ADMIE Holding — Infrastructure upgrade offers growth opportunity

ADMIE Holding owns a 51% stake in IPTO, a utility which owns and operates the Greek electricity transmission grid and is fully regulated by the Greek Regulatory Authority for Energy (RAE) with a simple framework. IPTO is engaged in a large investment plan of c €4bn over the period 2019–27 to modernise, upgrade and extend the transmission network with the objective of increasing security of supply, reducing costs for consumers and improving environmental sustainability. Similarly to other European utilities, RAE periodically updates the RAB value and the allowed remuneration, setting all the parameters required to calculate the revenues of the company. The current four-year regulatory period is 2018–21, hence the company has good visibility on the economics for the next three fiscal years.

ADMIE Holding is trading at a large discount to other European regulated utilities on P/E, EV/EBITDA and dividend yield, despite the significantly stronger growth outlook on the back of the anticipated large capital programme. In addition, ADMIE Holding is trading at a c 40% discount to equity RAB, even though we believe allowed returns are broadly in line with its WACC. Our RAB-based valuation of €2.83 is c 60% higher than the current share price, and implies no premium/discount to RAB. While we believe the discount to RAB value and European peers is excessive, some risk factors may justify a certain discount, such as the limited liquidity of the stock, the higher country risk premium, the shorter track record of stability of the regulation for IPTO and the government ownership of ADMIE Holding.

As there is high visibility on return on investments, we generally have a positive view on regulated utilities with large capex opportunities, as long as returns are adequate and leverage is under control. A level of capex above depreciation allows for RAB growth and growing earnings, which drives dividend expansion. We believe a good dividend yield with a good growth outlook is one of the key attractions for investors in regulated utilities. IPTO has launched a c €4bn investment plan for the interconnection of the Greek islands, with the objectives of reducing costs for the consumers, improving security of supply and environmental sustainability. The investment plan is very large when compared to the current RAB of IPTO (€1.4bn at the end of 2018) and we estimate it should result in an 11% 2018–27 RAB CAGR (in real terms). We forecast FY19–23 EBITDA and net income CAGR of 18% and 11%, respectively, for IPTO, based on the assumption that the capex plan is implemented in a timely manner. This translates into a 11% EPS CAGR for ADMIE Holding. IPTO has a target of a minimum 50% payout ratio on earnings. Assuming a flat dividend payout ratio on earnings of 50% for IPTO, we forecast a 5% DPS CAGR for ADMIE Holding. We note the payout ratio of 50% is well below the average level of European regulated utilities (70%+), which indicates the future growth potential of the dividend is significantly higher than other European peers. Because of the high level of capex, we expect an average annual cash outflow of c €300m for IPTO. As a result, the leverage increases significantly but only towards levels broadly in line with other European regulated utilities (around 5x net debt/EBITDA and c 50% debt/RAB in 2025). In our view these levels do not suggest the need of a capital increase.

Compared to unregulated utilities (or hybrids part regulated/part unregulated), the business risks that regulated companies, including IPTO/ADMIE Holding, face are lower as they do not have exposure to volumes, commodities or other price fluctuations. However, changes in regulation or in market conditions may still have a material impact on profitability. The key elements of the regulation for IPTO are set until 2021 and, while changes are possible, large deviations from the current framework are unlikely in our view. The key risks that IPTO and ADMIE Holding face are a delay in implementing the company’s growth projects, political intervention risks, a rise in interest rate and, a change in market conditions (including country risk premium) not reflected in an updated rate of return.

ADMIE Holding was established by the Greek government in February 2017 and listed on the Athens Stock Exchange in June 2017. The company is 51%-owned by the Greek government. The only asset ADMIE Holding owns is a 51% stake in the Greek electricity transmission system operator IPTO and their activities, strategy and mission are fully aligned. The only income for ADMIE Holding is the dividend it receives from IPTO. IPTO owns, manages and operates the Greek electricity transmission grid (100% owned), which includes 11,801km of high voltage lines. IPTO’s mission is “to ensure Greece’s electricity supply in a safe, efficient and reliable manner while promoting the development of competition in the Greek electricity market and guaranteeing the non-discriminatory treatment of System users”. IPTO was previously owned by state-owned utility Public Power Corporation (PPC). In compliance with an EU Directive (2009/72/EC, “common rules in the organization of EU electricity markets”) and Greek law (4001/2011), IPTO was identified as Transmission System Operator for Greece. Full ownership unbundling was completed on 20 June 2017 when PPC sold a 24% stake in IPTO to State Grid of China Corporation for €327.6m and a 25% stake to state-owned DES ADMIE for €295.6m. A 51% stake was spun off into ADMIE Holding, owned by PPC shareholders. At the end of 2018, IPTO had 1,316 employees and ADMIE Holding only two employees.

A young and simple regulatory framework

IPTO is fully regulated by Greece’s Regulatory Authority for Energy (RAE). The regulator acts as an independent body to protect consumer interest at the same time as allowing the company a fair return on investments and sufficient revenues to maintain and upgrade networks. Similarly to other European utilities, RAE periodically updates the RAB value and the allowed remuneration for the company, setting all the parameters required to calculate the revenues of the company. The Greek regulation appears simpler and less sophisticated than the regulation of several other European countries, which we believe reflects the fact that it is relatively recent:

Very large growth projects are targeted

The Greek electricity mix is in a significant transition process. On the one hand, ageing lignite plants face environmental (lignite is responsible for >30% of total Greek carbon emissions, according to WWF), economic (rising carbon emissions have erased their profitability) and regulatory challenges (EU directives pose significant restrictions to their operations). On the other hand, the cost of renewable installations has reduced dramatically, and this has encouraged the Greek government to announce a plan of new renewable investments for 2.6GW of new capacity. In Greece as in other European countries, this transition from large central plants to smaller decentralised installations requires an upgrade of the network and is one of the key drivers of European electricity transmission grids.

In addition, Greece and IPTO have launched large projects for the interconnection of the Greek islands, with the objectives of reducing costs for the consumers, improving security of supply and environmental sustainability. In most cases Greek islands currently rely on expensive and polluting fuel-oil-fired plants (often close to touristic areas); currently the extra costs of running these plants is shared among all Greek consumers (this component represents 4%–12% of a retail consumer’s bill). The construction of interconnections should allow for the replacement of these plants (which would be put in cold reserve) with renewables and imports from the mainland, lowering both costs for the consumers and carbon emissions. We show in Exhibit 6 the key investments targeted in the Ten-Year Network Development Plan, as approved by the regulator.

A portion of the capex is covered by subsidies received by the European Union and these are subtracted from the RAB calculation (ie IPTO receives no remuneration on the portion of investments covered by subsidies). We show in Exhibit 7 a breakdown of the capex plan by project and in Exhibit 8 the annual investments planned by IPTO (gross and net of subsidies).

In addition, over the course of FY18, IPTO has set up the 100%-owned subsidiary ARIADNE as a SPV responsible for the c €1bn Crete-Attica interconnection project. Cash resources amounting to €200m have been injected in the company and IPTO is about to collect expressions of interest for the acquisition of a 39% stake in the company. We have assumed into our forecasts that the transaction is completed, hence we include disposal proceeds of €78m in FY19 (based on 39% of €200m) and adjust our net income forecasts to incorporate the impact of the related minorities. The project is currently identified as a project of major importance, hence it is eligible for additional remuneration (between 100bp and 250bp extra remuneration) for 12 years, although the remuneration will not start before the line is electrified (we assume remuneration from 2023 as the project is currently expected to be commissioned by the end of 2022; financial expenses related to the investments are capitalised until then). The assets related to this interconnection will be included in IPTO’s balance sheet and ARIADNE will have a concession contract with IPTO. ARIADNE will pay dividends to IPTO (61% stake) as well as to minority investors (39%) as soon as the asset is commissioned.

In the future, further investment opportunities may arise from the development of the Greek fibre optic network. For this purpose, IPTO set up a 100%-owned subsidiary “GRID TELECOM SINGLE MEMBER SA” in January 2019. While we understand this may be a source of significant development potential for IPTO (this business has generated annual revenue of €2m), not many details are available and it is difficult to assess the implications for the growth outlook of the company at this stage. We expect more details on this in FY19–FY20; the presentation of a more detailed plan may be a positive catalyst for the share price.

ADMIE Holding’s strategy is fully aligned with IPTO’s. IPTO aims to guarantee a safe, efficient and reliable electricity supply in Greece. In addition, IPTO promotes the development of competition in the Greek electricity market and guarantees the non-discriminatory treatment of system users. IPTO targets the timely implementation of a large capex programme that has been designed mainly to lower costs for the consumers and to improve security of supply (especially in the islands). IPTO expects the investment plan to generate value for its shareholders, with the RAB growth translated into growing profits and dividends.

The management teams of ADMIE Holding and IPTO include managers with a mix of technical and economic backgrounds. Eleni Zarikou is chairman of ADMIE Holding and director of finance at IPTO, and has a background in auditing, accounting and financial analysis, with roles at multinational companies in Greece. Yiannis Kampouris is vice chairman of ADMIE Holding and has a background in electrical engineering, and over 30 years of professional experience in the field of energy. Manos Manousakis is chairman of the board of directors and has been chief executive officer of IPTO since June 2017. His career combines business development leadership and complex project management with country strategic planning.

IPTO targets a c €4bn capex plan over the period 2019–27, which we calculate will result in 11% real enterprise value (EV) RAB CAGR, supporting earnings and dividend growth for ADMIE Holding. Based on the company’s capex plan, the growth outlook stands out when compared to other European regulated utilities, which we believe reflects the fact that large investments in electricity transmission were made earlier in other European countries than in Greece. The growing RAB is remunerated with an allowed return that we estimate is broadly in line with the WACC and IPTO’s underleveraged balance sheet provides room for the large planned spending.

As there is high visibility on return on investments, we generally have a positive view on regulated utilities with large capex opportunities, as long as returns are adequate and leverage is under control. A level of capex above depreciation allows for RAB growth and growing earnings, which drives dividend expansion. We believe a good dividend yield with a good growth outlook is one of the key attractions for investors in regulated utilities. Southern European utilities such as Terna, Snam, Red Electrica and Enagas have been successful equity stories; by implementing large capex programmes they have boosted both earnings and dividends for shareholders.

Similarly for IPTO, the large growth capex plan should result in a strong RAB growth profile. Incorporating the planned capex into our forecasts, we would estimate a 19% 2018–21 RAB CAGR (including work in progress; excluding this, CAGR would be 8%) and an 11% 2018–27 RAB CAGR for IPTO.

We show in Exhibit 11 that this RAB growth stands out among European regulated utilities’ targeted RAB growth. In our view this is because IPTO is at an earlier stage of development than EU peers, as most other European regulated utilities have implemented large and high-priority investments over the last 20 years, growing their RAB very strongly. In most cases their capex is now much more aligned with depreciation.

The EV RAB growth is translated into an equity real RAB CAGR of 3.0% in the period 2018–27 (net debt growth means equity RAB growth is lower than EV RAB growth).

Historically IPTO, as a subsidiary of state-owned PPC, experienced delays in implementing its capex plan. However, a new management team was appointed when the company was listed (and is now independent from PPC), and capex has been increased. Investments in 2018 were above the company’s plans (€171m vs €138m capex incorporated in the RAB). The improvement in Greek financing conditions, the ability to access financing from EIB and Chinese banks (thanks to the partnership with the shareholder State Grid of China) and the underleveraged balance sheet structure support a pick-up in investments. While the risk of delays should be considered by investors, in the valuation section we show that the company’s current valuation is not discounting any growth potential, hence risks to the share price appear limited.

The extra costs deriving from the Greek islands’ inefficient and expensive power generation system (in most cases dominated by polluting and high-cost fuel oil-fired power plants) are currently shared by all Greek consumers. As shown in Exhibit 12, the extra costs represent 4%–12% of a typical residential consumer bill (depending on consumption).

When compared to other listed utility assets, the allowed return on capital for IPTO is set at the highest level, which reflects the higher country risk premium. On our calculations the return on capital allowed by the regulator is broadly in line with our estimated WACC for IPTO.

Benchmarking with other European regulated utilities

When comparing IPTO to other European listed regulated utilities, its 2019 allowed rate of return is the highest in the sample we consider (Exhibit 13).

However, the high level of the allowed return for IPTO clearly reflects the higher country risk premium. By deducting from the allowed rate of return the respective countries’ 10-year government bond yields, we show that the country risk-adjusted level of WACC (3.6%) is not distant from the median value (3.9%).

Is the allowed return fair? Marking to market the WACC

We have marked to market the components of the allowed return set by the regulator to assess how it compares to IPTO’s cost of capital. We believe there are four WACC components that deviate from the current market levels (Exhibit 15).

Overall our forecasts for the cost of capital we estimate for ADMIE is broadly in line with the current allowed rate of return set by the regulator.

One of the key strengths of ADMIE Holding is IPTO’s currently underleveraged financial structure, which is key to support its very large capex programme. As set out in Exhibit 16, IPTO’s net debt/EBITDA at the end of 2018 was 0.9x, well below the average 5.3x for other regulated utilities. Looking at net debt/RAB metrics the result is similar: 12% for IPTO vs other regulated utilities typically ranging between 50% and 70%.

As investments are carried out, we expect leverage to increase significantly. However, as we show in Exhibit 17, the levels of net debt/EBITDA and net debt/RAB (including work in progress assets) in a few years’ time are broadly in line with the average levels for the other regulated utilities and the company is unlikely to require equity injections in our view. The company has not set a maximum leverage target.

Importantly, IPTO can access financing from international lenders. In particular, IPTO has loans with Bank of China (€199m out of €693m total debt at the end of FY18), European Investment Bank (€270m) as well as Greek banks (€224m). This should support availability of credit and an attractive financing cost. We estimate a 3.6% cost of debt in 2018 and expect a further reduction in 2019 to around 2.5%, based on recent company renegotiations.

The management teams of ADMIE Holding and IPTO include managers with a mix of technical and economic backgrounds. Eleni Zarikou is chairman of ADMIE Holding and also director of finance of IPTO. She has a background in auditing, accounting and financial analysis, with auditing and finance positions at multinational companies in Greece. Prior to IPTO, she was a financial advisor to the secretary general at the Ministry of Economy and Development. She holds a degree in organisation and business administration from the University of Piraeus and a postgraduate degree in applied economics and finance from the National & Kapodistrian University of Athens. She holds a professional qualification with the Certified Auditors and Accountants Training of the Body of Chartered Auditors and Accountants.

Yiannis Kampouris is vice chairman of ADMIE Holding and has a background in electrical engineering including a PhD from the National Technical University of Athens. He has over 30 years of professional experience in the field of energy. Since June 2017 he has been a member of the board of directors of IPTO SA and chief officer of operation, infrastructure and market. Prior to these positions, he was CEO of IPTO, director of the Transmission System Planning (IPTO SA and HTSO SA), director at the chief executive director office (IPTO SA) and head of system planning department (HTSO SA). He is author or co-author of more than 150 publications in international journals, national and international conferences.

Manos Manousakis is chairman of the board of directors and chief executive officer of IPTO since June 2017. He was previously the chief executive officer of two subsidiary companies of the OTE group, which provide telecommunication services in the wholesale market. He has also served as a director of the board of OTE SA and has held various positions of responsibility in the company. In addition, he served as secretary general of the Ministry of Economy as well as a director of Black Sea Trade and Development Bank. He has previously worked as a scientific associate in the Hellenic Parliament, and as a consultant in telecommunication projects for public and private sector companies. He holds a PhD in electrical engineering from the National Technical University of Athens and has academic experience. His career combines business development leadership and complex project management with country strategic planning.

The corporate governance for IPTO is regulated by a shareholders’ agreement. ADMIE Holding proposes the chairman and CEO and deputy CFO. State Grid Corp. of China (SGCC) approves the chairman and CEO and appoints the deputy CEO and CFO. The board of IPTO is composed of nine members: two appointed by the Greek government, three by ADMIE Holding, three by State Grid and one who is a representative of the employees.

Compared to unregulated utilities (or hybrids part regulated/part unregulated), the business risks that regulated companies, including IPTO/ADMIE Holding, face are lower as they do not have exposure to volumes or price fluctuations. However, changes in regulation or in market conditions may still have a material impact on profitability. The key elements of the regulation for IPTO are set until 2021 and, while changes are possible, large deviations from the current framework are unlikely in our view. One of the largest risks is a delay in implementing the company’s growth projects, which may have an impact on the growth outlook of the company. More in detail, key risks for IPTO and ADMIE Holding are:

We show that ADMIE Holding is trading at a large discount to European regulated utilities on all valuation metrics despite the stronger expected growth and at a large discount to RAB. An FY19e RAB-based valuation (including work-in-progress assets) of €2.83/share (assuming no premium/discount to RAB) is c 60% higher than the current share price.

At a large discount to European regulated utilities on all valuation metrics

As set out in Exhibit 20, ADMIE Holding is trading at a discount to other European regulated utilities on P/E, EV/EBITDA and dividend yield, despite the significantly stronger growth outlook.

As set out in Exhibit 21, applying the average EV/EBITDA and P/E of European regulated utilities to ADMIE Holding, derives significant upside to the current share price (c 60% and 30%, respectively, based on FY1 multiples). It is important to note that we see valuation upside even though on our forecasts IPTO’s earnings are not benefiting from the large investments in ARIADNE, which do not contribute to our earnings until completion (in FY23 on our assumptions). A valuation based on dividend yield would provide downside (c 5% on FY1) as the dividend payout ratio for IPTO (50%) is well below the average level for European regulated utilities (70%+).

Investors should note that the current limited liquidity of the stock may be part of the reason for the discount as the stock has traded less than €0.2m/day since the beginning of 2019.

ADMIE Holding also trading at a large discount to RAB value

We calculate that the current ADMIE Holding share price implies a large discount to RAB value, as shown in Exhibit 22, in contrast with most other European regulated utilities that generally trade at a large premium to RAB values.

We have used a similar approach to derive an RAB-based valuation for ADMIE Holding in Exhibit 23, to show at what premium/discount to RAB the stock should trade according to our estimates. Starting from IPTO’s EV RAB, we calculate the implicit equity values for IPTO and ADMIE Holding. As the absolute profitability we estimate for IPTO is broadly in line with the allowed return by the regulator, we include almost no value for the financial over/underperformance. As a result, we derive a valuation that is broadly in line with RAB. The RAB-based valuation of €2.83/share is c 60% above the current share price.

While we believe this discount is excessive, there may be some reasons that partly justify a discount to RAB or other European peers, such as the limited liquidity of the stock, the higher country risk premium, the fact that the company is controlled by the Greek government and the fact that the regulation for IPTO has a shorter track record than other European countries.

We forecast FY19–23 EBITDA and net income CAGR of 18% and 11%, respectively, for IPTO. This translates into an 11% FY19–23e EPS CAGR for ADMIE Holding.

IPTO’s EBITDA is mostly driven by growing revenues (14% CAGR FY19–23e) as a result of RAB expansion. We have assumed allowed returns broadly in line with the regulator’s assumptions until 2021 (the only difference being a declining corporate tax rate, as we have assumed the regulator adjusts the calculation during the current regulatory period) and unchanged thereafter. We have incorporated into our forecasts extra returns of 100bp (vs the regulator’s indication of 100–250bp) on certain projects of major importance (we have assumed only ARIADNE’s project, which represents c 25% of total capex, qualifies for this, although we recognise that other projects may be designated in the future). We have also assumed IPTO’s opex to be in line with the regulator’s assumptions (excluding opex related to other non-regulated activities, which are small).

Below EBITDA, we have assumed a declining cost of debt for IPTO in 2019 (to 2.5% from 3.6% in 2018, reflecting recent renegotiations as well as the likely lower cost of new debt) and flat thereafter. In addition, we have assumed a corporate tax rate declining by 1 percentage point a year to 25% in 2022 (in line with current Greek legislation).

We have not included any growth related to the fibre optic network business as currently not enough details are available to assess the economics of this activity. However, the growth opportunity is likely to be significant and we see medium-term upside risk to our forecasts as a result.

IPTO has a target of a minimum 50% payout ratio on earnings. Considering the financing needs implied by the large capex plan, we have conservatively assumed a flat dividend payout ratio of 50% for IPTO. ADMIE Holding’s dividend policy is to pay 95% of the dividend it receives from IPTO, net of expenses at ADMIE Holding (which we estimate at €0.3m for FY19). We forecast a 5% DPS CAGR for ADMIE Holding (please note that the dividend for ADMIE Holding increases significantly in FY24 as IPTO pays out in that year the first dividend related to the increased earnings thanks to the contribution of ARIADNE). We note that IPTO’s payout ratio of 50% is well below the average level of European regulated utilities (70%+), which indicates the future dividend growth potential is significantly higher than other European peers.

Because of the high level of capex, we expect an average annual cash outflow of c €300m for IPTO throughout 2021 (assuming no significant deterioration in working capital). As a result, the leverage increases significantly (see Exhibit 17) but only towards the levels broadly in line with other European regulated utilities (around 5x adj. net debt/EBITDA and c 50% adj. net debt/RAB in 2025). In our view these levels do not suggest the need of a capital increase. That said, there is no guidance from the company on the target gearing levels.

IPTO group reported FY18 EBITDA of €182.7m, up 6% y-o-y, and net profit of €85.9, up 39% y-o-y. However, the results included various exceptional items including the positive impact of a provisions reversal of €26.6m due to dismissal of a contractor lawsuit. Correcting for that, EBITDA was down 5% y-o-y and net income was up 13%. IPTO managed to step up capital spend significantly, with total capex of €183m, up 154% yoy. Despite this, group net debt reduced significantly to €171m (from €286m one year earlier) thanks to a large positive variation in working capital (we understand the company expects no significant changes in working capital going forward).

ADMIE Holding reported an FY18 net profit (pre-exceptionals) of €42.3m, up 83% y-o-y (+73% y-o-y including exceptionals in FY18/FY17), and said it expects to distribute €0.087/share in dividends over the course of 2019 (cash dividend, ie the sum of the balance of the dividend related to FY18 of €0.028/share and of the interim dividend for FY19 of €0.06/share).