mandate.

c. Expected lower energy consumption as the electricity bill continues to rise to close the tariff deficit (3bn/year, a burden to be shared between consumers and producers –and especially clean tech generators among the latter

3. Higher O&M costs going forward due to older wind farms and worse WT technology (acciona

4. Higher country risk premium yet to be fully incorporated in the discount rate. And getting worse

International

1. Lower world GDP growth to be felt in the infrastructure division

2. Regulatory overhang in the US. Little visibility over the extension of the cash grants and PTCs

3. Energy prices in a long-term downward trend, as fracking continues to expand and a higher percentage of the energy generation and consumption is switched towards natural gas.

Capital Structure

1. Despite high leverage (Net Debt/EBITDA over 5x), management initiated share buy-back programme during the last quarter (1.5mn shares at c.66 eur/share for 100mn)

… a price above our fair value / target price

The outlook on Spain and the US, in both regulation and energy prices is negative. In Spain, the PP has not yet disclosed what will be the Energy Policy going forward, but most likely it will take a less benign approach to the renewable energies sector than the incumbent socialist government.

The conservative party has always had a penchant towards lower costs of generation and lower energy bills rather than to subsidy and increased generation share of the clean energies. Several articles appeared in the Spanish press (eg.: expansion / libertad digital) in the latter months have called attention to the dramatic increase in the costs of generation caused by the subsidies to the renewable energies, and how they have destroyed c. 2.2x more jobs than created, due to the industrial sector sensitivity to higher energy costs.

Furthermore, J.M. Entrecanales, CEO and Chairman of Acciona is a close friend of the Prime Minister Rodriguez Zapatero. This does not auspicious a more lenient regulation framework if the government changes, given that Acciona is the biggest national wind farm developer, with a different tariff regime from that of other peers (like EDPR), operating in a market that currently has 3bn euro deficit p.a., already amounting to eur. 20bn.

All these factors call for prudence in relation to the future tariffs in Spain. Besides, the upside potential embedded in the current tariff structure won’t be triggered. As energy prices in Spain won’t reach the level at which pool prices (market price+premium) will become more attractive than the current tariff. The gap stands currently at 7? eur/MWh, and the required increase in demand to close the gap is simply not there.

Elsewhere, PPAs in the US will also remain depressed in price levels and duration for two factors. First, policy makers continue to favour a strategy of energy independence. Shale gas extraction (known as fracking) has been the method gaining more market share and is indeed lowering the prices of natural gas in America. As a consequence, an increasing proportion of the generation and consumption of energy in the US is switching towards natgas. Second, the subdued economic outlook is dragging down the energy prices and the inflation expectations of the US, the two factors that determine the pricing of the PPAs. The alternative to not signing PPAs is to sell the energy directly in the wholesale market, but this exposes them to the price fluctuations.

Acciona has been investing heavily in wind energy projects with low IRR-WACC margins during the early stages of the development cycle of this technology. So far, a reality check about the growth prospects for wind, in combination with the worsening of the macroeconomic variables have dragged this margin to negative territory, with a spread of c. 140bp. We expect that higher-than-expected O&M costs will increase this spread further.

Furthermore, the company has very poor disclosure within its Energy division. It has only mildly improved the disclosure on its non-generating Energy activities (which include the loss-making WT manufacturing facilities), but overall remains far from sufficient for valuation purposes.

Given the few opportunities to achieve a project specific-IRR above its cost of capital with a comfortable margin, we think that the management strategy going forward will be to increase FCF by reducing CapEx even further. On the other hand, management appears to be comfortable with the current gearing of the firm at xx D/E, for that reason we think that a flattish debt evolution and a gradually declining Debt/EBITDA is the most likely capital structure scenario.

The company could certainly dispose assets above book value realising capital gains, but most of the value that could have been rescued by disposals in the appropriate geographies (mostly Spain) has already been lost, as the market has re-priced the sovereign risk accumulated throughout the last economic and political period, and a government of the PP conservative party seems would be committed to improve the economic stability (which would reduce the cost of capital in the long-term).

In this sense, we also see the political environment in Chile as stable and favourable to investments (as in all the other geographical areas in which Acciona is invested: US, Canada, Mexico, Australia and Poland -infraestructure), and do not find much added value in the disposal programmes carried away in Chile.

Corporate Governance details

Does the company have a combined chair/CEO? Yes

Percent Independent Directors 58.30%

Does the company disclose its corporate governance policies or guidelines? Yes

Do all executive board members own shares after excluding options held? Yes

Is the company currently under investigation for accounting irregularities? No

Do all common or ordinary equity shares have one-share, one-vote, with no restrictions? Yes

Do shareholders have a right to convene an EGM with 10% or less of the shares requesting one? Yes

Do shareowners have a right to act in concert through written communication? No

Potential Dilution from Stock Options Outstanding + Not Yet Granted Under Old or New Plans 0.00%

Is there a single shareholder or shareholder group which controls a majority of the voting power of the company? Yes

Has the company adopted a shareholder rights plan ("poison pill")? No