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In a previous article, back in early 2020, I identified RWE AG (OTC:RWNEF) (OTCPK:RWEOY) as an interesting long term investment on account of its potential to increase its profitability in the course of a strategic pivot towards renewable energy generation. The stock trades higher now than at the time of my initial article’s publication, but significantly underperformed the broader market at large to date.
Despite a very strong 2023 (€4.5 billion in net profits based on preliminary figures), the stock price took a significant downturn recently, following lowered expectations for 2024. The company now expects 2024 earnings to be towards the lower end of its guidance, thus in the vicinity of €5.2 billion of adjusted EBITDA. While this is not exactly good news, I nonetheless believe that RWE continues to offer an attractive investment profile in the long run. Below, I will give an update on the company and explain my thesis.
Capacity Growth Is Key
The cornerstone of the investment case for RWE is its generation capacity growth. The stated goal is to increase overall capacity to more than 65 gigawatts (the target mark being raised from 50 gigawatts) by the end of the decade, despite phasing out nuclear and coal plants. A net addition of around 5 gigawatts per annum may be ambitious, but it appears achievable. Between 2021 and late 2023, RWE achieved net additions of 9 gigawatts. While this does not quite average 5 gigawatts, it should be noted that within this very time frame, the entirety of RWE’s nuclear capacities was phased out. The company is actually ahead of schedule, so to speak. There are also close to 8 gigawatts of capacities currently under construction already.
RWE achieves growth both organically and via M&A. One notable example is the acquisition of Consolidated Edison, Inc.’s (ED) renewables business (which made it America’s second largest solar operator). As I already noted a few years ago, RWE is much “greener” than its image. Its generation portfolio is, also, much more globally diversified now than it was a few years ago.
Once known primarily for its coal plants, RWE today is the global number two provider of offshore wind energy. On top of that, the company secured the potential for up to 2 gigawatts of additional offshore capacities in a DoI auction for development areas in the Gulf of Mexico. Another 3 gigawatts are due to be added off the UK’s coast, subject to regulatory approval. For this project named “Dogger Bank South”, RWE is partnering with the UAE’s Masdar.
Within the decade, it will also have phased out high emission thermal coal. That could go a long way in endearing the company with ESG based funds – which despite (not entirely meritless, in my opinion) continue to grow in overall volume. More importantly, the coal business is far more labor-intensive than RWE’s other means of power generation. Of its global workforce of just shy of 20,000 (full time equivalent, as of September 30th, 2023), around 8,000 personnel are attributable to the goal business. In other words: exiting coal has the potential to significantly reduce payroll. An additional benefit is that the accelerated coal phase out by 2030 will see RWE receive €2.6 billion in government compensation (the European Commission gave its approval in December).
Meanwhile, the German Federal Government’s recently adopted renewables strategy may give an additional growth impulse. The plan is for up to 10 gigawatts worth of new hybrid gas plants (i.e. such plants that can easily be converted to hydrogen instead of LNG) to be built. To that end, faster planning and approval processes are to be implemented. In this context, it may be of some interest that European power markets generally function under the merit order principle (although it should be noted that a reform process is underway).
Dividends
Traditionally, utilities are often bought as an income play. When I last covered the stock, RWE had just reinstated annual distributions. As I predicted, dividends have been growing regularly since. It is set to grow to €1 for FY2023 (from €0.9), subject to shareholder approval. The stated target for FY2024 is another 10 percent increase to then €1.10. Of course, given higher interest rates, dividends as a means of income generation are relatively less attractive today than they were two or even four years ago. Nonetheless, I think that reliable, growing dividends are a very positive property of an investment. I will also reiterate my belief that RWE’s shareholder structure incentivizes dividends, as a significant portion of outstanding shares is owned by various municipalities in Western Germany (I explained this in more detail previously).
Risk Factors
Naturally, there are also certain risks to be considered. First of all, there is RWE’s net debt of €6.2 billion. That is a rather manageable level, in my opinion, even in the current rate environment. However, it should not be neglected that the figure might rise in the course of aggressive capacity growth, especially growth through acquisitions. Markets were, for example, rather spooked recently when reports of its interest in Orsted AS (OTCPK:DOGEF) (OTCPK:DNNGY) surfaced. Any potential seller obviously knows of RWE’s capacity targets. At the same time, there is only a finite number of sufficiently sized potential acquisition targets. So, in order to move the needle, RWE might have to somewhat overpay.
There is also the risk of dilution as an unwelcome side effect of acquisitions. For example, the Con Edison assets were partly financed through the issuance of convertible bonds to Qatar Investment Authority, which represented close to 10 percent of the company’s outstanding equity at the time.
Furthermore, the political angle ought to be considered. In particular, the outcome of the upcoming US presidential election is highly relevant, I believe. An incoming Trump administration (which, at this point, I consider a probability) may cut back on lucrative renewables subsidies as compared to the current Biden administration. Nor should be forgotten that the coal business is in constant decline. While this is arguably a necessary sacrifice in the long run, it nonetheless still accounts for around €700 million in annual EBITDA.
Conclusion
All in all, I continue to see long term potential for RWE based on its ambitious capacity targets and proven execution so far. That notwithstanding, I would not rule out short term setbacks for the stock. Consequently, I continue to rate the company a buy in the long run. I will, however, caveat, that RWE is currently not a stock that I am in a particular hurry to buy. I will, however, keep an eye on the stock.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
