Verbund: Initiating Coverage With Fair Value Estimate of EUR 66 and Wide Moat Rating

We initiate coverage of Verbund VER with a EUR 66 fair value estimate, wide economic moat rating, and High Morningstar Uncertainty Rating. Our fair value estimate involves a 2023 P/E of 10.1 and enterprise value/EBITDA of 6.2 due to the record profits that we expect in 2023 on the back of high achieved power prices. We don’t see enough margin of safety to buy shares at the current price.

Verbund is the leading power producer in Austria and has a unique power generation mix with hydropower accounting for more than 90% of power output. European power prices are set by combined cycle gas turbines, and in turn by the costs of CO2 and gas, which are not incurred by hydropower producers, giving them a key cost advantage. On the bottom line, the profitability of hydropower and the whole group is highly geared to power prices, implying high earnings volatility. A EUR 10/megawatt-hour change in power prices would have a valuation impact of EUR 9 per share or 14%, which is the second-highest sensitivity among our coverage.

We conservatively forecast a long-term power price of EUR 60/MWh from 2027 onward, well below current forward prices of around EUR 140/MWh, but above the average of EUR 45/MWh between 2010 and 2020. At EUR 60/MWh, we calculate the company will achieve comfortable economic profits. Further, hydropower’s competitive advantages over other power sources will prevail in the long run in our view, buttressing Verbund’s wide moat.

We forecast a 2022-27 EBITDA and EPS CAGR of negative 4.7% and negative 7.3%, respectively, as the decline of hydropower profits in the wake of the fall of achieved power prices toward our EUR 60/MWh midcycle assumption will largely offset the growth of the grid and new renewables from growth investments.

Verbund’s earnings volatility drives limited dividend visibility. The 50% payout expected in 2023 is lower than the 70% typically paid by other diversified European utilities.