Mytilineos — The future is bright

Mytilineos is a diversified industrial company operating in four main business areas: power generation/supply (Power & Gas division, or P&G); alumina/aluminium production (Metallurgy division); engineering, procurement and construction (EPC) of power and sustainability projects (Sustainable Engineering Solutions division, or SES); and renewables/energy storage development (Renewables & Storage Development division, or RSD). It has been investing heavily to benefit from the energy transition. It has invested c €1bn over five years (2017–21), including our estimated capex for 2021 of c €0.5bn equating to 5x depreciation. Investments have been made in renewables, including 211MW owned renewable generation assets, mostly wind farms, and we expect a further 1.5GW of solar plants to be developed and kept (in P&G); renewable development assets (mostly solar photovoltaic, PV) of over 4.3GW at various stages of development and construction (in RSD); improving aluminium production efficiency; expanding its recycled aluminium capacity; and a high efficiency 826MW combined cycle gas turbine (CCGT) plant, which is on track for completion by end-2021.

Over the years, Mytilineos has leveraged the synergies between the divisions to build a portfolio of assets that have in common a low-cost, competitive positioning. In the Metallurgy division, the company is first quartile on the global cost curve for both alumina and aluminium production; the gas-fired power plants are some of the most efficient in Greece (or the world, in the case of the new 826MW CCGT plant) and are among the lowest-cost thermal producers in the country. Mytilineos has built a track record of diverse infrastructure development internationally and is leveraging its competencies to benefit from growth in sustainable development projects, which are seeing a significant increase in government funding globally. Since the start of the pandemic, governments globally have announced over $12tn in stimulus packages, including the United States with c $2tn and Europe with c $1tn (its €800m recovery fund). A sizeable portion of these funds are being allocated to sustainability projects. McKinsey estimates there are $1tn of unassigned energy and environmental projects for 2020–22.

Its new RSD division, which focuses on solar and energy storage developments, also leverages competencies in EPC and infrastructure and will benefit from strong long-term growth rates as renewables displace fossil fuels as the main source of energy globally. We estimate that annual solar installations could grow at 10% pa over the next 10 years. The RSD division undertakes full development projects, using its own development pipeline, which are either sold to third parties (currently assumed) or potentially kept internally (in its P&G division), as well as EPC contracts for third parties.

We forecast that Mytilineos increases its earnings (EBITDA) from energy transition activities from 25% in 2020 to 60% in 2025 (and 65% in 2030). This translates into a five-year EBITDA CAGR of 32% in energy transition-related activities (from c €80m in 2020 to c €325m in 2025), and a five-year group EPS CAGR of 16%. Annual growth rates are even higher over 2020–23, as by 2025 we taper down our pricing assumption for aluminium (LME price + premium) to more normalised long-term levels.

Our valuation is based on a 10-year DCF for each division. We update our DCF methodology to better reflect the longer-term energy transition; we adopt a 10-year cash flow forecast period followed by a terminal value, and formulate a bear, base and bull case to better understand the risk-reward balance for the shares. We believe we have been conservative in applying 1% terminal growth across Metallurgy, P&G and SES; and 2% for RSD. We discuss our modelling assumptions in the following sections.

Our bull case gives a per-share valuation of €38, which is more than double (c 130%) the current share price, compared to our bear case of €13, which is just c 20% below the share price, implying an attractive risk-reward balance. Our base case of €24.0 per share implies c 50% upside. For the develop and keep solar plants, we estimate value accretion of c €7m for every 100MW, based on a €40/MWh electricity price and a WACC of 7.0%; however, if we were to assume a nominal 70% project finance, then this would increase to €14m. For 1.5GW of solar projects this would increase our share valuation by a further c €100m (as the valuation of the solar projects, assuming project finance, equates to €210m) or a further 5pp of upside.

We use peer valuation as a cross-check, rather than driving our valuation, as we believe near-term earnings multiples do not accurately reflect Mytilineos’s long-term growth prospects. We take a sum-of-the-parts (SOTP) divisional based approach, which best reflects the uniqueness of the Mytilineos business. Adopting EV/EBITDA multiples of comparable peers on a divisional basis suggests an SOTP valuation of, on first impression, c €19.9/share, which when adjusted to adequately reflect the competitive strengths and growth prospects of Mytilineos’s divisions relative to their peers (we assume a 20% premium to the median peer multiples) increases by c €4,0/share to c €24/share. This agrees with our DCF-based share valuation.

We forecast that net income (after minorities) will increase by 103% over 2020–22 (which is in line with management’s informal guidance of doubling earnings between 2020 and 2022), and EPS increases by 112% (reflecting the ongoing share buyback program). We expect strong growth across Metallurgy, SES and RSD, as these businesses recover following a downturn during the pandemic. We expect EBITDA for P&G will be down by just over a quarter in 2021 after an exceptionally strong year in 2020; however, by 2023 it should increase above the 2020 level, driven by the new CCGT plant (and with the Korinthos Power CCGT plant back at full capacity).

We expect Mytilineos’s return on capital employed (ROCE) to average 11% over the next 10 years. This suggests the company is putting capital to good use. Free cash flow (FCF) is negative in 2021 due to large capex (new 826MW CCGT) and working capital investments (increase in renewable energy systems (RES) development). It will remain suppressed in the coming years as Mytilineos invests in 1.5GW of solar plants it plans to keep (we estimate capex of €0.8bn over 2021–26). Once it starts to see a return on this investment, FCF yield rises to c 7% in 2024–25 (despite the ongoing investment in solar projects) then to 13–17% from 2026. Assuming Mytilineos continues its current dividend pay-out ratio of c 35%, we estimate its dividend yield will increase to 4–5% from 2022 and this is in addition to its ongoing share buyback programme (we estimate c €70m of shares have been repurchased so far over 2020–21).

Mytilineos has a strong balance sheet with our forecast net debt to EBITDA ratio peaking at 2.8x in 2021, decreasing to 0x by 2028. Furthermore, it successfully raised €500m in ‘green’ bonds in April at an interest rate of 2.25%, demonstrating investor confidence in Mytilineos’s ability to deploy capital into value accretive renewable and sustainability projects. Including the bond issue, it has financial flexibility of over €1.5bn (€0.6bn cash and €0.9bn credit facility).

EPS increased by 17% to €0.57 per share (in H121) from €0.49 per share in H120. H121 results showed a significant turnaround in the SES (EBITDA of €25m from a loss of €6m in H120) and Metallurgy businesses (EBITDA of €77m up from €66m in H220). RSD showed some promise with the EBITDA margin improving to 6.4% from 2.5% in H220; however, revenue will be heavily skewed to H2 due to order deliveries. The P&G division was affected by a scheduled three months of maintenance for the Korinthos Power CCGT plant. FY20 was a record-high performance for P&G due to higher spark spreads benefiting Mytilineos’s market-leading generation business.

Aluminium prices and premiums have been on an upward trajectory since Q420. The aluminium price has increased from an average of c $2,000/t in January to $2,400/t in June and premiums from an average of c $400/t in January to c $1,000/t in June. They have recently been given a further push upwards from the announcement, in June, that Russia is planning an export duty on aluminium, nickel, steel and copper to help keep domestic inflation under control. An export duty of 15% applies from 1 August to 31 December. The aluminium price has since risen above $2,600/t in August and the premium to $1,150/t. In addition, there have been suggestions on some newswires that Russia might replace the export duty with a more permanent mineral extraction tax from 2022. We note that our base case valuation, which assumes a price of $2,350/t for 2021 then $2,300/t for 2022–24 followed by $2,200/t from 2025 and premiums peaking at c 30% in 2022 (lag effect) before reducing to c 15% from 2025, appears conservative on this backdrop.

It has been long accepted that companies that embrace good ESG practices are likely to be well run, have better cost efficiencies and profitability, and therefore achieve superior returns to similar companies that do not. Mytilineos is a good example of a company where good ESG practices, particularly in relation to the emissions reduction and the energy transition (the ‘E’ of ESG) should have a positive impact on earnings. The management team has positioned Mytilineos as a leader among Greek companies in ESG practices. It is among the first companies to set net zero carbon emissions targets (by 2030 for SES and RSD and by 2050 for the entire group). It held a successful ESG summit in February with participants from government, industry, finance and NGOs. It is targeting a 65% reduction in emissions in its Metallurgy business by 2030, which due to the energy intensive nature of aluminium smelting, means decarbonising its electricity supply. In the most recent (May) RES auction in Greece, winning tariffs ranged from c €33/MWh to €51/MWh. This provides a significant opportunity for Mytilineos to reduce its cost of electricity in Metallurgy. Indeed, it recently announced a 200MW 10-year solar PPA signed with Egnatia at €33/MWh. Mytilineos is implementing a whole range of ESG measures, including adopting the UK Corporate Governance Code 2018, and has been scoring well with ESG ratings providers (including improving its score in seven out of eight ratings in 2020).

Mytilineos is a diversified industrial company operating in four main business areas: power generation/supply (P&G); alumina/aluminium production (Metallurgy); EPC of power and sustainability projects (SES); and renewables/energy storage development (RSD). A majority of its operations are in Greece; however, it has been increasing international exposure, particularly through its SES and RSD businesses. EBITDA from SES and RSD increases from a combined 8% in 2020 to 25% by 2030. We discuss each division’s activities in more detail, including proportions of earnings from energy transition-related activities in the following sections.

We have undertaken detailed scenario-based modelling of Mytilineos, which comprises:

We discuss the trends, Mytilineos’s strategic activities and our assumptions for each of the four divisions in separate sections below. We summarise our detailed assumptions and financial forecasts by division in the financials section.

Exhibits 5, 6 and 7 below present our EBITDA forecasts for each scenario, along with the percentage of EBITDA that is derived from the energy transition (RES and sustainability) activities. The areas we model that relate to energy transition include:

Strategically, as outlined in a corporate presentation dated September 2020, Mytilineos targets >40% of 2025 EBITDA from energy transition activities and expects this will help to double group earnings by 2025. However, we believe this guidance has now been superseded (due to significant positive developments in the aluminium market, among other things) by informal guidance given since the AGM in June, when it was suggested that earnings could double by 2022. In addition, on a group level, it has committed to reducing direct and indirect CO2 emissions by at least 30% by 2030 compared to 2019 and to achieve zero emissions by 2050.

In our base case, EBITDA increases by 69% over 2020–25e, implying a CAGR of 11%. EPS increases by 112% or a 16% CAGR. We forecast an increase in EBITDA from energy transition activities from 25% in 2020 to 60% in 2025, above Mytilineos’s strategic target of >40% (in 2025).

In our bull case, we forecast energy transition-related activities to increase to 63% of EBITDA in 2025. EBITDA increases by c 105% over 2020–25, implying a CAGR of 15%, and EPS increases by c 185% or a 23% CAGR, which is significantly above Mytilineos’s strategic target.

In our bear case, we forecast energy transition-related activities to increase to 56% of EBITDA in 2025, again above Mytilineos’s strategic target. EBITDA increases by 29% over 2020–25, implying a CAGR of 5%, and EPS increases by 28% or a 5% CAGR.

Mytilineos has been gradually increasing its share in domestic electricity production through adding RES generation capacity totalling 222MW by end-2020, 205MW of which are wind farms. As the wind farms were built before end-2020, they benefit from favourable tariffs of €98/MWh. Assuming total installed costs of €1.2m/MW and operation and maintenance (O&M) costs of €33/kW equates to a project internal rate of return (IRR) of 16%, or an equity IRR of 34% (assuming notional project finance leverage of 70%). From 2021, Greece moved to a new system for RES; tariffs are determined on an auction basis. Even at €51/MWh, which is the top end of successful bids in the May auction, we estimate project IRRs for wind at below 7.5% (ie barely above our estimated weighted average cost of capital (WACC) for Mytilineos of 7%) and equity IRRs below 9% based on the same assumptions. Based on this, we believe Mytilineos will switch its focus from investing in wind farms to investing in solar plants, where the economics are more favourable. We estimate that Mytilineos will add 300MW pa of solar capacity over 2022–26, as it develops and keeps (build to keep) its mature pipeline of 1.5GW (mostly) solar projects in Greece (acquired in February). At €40/MWh, we estimate that solar projects can achieve project IRRs of 9% and equity IRRs of 16%, based on total installed costs of €0.55m/MW and O&M costs of €10/kW. We note that in the recent renewable auction (in May) in Greece, the average tariff for successful bids was €38/MWh (with a range from €33/MWh to €51/MWh).

Mytilineos is on track to complete construction of its new 826MW CCGT by end-2021 (total investment cost of c €330m) and will commence operation following a test period in H122. Assuming it reaches full capacity in 2023, Mytilineos will, we estimate, achieve a 20% share of domestic production.

On 1 November 2020, Greece implemented the European Union’s Target Model for electricity, which is the cornerstone for the development of a single electricity market in Europe. Greece’s electricity market is primarily coupling with the Italian and Bulgarian markets, where there are plans to increase the capacity of existing interconnecting infrastructure. It is anticipated that the new markets will lead to increased competition, greater transparency and an integrated market for the benefit of participants and end-consumers alike, as the EU transitions to low-carbon electricity. Greece, which had been slow to implement the scheme, has among the highest wholesale prices in Europe.

Greece’s state-owned power utility PPC has committed to cease operating all its existing lignite-fired power plants (c 2.6GW) by 2023. As the lignite plants have been running on significantly reduced load factors (<20%), due to a strong increase in carbon prices (to c €50/tonne), this will remove approximately 4TWh from energy supply. Mytilineos’s new 826MW CCGT plant, which is scheduled to commence operation next year, will replace this by adding 4.4TWh from 2023. In addition, PPC plans to convert a coal-fired thermal plant under construction to a 1GW gas power plant 2025. Assuming a load factor of 50%, this could add another 4TWh.

At end-2020, Greece’s energy mix comprised c 20% renewables and its electricity mix c 30%. Greece has a legally binding target of 35% renewables in final energy consumption by end-2030. Of this, RES is set to account for 61% of electricity consumption by 2030. Greece’s national energy plan mandates 7.7GW of solar PV capacity by end-2030 (up from 3.2GW end-2020) and 7GW of onshore wind (up from an estimated 3.5GW end-2020). This increased capacity could reduce Greece’s reliance on imported electricity; in recent years, it has met more than 15% of its electricity demand -by net imports. We assume electricity demand growth of 3% in 2021, 2% in 2022 and 2023 then 1% thereafter, with electricity demand returning to pre-pandemic levels (c 58.7TWh) during 2023. We assume oil generation capacity is withdrawn by end-2030.

We summarise our modelling assumptions in Exhibits 11 and 12 and discuss them in detail in the Appendix.

Mytilineos owns Europe’s only integrated aluminium production facility, with aluminium capacity of 250kt (including primary aluminium capacity of 190kt), alumina capacity of 875kt and bauxite capacity of 650kt. It has proactively set emissions reduction targets to reduce total CO2 (scope 1 and 2) emissions in the Metallurgy division by 65% and reduce specific emissions by 75%, per tonne of aluminium produced by 2030 (relative to 2019 emission levels). Its strategy for meeting these targets includes sourcing cleaner electricity and increasing its recycling capabilities. From 2024, we estimate that c 80% of Metallurgy’s earnings will be derived from energy transition activities. This is due to an increasing portion of recycled aluminium (roughly a third of production by 2024) and 70% of electricity sourced from renewables, which results in less than four tonnes of CO2 per tonne of aluminium produced, allowing all primary aluminium to be classified as green aluminium. Pre-2024, the main contributor to energy transition earnings for Metallurgy comprises earnings from efficient CHP production, which we estimate at c €35m.

Aluminium production is one of the most carbon-intensive industries, due to high levels of electricity required for aluminium smelting. It emits nearly 1.1bn tonnes of CO2 globally and is not helped by China accounting for c 55% of global production. To put it into context, China used 485TWh of electricity in aluminium production in 2019, of which 90% (430TWh) was from coal-fired plants, and a majority of these are subcritical (low efficiency). This resulted in 667Mt of CO2 emissions from Chinese aluminium production, which is almost double the entire UK’s CO2 emissions (c 370Mt) and higher than all but the top seven CO2 emitting countries globally.

The aluminium industry must reduce its emissions by 77% by 2050 to meet global climate targets. This will largely be met through shifting to green electricity and assisted by increasing recycling capacity and efficiency (recycled aluminium uses c 5% of the electricity required for primary aluminium production). The International Energy Agency has called for a shutting of all subcritical coal plants by 2030; this equates to the removal of c 60% of China’s aluminium production (c 30% of global supply) in under 10 years. China has put caps on production but will need to take drastic measures to comply with global climate targets.

This enormous challenge for the supply-side, which the International Aluminium Institute (IAI) estimates could cost $0.5–1.5tn, is exacerbated by strong demand for aluminium due to the energy transition. It is a light-weight material used in electric vehicles, for ‘green buildings’ and power cabling. Based on the IAI’s projections, demand could increase by 80% to 171mt by 2050 (from 95mt in 2018). The IAI suggests secondary aluminium production will increase its share from a third in 2018 (31mt) to nearly 50% (81mt) by 2050, which implies growth in primary aluminium production is still required (from 64mt in 2018 to 90mt in 2050), albeit produced using green electricity sources.

We summarise our modelling assumptions in Exhibits 15 and 16 and discuss them in detail in the Appendix.

Mytilineos set up the RSD division in 2020 after its acquisition of the remaining 50% in subsidiary Metka. It has built up a track record in solar PV and energy storage EPC projects since 2015 and has more recently started developing its own pipeline of projects. For EPC contracts, it has won repeat business from Total Eren, a global renewable developer in which oil major Total Energies holds a stake and also PPC Renewables, which is building a pipeline of renewable assets and tendering >500MW of projects. Total Eren has 3.5GW of RES under construction or operation and is targeting 5GW by 2022. Data from the International Renewable Energy Agency (IRENA) suggest that annual solar installations could grow at a 10% CAGR to 2030, suggesting very strong long-term growth potential for Mytilineos.

We see significant growth potential in this division, with a five-year earnings CAGR of c 35%, albeit from a low base of €15m (EBITDA) in 2020. We believe company guidance of >1.5 GW of BOT projects over 2021–25 is conservative given the maturity of projects coming through its >4.3GW pipeline (of mostly solar PV projects). In our base case, we forecast 1.7GW, which would be higher if Mytilineos were to sell some of the 1.5GW of solar plants in Greece that we are assuming it keeps.

We summarise our modelling assumptions in Exhibit 21 and discuss them in detail in the Appendix.

In 2020, the former EPC & Infrastructure business was transformed into SES. We believe this marks a turning point for the business, which has seen orders and revenues trending downwards over the last few years. We estimate that new orders increased threefold in 2020 (c €600m versus an estimated c €200m a year earlier) and forecast increasing revenues and improving profitability in the coming years, as the business expands into sustainable development infrastructure, while continuing to pursue opportunities in the construction of thermal plants and selected construction projects. The new business unit is increasing its share of projects in areas such as solid and liquid waste management, hybrid and off-grid energy projects, energy upgrade projects and innovative first-of-a-kind energy projects (such as hydrogen projects). Sustainable development projects account for 21% of the committed order backlog of €0.9bn at end-H121, up from 19% at end-2020, and there are mature projects worth nearly €0.8bn that could potentially be converted to new orders, 50% of which are sustainable development projects.

Since the start of the pandemic, governments globally have announced over $12tn in stimulus packages, including the US with c $2tn and Europe with c $1tn (its €800m recovery fund). A sizeable portion of these funds are being allocated to sustainability projects. McKinsey estimates there are $1tn of unassigned energy and environmental projects for 2020–22.

We summarise our modelling assumptions in Exhibit 26 and discuss them in detail in the Appendix.

We have enhanced our traditional valuation approach for Mytilineos by including a 10-year DCF analysis (on a SOTP basis), which, we feel, better considers the longer-term impact of the energy transition. We place less emphasis on peer valuation, using it only as a cross-check.

Our DCF approach suggests a per-share valuation of €24.0, which implies c 50% upside versus the current share price (€16.1) and is up €11/share versus our last published valuation (in October 2020) of €13/share. The uplift in valuation can be attributed mostly to increased valuations for the RSD and SES divisions (+€9.5/share), P&G (+€2.5/share), Metallurgy (+€3.0/share) and is in spite of increased net debt and other adjustments (-€4/share).

We update our DCF methodology to better reflect the longer-term energy transition; we adopt a 10-year cash flow forecast period followed by a terminal value and formulate a bear, base and bull case to better understand the risk-reward balance for the shares.

Key assumptions and drivers for our cash flow model are as follows:

The key differences in driver between our bear, base and bull cases are summarised in the scenario analysis sections above.

Our bear and bull cases suggest a favourable risk-reward balance of c -20%/+130%. We note in particular an asymmetry in our valuation of RSD, with the bull case c 70% above our base case (versus bear case just c 40% below base case); this is because we believe the growth potential of the BOT business is notably higher than management’s (formal) guidance of 1.5GW over five years, which we adopt in our base case; our bull case reflects 2.0GW.

We use peer valuation as a cross-check, rather than driving our valuation, as we believe near-term earnings multiples do not accurately reflect Mytilineos’s long-term growth prospects. In our approach, we use EV/EBITDA multiples (using current EV) applied to peers for each division. We use 2022 EBITDA given that we are now more than halfway through 2021.

The peer valuation suggests, on first impression, €19.9/share, which is €4.1/share below our valuation of €24.0. However, we do not believe the multiples adequately reflect the competitive strengths or the growth prospects of Mytilineos’s divisions versus their peers:

We apply a 20% premium to multiples for each of these divisions/business units. Collectively, this would increase the valuation by c €4.0/share, to an adjusted €23.9/share, which is consistent with our DCF valuation.

We estimate capex of c €0.5bn in 2021, which combined with an estimated €70m working capital contribution for upfront expenditure on solar plants developed for sale to third parties compares to company capex guidance of €0.6bn (which we believe may include BOT solar plants as capex rather than working capital). The investment programme has been funded partly through operating cashflow (Mytilineos is highly cash generative) and partly though net debt, which increased from €420m at end-2019 to €536m at end-2020 and we forecast an increase to c €950m by end-2021, when its net debt to EBITDA will peak at 2.8x, which is well below sector average.

We reduce the effective tax rate from 16% in 2020 to 15% in 2021 to reflect the fact that the Greek government announced in May that it would retroactively cut the corporate income tax rate from 24% to 22% for 2021 onwards. We increase the effective tax rate to 20% by 2025 and 22% by 2030.

We include €500m green bonds issued in April on the balance sheet by increasing both long-term debt and cash balances. The bonds have a maturity of 2026 and an interest rate of 2.25%.

We reduce the implied interest rate on debt from 3.6% to 2.5% for 2021 to reflect the lower interest rate received on the €500m green bonds (dated 2026), and increase back to a long-term rate of 3% from 2025 onwards.

Based on company announcements, we calculate Mytilineos repurchased 944k shares between 1 January and 9 August, with an estimated value of €13m based on an average price of €14 per share over the period. We reflect this in our cash flow statement and adjust the number of shares (excluding buybacks) from 136.8m (end-2020) to 135.8m.