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EDP (OTCPK:EDPFY)(OTC:ELCPF) is a European utilities company that after a run-up from March lows has slid back. Utilities continue to remain a sector of interest to the prudent investor, as the eventualities of COVID-19 remain nebulous with continuing questions around vaccine efficacy, timing and the extent of the economic damage once stimulus comes to a close. EDP, like many European utilities are focused on two activities, generation on one hand (primarily in renewables), and distribution/transmission on the other. Now trading at levels where the dividend yields 4.4%, it screens as an interesting income proposition. With emerging market exposures being a key issue for some utility companies, EDP is substantially spared thanks to the substantial risk sharing with minority holders in their Brazilian operations. With good insurance from their positive geographic mix, their ample dividend should be strongly considered by income investors.
Summary Segment Data
Before we look into their dividend coverage situation, first we need to understand the mix of activities. The EBITDA breakdown of these activities is as follows:
(Source: EDP H1 2020 Pres)
The transmission segment includes both distribution and transmission activities. Distribution lines are lower voltage and usually require a little more work to operate, while transmission lines are high voltage and long-distance. This segment is affected by political factors, where remuneration scheme changes in periodic reviews can impact income, as well as more market-based factors like the level of interest rates, where income rises with interest rates, and also FX effects. Between review periods, however, transmission income tends to have low volatility.
The renewables segment is primarily involved in the business of generating electricity. This segment is less volatile in the long-term and depends primarily on market-based factors. It can be volatile in the short term due to environmental conditions like windiness, sunlight and precipitation. Due to COVID-19, electricity prices have fallen somewhat, but the commodity has proven resilient in the face of these effects. EDP has a variety of methods for electricity generation, with the vast majority being renewables, and critically a minimal exposure to coal.
(Source: EDP H1 2020 Pres)
Geographical Exposure and Risks
However, the key question with EDP in a COVID-19 environment is to do with their geographical exposure. Most pertinent are the risks related to their less diversified, and more politically vulnerable transmission/distribution business. Spain we know is fickle with its remuneration schemes. Brazil is less fickle, but the Real has depreciated more than 36%, which will be an effect not entirely (although seemingly somewhat) hedged. Moreover, the Brazilian Central Bank has instituted a very accommodative monetary policy. Unfortunately, monetary accommodation has a dual negative effect both through currency depreciation caused by lower interest rates, and lower remuneration under government schemes which is tied to interest rates. Portugal is not particularly difficult as a government, but the political risks remain nonetheless. Thankfully the transmission business is less than 25% of EDP EBITDA, with Brazil, the riskiest exposure only being about 20% of that. Moreover, only 50% of the Brazilian transmission business is even owned by EDP, since it’s contained in EDP Brasil which is only barely majority owned, so the economic impact is half that.
(Source: EDP H1 2020 Pres)
Geographical exposure also matters to an extent with the generation assets, primarily due to currency effects. For both transmission and generation, we rely on EDP, as we would any other global utilities company, to trade and hedge the currencies well to help achieve less volatile business performance. Nonetheless, only 8% of renewable EBITDA is from Brazil, and these assets are also owned through half-owned EDP Brasil. This is very consistent with data on installed capacity by country, and totaled with the transmission exposure results in less than 8% of EBITDA.
(Source: EDP H1 2020 Pres)
Dividend History and Coverage, Conclusions
This leads us to a discussion of the dividend. In terms of dividend history, EDP has an essentially unimpeachable record. They currently have a dividend yield of 4.4% which pays once a year which is likely to start growing again once they’ve deleveraged a bit.
(Source: EDP Website)
This is on a payout ratio of not more than 77% based on income attributable to EDP shareholders (minus the NCIs). Understanding the limited degree of exposure to more risky exposures shows that the dividend is very likely to be safe.
On the basis of this minimized risks, we think that the recent slide in EDP’s price presents an interesting opportunity. At a 4.4% dividend yield, the income proposition is strong, and the fundamentals are robust to many of the eventualities of COVID-19. We think that now is as good a time as any to get into this renewable player and get paid to wait for a bigger crowd in the renewable space, which will boost accretion on their successful asset rotation strategy. As such, we rate EDP a buy.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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